In assessing the U.S. housing market as I do each month, there are many lenses through which to look. Back in March I wrote that the housing market would soon see a bottom in the various sales rates. This has happened. Last month it was clear that housing was technically no longer a drag on the U.S. economy but that the market is only being sustained by heavy government intervention.
Today sales rates are up more than 30%, inventories have been cut anywhere from 22% (existing homes) to 54% (new homes), and interest rates are back to historic lows of April. By almost all measures, the worst of the U.S. housing crisis has passed. Yet if the housing market is so healthy all of a sudden, then why are there so many foreclosures looming out there?
Proponents contend that mortgage modification programs (many of which are still in trial phase) will eventually bring the bulk of these loans current after banks capitulate and write down part of the loan principle. Critics contend that we are just postponing the inevitable and this stock of delinquent loans will eventually result in a wave of forced sales sending the housing market down further as early as next year. So who is right? Maybe neither is. History suggests the stock of foreclosures might never totally return to pre-crisis levels.
First let’s look at the slew of measures that convey the positive trends in the housing market.
Existing home sales rate surges past six million. Sales of existing homes jumped more than 10% in October to an annual rate of 6.1 million homes as buyers rushed to close their sales before the tax credit was set to expire at the end of November. Inventories of existing homes have declined and now stand at seven months of supply, no longer an abnormal level. Even the Pending Home Sales Index released Tuesday was up for the ninth month in a row, suggesting momentum isn’t about to stop abruptly. The graph above overlays existing homes sales and the PHSI with a two month offset to account for the roughly 60 days required to close on a home. The PSHI has proven to be a reliable indicator for future sales.
New home sales regain some momentum. Sales of new homes rebounded in October, jumping more than 6% to an annualized rate of 430,000 homes. The inventory of new homes for sale continues to decline and now stands at 239,000 homes, which represents 6.7 months of inventory. Momentum, which had stalled in this measure as of late, returned in October. With the home buyer’s tax credit now having been extended and expanded, support for the entry level segment of the market should continue through next spring.
This large jump in sales volume and decline in inventory is interesting. Could it simply be just the market clearing of the large inventory of foreclosed homes? So far, not so much.
Foreclosures were not the driver of the jump in sales in October. Many critics argue that home sales figures are being driven by homes in foreclosure. From September to October the number of homes sold through foreclosure sales declined slightly (according the RealtyTrac.com) while the sales of underlying homes jumped during a month that tends to be seasonally weak. Foreclosure sales in October represented just 26.2% of all sales, the second lowest monthly reading in 2009.
Those that want to be critical of this measure are best off looking at the raw (non-seasonally adjusted) sales figures. Factoring out those 130,000 sales attributed to foreclosure, a market following a more typical seasonal pattern would have seen 35,000 less homes sold in October versus September. Instead, the number of homes sold in October jumped up by roughly that amount rather than declining.
You could argue it was simply these 70,000 home buyers chasing the tax credit that moved the annual rate from 5.5 million to 6.1 million. Jumps in seasonally weak months can have a large impact on annual rates. The fact that there were an extra 70,000 homebuyers that were willing to be incentivized to jump into to the market still says something positive.
Rates are back to historic low levels. The Freddie Mac weekly survey of mortgage interest rates registered a rate of 4.78% for 30-year fixed rate mortgages last week. This matched the low set back in April of this year. It has taken a trillion dollars of purchases of mortgage securities by the U.S. Federal Reserve to achieve these rates but the rates are low and the trend is in the right direction to help the housing market. This relief is only temporary as the buying program is scheduled to end by March 2010.
So what about the millions of homes in foreclosure? They aren’t yet showing up on the market. Neither are they being permanently modified into affordable mortgages as evidenced by the U.S. Treasury Department's renewed pressure on mortgage servicers Monday. They just keep building in backlog, now approaching four million loans according to the Mortgage Bankers Association.
The backlog of loan delinquencies just continues to build. Since 2007, there has been a steady increase in loans considered “seriously delinquent” (more than 60 days late in payments). Since the beginning of this crisis roughly 200,000 properties per month have begun the foreclosure process but only half that amount actually finishes the process. The rest stay in the backlog.
The U.S. administration estimates that 3.2 million of these loans are eligible for modification programs. To date, the number of permanently modified mortgages is less than 2,000. There are more than 650,000 currently in trial phases.
If these efforts to modify these mortgages fail (in the past, such mortgages were falling into default again at a rate of more than half), the expected result is a wave of foreclosure sales. This tidal wave has been forecasted for more than a year now, but has yet to hit shore.
The answer to whether the housing market truly recovers or takes another leg down in 2010 rests squarely on what happens to this backlog of four million properties. In years past these situations would quickly lead to foreclosure and sale of the property by the bank or loan holder. At least that is what I thought until I looked more carefully.
Of course, this assumes that during previous housing cycles the market eventually capitulated – banks evicting delinquent homeowners en masse to clear the market and return to normal. Isn’t that the lesson to be learned when an economist harkens back to the Resolution Trust Corporation, created to deal with the 1980's Savings & Loan Crisis?
I was surprised to find that history does not bear this out. Good data for inventory of delinquent mortgages and foreclosures goes back to 1979. This is far enough back to capture the past few recessions and the last big housing bust in the early 1980s.
The 1981-82 recession also saw big jumps in foreclosure starts and stock of delinquent loans. The last time a housing collapse combined with a recession and double digit unemployment was 1982. While the numbers back then were an order of magnitude less than now, the rate of foreclosure starts did jump from .13% in the second quarter of 1980 to twice that in 1986. The stock of homes with delinquent mortgages climbed almost four fold in that period as more homes went into foreclosure than came out through an eventual eviction/sale or through the mortgage becoming current again.
Despite the strong growth in the economy that began back in 1983 and continued for the rest of the decade, the rate of foreclosure starts never fell back to the original levels.
Even during the decade of the 1990s rates of foreclosure starts held steady and gradually increased despite the great prosperity of the 1996 – 1998 period. The housing and mortgage lending market grew accustomed to the new levels of foreclosures and an increasing number of homeowners behind on their mortgages. This just became part of doing business and a cost of expanded homeownership in the United States.
The market eventually settled out at .45% of current mortgages each quarter becoming behind in payments and falling into foreclosure. By the end of 1999 (at the height of the dot com wealth boom) half a million homes were seriously delinquent on their mortgage. These became the new pre-crisis levels that we refer to when looking at problematic mortgages today. Even if you adjust for a larger housing and mortgage market today than in 1980, you still come to the conclusion that the market never corrected back to pre-crisis levels.
I am not specifically arguing that we will have more than four million homes in foreclosure indefinitely but that history suggests that it is a distinctly possible outcome here. Many observers are waiting for government-sponsored mortgage modification programs to succeed. Others are expecting this to fail and bracing for the onslaught of foreclosed properties to hit the market. We might be waiting a long time for one of these two outcomes to be realized.
Four million homes seems to me excessive but the ‘new normal’ (defined by Mohamed El-Erian of PIMCO as a protracted period of U.S. economic growth below potential) could very well include a couple million folks struggling to stay in their homes; never fully becoming current on their loans but never being evicted either. With the U.S. government putting its sovereign credit rating at risk to fight asset price deflation and keep the voting public in their homes, it is possible the market will never clear like we learn it should in economic textbooks.
Disclosure: Long the PMI Group (PMI)