A consensus seems to have formed in the press lately that the housing market has finally turned around and we are at last back in bull territory. I tend to believe that such analysis is in bull territory, the sort of bull territory you wouldn’t want to get your foot stuck in as you scramble across the pasture. We may have already witnessed the most precarious price plunges in housing, but expect to see continued decline regionally, especially at the mid-to-high end of the market.
Be very careful when listening to reports about the economy in the mainstream media. Even trusted institutions such as National Public Radio are prone to unfounded cheerleading for the recovery these days. I was dismayed to hear senior economist Mark Vittner of Wells Fargo spewing blatantly false information on the health of housing on Marketplace Morning Report recently.
“The actual low in home prices is behind us, and it is behind us in virtually every part of the United States,” Vittner boldly asserted.
Sadly, Mr. Vitner’s statement indicates a complete lack of understanding regarding the fundamentals moving the housing market as well as the economy at large. The Marketplace report focussed on foreclosures, reporting in the most unspecific way that while foreclosure “activity” rose in June it was down on a year-to-year basis. The reporter then went on to conclude “… as the inventory of foreclosed properties goes down, housing prices should continue to go up.”
Uh… WRONG… on two fronts. First, the number of foreclosure starts is not decreasing, so inventory is still accumulating. Secondly, the shadow inventory of properties already in foreclosure that has yet to hit the market is massive and will continue to depress prices.
While actual bank repossessions of property (REOs) have decreased recently, there has been a steady increase in the number of properties entering the foreclosure pipeline. Filings of initial notices of default have increased on an annual basis for three months in a row! The number of homes falling into repossession has slowed only because banks put the repo process on hold while awaiting a major federal ruling against mortgage providers. At the same time, banks increased their use of short sales to clear inventory. A short sale allows the distressed owner to sell at a steep discount in order to avoid bank repossession of property, but it results in the same downward pressure on market prices that a repo would.
“Lenders are much less likely now than they were even a year ago or two years ago to repossess a property after they’ve started the foreclosure process,” says Daren Blomquist, a vice president at RealtyTrac. “Completing the foreclosure process can potentially open banks up to liability if they’re accused of improper procedures.”
It is estimated that as much as 90% of foreclosed property is still in the shadows. I recently did a spot inventory check on Woodland Hills, a mid-to-higher priced suburban area near to where I live in Los Angeles. I found over four times the number of properties in the foreclosure pipeline as are actually listed for sale there. Woodland Hills is a desirable middle class area with good public schools and a median income considerably higher than that of the greater Los Angeles area. It is a good example of a mid-to-high tier market that has yet to fully realize losses in property values.
While California posted the nation’s highest foreclosure rate last month, the process here is relatively streamlined and quick. Many other states, like New York, require foreclosures to be approved through the court system. This means the foreclosure process is vastly slower in New York than in areas without such restrictions, like California. As a result, in New York there are enough foreclosures still waiting to be processed to keep the courts busy for the next 57 years! The problem is so horrendous, an unprecedented initiative was established earlier this year to allow the state to create new foreclosure courts dedicated solely to handling the mess. New York, New Jersey, Florida and the many other states where foreclosures are processed through the courts are facing massive losses in property value ahead.
Foreclosures are just one force affecting housing prices. There are many other variables indicating that housing will remain in the doldrums for some time to come. Even if we do see a bottom in prices, we will certainly not see a sustainable rise in values any time soon. Some of the other factors pushing prices down are continued high unemployment, massive numbers of underwater mortgages, shifting social demographics, psychological pressures and weakness in the national and global economies.
Unemployment will continue to keep people out of the housing market. People don’t buy homes when they don’t have jobs. Not only are unemployment numbers high, but those who do find work are getting lower paying jobs than they had in the past. Many of those folks who managed to avoid unemployment during the recession have seen their wages and benefits cut. People are making less money and therefore have less to spend. There is also a strong psychological effect of high unemployment. People are just less willing to commit to large purchases as they worry about the security of their future income streams.
There are large numbers of homeowners underwater on their mortgages in today’s market, and as prices continue to fall more slip into the danger zone. A mortgage is underwater when the holder owes more on the loan than the property will currently sell for. Evidence shows that people are much more likely to cease payment and walk away from their homes under such conditions. In fact, we have record numbers of folks doing just that. These properties will continue to add to foreclosure inventory, and in turn that will push prices down further in a vicious deflationary cycle. Government stimulus and the promise of loan modification have stalled the speed of this deflationary cycle, but these are temporary patches and will not stop the bleeding.
Demographics play a role in determining the direction of housing prices, as well. As the huge baby boomer generation heads into retirement, many will hope to sell their homes. They’ll want to downsize as their children leave home, or supplement their generally poorly funded retirement savings. But who can afford to buy these houses at current prices? Certainly not the upcoming generation of younger Americans. The younger people that would normally have taken that role are not only a much smaller group in number, but they are experiencing depression level unemployment and debilitating college debt that leave them unable to afford homes at current prices. They have also grown up seeing the losses their parents experienced in real estate and are not particularly eager to buy property. The health of real estate depends on first time buyers, and today there are few.
Psychology is often ignored by economists, but behavioral economist Robert Shiller at Yale University who co-created the famous Case-Shiller housing index believes it is one of the most influential factors determining the direction of the housing market. I would agree. Long term momentum keeps prices heading in the same direction despite shifts in fundamentals. When people saw the kind of money others were making in real estate during the bubble years it kept them buying and driving up prices even when fundamentals were totally out of whack. This phenomenon is called a “feedback loop.” Feedback loops become stores of psychological energy that drive the market further along in the direction it is already going. They work on the way down as well as the way up. For this reason, we can see that historically markets tend to overshoot to the downside after a bubble collapses. We have not yet seen any kind of overshoot to the downside in housing prices. This would imply there may be discounts ahead.
On a global level we are seeing all kinds of fraudulent banking behavior. There is a huge potential for something to go awry in the derivatives market. The LIBOR rigging scandal shows there is no way to meaningfully assess the market value of just about anything. Europe is pretending to have a solution to its problems when there is none. Manufacturing is down worldwide. Public pensions everywhere are headed for collapse. The threat of major warfare continues to loom. We are in the midst of a global economic crisis. Uncertainty is extreme. In the short run US bonds look comparatively good, but none of this bodes well for the US economy in the long run. What is bad for the US economy is bad for the US housing market.
I am putting my money on the likelihood we are in for further declines in housing prices in many areas of the United States. Don’t step in the housing bull crap.
Indianapolis Business Journal
National, State Foreclosure Starts On The Rise
August 9, 2012
Wall Street Journal
Is This The End Of The Housing Bust? Not So Fast, Says Shiller
August 6, 2012
AOL Real Estate
Shadow REO: As Many As 90% Of Foreclosed Properties Held Off Market
July 13, 2012
Marketplace Morning Report
With New Forclosure Data, A Look At The Housing Market
July 12, 2012
New York Creates New Foreclosure Courts To Clear Backlog
February 18, 2012
Mish’s Global Economic Trend Analysis
Foreclosure Pipline In NY Is 693 Months…
August 30, 2011