We have been saying for some time that a housing recovery was quite a way off, and official opinion has finally caught up with our views (or more accurately, has decided to acknowledge obvious but unpleasant reality).
The Weekend Wall Street Journal reports in a page one story, “Economists See Housing Slump Enduring Longer.” The negatives we’ve discussed before, namely an overhang of unsold houses and tightening lending standards across the credit spectrum, will likely be compounded by rising interest rates. The consensus seems to call for a weak housing recovery beginning sometime in 2008, but that presuppposes other sectors of the economy taking up the slack. With corporate profits at a cylical peak, consumers overstretched and less inclined to tap home equity in a weak market, and interest rates on the rise, the hoped-for engines of growth are likely to come up short.
From the Journal:
Economists are giving up on the idea that the U.S. housing slump will be quick and relatively painless.
Instead, more are concluding, the downturn that began nearly two years ago will last at least through the end of 2007, remaining a major drag on the U.S. economy. The culprits: a glut of homes for sale and growing caution among lenders who now regret being so free with their mortgages during the boom.
Most forecasters still expect the economy to regain some momentum this year after a slow first quarter. Recent data have shown manufacturing, business investment and trade on track to help offset the negative effects of falling home values on consumer spending. Even so, some economists expect economic growth this year to remain tepid, largely because of the weak housing market.
This worry coincides with a surge of inflation anxiety that has roiled stock and bond markets in recent days. Yields on 10-year Treasury bonds, which influence the cost of various forms of borrowing throughout the economy, have risen above the psychologically important 5% level to the highest point in nearly 11 months. That in turn has led to a big drop in stock prices: Both the Dow Jones Industrial Average and the Standard & Poor’s 500 fell nearly 2% for the week after hitting all-time highs early on.
The rise in interest rates is only adding to the gloom. The average rate for 30-year fixed-rate mortgages stood at about 6.65% Friday, up from 6.35% in early May, according to HSH Associates, a financial-publishing firm in Pompton Plains, N.J. Though that rate remains far below the 8.2% average of the 1990s, the recent jump makes it harder for many Americans to afford new homes. “That’s putting more pressure on housing and delays its ultimate recovery,” says Andrew Tilton, a senior economist at Goldman Sachs in New York.
Federal Reserve Chairman Ben Bernanke acknowledged in a speech Tuesday that the housing market remains weak, and warned that residential construction “will likely remain subdued for a time, until further progress can be made in working down the backlog of unsold new homes.”
The market started to cool in mid-2005 after a buying frenzy that drove up the average U.S. home price nearly 60% in the first half of the decade and more than doubled prices in many areas near the East and West coasts.
Late last year, some economists were saying the market would start bouncing back by the middle of 2007. That hasn’t happened, partly because inventories of unsold houses have continued to grow and a surge in mortgage defaults has made lenders much more reluctant to grant credit to people with spotty payment histories.
David Resler, chief economist at Nomura Securities International Inc. in New York, says he is surprised by the degree to which speculation caused builders to overestimate demand, leaving a glut of houses and condominiums.
That means single-family housing starts, which have declined 33% since early 2006 to a seasonally adjusted annual rate of about 1.2 million in April, will remain low, around the current level, through the first quarter of 2008 before starting to recover gradually, Mr. Resler predicts. Goldman’s Mr. Tilton thinks single-family starts will drop to an annual rate of one million or so before bottoming out in the second half of this year.
Reflecting this worse-than-expected slump, Mr. Resler recently trimmed his forecast for economic growth in the second half of this year to an annual rate of 2.8% from 3%. He sees about a 33% chance that the U.S. economy will slip into a recession in the next year. If it does, he says, the weak housing market would be largely to blame. Among the risks, he says, are that depreciating home values will make consumers more cautious in spending and that many more housing-related jobs will be lost.
Ian Shepherdson, chief U.S. economist for High Frequency Economics, a research firm in Valhalla, N.Y. , doesn’t expect a recession but says weakness in housing will help keep U.S. economic growth at a sluggish pace averaging less than 2% for the next several quarters.
Housing accounts for a lot of jobs, not only in construction but in related areas such as mortgage finance and furniture sales. Zoltan Pozsar, senior economist at Moody’s Economy.com, estimates that housing-related sectors created nearly 1.3 million jobs between January 2003 and March 2006. Since then, he says, housing jobs have declined by almost 300,000. He sees more losses to come during the summer, which is usually a big building season.
Home values can also influence consumer spending, as people use cash-out mortgage refinancings and home-equity loans to pull money out of their houses. At the peak of the housing boom in the third quarter of 2005, people were taking cash out of their homes at an annual rate of $709 billion, according to Michael Feroli, an economist at J.P. Morgan Chase & Co in New York. As of the first quarter of 2007, that number had fallen to $178 billion.
A prolonged housing slump would be particularly painful for retailers of the kinds of things people often buy when they move, such as building and gardening supplies. According to the Commerce Department, those retailers saw sales drop by 6% in the year ending April.
Meanwhile, empty houses are multiplying. A recent Merrill Lynch report tallies a record 2.2 million vacant single-family homes and condos for sale nationwide, about one million above the norm. Florida’s Miami Dade County has a 31-month supply of existing condos on the market. About 20,000 new ones will be completed by the end of 2008, says Jack McCabe, a consultant in Deerfield Beach, Fla. He says about two-thirds of those have been sold, but many buyers are canceling orders rather than taking possession of a depreciating asset.
Some local markets remain strong. Prices have continued to rise in Manhattan, Seattle, Houston and some other areas. But in much of the country, home prices have been flat to moderately lower over the past year.
Economists at Merrill Lynch admit it is hard to predict how the slump will play out from here. “We are not sure how deflating a $23 trillion asset class — the value of real-estate assets on the household balance sheet — will end, but we doubt that it will end well,” Merrill economists wrote in their recent report.
The outlook is confusing for the average home shopper, too. Bill Shakespeare, a marine-engine salesman who doesn’t mind the inevitable jokes about his name, attended an auction of foreclosed homes in San Diego last month, hoping for a steep bargain. Wearing a red baseball cap and windbreaker, the 74-year-old Mr. Shakespeare made an initial offer of $140,000 for a 600-square-foot condominium. Then he gave up when the bidding spiraled to the winning level of $180,000.
Mr. Shakespeare, one of more than 1,000 people who turned up at the auction, notes that there are plenty of other condos on the market, some of which have been unoccupied for months. “We’re not going to be rushed into anything,” he insists.
The auction in San Diego was one of three held in Southern California last month by Real Estate Disposition Corp. of Irvine, Calif. The auctions, at which a total of about 280 homes were offered, attracted several thousand people, demonstrating that there are lots of bargain hunters waiting to pounce on the right deal. But the auctions also underlined the trouble some of those opportunists have in obtaining credit. In several-dozen cases at these auctions, homes had to be put back on the block after initial winners failed to qualify for a loan.
Lenders have eliminated most no-money-down “subprime” loans for people with weak credit records. That means many people who hoped to buy homes this year will have to wait until they can clean up their credit records and save for a down payment.
At a conference of mortgage lenders in May, David Lowman, head of the mortgage business at J.P. Morgan Chase & Co., warned: “The largest part of the problem in the subprime space is ahead of us, not behind us.” Many borrowers who got loans the past couple of years are still paying the low initial monthly payments and have yet to face the steeper adjustable rates that kick in after two or three years. Once they do, foreclosures are sure to rise.
Mark Zandi, chief economist of Moody’s Economy.com, a research firm in West Chester, Pa., expects lenders to acquire about 900,000 homes this year and roughly the same number next year through foreclosures, up from an average of about 500,000 a year from 2000 through 2006. That will add to the glut of homes on the market, further depressing prices in some areas.
At the San Diego auction, homes typically sold for around 25% less than their most recent sales prices or appraised values. (The comparison includes a 5% commission paid by winning bidders.) Demand seemed stronger at another recent auction of foreclosed homes in Los Angeles and Orange counties. Many of the houses offered there sold for about 85% to 95% of previous prices or appraisals.
At the Los Angeles auction, Suresh Gupta, a condo developer, made the winning bid of about $1.2 million for a three-bedroom home in Pasadena, where he and his family plan to move. The house had a previous value of $1.5 million. Mr. Gupta thinks the auction price compares favorably with what he could get through a conventional purchase. “There is no justification for the prices many homeowners are asking for,” he says. “They are living in a dreamland.”
Notice in this story the absence of forecasts from the usual shills, such as the Mortgage Bankers Association or the National Association of Realtors.
Anyone with an operating brain cell knows better than to take research by people who have a vested interest in the results seriously. Yet too often the press treats the market forecasts of the National Association of Realtors as if that industry had some legitimacy, despite the fact that the public at large knows better (a 2006 Harris poll ranked real estate brokers at the bottom of 23 professions).
At Seeking Alpha, Barry Ritholtz performs a public service by assessing NAR forecasts. Predictably, he finds them to be wanting:
With the oft hallucinatory [NAR Chief Economist] David Lereah now gone from the NAR, one would expect hope that the Realtor Group would take off the cheerleading outfit and get real.
So far, that wish appears to be unfulfilled. There have been only grudging signs of any reality check taking place. Wednesday’s NAR release noted:
“Existing-home sales are projected to total 6.18 million in 2007 and 6.41 million next year, in contrast with 6.48 million in 2006. New-home sales are forecast at 860,000 this year and 901,000 in 2008, down from 1.05 million last year. Housing starts are likely to total 1.43 million units in 2007 and 1.49 million next year, below the 1.80 million recorded in 2006.
The national median existing-home price should ease by 1.3 percent to $219,100 in 2007 before rising 1.7 percent next year. The median new-home price will probably fall 2.3 percent to $240,800 this year, and then grow by 2.6 percent in 2008.
Unfortunately, the Realtor group remains a spin organization, unable to release information without sugarcoating it. Their headline is the reality-challenged “Home Sales Projected to Fluctuate Narrowly With a Gradual Upturn.”
Further, they somehow omitted the simple fact that, even by their own too cheery data, Existing-home sales are forecast to drop 4.6% (they provided the data, but refused to do the math). And the group still has failed to acknowledge the extent of the overbuilding and inventory problems, insisting “We continue to experience a temporary distortion in comparing median existing-home prices.”
Um, no. It’s a major correction after an enormous run up due to free money. And as mortgage rates tick higher, that 30% correction (first mentioned here) is looking more and more possible.
Regardless, Investech’s Jim Stack has disabused the group of its forecasting accuracy. In a June 1st commentary, Stack looked at his Housing Bellwether chart, and plotted some of the more outrageous/egregious comments from former NAR Chief Economist:
By being such dishonest brokers of information, the NAR has now made themselves look ridiculous. No one knows what the future will bring, but consistently absurd spin offered up by the Realtor group not only does a disservice to the public, but is now working against the interest of Realtors themselves.
My advice to them: Stop the crap, and try a little honesty.
