Hope for Housing

It is not reasonable to consider “what if” until we establish a clear understanding of “what is.”

We have long assumed that the Federal Reserve has been targeting housing above all else with its seemingly endless series of stimulus measures. Housing has been squarely in the eye of the storm since the financial crisis began, and it would be housing, we surmised, that would finally get us back on the road to sustainable recovery. At least that’s what we assumed Mr. Bernanke was thinking in the days and weeks leading to either another rate cut or the announcement of QE1, QE2, Operation Twist, and QE3.

Whatever was going through the brilliant minds at the Fed, recent evidence does indeed suggest that housing may finally be showing the signs of life we have so desperately been seeking. True, the improvement we are seeing is off of very low levels, but it is improvement nonetheless. Moreover, the stabilization we are now seeing comes despite significant macroeconomic concerns, including the looming fiscal cliff, the situation in Europe, the slowdown in China, and weak employment growth.

So what are these “green shoots” we are seeing in housing. Consider the following:

-The S&P Case/Shiller 20-City Home Price Index rose for the sixth straight month in July (on a seasonally adjusted basis) and now stands 4% above the low reported in January of this year.

-Existing home sales were up 8% in August compared to July, representing the highest monthly volume in over two years. New home sales came in at 2+ year highs as well for the second month in a row in August.

-Housing starts and building permits continue to increase steadily, with the August readings representing close to 4-year highs for each metric.

-The for-sale supply of listed homes would last just over six months at the current sales pace, representing the lowest level of supply since the prior to the housing crisis.

-Thanks to super-low mortgage rates and falling prices, housing affordability is the strongest its been in decades.

Of course, it is still far too early to crack the bubbly, especially if you are Ben Bernanke or one of the millions of “homeowners” stuck with an underwater mortgage. The remaining areas of concern, which stubbornly won’t go away, are 1) the backlog of delinquent and foreclosed homes, and 2) the huge amount of negative equity. At some point, all those damaged mortgages, which according to the Mortgage Banker’s Association still represent nearly 12% of total mortgage loans outstanding, will have to work their way through the sales process. This will create an overhang of supply for many months to come, and the increased supply may offset the price increases we have been experiencing as of late.

The problem of negative equity has especially negative ramifications for the economy at large. Many of these homeowners will not be able to take advantage of record-low mortgage rates to refinance their existing mortgages. Therefore, all of the Fed’s work to free up disposable income will be lost on these borrowers. In addition, these homeowners create problems in the labor market because they have limited mobility to move to where the jobs are. And finally, there is a risk that these borrowers, frustrated with their lack of options, start to walk away from their mortgages en masse. Obviously, widespread “strategic mortgage defaults” could negative effect home prices, if that were to occur. For all these reasons, we think it is imperative that the next administration do a more effective job of addressing this serious issue.

So, for my part, I still have trouble getting too giddy about the “less bad” housing data we have received in recent weeks. My overarching concern is the fact that it has taken 3.5% mortgage rates in order to get this market to stabilize. On top of that, banks are still not retaining the loans they make. The lion’s share of new mortgage originations continues to be underwritten via FHA standards or sold to Freddie Mac or Fannie Mae. In other words, the federal government is still assuming most of the credit risk for new mortgage loans. Until the government is out of the game, we will not have a fully recovered housing market. Unfortunately, if the government hadn’t been so involved, we wouldn’t be as anemically well-off as we are.

Worries about “what if” aside, it is clear that “what is” is improving. My grandmother (now 104 years old) advises us to “take the tarts when passed.” The improvement in data, however wrought, is positive, and we should be heartened that the fury of Federal Reserve activity has moved the needle in a positive direction. Nana would suggest we take a moment and enjoy some tarts.