By now, uncertainty, hope and anxiety for housing should be at a peak. Government support is waning: The homebuyer tax credits expire at the end of this month (to sign binding contracts, the sales must be closed by June), and the Fed should have bought the last of its $1.25 trillion mortgage-backed securities last month.
And by now the normal seasonal upturn in housing activity should have begun. Most analysts took last summer’s modest lift in home prices as a signal that the free fall in housing markets was over, but prices and sales slumped again in an especially hard winter.
Now it’s a burning question if the recovery can revive. Or does housing head for a double dip? Can seasonal forces bring last year’s gains back? Will demand be strong enough without government aid to absorb the relentless slide of foreclosed properties onto the market?
[T]his is not a normal economic downturn. Homebuilders overbuilt during the housing bubble. Although new-home sales peaked with existing-home sales in 2005, housing starts continued to rise into 2006 and the number of new homes for sale reached an unprecedented peak of 570,000 units in mid-2006. (By contrast, peak inventory in the housing booms of the mid-’80s and mid-’90s ran around 370,000 units.)
Now they are barely building. Housing starts dropped last year to the lowest levels recorded since the government began tracking in 1959. By dint of virtually ceasing new construction, builders have succeeded in working the inventory of new homes reported for sale down to the lowest levels seen in almost four decades. Measured against the current monthly sales rate, however, inventories still look heavy — 11.1 months as of January. Months’ supply peaked in January 2009 at 14.3; by contrast, it was 4.8 in January 2005.
This situation is not likely to change so long as there is a “foreclosure crisis” in the existing-housing market. Builders, according to BarCap analyst Michelle Meyer (writing in February), are “unwilling to offer aggressive incentives or price concessions necessary to compete with foreclosures.” Or, as FTN Financial analysts Chris Low and Lindsey Piegza put it in a January Housing Update, “At this stage, then, the housing problem is an existing-home problem, not a new-home problem.”
The Visible Hand of Government Support?
In addition to MBS purchase programs that bid mortgage rates to historic lows, the government has supported home purchases with three different tax-credit schemes. The first, good in 2008, amounted to a loan out of taxes due repayable over 15 years. I believe it was entirely ineffective. In early 2009, the stimulus package authorized a $7500 tax credit for first-time home purchases closed between Jan. 1 and Nov. 30, 2009. (Buyers who maintain the house as their primary residence for three years need not repay Treasury.) Early in November, the Worker, Homeownership and Business Assistance Act of 2009 expanded the program to include repeat buyers and extended it to June 30, 2010 (for closings, binding contracts must be signed by April 30).
Relief from the Supply Side
Tax credits, rock-bottom mortgage rates and distress pricing undoubtedly feed existing-home sales, but the biggest benefit to home prices may have come not from the demand side, but from the supply side, judging from the dramatic slowdown in foreclosures.
The slowdown is evident in foreclosure starts tracked by the Mortgage Bankers Association. Across all loans (the survey includes about 44 million single-family loans serviced by 120 reporters), the rate at which foreclosures were started dropped during Q4 2009 from 1.14 to 0.86. Similarly, in non-agency mortgages, FTN analysts indicate that the rate of foreclosures stabilized (after ramping sharply in 2007 and 2008) and began to slow in 2009.
Much of the slowdown is owing to government policy, especially the Home Affordable Modification Program (HAMP). Ramping up the HAMP machinery took months, and various moratoria halted foreclosures while it was coming online. Now live, the full HAMP process can take more than six months. By the end of January 2010, active trial or permanent HAMP modifications had pulled almost 1 million loans out of the pipeline. (Compare that to 5.2 million existing homes sold in 2009.) On top of that, loans that fail HAMP guidelines can still be evaluated in servicers’ proprietary modification programs. Even niche programs like the GSEs’ Deed for Lease exchange siphon off some potential foreclosures at the margin.
Analysts are attempting to quantify the impact of strategic default. In February, JP Morgan analysts estimated that about 27 percent of mortgage loans are underwater. If home prices are flat, borrowers on 20 percent of total loans would have incentive to walk away if they evaluated their situation on a five-year horizon. A modest 3 percent rate of appreciation nationally shaves that down to about 10 percent of borrowers. Even under this rosy scenario, average incentives range from $40,511 for borrowers on fixed-rate agency loans to $105,608 on option ARMs.
Folding this analysis into their estimates of shadow inventory, JPM observed that if all borrowers with a positive incentive do walk, shadow inventory could go as high as 9.5 million units. In their opinion, this is highly unlikely. Undoubtedly, they are hoping such non-quantifiable issues as social stigma and impact on credit rating will still matter to folks intent on outsmarting the bank or the market.
Stigma seems to be fading, but credit rating affects more than the availability and price of credit for years thereafter. It also affects ex-homeowners’ ability to rent, something I hope default “strategery” takes into account!
Can I draw a conclusion from this washbasin full of discouraging information? Yep — the best scenario I can envision is one in which home prices move sidewise for many, many years. But I don’t attach a high probability of a flat-line scenario starting in 2010.
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