U.S. housing’s sinking feeling

May 31, 2011

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

HUNTSVILLE, Ala. — Housing in the U.S. is in the midst of a double dip in prices, a threat to the economic health of banks, households and the country itself.

S&P Case-Shiller will release on Tuesday their house price index, which will likely show a fall to a new post-bubble low, with prices now back to where they were in the middle of 2003.

House prices have hit a new post-bubble low, down almost a third from their 2006 peak, according to data released on Tuesday by S&P Case-Shiller.

Pending home sales, released last week by the National Association of Realtors, fell by 27 percent in April compared to the year before, an 11.6 percent fall in the month.

Given that we are supposed to be in the Spring home selling season, the outlook for the rest of the year is not good.

There are, in the current market, very few normal buyers; many are swamped by negative equity in their current house and those who are not are reluctant to commit their own capital to a falling market.

Given tighter underwriting standards someone who now owes more than their house is worth faces a double burden if they choose to buy a new one; cut one fat check to their existing lender to cover the shortfall and an additional one for a chunky down-payment for the new house.

And while mortgage rates remain low, and may well fall from here, underwriting criteria, outside of some government-backed programmes, are tight.

The pressure from sales of foreclosed homes is one of the prime forces driving prices lower. Banks are far more willing to cut prices to get a sale done than homeowners and many foreclosures are in poor condition, requiring further discounts to entice buyers.

The foreclosure system is overwhelmed, even despite a drop in new foreclosure starts and delinquencies. A scandal and lawsuits over improper foreclosure procedures has slowed the process, and it may be that banks are deliberately holding properties back so as not to further erode prices. At the current rate of sales it will take more than four years for banks to sell off their existing inventory of foreclosed or seriously delinquent houses. More than 40 percent of delinquent mortgages have been delinquent for more than a year, according to Lender Processing Services. That makes arguments that housing has reached fair value irrelevant. Four more years of foreclosure sales makes the market unattractive to all except for cash buyers looking for cash flow from renting the property and willing to wait patiently for capital values to rise.


The long fall of housing has three main impacts; on the banking system, on the economy and on the psychology of U.S. consumers.

Even after the crisis, real estate remains a huge exposure for the banking system, both in terms of “toxic” assets from before the crash and prime and near-prime loans.

The Markit ABX AAA 2007-1 index, a tradable derivative based on sub-prime loans, has fallen about 20 percent in just over three months, reflecting weakness in housing and the very poor recovery rates banks are able to get from foreclosed houses. The longer a house remains in foreclosure, the higher the chance that it enters the market damaged, meaning investors can end up with far smaller payouts as a percentage of their capital then they would have planned on in even the direst scenario planning session.

“We are looking at some sort of an echo of the credit crisis coming up here,” noted bond fund manager Jeffrey Gundlach, of DoubleLine Capital, told CNBC television.

“You have to wonder about how these recovery rates are gong to do anything but go down and that will lead to an awareness of strains in the financial system. who’s to say that we won’t get an echo that re-prices

Bank shares are beginning to reflect that risk, having fallen about 5 percent since February and underperformed the S&P 500 .SPX by 10 percentage points since the beginning of the year.

The economic impact of housing is broad, with home building usually driving the business cycle. The lack of a broad recovery in housing, despite government life support, is one of the reasons that the recovery has been so weak. A sustained double dip in house prices will further depress home building and other allied activity.

The biggest impact may prove to be psychological. Americans have had a 60-year romance with real estate and have come to conflate housing consumption with real estate investment. This has driven them to take on more leverage, to own multiple homes and to take on ever more risk. That mind-set has been slow to erode, even in the face of four years of evidence.

If Americans begin to scale back their expectations, both of how much house they need and how much housing will appreciate, the double-dip may turn into a decade-long grind lower.

(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.)

House prices have hit a new post-bubble low, down almost a third from their 2006 peak, according to data released on Tuesday by S&P Case-Shiller.

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