Why Are Home Sales Plummeting?

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Why are home sales plummeting?

On the surface, it is because the government's tax-credit for first-time home buyers lapsed in April.  
It takes a couple of months lag-time between buyer purchase decisions
and the actual close of escrow, and so the expiration of the tax-credit
is just now hammering the market.

And there is a huge backlog of housing stock.

And sellers are holding out hope that they can get close to peak prices
for their homes, while buyers believe that prices will fall further -
and so are waiting until prices decline further.

But there is a more fundamental reason that home sales are plummeting.

Specifically, when housing crashed in 2007 and 2008, the government had two choices. It could have:

(1) Tried to artificially prop up housing prices;

or

(2)
Created sustainable jobs, broken up the big banks so that they stop driving our economy into a ditch, and restored honesty and trustworthiness
to the economy and the financial system. All this would have meant
that the economy would recover, and people would have enough money to
afford to buy a new house. (See this).

The government opted to try to prop up prices.

Indeed,
as I have repeatedly pointed out, the government's entire strategy has
been to try to artificially prop up the prices of all types of assets.

For example, I noted in March:

The leading monetary economist told the Wall Street Journal that this was not a liquidity crisis, but an insolvency crisis. She said that Bernanke is fighting the last war, and is taking the wrong approach. Nobel economist Paul Krugman and leading economist James Galbraith agree. They say that the government's attempts to prop up the price of toxic assets no one wants is not helpful.

The Bank for International Settlements – often described as a central bank for central banks (BIS) – slammed
the easy credit policy of the Fed and other central banks, the failure
to regulate the shadow banking system, "the use of gimmicks and
palliatives", and said that anything other than (1) letting asset prices
fall to their true market value, (2) increasing savings rates, and (3)
forcing companies to write off bad debts "will only make things
worse".

***

David Rosenberg [former chief economist for Merrill Lynch] writes:

Our
advice to the Obama team would be to create and nurture a fiscal
backdrop that tackles this jobs crisis with some permanent solutions
rather than recurring populist short-term fiscal goodies that are only
inducing households to add to their burdensome debt loads with no
long-term multiplier impacts. The problem is not that we have an insufficient number of vehicles on the road or homes on the market; the problem is that we have insufficient labour demand.

Indeed, as I pointed out
in April, unemployment is so bad that 1.2 million households have
"disappeared", as people move out of their own houses and move in with
friends or family.

BIS wrote in 2007:

Should
governments feel it necessary to take direct actions to alleviate debt
burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.

I pointed out in March 2009:

Paul Krugman wrote a couple of weeks ago:

The
truth is that the Bernanke-Geithner plan — the plan the administration
keeps floating, in slightly different versions — isn’t going to fly
....

Why won't it fly?

One reason is that
economic psychologists tells us that consumer psychology has shifted
for many years to come, and Americans are hunkering down and not buying
anything other than the bare necessities. The Fed can try to play the part of all of the actors in the economy, but it won't work.

Today, Edward Harrison's must-read post
explains provides additional reasons why the Geithner-Summers-Bernanke
plan to prop up asset prices cannot succeed (if you don't read the
whole post, at least read the following excerpts):

The U.S. government's efforts point in [only one direction]:

Increase asset prices. If
the assets on the balance sheets of banks are falling, then why not buy
them at higher prices and stop the bloodletting? This is the purpose
of the TALF, Obama's mortgage relief program and the original purpose
of the TARP.

***

There is only one direction
the government is headed: increase asset prices (or, at least keep them
from falling). Read White House Economic Advisor Larry Summers'
recent prepared remarks to see what I mean. (Summers on How to Deal With a ‘Rarer Kind of Recession’ - WSJ) ....

These plans are not going to work
As
aggressive as this campaign by the U.S. government is, it will have
limited effectiveness because the extent of the writedowns of assets
already on the books is going to be too massive. ...

And Ryan Grim pointed out in April 2009:

Critics
of Geithner, including Nobel Prize winning economist Paul Krugman,
insist that the real problem is an asset collapse that led to a crisis
of solvency in the banking system. In other words, Krugman
argues that home values have come back to Earth, while Geithner hopes
to solve the problem by pushing home values back to where they were. The conflict is a serious one because it dictates what response is appropriate.

***

At
a closed-door meeting with House Democrats on Monday night, according
two members of Congress who were in the meeting, Geithner repeated that
he believed the problem with the financial system was a lack of
liquidity and that if he could get credit flowing again, the problem
would right itself. Key to this
analysis is the question of whether one thinks the rise of housing
prices was an artificial bubble or if the collapse is reversible and we
can return to those highs. Policymakers have resisted labeling
it as a bubble. [head of the president's Council of Economic Advisers
Christina] Romer, on Monday, came close, referring to a "run-up in
housing prices that sure looks like a bubble."...

If the crisis
is understood as one of liquidity, then the appropriate response is to
continue injecting capital into the banking system and fiscal stimulus
into the general economy until asset prices return toward previous
highs. Japanese policymakers initially understood their crisis to be
one of liquidity and injected hundreds of billions during the 1990s, to
little effect. But if the problem is something different -- a solvency
crisis brought on by essentially permanent asset-price declines --
then the policy response needed is different.

So were housing prices in a bubble or not? And - if so - have housing prices now come back to earth?

Well, as liberal PhD economist Dean Baker points out:

Real [i.e. inflation-adjusted] house prices are still 15-20 percent above long-term trend.

In other words, housing was in a bubble, and still has a ways to go before it is back to normal.

As the Wall Street Journal wrote in January:

Housing
economist Dean Baker, the co-director of the Center for Economic and
Policy Research, laid out his case at a risk conference last week for
why we still have a housing bubble. Adjusted for inflation, home prices
are still 15-20% higher than they were in the mid-1990s. “There’s no
plausible fundamental explanation for that,” he says.

Why?
Simple, he says: Economic fundamentals are all going in the other
direction. Rental apartment vacancies are reaching record highs. Many
segments of the housing market are still oversupplied. And the core
demographic in the country—the baby boomers—are reaching the age where
they’re more likely to downsize, buying less house in the years to come.

Far
from some rosy estimates that housing is going through a temporary,
once in a lifetime downturn, and that once the market bottoms, homes
will again appreciate well beyond the rate of inflation, Mr. Baker
argues that home prices are far more likely to increase annually at the
rate of inflation, at best.

“If anything, I expect housing to be
weaker than normal rather than stronger over the next decade,” he
says. “People who say this is a temporary story, there’s no real reason
to believe anything like that.”

The recent burst of good housing news has been fueled by government stimulus, including the tax credit, low mortgage rates and easy financing
from the Federal Housing Administration. Mr. Baker, who had been a
skeptic of the tax credit, concedes that it has worked. So, too, he
says, has the FHA effectively supplied credit to goose sales.

But that’s likely for the worse, he argues, taking the opposite view of policymakers at the FHA.

“As
a matter of policy I can’t see that we want people to buy a house in
2009 that’s 10-20% higher than it would sell for in 2011,” he says. “In
so far as the FHA was encouraging people to buy homes in bubble
markets that were not deflated, that’s not good for the FHA and you
didn’t help the homeowner. We didn’t do those people a favor.”

Indeed, Baker said last November that the government's hasn't really helped homeowners, but has really been helping out the big banks instead:

The
big talk in Washington these days is "helping homeowners".
Unfortunately, what passes for help to homeowners in the capitol might
look more like handing out money to banks anywhere else.

***

So,
who benefits from "helping homeowners" in this story? Naturally the
big beneficiaries are the banks. If the government pays for a mortgage
modification where the homeowner is still paying more for the mortgage
than they would for rent, then the bank gets a big gift from the
government, but the homeowner is still coming out behind.

***

There
are simple, low-cost ways to help homeowners who were victims of the
housing bubble and lending sharks.... But this would mean hurting the
banks rather than giving them taxpayer dollars, and we still don't talk
about hurting banks in Washington DC.

Similarly, Zack Carter wrote yesterday:

The
Treasury Dept.'s mortgage relief program isn't just failing, it's
actively funneling money from homeowners to bankers, and Treasury likes
it that way.

***

Economics whiz Steve Waldman [writes]:

The program was successful in the sense that it kept the patient alive until it had begun to heal. And the patient of this metaphor was not a struggling homeowner, but the financial system, a.k.a. the banks.
Policymakers openly judged HAMP to be a qualified success because it
helped banks muddle through what might have been a fatal shock. I
believe these policymakers conflate, in full sincerity, incumbent
financial institutions with "the system," "the economy," and "ordinary
Americans."

Baker has also said in numerous interviews this week that the only
thing the temporary tax break for first-time buyers has done is moved
home purchases up by a couple of months. In other words, the credit
didn't motivate people who weren't planning on buying a house in the
near future to buy. All it did was motivate people who were already
planning on buying this year to buy before the credit expired, thus
creating no real boost to the housing market.

The bottom line is that home sales are plummeting because housing was in a bubble.  
While most assuming that Americans are being more frugal and
deleveraging - so that we will soon "get thorough this" and home sales
will finally bottom - that assumption might not be true.

And there are huge waves of foreclosures coming down the pike. See this, this and this.

Indeed, it is possible that housing prices may never return to their peak bubble levels. See this, this and this.

Instead of fixing the real problems
with our economy or genuinely helping struggling homeowners, the
government has made everything worse by trying to artificially prop up
asset prices in a way that only helps the big banks.

Comments

[boeing747]

Because of strong dollar! Our area San Jose, California, more 'On Sale' signs quietly shown up like early 2009. That's the cost of promoting Treasures.