Activity in the U.S. housing market has bottomed - a huge plus for the economy - but a recovery in prices will not be sustained and the threat from real estate to bank capital remains acute.

We are over the worst, but only because of massive official support, support that will soon ebb. That could lead to a relapse, especially among more expensive houses, but nothing along the lines of what we have suffered so far.

The news has been good.

Newly built homes sold in July at the fastest pace in ten months, up 9.6 percent, in U.S. Commerce Department data on Wednesday. This echoes a fairly good showing in last week's data on sales of existing homes which are selling at the fastest pace in almost two years.

Miraculous to say, prices now look to be rising, at least as recorded by the Case-Shiller home price index which rose 2.9 percent between the first and second quarters, the biggest jump in close to four years.

This all comes as a huge relief. You can construct an argument that we are now most of the way through the most painful adjustment in house values and sales activity since around the time great clouds of dust blanketed the mid-west in the 1930s.

There is no doubt that a pickup in activity, even from very low levels, will be helpful for the economy and will gently support the services and construction sectors as well as theconsumption of durable goods.

But the supply of housing, though it has dropped, remains high and is probably under-measured given a large "shadow" inventory of both repossessed houses and houses of frustrated sellers which will come back on to market to meet and probably exceed any pickup in demand.

In the more bombed out areas of the U.S. - think Las Vegas and Cleveland - it is easier to come to terms with the idea that prices will now rise.

Demand is coming not just from first time buyers but more importantly from cash investors looking, not to flip as prices rise, but to get a decent income stream from renting. These investors are a healthy part of the process of turning a marginal group of house-owners back into renters.

It is hard to look at the national data, especially at the higher end where inventory in many areas is measured in years of supply not months, and conclude that we will not see any more falls.

"Perhaps a respite is in order, but with the true underlying unsold inventory near 12 months' supply, which is double what would typify a balanced housing market, it would seem like wishful thinking that we have suddenly achieved a fundamental low in real estate values," David Rosenberg, of Gluskin, Sheff told clients.

THE GOVERNMENT GIVETH...

The recovery in housing, such as it is, has to be seen in the context of the absolutely heroic support it has received from government.

The Federal Reserve has slashed interest rates to unfathomable lows, and not content with that, also intervened directly in mortgage markets, buying something on the order of $750 billion net of mortgage securities in an attempt to drive down mortgage rates.

The Fed has a 2009 target of buying up to $1.25 trillion of agency mortgage backed securities, $300 billion of Treasuries, and $200 billion of agency debt, all of which is keeping effective borrowing rates 0.5 to 1.0 percentage points lower than they would otherwise be. That program may be extended into next year, but not in size, given a well justified fear by the Fed that such intervention invites tighter political oversight.

So, all things being equal, mortgage rates may rise relative to prevailing rates, unless of course the securitization machine rises from the dead.

An $8,000 tax fillip for first time buyers is definitely a factor behind increased turnover and improving prices, particularly at the lower end. But that program is due to expire November 30.

Like the "cash-for-clunkers" plan for cars these programs partly encourage pent up demand to get off the sidelines but also simply move some activity forward in time. Look for a bit of a slump as the effect, which is now at its height, wears off.

Late paying borrowers are proving far less likely to get back on track than they were in previous cycles, according to a recent report from ratings agency Fitch. This argues for a continuing supply of houses coming back onto the market as foreclosures, especially in light of the poor success of mortgage modification programs.

To be sure, things are better now than they have been and the very steep falls in price make housing less of a one way bet.

The real estate market is usually seasonal, with a spring spurt and a winter freeze. This year we've seen the return of the spurt, but the freeze to come may buckle some foundations.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

Optimism has been all but extinguished from the U.S. housing market.

The number of Americans lining up for new home loans is shrinking again, according to Wednesday's release from the Mortgage Bankers Association, and the best that can be said of homebuilding is that it has stabilized at almost 80 percent below its peak.

With no end in sight to falling prices, perhaps we should look on the bright side. Indeed, there are three good reasons why sliding prices are not such a bad thing.

Falling house prices are usually seen as wealth destruction. But they can also be seen as wealth transfer. The next generation of homebuyers will benefit from our loss. Those young homebuyers who have been able to cling onto their jobs are already reaping the advantage. The American dream of home ownership can now be achieved at bargain basement prices.

Take San Francisco. If you earned the median wage in San Francisco at the peak of the housing market in 2006, you would have needed to devote 75 percent of your income to meet mortgage payments on the average home. Now people will pay just 35 percent of their income, according to Ian Morris, chief U.S. economist at HSBC.

It would no longer be any surprise if prices remained stagnant for a decade - spreading the benefit of cheap housing for at least 13 million new households.

Americans may also reflect that much of their temporary housing wealth was illusory anyway. Since house prices in a given area tend to rise in tandem, the only way to cash out was to borrow against equity, or move to a cheaper area or smaller space, or die.

A second consolation is political. Tumbling prices have exposed the flaws in the American government's efforts to subsidize housing.

It is now clear that these efforts did more harm than good. More thoughtful U.S. politicians must now question the mortgage interest tax deduction. The benefit of this tax was heavily skewed towards high earners since they paid a stiffer tax rate. Instead of fostering broad home ownership, the deduction encouraged rich Americans to borrow more and build bigger homes.

This is bad financial and even worse environmental policy. At the very least, Congress should now cap this deduction at $500,000.

The third source of solace is macroeconomic. For several years America borrowed money from abroad to make an investment that did nothing to expand its productive capacity or its ability to export. Residential construction in 2005 reached 6.3 percent of US national income -- its highest level since 1951.

A more sober level can be gauged from the average since 1980, which is 4.5 percent. Rampant home building went far beyond the actual housing needs of Americans. Over the past five years around 8.9 million housing units were built and just 6.7 million new households were created, according to Harvard economics professor Edward Glaeser. The number of vacation homes jumped from 3.6 million in 2002 up to 4.8 million now.

An ever-growing number of U.S. homes were also vacant, as investors waited for tenants or buyers. Not only did houses become more numerous, they also got bigger. The average square footage of a U.S. family home expanded from 2,200 to 2,500 over the past eight years. "Mistaken beliefs about housing may have crowded out more productive investments," argues Glaeser.

Since two-thirds of Americans own their homes, falling prices are never likely to inspire street parades. The economic loss has certainly outweighed the gains and the banking system may take years to fully recover. Even so, our loss is a hidden accounting gain for the next swath of homeowners. A more balanced economy and housing policy may now emerge. For more philosophically minded Americans, this is a cloud with a silver lining.

The housing market is probably one of the most keenly followed markets in Britain. Every month we are hit between the eyes with no fewer than eight separate indices that provide pointers to the state of play in the property market. These include supply side figures from Rightmove, demand side numbers from Nationwide and mixed-adjusted indices from the Department of Communities and Local Government.

The plethora of indices is enough to make anyone draw the curtains and lie down in a darkened room. But it is important to appreciate that each set of data will be different because they are drawn from very different data pools. For instance Rightmove’s index is based on sellers’ asking prices, which tend to be more optimistic than say, Nationwide’s index which is based on agreed sale prices. Additionally, Nationwide’s index is derived from mortgage approvals, and not everyone may need to apply for a mortgage.

Our anxiety over house prices probably stems from the fact that a home is the single biggest purchase that most of us will make in our lives. So, it is understandable that we want to know that our money is well spent. Worryingly, there are some seven million people who are hoping that rising house prices will save them from poverty because they have not put away enough money for their retirement.

If you are wondering if house prices have bottomed, the answer is probably not. Currently, the price of a typical home in the UK is around £153,000, which is still six times the average annual wage of a British worker of £24,000. The cuts in mortgage rates have helped to ease the burden of servicing mortgages. However, there are dangers to relying on low interest rates.

Whilst house-price watching is a popular national pastime, and one that I have to do professionally, it has never interested me that much on a personal level. That’s because I have neither considered my house as either an investment or as a substitute for my pension.

I have always thought of my home as a roof over my head that meets my living needs. After all, if I didn’t buy one then I would have to pay rent to a landlord, which wouldn’t bother me too much. At least as a tenant I wouldn’t find myself knee-deep in sewage unblocking a drain with a plunger on a sunny Sunday afternoon.

During my twenty or so years as a homeowner, I have seen property prices rise and I have also seen them fall. That said, over the long term I have been fortunate to benefit from rising house prices. The appreciation in property values has allowed me to steadily build up equity in my home albeit punctuated by periods when prices fell. Nevertheless, house prices would now need to drop quite significantly to catch my attention.

Clearly, adopting a relaxed attitude towards house prices has taken many years of practice. It has also been helped by regularly channelling money into other assets such as the stock market, bonds and cash. By doing so, the value of a home, no longer becomes a fixation but instead just another part of your growing portfolio.

The allocation of assets, albeit crudely in the case of offsetting rising property values with shares, is one of the keys to building wealth over the long term. So, if property prices rise, it is important to adjust the mix of assets you own by investing more in assets other than property. This means investing not only in shares but also in bonds and cash. In other words, it is important that you have a well diversified portfolio.

One thing to bear in mind is that asset allocation will not maximise your returns. But it should do the next best thing. It will reduce the risk to your wealth. In a nutshell, living modestly, overpaying your mortgage and having a properly diversified portfolio will enable most of us to ride out market downturns. And any paper losses you may incur from time to time will not affect your life too much because you are not losing actual cash!

-- James Saft is a Reuters columnist. The opinions expressed are his own --

Deep breath. Ok, here goes: For the first time in a very long time U.S. housing might actually be a reasonable buy on a five-year view.

As a long-time housing bear and someone who believes there is still considerable pain to come in the U.S. economy and banking system that is quite a hard thing to say.

However historically cheap long-term fixed-rate financing (less than 5 percent on a 30-year mortgage) and the prospect of some nasty inflation a year or two out, both courtesy of current Federal Reserve and government policies, make owning a real asset that is debt financed a lot more attractive than would have been the case just three or six months ago. For full coverage of the U.S. housing market click here.

What I am not doing is calling the bottom of the housing market; there are still reasonable falls to come on top of the 20 percent or so declines we have already seen nationally.

Futures show an expected decline of about 4 percent on the Case-Shiller 20 City national index between May of this year and May 2010 and a recovery to current levels only in 2012. I actually think it might get a good bit worse than that; there are still substantial repossessions that need to filter through, unemployment will surely rise from here and an economic recovery, when it comes, will likely be pretty weak. This is not an argument about the housing cycle turning and leading us, as it has so many times before, out of recession.

Having said that one very important thing seems clear: the Federal Reserve will do what it takes, and very possibly a good deal too much, to stop deflation.

Indeed, there is a reasonably high risk that inflation will get away from the Fed or that buyers of Treasuries take a pass. This inflation will be very handy for those who've leveraged up to buy housing.

Economist Tim Lee of Greenwich, Connecticut-based pi Economics, a long time "deflationista", now thinks that while deflation may still have the upper hand, current policies will inevitably be inflationary.

"The amount the Fed is doing will be enough to cause inflation, and I think that's even if economic growth is fairly poor," Lee said in an interview last week.

Broad money supply in the U.S. is rising at a more than 14 percent annual clip, the fiscal deficit will be about 13 percent of GDP this year and the Fed's balance sheet has ballooned.

A REASONABLE ALTERNATIVE

And while housing won't exactly thrive in a period of high inflation and low growth, it may perform reasonably well compared to the alternatives. Government bonds will get whacked by inflation and stocks may do a bit better than bonds over the medium term though they will suffer as the quality of earnings declines.

Stock market investors now are conflating the end of the very steep declines in the economy with a return to productive investment and a sustained rebound that will drive profits. That might be an optimistic reading. Stocks do offer some protection against inflation but they are far from a perfect hedge.

It is also heartening that investors are returning to many of the hardest-hit real estate markets in the U.S., such as Florida. These are people who do not rely on a lot of leverage and are happy to take the very positive cash flow from rents.

Mortgage rates are at an all-time low despite the absolutely terrible performance of recent vintage mortgages. This partly reflects the very low interest rate environment, but also is a function of the Fed intervening directly into credit markets in order to drive down rates to below where they very likely would be if investors demanded the kind of premium you would expect given recent experience. It also remains true that if things become really terrible, you can always walk away from a loan in the U.S., though it is pretty unlikely that this comes into play for a borrower who puts 20 percent down now.

Remember too that stabilization in the housing market is an absolute precondition for a recovery in banking and the economy generally, and it is clear from the steps the Fed and government have taken, in driving rates down and keeping the taps of government insured loans flowing, that they understand this and will act on it.

They will likely not be successful enough to save some of our largest banks, and all too successful from the standpoint of staving off deflation, and for someone borrowing at five percent interest for 30 years to buy a house in a part of the country which is not dependent on financial services, they may be very successful indeed.

It almost certainly won't look that way in a year, but could well in five or seven.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. --

]]> http://blogs.reuters.com/great-debate/?p=3081/feed/ http://blogs.reuters.com/great-debate/?p=2750 http://blogs.reuters.com/great-debate/?p=2750#comments Mon, 30 Mar 2009 14:31:07 +0000 James Saft http://blogs.reuters.com/great-debate/?p=2750 -- James Saft is a Reuters columnist. The opinions expressed are his own --

When prophetic long time bears turn a bit cuddly, it is usually best to take notice.  A real estate maven who rejoices in the "nom-de-blog" of Professor Piggington has now, after five years of correctly shouting bubble, labelled San Diego housing prices "reasonable" based on the latest available housing data.

Remember, San Diego has been, along with Phoenix, Las Vegas and parts of Florida, among the most bubbleicious markets in the U.S., and the massive busts there still represent a huge problem for bank balance sheets, for employment and for the U.S. economy generally.

So a bottoming, if that is what we are seeing, would be very significant. Housing is usually among the first sectors to recover in the aftermath of a recession and many economists argue that it actually drives the economic cycle.

Piggington, whose mother knows him as Rich Toscano, is making more modest claims; that prices are reasonable historically, but his arguments have some merit and fair value is a necessary but not sufficient precondition for a bottom and a turn.

He argues that, based on the historical relationship between San Diego county house prices and both incomes and rents, prices are now not so bad. The ratio of home prices to per capita income in December was below eight (remember San Diego housing has always been expensive!) as opposed to a bubble peak above 14. And buying the average single family home now costs the equivalent of just about 200 months of the average rent, as against well over 350 at the peak.

I think it's fair to say that we are getting ever closer to a bottom in some of the bombed out markets, not just San Diego, but I don't think we are there yet. On the plus side, in many of these markets transactions are now well above last year's extremely low levels, driven by banks selling foreclosed properties at aggressive prices. And many of the buyers in places like Florida appear to be investors who are happy to take the quite positive cash flow from renting, a real sign of health, as opposed to 2006's flippers.

But be cautious: we are in the midst of an awful recession and the employment effects will last long into 2010. Prices also are liable to overshoot on the way down, as they have in the past, including in California.

That means that price measures are now biased to the lower end of the market and don't give a true picture of affordability. Professor Piggington may have more pain to chronicle as more prime and jumbo foreclosures hit the market.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund --

Our own Reuters poll of 37 analysts at UK banks, published today, predicts that prices are likely to drop by about 11 percent this year and that it will take until 2010 before it gets better.

How much do you think house prices will fall in 2009?

Even in the good times, many British consumers were borrowing against their houses just to fund routine consumption, indicating a big hit to come for retail sales and for the banks who hold the loans.

With house prices falling rapidly and mortgage debt tougher to get, it is no surprise that homeowners are less able and inclined to borrow against their houses in order to spend.

That will be hitting the High Street now - analysts are expecting a 0.6 percent fall on the month in retail sales for November when data are released later this week. But a rise in unemployment next year could expose a really serious weakness in household finances, as consumers who counted on being able to extract wealth from their houses to smooth consumption in bad times find that, when bad times come, the wealth isn’t there and the banks don’t want to lend anyway.

Researchers at Durham University looking at survey data found that 37 percent of homeowners borrowed against their house between 2002 and 2005, typically realising about 6,000 pounds. That’s a lot people borrowing a lot of money against very illiquid and now hard to realise assets.

Even more interesting is the pattern of what householders were doing with the money and what was happening to them when they decided to borrow. Over time the proportion of people borrowing to re-invest in their houses through improvements fell, while more was finding its way into day-to-day costs, according to Susan J. Smith, a professor at Durham and one of the authors of the study.

This was borne out by a high percentage of equity borrowers who had lost their jobs, become pregnant or had a child in the year they borrowed.

How exactly a borrower who has lost his job gets a bigger mortgage is a puzzle, but one that evidently banks and borrowers in Britain together have somehow managed to solve. The record in the United States shows that the housing boom brought with it a tremendous amount of mortgage fraud, much of it abetted by people within the lending industry.

In short, it seems that even during boom times in Britain people weren’t borrowing against their houses simply to buy BMWs and fund vacations, but often to keep their households ticking over during tough times.

“The rising property market was central to encouraging people to borrow more for non housing expenditure,” said Ross Walker, economist at Royal Bank of Scotland in London.  “And with the housing market now in reverse you would expect to see a retrenchment. It reinforces the potential fault line for the UK household sector: there is a big debt exposure and the real test will come next year as unemployment rises.”

BORROW NOW, DEFAULT LATER
The housing safety net, such as it was, simply won’t be there next year when unemployment vaults higher, which is very likely to exacerbate a spending slowdown which itself will feed unemployment. And remember, these weren’t people who were defaulting on their house loans in order to be able to pay their grocery bills, but people who were in part paying their grocery bills because they could borrow against their houses.

I wouldn’t want to be the bank that made those loans, or the government that insures that bank. It also goes some way, in my view, towards explaining the very precipitous fall in the pound, which is down more than 30 percent on a trade-weighted basis this year.

According to a survey of households just released by the Bank of England, credit is much harder to get as compared with a year ago. A total of 16 percent of households said they had put off spending because they were concerned about access to credit, up by a quarter from a year ago.

Only six percent of mortgage borrowers said they had taken out an additional secured loan, compared with 10 percent last year and 14 percent in 2006. Nearly 40 percent took out these loans to pay down other debts. That points to higher credit card losses and delinquencies next year, as unemployment interacts with an inability to access fresh secured loans.

So 2009 looks like it will feature higher unemployment, much reduced consumer spending, impaired access to credit and a default cycle that will worsen the already difficult capital problems of the banking sector. There has been a lot of effort and exhortation to try and keep banks lending to consumers in Britain, presumably on the view that it’s best to sober up gradually.

That can only work so long, and if it comes at the expense of capital for businesses that make and sell things, especially overseas, it may in prove to be a mistake.

And while big ticket items like automobiles, which are easy to defer, are now suffering, next year may see very tough times on the British high street for more basic items.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)