THE ANSWER TO A HOUSING RECOVERY: LOWER PRICES

The simple economics behind the situation in housing is beginning to become more apparent as the weeks go by.  As we’ve noted for several years now the primary problem in the US housing market remains one of supply and demand.  As the jobs market continues to weaken, deflation takes hold of the US economy and the shadow inventory floods the market the math here remains simple enough for an Econ 101 student to understand.  In order for the housing market to build a firm foundation that does not require government aid we will need to see a reduction in prices.  In a recent research report Merrill Lynch described just how extreme the supply/demand imbalance has become in recent months and years:

“The collapse in housing demand means that it likely will take even longer to clear the inventory of homes for sale. In the new market, builders have continued to slash construction, maintaining incredibly lean inventories, and yet there is still supply of 9.1 months. Even more worrisome, however, is the existing home market where inventory is still on a decisive uptrend. As such, it takes 12.5 months to clear the inventory at the July sales pace. This widening gap between housing demand and supply means that construction likely will remain depressed and prices will dip lower (Chart 5).”

More worrisome is the huge increase in shadow inventory that Merrill expects:

“The inventory of existing homes for sale is set to increase further as “shadow inventory” moves into the market. According to the latest Mortgage Bankers Association’s report, 9.1% of loans outstanding, which translates to 4.8 million, were seriously delinquent at the end of Q2 (capturing 90+ days delinquent or in the process of foreclosure). Unfortunately, this is not the end of the foreclosure pipeline. There were 2.6 million of mortgages either 30 or 60 days delinquent (Chart 6). It is likely that re-defaults from failed modifications – there have been 616,839 failed HAMP modifications – have contributed to early stage delinquencies.”

Based on Merrill’s estimates the housing market is unlikely to normalize before 2015.  The supply/demand imbalance is simply staggering at the current levels and is likely to deteriorate if the economy weakens further:

“We define a normal housing market to be one in which housing starts are trending at the historical average of 1.5 million homes a year. In our view, we are several years away from this state of normalcy. Housing supply has outpaced housing demand by about 2 million homes over the past few years and is on pace to add another 500,000 excess homes by the end of 2012. For this excess to clear, housing starts must remain at a depressed level, not returning to normal until 2015. This would make it the slowest housing recovery in post-war history.

If we pencil in our baseline forecast for housing starts of 590,000 this year and 690,000 next year, another 500,000 excess homes will be created. Looking ahead, we must be more judgmental. A reasonable scenario is that starts slowly edge higher to 1 mn by 2013 and reach the “normal pace” of 1.5 mn by 2015. At this point, most of the excess supply will have nearly cleared, allowing starts to pick up to match the pace of demand.”

Congress is currently discussing creative new ways to prop up this market.  It should be plain as day at this juncture that the government cannot fix the housing market with their incessant fidgeting.  The market needs to correct further before reaching a sustainable bottom.  Lower prices will act as an automatic stabilizer by generating significant demand.  At this point, more government intervention merely kicks the can down the road by pulling demand from the future.  We can continue to deny the simple economics at work here, but at some point the market will prevail and prices will settle at a level that the market can absorb. In my opinion, the sooner this happens the sooner we can get on with the recovery process.  Unfortunately, politicians have elections to win so they will continue to use their law degrees to attempt to change the laws of economics.  It won’t work.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

    • That’s a good read. It’s sickening what we continue to do. Almost all actions in terms of govt intervention are designed to cushion the collapse in the banking sector. Of course, housing is the epicenter of the banking balance sheet so it must be protected at all costs. Or so we’ve been led to believe….

      But a funny thing has occurred over the last 12 months. The banking profits have recovered. The banks have been bailed out. The bank balance sheets have been supremely padded and altered. And it has had almost zero impact on main street.

      When do we realize that a smaller banking sector might be what the US economy needs? Then maybe we’ll stop shoveling money down that rat hole….

  1. Congress is currently discussing creative new ways to prop up this market. It should be plain as day at this juncture that the government cannot fix the housing market with their incessant fidgeting. TPC

    What Congress should be doing is thinking of principled ways to fix the market. That would involve bailing out the underwater homeowners with an equal amount to the savers. Since Congress won’t and since the Treasury and the Fed is already bailing out the banks this represents a transfer of wealth to the guilty parties in this mess, the banks. But hey, we can’t live without money so we can’t live without banks? It’s long past time to eliminate that choke-point on the American economy. If we don’t then we will have perpetual need for government intervention.

    • wait, you think renters should bail out homeowners? ridiculous.
      being underwater is not a threat to your life. pay your bills.

  2. Well I am afraid that as long as the government allows lobbyists in Washington, things won’t change at all in the foreseeable future. IMHO, this “legalized” corruption plays a big part in all the current issues because most of politicians have only their self-interests in mind. Rational and pragmatic thinking is not in their vocabulary…

    • You have “hit the nail on the head”! The financing of our elections by corporations has created a plutocracy that precludes any pragmatic legislation. IMHO the key to dismantling the empire is campaign finance reform.

      • yessssirrr,… as long as politicians need donatedc money to get elected we will never have pragmatic capitolists there

  3. Isen’t the lethargic jobmarket also a major factor in the housing market, no only prices?

  4. TPC,

    As usual, great post. Here is a article about MMT by By Scott Fullwiler, Associate Professor of Economics at Wartburg College, you might want to check out.

    http://www.nakedcapitalism.com/2010/08/guest-post-modern-monetary-theory-%e2%80%94-a-primer-on-the-operational-realities-of-the-monetary-system.html

    I have worked in the home contruction industry since the mid 90′s. I saw first hand the madness. I work south of Chicago and cover from the southwestern area into northeastern Indiana.

    You have a great site. Keep up the good work.

    Kamala

  5. While I completely agree with the premise and conclusions of your post, I disagree w/this so-called massive “shadow inventory”.

    Many of these foreclosed homes are in neighborhoods and areas that never should have had homes built in the first place – we’re talking $500K homes in Merced, CA, massive communities built in the middle of the Arizona desert 20 miles from even a convienence store (same w/Las Vegas), developments built on mosquito-infested swampland in the center of Florida … the value of these homes, while not zero, is not a whole lot above it.

    I don’t have the data, but it is my guess that much of the “shadow inventory’ is in places like this. Its not like Rye, NY or Gladwyne, PA or Chevy Chase, MD has a looming overhang of foreclosed homes that is holding prices back. Prices need to come down, and government policies seem to be attempting to stop this process. However, liquidating shadow inventory in places like Merced, CA is not going to have any effect.

    • While you’re probably onto something regarding the concentration of “shadow” foreclosures in largely undesirable/saleable areas, this does little to assuage the fact that the banks are still sitting on the REO and have yet to take the writedown.

      Ultimately, the less saleable the more likely the mark- or loan loss will be severe.

      • this does little to assuage the fact that the banks are still sitting on the REO and have yet to take the writedown.

        Sure it does. The banks are in a much better position today to write off those assets than they were two years ago. That position should continue to improve over time.

        Part of the federal strategy was to rebuild bank balance sheets, so that the banks could eventually afford to take those hits. (Of course, the banks are milking it for all its worth; the feds figured out the carrot side of the strategy, but has pussyfooted around with the stick that should go with it.) Timing matters.

  6. Many of these foreclosed homes are in neighborhoods and areas that never should have had homes built in the first place – we’re talking $500K homes in Merced, CA, massive communities built in the middle of the Arizona desert 20 miles from even a convienence store (same w/Las Vegas), developments built on mosquito-infested swampland in the center of Florida … the value of these homes, while not zero, is not a whole lot above it.

    I’m in CRE, and for what it’s worth, I agree with the sentiment (although the micro-level local data needed to quantify it is hard to come by.)

    The “shadow inventory” story is overhyped. Go out in the marketplace in the real world, and you won’t find much of it lurking in desirable locations. There are enough anecdotes to suggest that a lot of this so-called shadow product is ghetto or outlying locations in which the average middle class homebuyer has no interest in residing. Meanwhile, the better locations have established a floor and seen some modest price gains.

    What you’re seeing in that is the unwanted froth that won’t even hit the radar of the average earnest home shopper. When the floor of that bottom-end submarket has been set, that’s when you’ll see more of it come out of the shadows, and I suspect that a lot of it will be wholesaled to experienced slumlords. You can’t just look at averages; you have to compare the various tiers of the market and assess them accordingly.

  7. The real world says that the shadow inventory is in residential suburbs that were built more than 10 years ago and the weight of these properties on the market is a 25-50% haircut. There is plenty of inventory at the $417K+ sitting on the banks books.

    The reality is that if we let the market find it’s clearing price we’ll see it overshoot to the downside where many of the transactions will occur…that is what creates bottoms in markets.

    Let the real estate market clear, the banks fail, the traunches collapse, confidence collapse (what’s left of it) and we’ll experience a prolonged depression.

    There are many brave soles that complained when the government stepped in and saved the economy from collapse. Few would have had the ability to survive the collapse let alone afford running to the nearest sporting goods store to stock up on ammo.

  8. Housing is a spread trade. Low end good. High end bad.

    On another note, there is no more direct example of twisted policy goals than “keeping housing expensive”. Think about this for a minute. MORE expensive housing?

    I’m picturing a politician running in the 2010 midterms,,,

    “Lower taxes!!!!’ (cheers)

    “End the War!!!!” (cheers)

    “Energy independence!!!” (cheers)

    “More expensive housing for everyone!!!” (confused cheers)

    I get it though, gotta save the banks…

    • So at what point do people actually begin to figure out – well, if the banking recovery didn’t revive us then maybe if we stop subsidizing them their failures also won’t sink us? In other words, the banking sector isn’t the problem here…

  9. “When do we realize that a smaller banking sector might be what the US economy needs? Then maybe we’ll stop shoveling money down that rat hole….”

    That is so true.
    There are many very good small banks in the US. They serve there communities with commonsense lending practice. They are not sophisticated like the Monsters Banks that offer exotic derivatives packages but they don’t need to be baled out do they?

  10. ” It’s long past time to eliminate that choke-point [ counterfeit banking cartel ] on the American economy. If we don’t then we will have perpetual need for government intervention.” (F.Beard)

    The federal government (ie. plutocratic oligarchy ) most likely would embrace a ” perpetual need for government intervention ” which translates into the preservation of the governmental status quo even as overall economic wellbeing diminishes and increasingly more people are entrapped by the economicly dysfunctional political money system . The plutocrats easily recapture the dissipation of wealth via global investments and international corporate holdings .

  11. LOL I have been saying that for more than a year… Government should stop propping the housing market, let the house prices fall and then we may have people willing to start buying again AFFORDABLE homes with 20% down and sane monthly payments

  12. Prices doubled and tripled in some areas and now that they are down 25% everyone is acting as though it’s a fire sale. According to the long range charts another 25% drop would put us back in the normal range.

  13. The idea that anyone should be bailing out someone who took a flyer on a home is absurd. Remember..a home purchase is a business arrangement between a lending group with a well financed mortgage analysis arm and a homeowner..IF the home is underwater why should that be anyone other than those 2 principle’s problem?????

    Homes are still overpriced and there has yet to be a market clearing of prices….let the haircut begin.

  14. Where there is a policy (which means artificial distortion) there is neither principle nor ethics.

  15. I live in Ventura California close to the Pasific Ocean. Prices here have fallen over the past three years and are no longer decreasing.
    Homes in my neighborhood are on the MLS for less than 10 days before going Contingent Backup or sold outright.
    Anything under $500K in going very quickly. I really don’t think there’ll be further depreciation here.