Housing’s Humpty Dumpty moment
(James Saft is a Reuters columnist. The opinions expressed are his own)
All the King’s horses and all the King’s men have been busy propping up the housing market but sometime this year, perhaps soon, it will face a Humpty Dumpty moment.
While it gets a lot less attention than the banking bailout, the official forces targeted at supporting house prices are truly vast; a generous tax break for buyers and a mortgage market that has essentially been nationalized.
That’s bought a recovery of sorts — Standard & Poor’s/Case-Shiller home-price index released on Tuesday showed that in 20 major cities home prices rose 0.2 percent on a seasonally adjusted basis between October and November, despite a national unemployment rate of 10 percent and a slow-motion cascade of foreclosures.
But like the egg in the nursery rhyme, which once broken cannot be reassembled, housing still faces some pretty horrendous fundamentals. It needs a strong recovery in employment to arrive before political consensus for housing support cools. (Full disclosure: I just bought a house, but hey, everybody’s got to live somewhere).
Already there are signs that housing may be faltering. Existing home sales declined sharply in December, though this was partly because many rushed to close purchases before a now extended deadline for tax rebates expired on Dec. 1.
Housing starts too fell in the month and, significantly, the Federal Reserve removed language pointing to improvement in housing from its statement accompanying its decision to keep interest rates at record lows.
The amount of official support housing has gotten is stunning. Between Fannie Mae, Freddie Mac and the Federal Housing Administration, the mortgage market is getting more direct government support than ever before. FHA loans, which can be made to borrowers with small down payments, have been especially important given bank lenders’ new-found preference to lend to buyers who can put up 20 to 30 percent of the purchase price. The FHA, facing rising delinquencies, is tightening terms to borrowers and may ultimately need to cut back on lending or receive additional support.
As well, the Federal Reserve will have bought about $1.25 trillion of mortgage bonds by the end of the first quarter, bonds which have become a political hot potato due to Congressional ire. If the Fed stops buying, rates will rise by at least a half a percentage point.
A program of tax credits has been extended through the Spring, but it is likely that these types of incentives simply move demand forward. Housing will soon need a strong jobs recovery to remain stable, something far from guaranteed.
CASH FLOWS NEVER LIE
Valuation is always a matter of opinion, but cash flow cannot be faked; without loose lending, house prices ultimately are ratified by the rent property can command or the amount of their earnings people are willing to allocate to buying.
Neither measure is reassuring for housing right now; rents nationally fell something on the order of 3 percent last year while stagnant personal income and high unemployment spell trouble for owner-occupied housing.
Remember too the relationship between unemployment and housing; high unemployment is bad for house prices but not nearly as bad as sustained high unemployment. As economists Carmen Reinhart and Kenneth Rogoff detail in their book, This Time is Different, one effect of a typical banking crisis is that it raises unemployment rates by seven percentage points and that, and this is worse for housing markets, unemployment remains elevated for five years. Ask yourself, what would be the effect on house prices if unemployment was still at 8 percent or more in two or three years?
For certain many borrowers are hanging on to their houses for dear life and against their own best interests. Many of these will convert into foreclosures as time passes as employment fails to materialize.
This is probably the untold story of housing stabilization. It has been done at huge expense in order to avoid finding a clearing price, to avoid allowing prices to come down to where natural and reliable demand would take them. FHA, Fannie and Freddie lending and Federal Reserve intervention have all combined to prop prices up, a policy intended to avoid exerting further pressure on the banking system. But in order to do this, huge amounts of capital are being deployed to keep housing expensive that could otherwise find better uses such as developing new technologies or increasing export competitiveness. Less of that kind of productive investment is going to happen because we’ve made a decision to not acknowledge our error in housing, allow it to fall and move on.
This is a Japan solution, and we’ll risk getting a Japan outcome: an extended resolution. This implies another leg down for housing, but perhaps a slow grinding fall rather than a tumble.
(Editing by James Dalgleish)
(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.)