The predictions about the end of the housing market mess have been greatly exaggerated. Most of the housing market pundits were predicting that the end of the downturn should have been years ago. Actually, the market is continuing to decline and, as time goes by, the problems with shrinking home owner equity, continuing risky and poor loans being granted by Government Sponsored Entities, a weak jobs market, and excess inventory are not encouraging for a recovery near term.
During the period from 2005-2007, consumers took an average of $600-$800 bn per year from the equity in their homes, and spent it! This was based on the belief that home values were only going to go up, until they didn’t! As a result of falling prices, this impetus to the economy has disappeared.
The number one problem in housing is negative equity (where the mortgage on the home is greater than the value of the home) and is getting worse as the home prices continue downward. Most of these problem mortgages are in the same areas that we continually read about such as Florida and California (each having around 2 million homeowners underwater). However, there are many other areas that also have problems with homes underwater. Arizona has about 630,000 homes underwater, while New Jersey, Maryland, and Virginia all have over 300,000. As you can see, the homes that are underwater actually are spread fairly evenly across the country.
President Obama has attempted to halt the slide in home prices by giving a break to homeowners that are current on paying off their mortgages but only if they have their mortgages with either Fannie Mae or Freddy Mac. Federal officials are making major changes to this “Home Affordable Refinance Program” to let more underwater borrowers qualify for refinancing. These homeowners are able to modify their loans and pay a reduced rate depending upon their current incomes.
These programs, that are initiated to prevent home prices from continuing to decline, will probably be as ineffective as previous “tax credits” for homes and “cash for clunkers” for automobiles. However, this housing program has even more problems as the total number of homeowners that could benefit from this program only come to between 1 to 2 million, while the total amount of mortgages underwater are about 11 million (or 25% of all homes with a mortgage). And if you take into consideration the homeowners that are “effectively underwater” (or have less than 5% equity in their homes) the number could be as much as 40% of the homeowners across America. These homeowners will all be underwater next year if the value of their homes drops by another 5% (and this is more than just possible, it is actually probable).
The problem with the housing market is secular and structural, and not just a typical, business cycle downturn that has occurred in the past. In fact, the past recessions post WW II were usually led out by a housing rebound. If the housing sector doesn’t improve the U.S. economy will have difficulty reviving. The current rebound from the financial crisis of 2008 is the slowest on record, mostly due to the deleveraging of household debt driven by homes purchased during the housing bubble from 2002 to 2007. The fourth quarter seems to be shaping up as a fairly strong quarter for the economy, but that is now over, and we believe there will be a disappointing start to 2012. You have to keep in mind that there are still 6 million fewer jobs than we had in 2007, before the “Great Recession.” And in order to bring the unemployment rate really down (not by losing participants in the labor force) we will need about 50% more than the 200,000 increase in jobs registered last month.
The FHA provides mortgage insurance on loans made by FHA-approved lenders throughout the U.S. It is the largest insurer of mortgages in the world, insuring over 34 million properties ($1.1 trillion). They specialize in insuring highly leveraged loans or loans where the buyer puts 5% or lower as a down payment. However, the FHA has become much larger and riskier as they have grown their portfolio by almost 400% since the financial crisis in 2007 and over that time period houses have fallen substantially. In fact, the FHA agency’s independent auditor recently warned that there is a 50% probability of needing a bailout next year. The audit found that the FHA’s reserves were less than one quarter of a percentage point. The reserves are $2.6 billion vs. guaranteeing a $1.1 trillion mortgage portfolio. Legally the housing agency is required to keep a 2% cash buffer, a target it has not met since 2008. If this decline in housing continues the FHA will join the other GSEs and add to the size of the next potential crisis.
Another problem with housing presently is the continuing lack of job creation. When jobs are created more people buy homes, and when workers are laid off, “For Sale” signs go up. And jobs are also a structural problem that is being treated as a cyclical problem. It will take a long time to replace the construction jobs lost as more and more homes were being built from 2002 to 2007. We will also have trouble replacing the manufacturing jobs lost over the past few decades.
Housing inventories, which had been a significant roadblock to a housing recovery, did decline in September, but we believe this drop was similar to the drop in the labor force (workers giving up trying to find a job) that continues to make the unemployment rate look better than it should have. As the robo signing scandal has created a false lull in foreclosures, the backlog has increased substantially, but will be coming on the market shortly. We also believe that many homeowners who have been trying to sell their homes have given up and taken them off the market since there are so few potential buyers. The latest Ned Davis Research shows the potential number of homes to be absorbed at close to 10 million homes. We believe that this overhang of houses will not be absorbed for the next few years and this will continue to accelerate the deflationary bear market we expect. We also expect that prices will overshoot on the downside after such an incredible extreme to the upside. You have to keep in mind that home prices vs. median family income reached an all time peak in 2003 and they are still above that level now.
Even when you get a little good news on the housing front, you can’t trust it. The organization that once said that the housing boom would never burst, The National Association of Realtors (NAR) said this past week that the market collapse was much worse than originally reported. They made a drastic statistical error by overstating the sales of previously occupied homes from 2007 to 2010 by 14% (over 3 million homes).