Could the Housing Market Be at a Bottom?
My previous article took aim at Chinese industrial production, asserting that its manufacturing sector would be the next casualty in this cascade of global recession events. It is as if, one by one, dominoes are falling throughout the world, one sector after another and one region after another. It started with a U.S. housing bubble that inflated, popped and brought down an over leveraged global banking sector. This fall starved the consumer sector of the credit needed to fuel its spending binge, thus bringing down the consumer spending sector (restaurants, electronics, and automobiles). This led to a contraction of manufacturing which is presently wreaking havoc on exporting nations. The final shake out will be one more leg down in commodities. Commodities have a bright medium and long term future but the near term is bleak. On the heels of today’s jump in housing starts, I want to turn my attention back to ground zero in this whole mess: the U.S. housing market. The adjustment down for home sales has been nothing short of unbelievable but has it been enough? Just maybe.
Are unsold home inventories at record highs or record lows? It sounds like a simple question but it all depends on how you interpret the data. The pessimistic case is all over the headlines. Inventories of existing homes (tracked by the National Association of Realtors) and new homes for sale (tracked by the U.S. Census Bureau) stood at 9.6 months supply and 13.3 months respectively. By this measure, the existing home figure is off its April ’08 level of 11.2 and the new home inventory is at a recent high. Five to six months might be considered a healthy level, causing many to lament, “It will take us more than a year to burn off this inventory at this rate.” These last three words, though, are the critical qualification here and reason to expect a turning point before this summer is out.
These much-quoted inventory figures result
from the number of homes on the market divided by the current
pace of sales, which as shown above is dropping like a rock.
Inventories of new homes on the market have actually been
in decline for 18 months from a high of 573,000 in July 2007
down to 342,000 yet the decline in the rate of sales is
outpacing the inventory correction.
It is not that we have so many new homes on the market
but that the rate of sales is at a record low.
For those that may have missed it, the 23,000 of new home
sales that occurred in the month of January corresponds to an
annual sales rate of 309,000 a level never seen before. So sharp
has been this decline that it has to stabilize this year.
It is true that something low can always go lower.
Thus it is possible that the sales rate might bottom out
at 250,000 or even 200,000 but at the current pace of decline,
it will reach those levels before the spring is out.
The ending 2008 inventory of new homes (342,000 units) is approaching the lows seen in previous housing recessions (above graph) of between 250,000 and 300,000 units. The population of the country has increased by 34% over this period, though. Adding the January ‘09 inventory level (shown in red in right hand graph) and adjusting for population, you can see that we have already reached historic trough levels (and will be below them by the springtime).
Foreclosures may not have peaked but notices of default (NOD) appear to have. There have been much said about defaults and foreclosures. Regardless of whether you believe the Obama administration’s foreclosure mitigation efforts will amount to much, the most current data shows a stabilization of households going into default on their mortgages. According to data from RealtyTrac the number of defaults (Notice of Default and List Pendings categories) has been hovering at the 100,000 per month since the beginning of last summer. Default is the first stage in the foreclosure process that RealtyTrac reports. The trend is more debatable in the later stages which include bank repossession and foreclosure sales because there have been various moratoriums on foreclosures. This may be holding back some foreclosures from happening.
The banking system, which is so much at the mercy of housing foreclosures, mostly marks to market and reserves losses based on notice of default, which has leveled out. Banks like Citi (C) and Bank of America (BAC) as well as GSEs: Fannie (FNM) and Freddie (FRE) may very well be holding back foreclosure sales and repossessions but there is anecdotal evidence that defaults, if anything, are inflated as homeowners are going into default to qualify for help from their lenders. Thus while the final step in foreclosure may be understated pending the outcome of government programs, there are few folks arguing that this is true for the first step, default (triggered by late payments). This dynamic can be seen by mortgage insurers like MGIC (MTG) and the PMI Group (PMI) that have set aside billions of dollars in reserves (based on defaults) but have been far behind in forecasted payouts rates (based on foreclosure sales).
This is not to argue that rising unemployment won’t continue to impact the housing market. A RealtyTrac executive commented last week that total foreclosures are increasing in previously untouched areas. He cited a 129% year over year increase in foreclosure activity the state of Idaho. But the 1,764 foreclosures (all categories) in Idaho are a mere fraction of those in California that is coming off a level that peaked above 100,000. The point is that the size of the subprime problem in four states (CA, AZ, NV, and FL) was so large that it overwhelmed the economy last year.
As this situation runs its course and subsides, the net result will likely be an improvement even in the face of rising unemployment. Please remember the U.S. unemployment rate is a lagging indicator, a reflection of poor economic activity, not a cause of one. Housing tends to lead the economic cycle, unemployment tends to lag it. One such indication is that in the western U.S., one of the hardest hit regions and first to adjust, new home sales are up 29% year on year while other parts of the country are still declining.
Home sales near a bottom but prices will continue their decline. So does this mean home prices will stop falling soon? Unfortunately, no. I compared the trend in sales (new home) to the home prices as tracked by the S&P Case-Shiller Index of 20 metropolitan areas. Case-Shiller is the most publicized of many home price indices but the picture is similar regardless of which one you use. Since the peak, home price trends are lagging the sales cycle by 12 to 24 months. If this relationship holds and we are nearing the bottom in home sales and inventories, it means we still have four to eight more quarters of home price declines. Government stimulus and home purchase tax credits could shorten this but first the effectiveness of such efforts needs to be demonstrated.
The first economic domino to fall in this global economic downturn was the U.S. housing market about three years ago. It put global banks and the American consumer into a state of paralysis, starting a chain of events which is only now ravaging Eastern Europe, China, and other markets. While the last domino is yet to fall, there is reason to believe the U.S. housing market is beginning to heal.
Disclosure: The author does have long positions in a mortgage insurance provider discussed.