October Surprise: No Bottom in Housing

Barron’s Alan Abelson cites research by Merrill Lynch’s David Rosenberg regarding the recent "stabilization" in Housing. It turns out that the only thing which is stabilizing is inventory — but at extremely high levels.

To get inventory numbers down to a balance between supply and demand requires a 10% drop in home prices (and hence, more sales), and a 20-25% drop in new Home Starts.   

Here are the details:

"In truth, the big October Surprise that the conspiratorial crew anticipated so anxiously is that there was no October Surprise. Unless you count the really punk showing of the economy in the third quarter disclosed last week, with GDP limping to a 1.6% annual gain, the worst performance since the first quarter of 2003, when the recovery from recession was still trying to find its legs. Even with its demonstrated ineptitude, though, it’s hard to see the administration conspiring to engineer 1.6% growth.

Merrill Lynch’s David Rosenberg nailed the GDP figure when the consensus among the soothsayers on the Street ran to 2.3% and some of the more exuberant types were forecasting 3%.

The incredibly shrinking housing market is unmistakably beginning to exert a vicious drag on the economy as a whole. And that’s despite the uptick in the housing stocks, buoyed by talk that the sharp decline in home sales is beginning to bottom out. The talk, it should be noted, comes from analysts desperate to see some signs of life in their group and realtors who are starting to worry about meeting their next mortgage payments. (They couldn’t help themselves: They weren’t able to resist the lure of adjustable-rate mortgages.)

We imagine neither bunch drew much comfort from the news that prices of existing homes in September suffered their biggest fall in 35 years. October, we’re afraid, has been more of the sae.

For his part, David Rosenberg isn’t buying the notion of a bottom in housing. He points out that existing house sales last month sank to their lowest level since January ’04 and over the past six months have plunged at a 20% annual rate. Only seven times in the past four decades have prices absorbed that sort of pounding and, significantly, in five of those instance, the economy really took it on the chin.

At best, David says without enormous conviction, the inventory of unsold homes and condos up for resale may be stabilizing — but at awesomely high levels. At last tally, backlogs of houses for sale weighed in at 7.1 months for single- family homes and 8.6 months for condos, a striking 60% higher than the level a year ago. And he points out that if "the inventory situation was truly a good- news story, then home prices wouldn’t still be falling." Sounds eminently logical to us…

To judge by past housing cycles, to get to a reasonable balance between supply and demand, he believes, will require at least a 10% drop in home sales and prices and 20%-25% fewer housing starts. Declines of that magnitude, he reckons, would nick the consumer’s balance sheet by something between $2.2 trillion and $4.5 trillion. That’s "t" as in trillion.

Pretty gruesome prospect. And no small reason why we see a recession looming next year."  (emphasis added)

One last tidbit — Rosenberg also makes the obvservation that the vast majority of the 10 million households
that bought an existing home since June 2005 are now underwater on their purchases.

What are the repurcussions of this? If you can afford to stay put, then none. Make your payments, and you will eventually be fine.

In the event of a sale, they take a small hit, perhaps losing some (or all) of what they put down to make the purchase. If they did a no money down, they may not be able to sell the house themselves, as they won’t be able to transfer title with a post-sale balance on the existing mortgage. That only happens if a house sells for less than the mortgage price.

The real problem is with those 37% or so of buyers who used variable APRs and/or the Interest Only (I/O) mortgages. As the market value of the asset comes down, they may not have sufficient equity in the property to do a refinance or a conversion from I/O or APR to a traditional 30 year fixed.

Both of the above examples are why we are seeing an ongoing increase in foreclosures.

Pretty gruesome, indeed.


October Surprise
Alan Abelson
Barron’s October 30, 2006   

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