Have Home Prices Stabilized?

Housing is actually doing better than I thought it would. We have now seen pretty good increases in new home sales, existing home sales, and even the Case Shiller index posted a month-over-month increase.

There is great debate over exactly how good these numbers are. I’m getting a little sick of the term “less bad is good” but it does neatly summarize where we are. In many ways, it depends on what exactly you are trying to analyze. Or put another way, what question are you trying to answer?

When will the recession end?

This is basically a question of GDP growth. The 4Q/1Q inventory liquidation will eventually turn into a rebuilding of inventories, which in turn will eventually result in positive GDP. In simple terms, inventories got so low that any sales activity required greater production activity. It isn’t that final sales activity is “normal” or “good” but that the economy was set up for lower final demand than we’re getting. Keep this theme in mind as we go.

In terms of housing, the direct impact was classically from home construction. Any kind of positive contribution from construction was long ago lost, so I see this as a minor element.

What about consumer spending?

The whole mortgage equity withdrawal game is also dead, and has been for a while. This was once a source of consumer spending, and its a source that isn’t likely to come back any time soon.

However, the negative equity story remains. Right now, based on Case Shiller, nationwide home prices are approximately where they were in 2003. Most people who bought their homes in mid-2004 or so, and put 10% down are now underwater. Foreclosures and “jingle mail” catch the media’s attention, but the reality is that most of these people who are underwater will just keep paying their bills month after month. Most of those same people can afford the payments, but won’t be able to afford to actually move out of the place until they have saved a lot more money. Home price appreciation from here won’t be enough. So basically we have people saving more and staying in their homes longer.

Therefore I see an elevated savings rate for many years to come. This will be consistent downward pressure on consumer spending, although it wouldn’t prevent consumer spending from increasing from one period to the next. Just that each period will be lower than it otherwise would have been.

Have home prices stabilized?

All the current trends say yes. Think back on why home prices started to fall in the first place. There was too much supply and not enough demand. In any good, when there is a supply/demand imbalance we’d expect to see a period of low generalized activity as both suppliers and consumers engage in price discovery. This is exactly what happened in housing, as activity plunged along with prices.

Now we’re seeing activity pick up. Both new and existing home sales have increased in 4 of the last 5 months, despite interest rates rising during that period. New home sales have risen a total of 17% since January, while existing home sales are us 9%.

Yes, the absolute level of sales is still anemic. I know. But these are numbers which have historically shown long dragged out trends. I believe that once a positive trend is established, these numbers will keep improving.

Besides, its worth noting that the “normal” level of housing transactions needs rethinking. If people are going to stay in their homes longer, then the velocity of housing transactions should be persistently lower.

Regardless, the uptick in activity suggests that buyers and sellers are coming together on prices. I think the fact that Case Shiller has basically been flat the last two months backs that up. This isn’t to say homes might not keep falling in some parts of the country, but the nationwide, generalized decline phase is over.

If housing is to take another turn lower, there will need to be some catalyst. I’d think the most likely would be that the Fed is forced to aggressively hike rates. I think that’s a low probability event, but possible nonetheless.

All this being said, I don’t have any particular reason to believe home prices will rise rapidly from here. It would seem that we’d need an improvement in employment before housing can advance significantly, at least on a national level.

What about the banking system?

That’s an uglier picture. Home prices can start rising from here, GDP can rise from here, but banks are saddled with all kinds of legacy problems. Home mortgages, developer loans, commercial loans, etc. Some of it directly related to housing, some not. I’ve already talked about the residential problem: that negative equity is going to take a long time to work off. Not only does that result in larger losses on each mortgage that must be foreclosed, but it means less turnover among their existing mortgage portfolio. Less fees, less cash flow, its a negative all around.

Commercial real estate is a whole other game. I think a lot of commercial real estate securities might be fairly priced, but commercial real estate loan losses are just beginning.

Now I’m not saying the banks are all going down, but I think there are some larger regionals that are in trouble. And as I said with CIT, a lot of them won’t be deemed To Big to Fail. Is KeyCorp too big? Fifth Third? Marshall and Ilsley? I don’t think so. In fact, I’m not 100% sure that Wells Fargo doesn’t need more capital before this is all said and done.

All this comes in context with how well the securities markets are doing. I personally don’t have much at all invested in stocks. I don’t understand why they’ve run as much as they have, but I’m also not here to say it ought to crash from here either. I just don’t understand it.

I guess my problem is with how the debate is being framed. Things are getting better in the economy. I don’t think that’s debatable. The debate should be more about the degree and the speed at which things can keep improving. At least, if you are trying to figure out how to make money trading, that’s the best question.

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About Accrued Interest 118 Articles

Accrued Interest provides unique, expert insight to developments in the U.S. bond market. It is written by an anonymous professional working in the field.

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