While both the media and stock investors believe that housing has bottomed, they are unaware of the massive supply of homes that are already in the foreclosure process that will certainly drive home prices down even further when they are sold. We have been projecting a "W"-shaped recovery for some time, and we are becoming even more convinced that we are right. The shape of the second leg down is almost completely dependent on the level of government intervention that will take place.

For a number of reasons, banks have not been aggressively taking title to homes and selling them, which has resulted in very few distressed sales in comparison to the actual level of distress in the market. This delay in REO sales, along with historically low mortgage rates and an $8,000 tax credit, has helped to stabilize the housing market — temporarily.

While both the media and stock investors believe that housing has bottomed, they are unaware of the massive supply of homes that are already in the foreclosure process that will certainly drive home prices down even further when they are sold. We have been projecting a "W"-shaped recovery for some time, and we are becoming even more convinced that we are right. The shape of the second leg down is almost completely dependent on the level of government intervention that will take place.

For a number of reasons, banks have not been aggressively taking title to homes and selling them, which has resulted in very few distressed sales in comparison to the actual level of distress in the market. This delay in bank-owned home (REO) sales, along with historically low mortgage rates and an $8,000 tax credit, has helped to stabilize the housing market — temporarily.

It is very clear that price stabilization is temporary unless something is done. Here are some facts to help project what housing will be like in 2010:

  • 13.54 percent of the 44.7 million mortgages tracked by the Mortgage Bankers Association are delinquent.
  • 7.57 million homeowners are delinquent, applying the same percentage to the 11.2 million mortgages not tracked by the MBA (55.9 million total mortgages in the U.S.). That means that 10 percent of all homeowners in the country are delinquent.
  • Based on historical trend analysis by Amherst Securities, 6.94 million homes that are already delinquent will be liquidated, which is more than a one-year supply of distressed sales poised to hit the market sometime in 2010 and 2011. During first-quarter 2005 that figure was only 1.27 million.
  • Defaults continue to grow at the rate of approximately 300,000 per month, assuring that the number of distressed sales will grow and will continue through 2012.

2009 government intervention

Government intervention to date has been extremely helpful in preventing an even more dramatic decline in home prices. As shown in the chart below, housing demand has fallen only to "normal" levels and stabilized there. Without historically low mortgage rates, support for Freddie Mac, Fannie Mae and FHA, and an $8,000 tax credit, how far would sales have fallen this year and what would that decline in demand have done to pricing?

 

Conclusion

Demand needs to continue to be stimulated to bring down supply, particularly while the country continues to lose jobs. Without continued government intervention, home prices will plummet, banks and the government-sponsored entities (GSEs) will continue to lose money, and the economy has virtually no chance of increasing overall employment in 2010.

Our grading system of the economy and the housing market is a "bell curve" model, with statistics at an all-time high receiving an "A," statistics near the long-term average receiving a "C," and the worst times ever receiving an "F." In this grading system, it is OK to be a "C" student.

Here is our current report card:

Economic Growth: D
Economic growth deteriorated in September as the economy remained very weak. Annual job losses continued, marking one of the worst losses in 60 years. The headline unemployment rate increased to 9.8 percent last month, after reaching 9.7 percent in August. Mass layoff events — defined as a cut of 50 or more jobs from a single employer — also increased this month, and are up nearly 43 percent year-over-year. Currently, it takes job seekers twice the normal length of time to find employment.

The Consumer Price Index, or CPI (all items), decreased at a slower rate in August, recording a decline of 1.5 percent, while the core CPI (minus food and energy) showed an increase of 1.4 percent. …CONTINUED

The final second-quarter gross domestic product (GDP) growth rate is at -0.7 percent, which is a significant improvement from the -6.4 percent decline in the first quarter.

Leading Indicators: C-
Many leading indicators continue to improve, and suggest that the worst of the recession is behind us. The Leading Economic Index six-month growth rate rose in August to its highest level since early 2004. The ECRI Leading Index — an indicator of future U.S. growth — has increased almost 21 percent since the beginning of the year — the largest growth rate since 1971. Stocks continued to rise through September and the four major indices now range from -10 percent to up 2 percent year-over-year. The Standad & Poor’s Homebuilding Index rose in August, increasing 14 percent from the previous month, but remains down 5 percent year-over-year and down 72 percent from its peak in July 2005.

The Net Employment Outlook turned negative for only the second time in the 20-year history of the index (the first was last quarter), as more employers that were surveyed foresaw staff levels decreasing than increasing. The average hours worked per week by Americans declined slightly in September, reaching its lowest levels on record, partly due to furloughs forced upon both government and private sector employees.

The price of crude oil declined to a monthly average of $69.46 per barrel in September, representing a 2 percent month-over-month decline.

Affordability: C-
Affordability improved in September as both mortgage rates and the median resale price fell compared to August. Currently, our housing-cost-to-income ratio has fallen to 26.7 percent, which is near the lowest level since we began calculating the index in 1981. Due to the correction in home prices and low mortgage rates, owning a home is now essentially the same cost as renting, making it favorable for first-time homebuyers to purchase a home. Household income has fallen 6 percent year-over-year to $52,856 as a result of job losses and furloughs. Despite the decline, the median-home-price-to-income ratio has fallen to 3.3, which is now equal to the historical average.

The 30-year fixed mortgage rate fell again in September, reaching 5.04 percent by month-end, while adjustable mortgage rates reached 4.52 percent at September month-end. The Fed’s overnight lending target rate remains at a range of 0 percent to 0.25 percent, which is the lowest level on record. The share of adjustable-rate mortgage (ARM) applications increased to 5.6 percent in the last week of August, according to the Mortgage Bankers Association. However, the share of ARM applications remains extremely low when compared to peak levels above 35 percent of total applications in early 2005.

Consumer Behavior: D-
Consumer behavior was mixed in September. Consumer confidence declined after increasing in August, falling to 53 — far below the historical average of 97. Consumer sentiment increased in September to 73.5, reaching its highest level since January 2008. The Consumer Comfort Index also increased in August to -46.4. The personal savings rate has fallen in the last two months after spiking at 6.9 percent in May.

The U.S. net worth increased by nearly $2 trillion in the second quarter compared to the first quarter. This represents the first increase in net worth in almost two years, and is largely due to recent large gains experienced in the stock market. Despite the recent improvement, the second quarter year-over-year decline is the third worst on record in the 50-year history of this data point, losing $7.4 trillion of wealth in the past year. Both unemployment and inflation increased in September, resulting in a rising Misery Index (the sum of the two rates).

Existing-Home Market: D+
The existing-home market remains weak yet seems to be stabilizing. Seasonally adjusted annual resale activity in August declined almost 3 percent from July to 5.1 million homes, an improvement of 3 percent compared to one year ago, according to the National Association of Realtors (NAR). The rolling 12-month count of resale sales activity has increased for the second month in a row. The national median resale price fell to $177,500, and has declined 12 percent year-over-year. Weak consumer confidence and increased foreclosure sales continue to put downward pressure on resale prices.

The S&P/Case-Shiller index, which tracks paired sales, fell 15 percent in the second quarter of 2009 compared to second-quarter 2008. In August, the number of unsold homes declined sharply to 8.5 months of supply yet remains elevated compared to history.

Pending home sales volume increased this month, and represents a 12 percent year-over-year gain.

As of the second quarter, 32 percent of all homes with a mortgage were worth less than the original value of the mortgage.

New-Home Market: D
A few components of the new-home market improved in September. Builder confidence increased last month to a Housing Market Index rating of 19 — the third consecutive month of an increasing index. The inventory of unsold homes continued to improve and has fallen to 7.3 months of supply. Seasonally adjusted new-home sales are down 3 percent year-over-year and are down 69 percent from a peak of nearly 1.4 million annual sales in July 2005.

The rolling 12-month count of new-home sales was flat compared to last month — the first time since 2005 it hasn’t declined from the previous month. The median single-family new-home price dropped sharply to $195,200 in August from July’s $215,600 median — representing an 11.7 percent year-over-year decline.

Housing Supply: F
Seasonally adjusted total permits increased to 579,000 as a result of a large jump in multifamily permits, while single-family permits declined slightly. Seasonally adjusted total new-home starts decreased in August to 479,000, due to a 3 percent drop in single-family starts, and are down 22 percent from one year ago.

John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis. He can be reached at jbrec@realestateconsulting.com.

Copyright 2009 John Burns

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