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No Evidence of Housing Turnaround on Horizon

Posted Wednesday, May 14, 2008

All the recent data continue to show no signs of any uptick in the housing market. The Homebuilders Housing Market Index for April remained near its record low, as there continues to be no evidence of any rush of new homebuyers. The Mortgage Bankers' four week average for its weekly applications index continues to trend downward. And the Realtors pending homes sales index hit a new low of 83.0 in March.

The new low is 8.5 percent below the February level. Even this low number understates the true falloff in sales, since many of these sales will not go through, most often due to financing problems. In contrast, in 2005, when the year-round average for the index was 124.4, nearly every sale went through.

The situation is the same with new homes. Toll Brothers reported yesterday that its cancellation rate for the most recent quarter was 24.9 percent. If this cancellation rate is typical for homebuilders, then the current 11 month inventory for new unsold homes would actually be 14.6 months at the current sales rate. Since this inventory does not include homes for which contracts were cancelled, the supply of unoccupied homes could be even more months of sales.
Yesterday, the NAR released data for the first quarter showing a decline in the median house price of 7.7 percent from the year ago level, the largest year-over-year decline since the data has been collected.

This drop is somewhat less than the 12.7 percent drop shown in the Case-Shiller index. Most of the difference is likely attributable to a composition effect. The Case-Shiller index tracks re-sales of the same homes. The Realtors' index does not control for changes in the mix. If fewer low-end homes are being sold due to the collapse of the subprime mortgage market, then the median home is likely to be a more expensive home in 2008 than in 2007.

The House passed the Frank bill which would allow the FHA to guarantee up to $300 billion in new mortgages. It is not clear what its sponsors hope to be the effect of the bill. Some proponents of the bill claim it will prevent prices from falling. While it will almost certainly not be able to accomplish this goal, since it is not nearly large enough (the stock of housing in the U.S. is valued at $20 trillion), it is not clear why it should be a public policy goal to sustain a housing bubble. This will mean that house prices will remain unaffordable for millions of low- and moderate-income families. Housing policy had previously been designed to make housing affordable to these families.

It is also not clear that the bill will help homeowners by guaranteeing new loans in markets that still have bubble-inflated prices. In these markets, the ratio of ownership prices to annual rents is often far above 20 to 1. This means that families can find themselves paying more than twice as much in housing costs if they own than if they were to rent a comparable unit. Since house prices are likely to fall further in these markets, homeowners are likely to again end up underwater, and selling their homes without accumulating any equity.

If Congress wanted to ensure that it was not guaranteeing mortgages at bubble-inflated prices, it could simply set the guarantee price as a multiple of the appraised annual rent for a unit (e.g. 15 times annual rent). Since there was little real increase in rental prices even at the peak of the bubble, using rents as the basis for price guarantees would ensure that the guarantees were grounded in the fundamentals of the housing market.

At the moment, there is substantial opposition to the Dodd-Frank bill in the Senate, so it may not be possible to overcome a filibuster. Even if the Senate does pass the bill, President Bush has said that he would veto it. However, if some version of the current bill does eventually get into law, its main beneficiaries are likely to be the banks who get bad mortgages taken off their books by the government, not homeowners.

By Dean Baker