Everything that the government has done so far, with a few minor detours, has been almost exclusively focused on maintaining home prices high, by tweaking either the supply or the demand side of the housing equation. As the bulk of consumer net wealth is concentrated in the housing sector, and a wealthy and confident consumer, much more so than the banking system, is critical to the recovery of America's economy, the Administration will do everything in its power to achieve its goal of artificially manipulating the housing market, thereby not causing an incremental loss of wealth to those still stuck with overpriced houses, while the real intersection of actual supply and demand curves would indicate a materially lower equilibrium price. This is ironic, as proper price discovery is critical for a true recovery, since Americans realize all too well that buying a house at prevailing levels in advance of the second down-leg in housing is senseless, the continued pursuit of such flawed policies by the Fed and President Obama merely pulls the market ever further away from its equilibrium, thereby making the anticipated second dip so much more likely and not that far off in the distant future. Below are 5 simple charts the highlight just how precarious the housing situation in the U.S. is, and how likely the second, and probably much more fierce, leg down in the markets is going to be.
A bearish report by CIBC 1captures precisely the highly unstable system that U.S. housing has become, and deconstructs it along the five key axes of weakness which while individually may be controllable to a degree, combined represent a recipe for disaster. CIBC's main sources of concern arise from:
- Short-lived remedies; used by the administration to prevent further price deterioration (tax-credits);
- Shadow Inventory; in reality when accounting for the surging shadow inventory which very few dare talk about, the total number of available unit sdouble to over 8 million, representing a record high 16 months of supply.
- Strategic defaults; the amount of households with negative equity is roughly 10 million or about 20%, in 2009 25% of all foreclosures were strategic; as populist anger against banks accelerates look for strategic defaulits to keep rising
- Quantitative Easing expiring; This needs no introduction: the sole reason why mortgage rates have been as los as they have, has been due to the Fed's constant manpulation of the MBS market via the $1.4 trillion MBS/Agency QE purchase program. With this program set to expire in 2 months, rates are set to explode.
- House Prices are already entering a double dip; Previously we discussed the Case Shiller NSA home price index number which indicated that a double dip in prices has already commenced. A positive feedback loop will only lead to further deterioration here
Analyzing CIBC's factors one by one:
During the past year in which the program has been in effect, sales of existing homes have climbed by 15%, while new home sales have actually dropped by 5%. In fact, the usually stable sales ratio between the two has more than tripled, recently hitting a record high 18 (Chart 1). But after being extended once by the Obama Administration, this tax credit will expire at the end of April—putting downward pressure on demand for existing home sales. That prospect will make it more difficult to clear out the next wave of foreclosures, prompting another down leg in US house prices.
the risk of a double dip in US home prices is not simply the result of properties being sold at “fire-sale” valuations, but also due to a deluge of shadow inventory coming onto the market. Although conventional inventories are trending lower, shadow inventories, capturing seriously delinquent and bank-owned properties, are just as large.
There are close to two million mortgages that are more than 90 days delinquent, and nearly all of these will end up in foreclosure, given that over the past three years the “cure rate” of this category fell from 40% to less than one percent. Add to that the 2.3 million properties that are in foreclosure or already seized by banks, and total inventories (conventional and shadow) are now running at over 8 million units (Chart 2). At current sales rates, that adds up to a record high 16 months of supply. True, this “shadow” stock will not hit the market all at the same time as banks manage their supply of seized properties, but this constant flow is likely to keep markets depressed for a while.
A big part of the problem is a still weak labour market, which has left a record 15 million Americans unemployed and another 9 million underemployed for economic reasons. However, just as significant is the roughly 10 million households in a negative home equity position of worse than -20%, for whom strategic default - failing to pay when one could - is a very real option. While negative equity is a necessary but not sufficient condition for default, it’s a clear risk; out of the 2 million or so foreclosures in 2009, roughly 25% were strategic (Chart 3).
It’s not just inventories and tax credits that are looming large over the housing market, but also interest rates. Aggressive central banks’ rate cuts along with large amounts of agency MBS purchases by the Federal Reserve have lowered mortgage rates by over 100 bps since the height of the financial crisis. That spurred a refinancing boom, which, according to First American Corelogic, saved $2.3 billion in mortgage payments—a roughly 10% reduction—in 2009 alone. Although we don’t expect policymakers to raise the fed funds rate until 2011, mortgage rates have already started to head higher, and could keep climbing towards the end of the first quarter when the Fed’s $1.25 trillion agency MBS purchase program is completed. Those purchases made up almost 50% of all MBS issuance last year, and despite the improvements in the securitization market, their absence will likely have a material impact on rates (Chart 4).
Price Double Dip
In the final analysis, the end of unprecedented government tax support for housing, along with the looming overhang of supply and a higher cost of borrowing will keep new home building activity trudging along at historic lows over the next two years and could see prices drop again by 5-10% (Chart 5).
And there you have it: the best that the government can hope for is to extend and pretend, and to avoid presenting the sad but very simple reality to the American public. Because lack of knowledge is half the battle. Alas, as long as the reset button is not pushed, the only beneficiaries are the very same Wall Street kleptocrats who want nothing more than further perpetuating the status quo. At this point nothing absent a complete socio-economic catharsis can help America; the rest is just Congressional hearings, angry presidential outbursts scripted on the teleprompter, and neverending smoke and mirrors.
- 1. U.S. Housing - A Double Dip; Benjamin Tal and Meny Grauman, January 28