Monday, August 18, 2008
The collapse of the housing market is the epicenter of the financial earthquake that has ripped through Wall Street over the last year. The S&P 500 is currently off its October 2007 high by 20%. Corporate credit spreads have widened back to levels not seen since the collapse of Bear Stearns in March. Bank lending has tightening substantially (according to the Senior Federal Loan Officer Survey conducted by the Federal Reserve Bank). Mortgage rates have risen from 6.0% in May to 6.5% in August. Mortgage applications are falling. Home prices continue their decent, and the housing market has failed to make a decided stabilization.
Today, shares of Fannie Mae and Freddie Mac, the two government mortgage entities, tumbled more than 22% each. The general consensus regarding the future of Fannie and Freddie now includes a necessary bailout; a recent Barron’s article predicts that the US Treasury will need to inject funds to cover the (possibly) insolvent balance sheets of the two firms, resulting in a liquidation of shares and huge losses to shareholders. A.K.A., get out…and get out quick.
In some sense Fannie Mae’s and Freddie Mac’s problems will subside if the housing market stabilizes; the financial markets will rebound if the housing market stabilizes; the labor market (almost 600,000 construction jobs have been shed since last year) will rebound if the housing market stabilizes; consumer spending will improve if the housing market stabilizes; US growth will improve if the housing market stabilizes. The recovery of the US economy depends on the stabilization of the housing market.
The big question is: When will the housing market stabilize? The answer is that the housing market will have initiated its stabilization perhaps by July, but will not rebound until well into 2009. First, the market for home sales must find their bottoms, both on the primary (new home sales) and secondary (existing home sales) markets. This is likely imminent, and may have already begun. Second, home prices must find a trough. Alan Greenspan, the former Chairman of the Federal Reserve, believes that prices will not bottom until early 2009. Third, new construction will pave a path to a real recovery. Housing construction (new construction) may bottom in the next few months, but healthy construction will not likely emerge until 2009.
Sales may have reached a bottom
The housing market has not decidedly reached phase one of its recovery (sales finding a bottom). In June, the level of existing home sales (4.86 million) fell 2.6%, its biggest monthly drop since September 2007. Further, new single family homes plunged 33% since last year; however, new single family home sales (533,000) are just 11% the size of existing home sales (4.86million), so the effect on the economy is really negligible. For that matter, who really cares about new single family home sales?
On an annual basis, the rates of declines in sales are falling – June’s existing home sales, pending home sales, and new single family home sales fell to -15.5%, -12.2%, and -33% - so a bottom may have been found.
Prices have not yet bottomed
As home sales start to bottom out, the inventory of unsold homes - including vacant homes (currently 2.8% of all homes owned) - will be picked up, and prices can stabilize. We are already seeing evidence of this happening since average existing home prices rose 4 consecutive months to $257,500 in June, but other indicators paint a very different picture. The Case Shiller composite 20 index of home prices fell another 0.9% in May (the most recent statistic) for a grand total of 15.8%-off since this time last year.
It is good news that existing home prices are rising, and even that the Case Shiller index is lagged by one month (it’s latest release is May, while all of the other housing data released June statistics), so it may have risen by now, but home prices are going to stay low until a sure-fire stabilization in sales occurs; that may be a while.
Healthy construction will not occur for a while
And finally, we come to the merits of tomorrow’s release by the Census Bureau, new home construction (housing starts). As soon as the excess supply of housing is absorbed and home prices start to rise again, new construction will resume at a more-healthy pace.
Currently, new construction has fallen to just 3.2% of total economic production in a year (GDP), which is 2.2% lower than 3 years ago. How low can it go? In 1991, construction fell to under 0.8 million units per year, which is much lower than the current 1.07 million units started in June. It can go lower, but the upside is that starts rose quickly following their Jan 1991 bottom.
Tomorrow’s release is expected to bring further reductions in new construction, perhaps down to 0.90 million. As a technicality, the Census Bureau’ June report showed that many new homes were started that would not have been started if it weren’t for a new piece of New York City regulation. Thus, the 1.07million units started in June cannot be sustained, especially since existing home sales prices continued to decline.
Starts may bottom soon, but they will sit there until the rest of the housing market works itself out. To be sure, it does look like newly issued building permits have hit a bottom, so new construction may not be too far behind.
The glimmer of hope
There is a glimmer of hope that the US housing market is showing some signs of stabilization, but the verdict is still out. There is much excess inventory to work through, prices have to stabilize and rise, and finally, new construction must again gain some momentum. Until all three components occur, the US housing market, the US financial markets, and the US economy are to remain prisoners in their own homes.