by Karl Smith
As I slowly work my way through the data that I have been separated from for far, far too long, I am increasingly concerned that the possibility for a second housing bubble exists.
Part of this - perhaps ironically - is related to the weakness of my previous forecasts. Originally, I expected multi-family housing to stage a large boom. In percentage terms it grew strongly but has yet to reach the absolute levels I was looking for. I then expected more families to opt for buying existing homes and for prices in the existing home market to rise. Again this has happened but slower than I would have expected.
One interpretation is that I just have no idea know what I am talking about and it is always important to keep that possibility in mind. Another possibility, however, is that even as the pressures on the housing market build, the the mortgage industry, the homebuilding industry and underwater homeowners have been slow to adapt. Once bitten, twice shy.
Thus the most striking development - and one that I did not expect to be so strong - is the dramatic collapse in existing home inventory.
Alone this doesn't give us the pure tightness of market measure that we might like, as there is a large though largely amorphous shadow inventory of homes somewhere on the road to foreclosure.
However, as fundamentals go, the keys, as always, are household formation, net construction and vacant homes. We know that formation though still depressed is running well ahead of net construction. The question mark is on vacant homes. My guess is that movement in the existing home inventory is a decent proxy for total vacancies. So, the rapid absorption rate and hence declining inventory of existing homes is telling us that there are relatively few vacancies, in spite of a potentially large shadow inventory.
If the shadow inventory was composed of many vacant homes then we would expect them to move rapidly out of the shadows and onto the normal market as the existing inventory fell.
If shadow inventory is not moving on to the regular market despite ample "room" then this suggests that there is someone doesn't want to expedite this process and that person is likely an individual who is currently depending on the shadow home as a place to live.
If that's the case then once the foreclosure process is complete the existing inventory gains a home, but the housing market gains a new buyer or - more likely - a new renter. So it's a net wash.
Consider also that on a cash flow basis homes are amazingly affordable.
This is in part because home prices have fallen but also largely because mortgages are at record lows. This puts us in a similar position as the early 2000s, where the number of buyers was not constrained by the payment as much as buy the bank's willingness to lend.
As banks eased on lending standards, buyers flooded into the market. This drove up prices, which because houses are collateral for housing loans, led to further easing in lending standards and a further increase in price.
A simple way to get to the heart of the whole matter is that when price is the rationing mechanism a negative feedback is set up. More buyers means higher prices which means fewer buyers. When credit worthiness is the rationing mechanism then a positive feedback is set up. More buyers means higher collateral values which means more buyers.
We are again in the regime where credit worthiness is the rationing mechanism. I had hoped we might mitigate this by increasing the rental stock and thus decreasing the number of potential buyers. I had also hoped for a "soft takeoff" wherein slow increases in price would eat away at the number of buyers while also increasing the number of new homes supplied.
Instead we are increasingly set up for a "hard takeoff" where all of a sudden traditional buyers will flood in even as cash investors are still looking for deals. This could lead to a very rapidly tightening market, accelerating prices and the rise of a new bubble.
Of course, I could be wrong, but even as predictions along the way have not been as robust as I would have liked, the fundamentals continue to build in the expected direction.
That's the kind of thing one would expect if we were to wind up with a situation where it looks like nothing is really happening and then woosh, it all happens at once.