Housing: No Bottom Yet in Sight

by: J.D. Steinhilber July 28, 2008    
J.D. Steinhilber

J.D. Steinhilber

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Prior to last Thursday's sizable setback, the stock market was engaged in a rather spirited rally off of its July 15 bottom. The S&P 500 had gained 7% in seven trading sessions, and bank stock indexes had soared in excess of 40% from their panic lows. Falling oil prices (crude oil has retreated 15% from its July 11 peak at $147/barrel) contributed to the atmosphere of relief.

Fittingly (since many of our current problems are traceable to the unwinding of the housing bubble), Thursday's gloomy report on June home sales from the National Association of Realtors provided the market a reality check and knocked the major averages back a couple of percent while slamming bank stocks with nearly a 10% loss on the day.

The NAR reported a larger-than-expected drop in sales of existing homes in June to a 10-year low. Combined new and existing home sales volume is down nearly 40% from its July 2005 peak. Meanwhile, an unprecedented total supply of 4.9 million homes (new and existing) sits on the market awaiting buyers. Clearly, all talk of a bottom in housing is premature as long as we continue to see the inventory of unsold homes hitting new record highs. There will be no reversal in home price trends until the inventory of homes gets reduced.

While the inventory overhang is the single greatest cause of house price deflation, tight mortgage credit is adding to the downward pressure on the housing market. Freddie Mac's posted 30-year fixed mortgage rates spiked 37 basis points last week to an 11-month high of 6.63%, reflecting record high yield spreads (i.e. 180 basis points) on government-backed mortgage securities. The "private label" (non-government backed) mortgage-backed securities market is virtually non-existent at present.

Until we see a light at the end of the tunnel for home prices, the risks to the economy and the financial sector remain skewed to the downside. Indeed, partly as a result of the weak housing market, the index of leading economic indicators we track from the Economic Cycle Research Institute [ECRI] had fallen to a five year low, prompting ECRI to comment that "a business cycle recovery is no where in sight." We will know when home prices have dropped enough so that the inventory of unsold homes begins to come down. Clearly, we have not reached that point.

Congress passed its latest emergency housing bill over the weekend in an effort to arrest the current self-feeding cycle of falling house prices, rising foreclosures, and escalating losses on mortgage loans. The most significant provisions of this latest government effort are (1) authorization for the Federal Housing Administration [FHA] to refinance up to $300 billion of troubled mortgages and (2) formal authorization of the previously announced bail-out of Fannie Mae and Freddie Mac. To accommodate this and other forms of deficit spending, Congress raised the government's debt ceiling by $800 billion.

Of course, the government's various relief efforts over the course of this credit and housing crisis have one thing in common - they represent a transfer of credit risks and losses to the U.S. taxpayer, and they ultimately weaken the credit and currency of the U.S. government. It is impossible to measure today the ultimate cost of this latest housing bill, because it will depend on the ultimate scope of mortgage credit losses, but it seems safe to conclude that the tab will reach into the hundreds of billions of dollars.

Turning back to the stock market, the odds seem to favor a continuation of the bear market rally that began mid-month. Sentiment indicators also support a further rebound in prices in the short term. Typically, bear market rallies retrace anywhere from one-third and two-thirds of the prior leg down in prices. In this instance, the prior decline from mid-May to mid-July was 240 points on the S&P 500, which fell from 1440 to 1200. A one-third retracement of this decline would be 80 S&P points, and would project 1280, a target we already reached prior to last week's setback. A two-thirds retracement would be 160 S&P points, which could take the S&P 500 back up to 1360, approximately 100 points above the current price level. We do not suggest that longer-term investors attempt to play this potential rebound. Bear markets have a way of reversing suddenly, and who knows when the next shoes will start dropping to restart the downward momentum. Until much more evidence develops to suggest otherwise, our assumption remains that the bear market is not over and that a lower risk buying opportunity still lies in the future.

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This article has 22 comments:

  •  
    Jul 28 11:11 AM
    You have made several strong points. I am in total agreement that we have not yet seen the bottom. Stabilizing the credit market though is a first step, otherwise the housing market will spiral downward without intervention.

    What troubles me though is the unlimited tax dollars the govt. appears to have right now. It's going to cost somebody something, so the question is what? Consumers via higher taxes? Greater US debt resulting in an even lower USD?
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  •  
    Jul 28 11:18 AM
    Great article and I just recently wrote about my (negative) views on the bill. Your points just conifrm why the housing relief bill will fail. The government again is trying to spend us out of an economic crisis, which is unlikely to work and only add to our national debt and the continued devaluation of the US dollar. Only time and a cleansing of the economic system will resolve the current mess.

    We talk about consumers getting out of debt, what about the government who seems to love debt more than anyone else.
    Reply | Link to Comment
  •  
    Jul 28 12:00 PM
    I agree that a bottom in housing is nowhere in sight, and here are 8 more reasons why home prices should continue to decline:

    1) The futures on housing prices point to further downside.

    2) The run-up in housing starts from 1991-2006 is much longer than any other recent run-ups in housing starts, and so the correction might also be longer.

    3) Unlike the other recent housing busts, this current bust began in relatively good economic times.

    4) According to Goldman Sachs, home price trends tend to lag an average of 9-12 months behind sales trends, (and 9-12 months is a very long time indeed during a massive credit crunch).

    5) National home prices have not yet mean reverted to their long term trend line.

    6) If the Federal Government ends up having to bail out Fannie Mae and Freddie Mac then mortgage rates could rise by about .5 percentage point.

    7) The peak years for higher resets of adjustable rate mortgages (ARMs) will be 2010-11.

    8) There is probably a great deal of "shadow inventory" waiting for the "right" time to sale.

    Disclosure: still short U.S. home prices.
    Reply | Link to Comment
  •  
    Jul 28 01:03 PM
    Reality Estate...

    the Reality Estate cycle! 10 minutes ago
    past Real Estate Cycles up/down/up/down current...had a "stable and growing high-paying job-base to support a recovery and return to an UP cycle.

    what's different "this time," is that due to WTO/Nafta agreements, it is now difficult to maintain that high-paying job base here.

    we were promised that "mainly mfr" jobs would go to places like China...however, in reality WE ARE ALSO LOSING HIGH-PAYING JOBS to, for example in the case of IT, to a "3rd world country" like India. You don't have to live in the U.S. to program over the "Inter-Network!&q...

    the other large sector of our recovery could be based on "illegals" ...but unless Real Estate tanks another 50% or so...they can't afford to buy either...WHO IS GONNA BUY THE RECOVERY?

    there's more...but have to keep short or server won't let post thru...

    flashrob

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  •  
    Jul 28 01:38 PM
    The legitmate portion (93 to 1999/ 2001, take your pick) of the last housing recovery was driven by both normal cyclical factors and the effects of the 90s tech and manufacturing booms.
    The latter drove eimployment and incomes. Plus , with the US fiscal policy during the 90s leading to lower interest rates financing stayed cheap.

    We know what happened next - the Fed inflated the end of the boom into the illegitmate portion of the cycle (2001-04) through very lax regulatory and monetary policy.

    Hard to imagine a repeat of the new industry fundamental economic performamance with the benign interest rate and fiscal policy environment of the 90s. No one is going to repeat the massive 90s PC roll out followed by the internet boom.

    So something else will have to drive recovery- if there is one
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  •  
    Jul 28 02:39 PM
    Flashrob: Please keep your pet issue posts (NAFTA/WTO) on discussion boards where they might actually be relevant. Your arguments are not only incorrect (most studies show that open trade increases average wages) but also beside the point (Even if wages could be higher under your proposed protectionist regime, housing prices are totally out of line with wages anyway. Increasing income by 0-5% doesn't fix this problem.)
    Reply | Link to Comment
  •  
    Jul 28 03:11 PM
    Solid article, JD. We’re increasingly convinced as we research markets across the country for real estate investors that there will in all probability not be a notable “bottom” in the national market any time soon. The worst (and majority of) markets are languishing – inventories are blossoming, local economies are highly stressed, sentiment is lousy, and many are not experiencing sufficient price corrections to stimulate market activity.

    What’s confounding, and very interesting, is the fact that there are however many local real estate markets across the nation with very sound fundamentals – including balanced for sale inventories, relatively stable prices, robust transaction rates, as well as solid demand driven by surprisingly vibrant supporting economies and impressive, sustainable population growth rates.

    We further agree that the housing rescue bill will transfer excessive to the taxpayer, and likely have little meaningful near term benefit for housing’s travails overall.

    Unfortunately the drag of the “disaster” real estate markets far overshadows the contribution of the healthier markets to the national housing picture.
    Reply | Link to Comment
  •  
    Jul 28 03:54 PM
    I forgot to mention a 9th reason why home prices will continue to fall:

    Historically, the price-to-rent ratio is still too high.
    Reply | Link to Comment
  •  
    Jul 28 05:03 PM
    When I graph the rate of change in housing prices on a per month basis, it forms a nice pretty sine function that bottoms in Q3 2009. The deteriorating economic conditions may change that, but you have to remember there is an awful lot of momentum in these kind of sine wave movements. The bottom will hold, unless it completely fall out.
    Reply | Link to Comment
  •  
    Jul 28 05:35 PM
    Solid article. Before my trading I was a full time real estate appraiser (for approx 20 years) and I saw SO much stupid inflation of homes where people were refinancing every 10 months. They were using their homes as an ATM machine. It will take much more time to work through the excess.
    Reply | Link to Comment
  •  
    Jul 28 08:19 PM
    There will be overshoot on the bottom, just as there was overshoot on the top. I read the other day that the ridiculous run-up took five years, why should we expect the run-down to take a year. We may be at a trough, but it will be a long time before prices go up.
    Reply | Link to Comment
  •  
    Jul 28 09:46 PM
    good article and good comments
    Reply | Link to Comment
  •  
    Jul 29 12:08 AM
    And how did we get in this mess?

    1. The Fed dropped interest rates to fundamentally unsound levels.
    2. Cheap money went looking for a new home.
    3. The Bush administration decided to cut taxes and borrow instead, further inflating the money supply.
    4. The financial and housing industries -- among the largest political contributors -- invented new instruments and modalities to A) create buyers out of people who weren't qualified and B) quickly recycle loans into MBS bonds so the money could be loaned out again, and again, and again.

    End result: disastrously over-leveraged banks and over-extended home owners, all sitting out on a limb that was guaranteed to break.

    Who allowed all this to happen? Could it have been prevented, perhaps by forcing banks to maintain reasonable lending standards (e.g., so Fannie and Freddie would buy the mortgages), by requiring banks to maintain a substantial interest in their loans instead of throwing them out the window as fast as they came in the door?

    This is what unregulated "free markets" do. They create excess that leads to crashes. If you want to moderate the cycle, you need reasonable regulation. Of course, that's difficult when our entire government is in the pocket of big contributors. The financial and housing industries come to mind.
    Reply | Link to Comment
  •  
    Jul 29 08:37 AM
    I say we have Iraq pay back some of the War Debt. When we started these Wars with Saddam oil was at $20 a barrel. Now we have liberated them and gave them a 700% increase in the price of their #1 resource. What would have happened if oil prices stayed the same? Surely they can afford to pay back the war effort with these inflated prices.

    Probably the only thing I see in favor of the housing market is the extreme negativity , which usually means things might be close to a bottoming process.

    What we need in this country is fairly simple..

    1- Get these bozos out of office. Give me Obama or McCain, anyone with a brain, a mind towards tending the record deficits and working across the aisle with the other party. This is America, not red nor blue states but people that can and will work together to solve problems.

    2- Start Building the "NEW AMERICA" we need

    a- Infrastructure spending
    b- Reinvigorated Space Program
    c- Alternative energy development on a grand scale

    We have spent many of the last years fighting a war with no material benefit, we need to invest in this country once again and also repair our image in the world.

    As a CPA in the northeast I can say the economy will be a huge challenge. I see the main problem is the concentration of wealth. Through outsourcing and exporting, large companies maintain wealth but distribute to far fewer here in the US.

    The profits of US companies are a subject for study in themselves. In the early 1980s 85% of jobs provided a company paid for pension and most had full benefits for insurance. Now 15% have company pensions and maybe 20-30% have full medical coverage. The more you take out of the pockets of workers the more "companies seem to earn" the multiple of which accrues to shareholders.

    401k wealth for most is a myth. 52% of 401k holder took a premature distribution last year. People are tapped out, this country has suffered the biggest period of mismanagement in its history.

    What worries me most is the group that stands to benefit from keeping the status quo. Before the last presidential election they pulled the Thurs evening Bin Laden video out, this time from what I read and hear from others it will be worse. An incoming Obama might lead to a pre election war with Iran or an elected Obama a post election pre inauguration war. Those with the money and power dont give it up easily to those seeking the level playing field and America for all.

    Id just remember what I said and hope that come next January you can all say, gosh he was wrong (I hope). IF you want a Depression the war scenario is the one way I see that happening. Absent that nightmare scenario I see either new man bringing us out of this mess.

    MA in CT
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  •  
    Jul 29 09:00 AM
    As usual, I agree with Kunst. For an example of effective banking regulations please take a look at Spain's dynamic provisioning rules:

    www.economist.com/spec...
    Reply | Link to Comment
  •  
    Jul 29 09:14 AM
    The rescue of Fannie and Freddie will allow scams like the following to continue, because banks can continue to pass off questionable loans to the taxpayer now. The raising of the mortgage limit to 729K has made this possible. This scam took place early this year, regardless of the hysteria about "sub-prime". Please check the following link:

    www.ocregister.com/bus...

    The scam works like this:
    1. Find someone with good credit and not much knowledge of English or with poor reading comprehension. Tell them they will be able to buy a house and make 50K in cash.
    2. Buy the house at auction for 300K after foreclosure, probably close to fair value at this price.
    3. Mark up the house to 600K, and loan the buyer 125K to satisfy the 20% down requirement. Cut an appraiser and a loan agent in on the deal.
    4. Wells Fargo approves the 500K mortgage since the buyer paid 20% down, and he/she has good credit, and they do not want to seem anti-minority or get sued!
    5. The "buyer" pays the scammer 500K - 50K = 450K.
    6. The scammer makes a cool 150K profit.
    7. Wells Fargo does not care since they are going to bundle up the loan and sell it to Fannie Mae or Freddie Mac, ince their conforming mortgage loan limits went up to 729K for jumbo mortgages.
    8. "buyer" goes out and buys a nice 50 inch LCD TV and sends some money home to Guatemala.
    9. The "buyer" suffers a job loss/divorce/deportati... problem and the house goes into foreclosure
    10. The foreclosed house now ends up on Fannie Mae's balance sheet, and is sold for 325K at auction, and the remaining 275K is added to the US taxpayer account.

    Chinese and Vietnamese language newspapers are full of these ads where a "buyer" is solicited and a cash offer is made. Now if Fannie and Freddie Mac were private entities, they would not ask for an independent appraisal and reject the loan. Still wonder why you pay taxes?
    Reply | Link to Comment
  •  
    Jul 29 09:42 AM
    Here's brand new evidence that the recent Barron's cover story about home prices having bottomed was dead wrong:

    www.bloomberg.com/apps...

    Note that Barrons is often a useful contrary indicator.
    Reply | Link to Comment
  •  
    Jul 29 03:04 PM
    Everyday I turn on the boob tube and hear: "are we at the bottom for real estate, yet." At some point the magic bottom will hit. Unfortunately, we won't know it until a few months later looking thru the rear view mirror. .. So that a breathe and forget talking about a bottom. It is so boring.
    Reply | Link to Comment
  •  
    Jul 29 03:14 PM
    kurt walter, those of us who work in finance would like at least a rough estimate of when housing prices will bottom because housing prices are still the main collateral in the global financial system such as with ABSs.
    Reply | Link to Comment
  •  
    Jul 29 04:52 PM
    I suppose I should be the last person to ask this question but why have real estate stocks been moving UP during the last three or four months?

    The short ETF, SRS, for example has been moving down.

    Are we simply seeing a rearrangement of deck furniture on the Titanic?

    It would be laughable if my money wasn't involved ;)
    Reply | Link to Comment
  •  
    Jul 30 07:45 AM
    carey_jim, my guess as to why this has been happening is that housing sales always bottom before home prices do and there has been stabilization of sales in just a few areas of the U.S.
    Reply | Link to Comment
  •  
    Jul 30 01:45 PM
    Marty says: I say we have Iraq pay back some of the War Debt.

    Yes, I'm sure they are so grateful for what we have done to/for them.
    Reply | Link to Comment
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