Housing Market Fortunes Tied To Banks, Higher Wages

Includes: BAC, C, IYR, VNQ, WFC
by: Joseph E. Meyer

Housing prices fell across the board in 2011 and will likely remain stable, if not falling further in some states throughout the country.

Anyone betting on a housing market recovery needs to wait another year, or two. This market depends on a healthier banking sector, and higher wages.

Prices for residential real estate fell 4% in the fourth quarter 2011 from the same period in 2010, Standard & Poor's Case-Shiller national home price index showed us this week. Prices are nearly 34% below their peak in 2006's second quarter, rolling back average home prices to 2002 levels. Even better, residential real estate declined in December from November in 18 of 20 major U.S. cities. Whoever called the bottom of this market must be having a hard time facing their clients in the morning.

Goldman Sachs said last year that the bottom will likely occur in the second half of this year.

Here's my big picture analysis on the situation. And keep in mind, it's not whether you're buying a house or not that matters here. The housing market is closely tied to the U.S. economy. A weak housing market means a generally weak economy. When that housing market turns the corner, it signals an upside to U.S. growth. So if you're a home buyer, now is a great time to buy if you have the stable income and can afford the 20% down payment required by the underwriters today. If you're an investor in broader indices tied to the market, like the Dow Jones US Real Estate (NYSEARCA:IYR) ETF or even a commercial REIT like Vanguard's Real Estate Investment Trust (NYSEARCA:VNQ), then now is a time to buy providing you can hold out for another year and watch the value of those securities dwindle on poor data announcements.

This is still a market that needs some love. And it's not getting it from the overall economy. U.S. real estate is still laid up in intensive care. At least now, it's not on life support. I, for one, am not ready to give that market an early dismissal on good health and here's why.

Last month a joint state/federal settlement passed in 49 states, clearing the way for a $26 billion mortgage settlement designed to help hundreds of thousands of troubled homeowners. The five lenders who are parties to the deal - Bank of America (NYSE:BAC), Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC) and Ally Financial - account for about 60% of the mortgage market. Many struggling home buyers are eagerly expecting to either refinance or reduce the amount of their mortgage through those firms. According to HUD, up to one million mortgage holders could see the amount of money they owe reduced.

This settlement will bring a wave of new foreclosures. Why? Primarily because of uncertainty surrounding the outcome of these negotiations, too many lenders held off on repossessing homes until a settlement was reached. Consequently, we now have a massive year-long backlog of toxic loans, many of which won't be helped by measures in the deal. In other words, because the banks waited and allowed a 34% foreclosure reduction in 2011, expect a tsunami of foreclosures in 2012. RealtyTrac, online marketer of foreclosed properties, estimates that new filings will climb from 1.9 million in 2011 to between 2.2 million and 2.5 million, or higher this year.

Only those borrowers who can afford to make payments will be helped by the settlement. For those many homeowners who have stopped paying due to prolonged unemployment or other severe economic distress, they cannot afford a mortgage payment no matter how it is restructured. For them, foreclosure is a certainty. These families will require some form of additional governmental assistance, pushing the deficit higher and placing an additional drag on the entire economy, in my view.

Until these toxic assets can be removed from the bank balance sheets, both a bottoming and a recovery in the housing sector will remain an illusion. I think Goldman can forget the bottom occurring in 2012. Maybe 2013. So if you're looking for a distressed asset to buy on the cheap, real estate equities - chosen wisely - are a good bet. But this is still not a growth market in the U.S. this year.

This cleansing of these lending institutions will be painful for all parties initially. It will certainly be painful for millions of homeowners about to go through foreclosure. It will also be painful for banking institutions that think they will receive top dollar for these assets.

I can't tell you with certainty that these banker's expectations will not be met. But what I can tell you is that in many states, like Florida and Nevada, all of this deleveraging will drive residential real estate prices lower. The sheer magnitude of 3 million homeowners either seriously delinquent on mortgages or in foreclosure, virtually insures a prolonged period of stagnation in the housing sector.

The takeaway here is that housing cannot yet be released from the hospital. There can be no recovery in the sector until the massive level of distressed loans is reduced on banks' books. To accomplish this goal we must go through the painful process of a combination of foreclosure and loan adjustments. At the same time, people must be put back to work on good paying jobs to assure that Americans can save enough to put a down payment on a home. And earn enough to keep it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.