The Housing Chronicles Blog: Is the housing crisis nearly over?

Wednesday, May 7, 2008

Is the housing crisis nearly over?

Despite the regularity of bad news about the housing market, two writers in the Wall Street Journal argue that we may in fact be hitting a bottom for the housing slump. First, from Brett Arends:

Is it time, at long last, to head down to Florida to start looking at homes?


And the nearby chart shows one reason why.

It comes from Wellesley College Prof. Karl E. Case, one of the leading experts on the housing market in the country. And it suggests we may be at, or near, the bottom of the housing crash.

Of course, even if he's wrong we won't know for sure for many months.

But new housing starts have at last slumped below the seemingly magical one million mark. That happened in March. Every time that has happened in the last 50 years, it proved to be the bottom of a recession...

There is no guarantee this market will be the same but the similarities with the past are striking. Each boom peaked at around the same level of 2.5 million starts as well...

Incidentally, contrarians will also love Tuesday's gloomy first quarter news from leading homebuilding D.R. Horton and from federally sponsored home loan giant Fannie Mae. Both announced massive losses following write-downs. Fannie is holding a $4 billion cash call and both slashed their dividends. You often see these kinds of capitulations at a market bottom, though of course you can see them on the way down as well...

Prices may still fall further. Yet if you are tempted to keep waiting for homes to get a lot cheaper, there are several reasons to think that might not happen.

First, there are too many other bargain hunters out there.

Second, the falling dollar has made these homes even cheaper to foreign buyers. There are plenty of people in Europe for whom Florida is now a bargain.

Third, interest rates are low right now. I hesitate to give my fellow Americans any extra incentive to borrow yet more money, but you can get a 30-year fixed-rate mortgage under 6%. If the economy recovers that won't last. If you are shopping for a home, it is probably worth seeing if you can lock in one of these rates cheaply.

Finally, in an age of weak currencies and rising inflation, "real" or "hard" assets are in demand. That should include land, bricks and mortar.

Next, from an opinion piece by hedge fund manager Cyril Moulle-Berteaux:

The dire headlines coming fast and furious in the financial and popular press suggest that the housing crisis is intensifying. Yet it is very likely that April 2008 will mark the bottom of the U.S. housing market. Yes, the housing market is bottoming right now.

How can this be? For starters, a bottom does not mean that prices are about to return to the heady days of 2005. That probably won't happen for another 15 years. It just means that the trend is no longer getting worse, which is the critical factor.

Most people forget that the current housing bust is nearly three years old. Home sales peaked in July 2005. New home sales are down a staggering 63% from peak levels of 1.4 million. Housing starts have fallen more than 50% and, adjusted for population growth, are back to the trough levels of 1982.

Furthermore, residential construction is close to 15-year lows at 3.8% of GDP; by the fourth quarter of this year, it will probably hit the lowest level ever. So what's going to stop the housing decline? Very simply, the same thing that caused the bust: affordability...

The next question is: Even if home sales pick up, how can home prices stop falling with so many houses vacant and unsold? The flip but true answer: because they always do.

In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.

The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in "months of supply" terms. That's the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.

Inventories are declining because construction activity has been falling for such a long time that home completions are now just about undershooting new home sales. In a few months, completions of new homes for sale could be undershooting new home sales by 50,000-100,000 annually.

Inventories will drop even faster to 400,000 – or seven months of supply – by the end of 2008. This shift in inventories will have a significant impact on prices, although house prices won't stop falling entirely until inventories reach five months of supply sometime in 2009. A five-month supply has historically signaled tightness in the housing market.

But what about the 30% decline in prices that many economists say is still forthcoming? Nonsense, says Moulle-Berteaux:

Many pundits claim that house prices need to fall another 30% to bring them back in line with where they've been historically. This is usually based on an analysis of house prices adjusted for inflation: Real house prices are 30% above their 40-year, inflation-adjusted average, so they must fall 30%. This simplistic analysis is appealing on the surface, but is flawed for a variety of reasons.

Most importantly, it neglects the fact that a great majority of Americans buy their houses with mortgages. And if one buys a house with a mortgage, the most important factor in deciding what to pay for the house is how much of one's income is required to be able to make the mortgage payments on the house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%. Comparing today's house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is misguided and misleading...

We are of course experiencing a serious housing bust, with serious economic consequences that are still unfolding. The odds are that the reverberations will lead to subtrend growth for a couple of years. Nonetheless, housing led us into this credit crisis and this recession. It is likely to lead us out. And that process is underway, right now.

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