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by Dirk van Dijk

In May, Existing Home Sales fell 2.2% to a seasonally-adjusted annual rate of 5.66 million. However, sales were up 19.2% from extremely depressed levels of a year ago. Sales were also far below the 6.10 million rate expected by the consensus of economists. The April number was revised ever so slightly higher to a 5.79 million rate from 5.77 million. The decline in sales came despite two very important factors that should have boosted sales. First and foremost was the homebuyer tax credit. Used home sales are recorded at closing, not when the contract is signed. Thus, homeowners who were trying to get in under the deadline will be recorded in May and June, not in April. Those homeowners have until June 30th to close.

If an $8,000 bribe by Uncle Sam is not enough to make people buy a house now, just how busy do you think the real estate market is going to be after that credit goes away? The tax credit probably did very little to actually create new demand. Most of the people who bought houses would have bought them anyways. It simply made them sign the contract in April rather than in May or June. As such, it was a remarkably ineffective part of the stimulus program. Much worse than the often derided "Cash for Clunkers" program, which actually reduced the supply overhang (by having old cars crushed). It had the important additional effect of increasing the fuel economy of the nation’s auto fleet.

Expanding the credit to allow existing move up buyers to be eligible was in particular a huge waste of money. This is the second time we have been through this. The tax credit was expected to expire last fall, but was unexpectedly renewed and expanded at the last minute (every congressional district has a large number of real estate agents in it, and the tax credit helps them out).

As the graph below (from Calculated Risk) shows, there was a huge spike in sales, followed by a big hangover. This month's sales should have been party time again, but it looks like the party was not as lively as the last one. That does not mean we will not have a hangover, just that most of the likely buyers already took advantage of the program last fall. The July numbers, which will be the first month where there is no effect from the tax credit, will probably fall back to the 5 million annual rate. The weak sales also came despite mortgage rates falling to 4.89% from 5.10% in April and just slightly above the 4.86% rate of a year ago.

The official inventory of homes listed on the multiple Listing Service [MLS] fell by 3.4% relative to April, but is 1.1% above the level of a year ago. The months of supply ticked down to 8.3 months from 8.4 months in April. There is, however, a massive shadow inventory of houses that are in the process of foreclosure or where the owners are far behind on their mortgages, and which are very likely to be foreclosed on.

The HAMP program, designed to help banks and homeowners restructure mortgages and keep people in their homes has so far been a resounding failure, with more people dropping out of the program after spending several months in a trial modification than actually moving on to permanent modifications. The number of new people coming into the program has been slowing. Even after permanent modification, the payment levels are so high relative to people’s incomes that a high number of re-defaults is likely.

Breaking down the numbers further, single family sales were down 1.6% from April to an annual rate of 4.98 million, but up 17.5% from a year ago. Condo sales fell 6.8% from April but are up 32.6% from last year. Regionally, all of the decline in April came from the Northeast, where sales plunged 18.3% on the month and are up just 12.7% year over year. Sales were unchanged in the Midwest for the month and up 22.0% year over year. In the South, sales rose 0.5% and are up 22.9% year over year. The West did the best with a 4.9% increase for the month, but up just 15.2% year over year.

The Northeast was also the only region where the median price fell (2.2%) from a year ago. Median prices were up 1.0% in the South, 2.2% in the Midwest and 7.4% in the West. Nationally, the median price was up 2.7% year over year. However, the median price is not the best measure of home prices, since it can easily be affected by the mix of homes being sold (repeat sales indexes like the Case Schiller Index are better). The percentage of distressed sales (either former foreclosures or short sales) declined to 31% in May from 33% in both April and in May of last year. That might have been part of the reason that the median price rose nationwide. Another part of the reason is that the transaction is being subsidized by the government through the tax credit. Economic theory tells us that when a transaction is subsidized, some of the benefit goes to the seller as well as to the buyer, even though the check is made out to the buyer. The benefit to the seller shows up in the form of higher prices.

This was a disappointing report; shockingly bad in fact, but used home sales are really not that important to the economy. New home sales, even though there are far fewer of them each month, are what really matters to the economy. If someone buys a used house, they might do a bit of redecorating and perhaps throw a new coat of paint on the walls. That is nice for firms like Sherwin Williams (SHW - Analyst Report) and perhaps furniture stores like Ethan Allen (ETH - Snapshot Report), but it really pales compared to the economic activity involved in actually building a whole new house (labor, lumber, wallboard, plumbing, electrical equipment, furnaces, etc). Traditionally it is the housing sector, particularly new home construction and sales, that pulls the economy out of recessions. That simply is not happening this time around, and that is the principal reason this recovery is so anemic.

The new home sales figures will be released tomorrow morning. Since new home sales are recorded at the time the contract is signed, they have already seen their party last month and should be suffering a big hangover.

Source: Used Home Sales: Shockingly Bad Report