Housing: Even Worse Than You Think

Includes: FMCC, FNMA
by: Reggie Middleton

From Bloomberg: Home Prices in U.S. Recede as Tax Credit Expiration Hurt Sales

Sept. 28 — Home prices in 20 U.S. cities rose at a slower pace in July from a year earlier as the end of a government tax credit hurt sales.

The S&P/Case-Shiller index of property values increased 3.2 percent from July 2009, the smallest year-over-year gain since March, the group said today in New York. The gauge is a three- month average, which means the July data are still being influenced by transactions in May and June that may have benefitted from the incentive.

Unemployment close to a 26-year high and mounting foreclosures will probably weigh on the housing market for the rest of the year. With joblessness projected to average more than 9 percent through 2011, some households will continue to have trouble making mortgage payments, indicating foreclosures will remain a hurdle for property values.

We saw this coming a while back. It wasn’t very difficult if you remained objective.

… Consumer confidence dropped more than forecast this month on growing concern over the outlook for jobs and wages, another report today showed. The New York-based Conference Board’s sentiment gauge fell to 48.5 in September, the lowest in seven months, fro 53.2.

… Economists projected prices would rise 3.1 percent year over year, according to the median of 28 forecasts in a Bloomberg News survey. Estimates ranged from increases of 2 percent to 4.2 percent. The gauge dropped 0.1 percent in July from the prior month after adjusting for seasonal variations, the first decrease since March. Unadjusted prices climbed 0.6 percent from June. The year-over-year measure provides better indications of trends in prices, the group has said. The panel includes Karl Case and Robert Shiller, the economists who created the index.

“Anyone looking for home prices to return to the lofty 2005-2006 might be disappointed,” David Blitzer, chairman on the index committee at S&P said in a statement. “Judging from the recent behavior of the housing market, stable prices seem more likely.”

I don’t see why he would say something like that. Maybe in a natural, capitalistic market with unfettered supply and demand, his statement holds water, but the reality of the situation is that the government has drastically and materially altered the dynamics of the market by attempting to artificially stoke demand. To date, the government has:

  1. created synthetic financing in the form of Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC), who underwrite what would normally be unmarketable loans;

  2. created perverse tax incentives to entice buyers to purchase housing in a falling housing market;

  3. drastically altered the interest rate structure of the mortgage market buy buying hundreds of billions (if not more) in mortgage backed securities, suppressing mortgage rates to a point where they naturally have no way to go but up sans the government interventions. This is a very big point, for the increase in mortgage rates will decrease demand at a time when supply will probably still outstrip demand by a wide margin;

  4. altered the supply landscape by placing moratoriums on foreclosures, which normally act as a clearing mechanism by forcing prices down to a point where buyers are willing to bite. This not happening now, and we have a backlog of foreclosures sitting in a market where prices are still too high to balance the supply/demand equation despite historically low interest rates (that really don’t have much more room to fall, but have a lot of room to rise).

Actually, things are considerably worse than this article blurb is make is making it out to be, and the article is actually rather negative. To begin with, the Case Shiller is a rolling 3 month average, and most of those months are still benefiting from the government bubble blowing in the form of tax incentives and artificially suppressed mortgage rates. That means that the few sales that do not have that (tax) benefit instantly started dragging the index average down.

Listening to Tom Keane on Bloomberg radio Tuesday morning, I heard that home sales were the slowest they have been since 1963. Do you realize how much larger the U.S. population is in 2010 than it was in 1963, in addition to near record low interest rates, and perverse tax incentives?

If you think that sounds bad, then you ain’t heard nothing yet. You see, the Case Shiller is an econometric marvel, and is actually rather sophisticated. Despite this, it is also a tad bit unrealistic, particularly where this particular housing crash comes into play. You see, a decent amount of the housing inventory that is overhung in the form of new construction from overzealous developers that were funded by banks who didn’t believe they were lending their own money. Don’t believe me? Then walk through the most dense and valuable real estate in the country, NYC.

Guess what? The CS index doesn’t capture condos or new construction sales, both of which are lagging heavily. Just ask the home builders, some of which are doing much better in the hedge fund business than the home building business.

Much of the foreclosure and distressed inventory came from investors who walked away from their investment when it became cash flow negative or sank underwater.

  • Guess what? The CS index doesn’t capture investment properties, only owner occupied homes.

A significant amount of the distressed and foreclosed inventory also came in the form of multi-family housing where the owners overestimated the ability of rents to keep up with ARMS and then fell behind.

  • Guess what? The CS index doesn’t capture multi-family housing, only single family detached/semi-detached housing.

Banks are dumping large amounts of foreclosed inventory on the market in the form of REOs which serves to depress pricing.

  • Care to hazard a guess of whether banked-owned REOs are included in the Case Shiller index calcuation?

Many investors have started flipping lower end housing for quick gains (bought close to wholesale) to retail buyers. These deeds are often held for a matter of months, if that long.

  • Guess what? The Case Shiller index has a minimum holding period to be included in the index which excludes practically all of these investor flips, which also tend to double count sales, when in reality only one real organic sale occurred.

You know, I can go on, but the more swift of you have probably got the message by now…

More on the state of the housing market from yours truly…

Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…

Because 105% LTV On Depreciating Property Wasn’t Good Enough for the US Taxpayer…

I Told You Housing Was Going to Take a Downturn for the Worse. I’ll Tell You Something Else, We Are in a Housing Depression! It’ll Get Worse Until Market Forces Rule Over Government Bubble Blowing!

As I Made Very Clear In March, US Housing Has a Way to Fall

It’s Official: The US Housing Downturn Has Resumed in Earnest

Disclosure: No positions