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.
>
Source:
October Surprise
Alan Abelson
UP AND DOWN WALL STREET
Barron's October 30, 2006
http://online.barrons.com/article/SB116198805085606512.html
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> the vast majority of the 10 million households that bought
> an existing home since June 2005 are now underwater on
> their purchases.
And what about the folks who were many years into a 15/30-year fixed mortgage, who did a cash-out re-finance at a 2004/2005 valuation 'appraisal'? Hmmm...
Posted by: Chuck | Oct 28, 2006 9:13:13 AM
I had a borrower with an option ARM contact me this week about refinancing. He bought his house for $360k in
Aug 2005. His loan amount is 292k on the first trust and 36k on the 2nd for a total of 328k.
Turns out houses in his neighborhood just like his are fetching a top price now of just 320k. You can see where I'm going with this. He is S.O.L. Stuck with his fully indexed rate of 8%.
I never liked those MTA's.......
Posted by: Lyon | Oct 28, 2006 10:02:06 AM
Ownership society indeed.
Posted by: Aaron | Oct 28, 2006 10:10:00 AM
The only nit that I'd pick with this analysis is that the ARMs and I/O's won't be headed very far north if we're headed into a recession. There is still danger of recession related foreclosure, and of course the re-indexing already underway from the teaser rates. But ongoing spikes in ARM interest rates won't be a factor - unless I'm missing something.
Posted by: tom | Oct 28, 2006 11:31:00 AM
Rosenberg says a 10% drop in prices AND a 25% drop in starts. Hahahaha. Are you kidding me? Does he mean a 25% drop in starts from CURRENT levels?
That would be disasterous. Calculated Risk has determined that 600,000 construction jobs will be lost in the next two years, at the CURRENT rate of starts. A 25% drop could put that number over 1 million. I don't know for sure, because CR's employment table doesn't go back far enough.
I'm only speaking of consruction workers. Factor in everybody else who relies on housing for a living, and that looks like a ton of layoffs.
Posted by: winjr | Oct 28, 2006 11:37:00 AM
Housing price gains are just deccelerating at a more accelerated rate. Housing is always a great investment. Americans are financially unsphisticated if they cannot use many of todays innovative debt products. This industry is the most financially sophisticated it has ever been. Low Credit ? No Credit? come on down .we want to put you in a new house.
Posted by: Dave Diarreah | Oct 28, 2006 11:39:48 AM
If you want to rely on Dave Rosenberg's forecasting prowess, go ahead. After all, a stopped watch is right twice a day, blind squirrels find nuts, etc... For the first half of the year, Rosenberg was forecasting deep rate cuts by year end (2006.) Time seems to be running out on him.
One of the dirty little secrets of the GDP report was that nonres construction actually ADDED 0.4% to annualized GDP....so maybe those construction workers shouldn't file for unemployment quite yet. Among the other forecasters to anticipate a relatively weak Q3 was Dick Berner at Morgan Stanley...who's forecasting an acceleration in Q4 and rate hikes early next year. Why not cite the guy who hasn't batted 0.000 for most of the last two years?
Posted by: Macro Man | Oct 28, 2006 11:53:52 AM
Starts are down, yes. That doesn't mean starts can't fall another 25%. While months inventories are merely on the high side, but not historic, for-sale-only vacancies are at levels never before seen as percentage of owner-occupied housing. I do caution that this series seems in a lon-term uptrend, but last quarter's increase in such vacancies was also the largest on record, up over 10% on the previous quarter and 30% on the previous year.
The last time for-sale vacancies moved like that was 79Q2-80Q3, which did not precede a good time for housing prices (especially in real terms) and coincided with falls off the cliff for starts. Year-over-year, starts were already dropping in 1979, falling to around -50% by May 1980. This time around, starts were dropping by the spring, with August so far the worst month at near -25%.
While I do not predict 50% year-over-year declines (though I have gone short homebuilders again recently), there is precedent.
Posted by: wcw | Oct 28, 2006 11:57:51 AM
There's been a self-propelling credit balloon the past few years. Exhaustion has been reached, evidenced by falling starts and soon sales (I believe new home sales upticked last month, probably due to loads of incentives.) Folks underwater and needing to get out are turning to the quickest market: auctions. These, such as the one in Naples recently shaved 35% or more off the "Zestimates" for the area (that effects comps.) The rapidly vanishing home equity is going to make a lot more people feel house poor. Consumer spending will slow down as a result, and being 70% of the economy could have deep and lasting implications for several years ahead. Will the Fed cut rates to stimulate the economy? They'll probably try. But keep in mind there's a large amount of dollars and U.S. treasuries in foreign hands these days and why should they stand by and let the Fed depreciate the value of their holdings? It's going to get complicated...
Posted by: Chief Tomahawk | Oct 28, 2006 12:04:28 PM
"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."
It is going to take MUCH more than a 10% drop in prices to get inventory down, regardless of home starts. Why? Prices are way too high relative to household incomes. Where I live [VA Beach], it is something like 5x. I know that places like SoCal, SF, FL, etc. are much more expensive on a relative basis, but that is my point - houses are too expensive EVERYWHERE.
I'd have to wonder why those perma-bull economists like Kudlow don't think about these things, but then I remember that they almost certainly bought before the run-up began and have absolutely no clue about what is currently going on in the world. So typical.
Posted by: bk | Oct 28, 2006 12:07:39 PM
Macro Man wrote:
"One of the dirty little secrets of the GDP report was that nonres construction actually ADDED 0.4% to annualized GDP....so maybe those construction workers shouldn't file for unemployment quite yet."
Yeah, an even dirtier little secret is that nonresidential construction's contribution to 3Q GDP was substantially less than it was for 2Q (20.3% growth then, vs. 14% growth now). In other words, nonresidential construction is headed in the wrong direction, and nobody is talking now of it "bailing out" residential construction.
Posted by: winjr | Oct 28, 2006 12:21:15 PM
On housing gains...I did calculated the average price of a home to be 6.8% based on the data that in BR's previous post. The average constant quality annual increase is 5.3%.
Posted by: Leisa | Oct 28, 2006 12:54:24 PM
From the October 12 Beige Book: "Commercial real estate markets were strong in most Districts, and activity increased at a faster pace in a number...Nonresidential construction was generally strong" Doesn't exactly sound like things are moving in "the wrong direction" terribly quickly. There generally remains pent up demand for nonres construction for the simple reason that it didn't actually stop declining post-recession until relatively recently.
Posted by: Macro Man | Oct 28, 2006 1:12:23 PM
If you want a real housing-price series, you could do worse than deflating the OFHEO's HPI by CPI ex-shelter. The geometric average real return from 75Q1 to 06Q2 is 2%.
This compares to a stat I have seen quoted that long-term real residential housing price returns historically in the US have been around 1%. Real HPI price returns were 1% from 75Q1 to 00Q4, from which point they jumped to 6% currently (down from 7% if you sold in 05Q4).
Just to play devil's advocate, the best soft-landing analysis I have seen lately is this Tim Duy Fedwatch column. On housing, this James Hamilton note effectively challenges the utility of the latest median-price change -- which is another reason I am waiting for the HPI instead. That's out December 1.
Posted by: wcw | Oct 28, 2006 1:12:50 PM
"From the October 12 Beige Book: "Commercial real estate markets were strong in most Districts, and activity increased at a faster pace in a number...Nonresidential construction was generally strong" Doesn't exactly sound like things are moving in "the wrong direction" terribly quickly. "
What is your thesis? That nonresidential construction will keep GDP from going negative?
Here's the historical relationship between private nonresidential and private residential investment (Courtesy Calculated Risk):
http://photos1.blogger.com/hello/243/2888/640/constspendingJuly06YOY.jpg
As you can see, nonresidential generally follows residential. Makes sense, does it not? Fewer homes, fewer malls.
Most nonresidential construction you see today is the result of plans put into motion years ago. As slow as the residential market is to react to a turning tide, the nonresidential market is even slower.
Going forward, nonresidential construction will be a drag on GDP, not a boost.
Posted by: winjr | Oct 28, 2006 1:43:51 PM
The thesis is simply that a decline in housing and values in isolation is not a sufficient condition for the economy to go into recession, or even tickle the edges of recession. The demise of a residential property boom has failed to produce a recession in the UK, Australia, New Zealand, and Ireland in this decade alone.
Corporate and household incomes are strong, disposable income in particular getting a boost from the decline in energy prices. Household wealth continues to grow courtesy of the equity market and interest income, mitigating the hit to consumers from the elimination of mortgage equity withdrawal.
In the postwar era there has never been a recession without a noticable decline in corporate profits as a percentage of GDP beforehand; right now, we are at the peak! (and why does it seem to be a bad thing that much of the incremental profit growth is from energy and resource companies? Doesn't it make sense that these guys would be coining it when much of the rest of the economy is hurt by rising energy prices?)
As for nonres construction, I am not sure what your chart demonstrates, other than a negative y/y correlation between residential and nonresidential consrtuction over the last cycle and a half. Sure, nonres construction will be a drag on GDP...at some point. But it ain't this quarter, and it may well not be until H2 of next year. Meanwhile, it seems rather unlikely that government spending will remain a drag on growth for much longer.
In short, my thesis is that the null hypothesis -don't bet against the US consumer- still holds, particularly when the corporate sector remains in such rude health.
Posted by: Macro Man | Oct 28, 2006 2:07:23 PM
Does anyone know of a website that actually keeps track of most analysts and their predictions, I mean forecasts. I mean a real scorecard.
Posted by: Caver | Oct 28, 2006 2:39:20 PM
"The demise of a residential property boom has failed to produce a recession in the UK, Australia, New Zealand, and Ireland in this decade alone."
What demise? Why does this nonsense get repeated by US bulls?
UK house price index:
http://www.communities.gov.uk/index.asp?id=1002882&PressNoticeID=2261
http://www.ft.com/cms/s/1d089640-fb60-11d8-8ad5-00000e2511c8.html
New Zealand house price index:
http://www.rbnz.govt.nz/keygraphs/Fig4.html
Ireland house price index:
http://www.finfacts.com/biz10/irelandhouseprices.htm
Overall discussion of house price indexes (using data from the Economist):
http://usmarket.seekingalpha.com/article/16746
None of these four countries saw a single y-o-y decline in housing prices (although house price growth did slow in a couple of cases). The US situation is markedly different, showing actual, national y-o-y house price declines in consecutive months.
"disposable income in particular getting a boost from the decline in energy prices."
This was already covered in a previous 'Big Picture' post. In no way does the "boost from the decline in energy prices" effectively offset the negative wealth effect of declining house prices.
"Household wealth continues to grow courtesy of the equity market and interest income, mitigating the hit to consumers from the elimination of mortgage equity withdrawal."
This has already been covered by countless others. 70% of the US population owns homes. Less than 50% of owns stocks. In addition, the wealth effect from rising home prices is twice that of rising stock prices. As for the elimination of MEW, no one here can forecast the full effects of that in 2007. Like Bernanke, we have to wait for the data.
Posted by: just_observing | Oct 28, 2006 3:17:18 PM
Poor underwater bastards. At least the CDS markets offer a place to profit from their pain.
http://guambatstew.blogspot.com/2006/10/how-to-gain-from-their-pain.html
Posted by: Guambat Stew | Oct 28, 2006 4:05:32 PM
New home inventory may be much larger than is being reported, and growing rather than shrinking:
“Cancellations were also left out of the new-home statistics. The Commerce Department records a new home as sold when the buyer and builder sign a contract. The home builders association said that cancellations had jumped by 50 percent in the last year.”
“‘The cancellation rate is really big,’ said Dave Seiders, chief economist of the association [NAHB]. ‘It’s exploded over the last year.’”
Posted by: anon | Oct 28, 2006 4:37:40 PM
The broadest and most accurate house price index in the US is the OFHEO index referenced by wcw above. The last data point (Q2) showed y/y growth of more than 10% in house prices. Now, it would be folly to suggest that that measure will not decelerate in H2 and next year- of course it will. But sequential house price growth in the UK has been negative very recently, it was negative in Ireland in 2001, and decelerated very sharply in the Antipodes. You are right to point out that the US is not like, say, the UK though. The UK has seen unemployment rise and wage growth fall off.
Disposable income growth is roughly 5 and a half times more important in explaining nominal consumption than net wealth. So while it makes a nice story to say that house prices are going to zero and thus so is consumption, the fact is that a positive income shock has a very real and immediate impact on consumer behaviour, viz the sharp rebound in consumer sentiment indices over the last month.
Hey, forecasting the death of the consumer is fun and has been for twenty years. But being profitable isn't about having fun; it's about being right (or at least knowing when the payoff from being right is substantially higher than the loss from being wrong.) One of the reasons why equities are doing so well is that people are too busy forecasting a housing market Armageddon to notice that the rest of the economy isn't actually doing too badly.
Posted by: Macro Man | Oct 28, 2006 5:42:03 PM
How many US consumers will continue to spend at their 'normal' levels when they are taking on bigger debt, already have done MEW's, real estate prices continue to fall, their salaries are stagnant or job may be outsourced or eliminated and they'll have to find another job at 2/3 of what they were making and so on...
What percentage of middle class consumers will continue their 'normal' spending levels vs percentage of more grounded ones that will realize they need to cut back ?
Posted by: km4 | Oct 28, 2006 5:51:12 PM
Macro Man: "If you want to rely on Dave Rosenberg's forecasting prowess, go ahead. After all, a stopped watch is right twice a day, blind squirrels find nuts, etc... For the first half of the year, Rosenberg was forecasting deep rate cuts by year end (2006.) Time seems to be running out on him."
Was Rosenberg flat out wrong or did he just underestimate the time it would take for this to unfold?
If housing were to drag the economy into recession and force the Fed to slash rates next March, would you call Rosenberg a blind squirrel?
For short-term stock trading the difference between "by the end of 2006" and "spring 2007" could be the difference between wrong and right. For longer term investment, calling a housing-led recession a year before mainstream wisdom catches on and before it gets factored into stock prices would be a highly profitable insight.
Posted by: Kevin_r | Oct 28, 2006 5:54:18 PM
"But sequential house price growth in the UK has been negative very recently"
That is simply wrong. Again, look at the first graph on this site (current to 2006):
http://www.communities.gov.uk/index.asp?id=1002882&PressNoticeID=2261
The national UK housing market has not seen negative house price growth.
"it was negative in Ireland in 2001"
Again, total nonsense.
Look up the pdf file "ESRI House Price Index 1996-2006 Review.pdf":
http://www.permanenttsb.ie/news/default.asp?nid=537
Go to page 4 of the file. No negative growth in 2001 (or any other year sine 1996).
"and decelerated very sharply in the Antipodes"
Dude, wrong again. Are you reading these charts correctly?
New Zealand:
http://www.rbnz.govt.nz/keygraphs/Fig4.html
House price growth is still at 10% y-o-y. Down from 25%, but still.
Australia (Average of the 8 Capital Cities):
http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/6416.0Main+Features1Jun%202006?OpenDocument
Wrong on all counts. I'm impressed.
Posted by: just_observing | Oct 28, 2006 6:30:53 PM
I am afraid I have to defend MM. While his post was more adversarial than responsive, I he gets at least a two-fer, and perhaps went 3-for-3. "Sequential" UK house price growth was negative in Feb06 , Dec05 and Oct05, which seems recent, and Antipodean price growth dropping from 25% to 10% is prima facie deceleration. For Ireland 2001, the charts you provide didn't provide a sequential index, just annual inflation, and since I am not intimate with those data I can't judge.
In re the consumer, I believe that all it takes for further GDP disappointments are for home prices to stay flat, rates to stay flat, and mortgage equity withdrawals to cease for a while. Goldman says 2/3rds of MEW goes straight to consumption, Greenspan 50%. Mortgage equity withdrawals have been running at roughly a trillion per year. Cut a half-trillion a year off the top of consumption and you don't need to predict the death of anything to worry about the economy.
Posted by: wcw | Oct 28, 2006 7:08:33 PM
