Tuesday, January 30, 2007

Bribing Beantown

In an desperate attempt to persuade young students and other residents to stay in Massachusetts rather than seek opportunities in some of the country’s growing and more affordable areas, Massachusetts state legislator Brian A. Joyce recently filled a new piece of legislation that would offer $10,000 for a down payment on a house or condo to those who would stay for at least five years.

The parameters are fairly simple, a recipient must have graduated from an accredited institution (college, vocational school, etc.), not make more than 135% of the community’s median income, and lastly, if they don’t stay at least five years, they must pay back the $10,000 with interest.

This seems like a fairly simple plan until you start putting it in the context of the current housing climate in the bay state.

Aside from being another example of government (this time local government) trying to mitigate affordability issues by essentially jumping in the fray of ridiculous behavior (i.e. doing anything they can to help first time buyers stretch to attain homes at absurdly inflated values), the plan itself simply wont add-up given the tremendous run-up in home prices that Boston’s suburbs have experienced in the last decade.

Given that many (if not most) of Boston’s suburban and metro areas have median household incomes in the range of $60K - $80K and that an extra 35% of income exempts you from the program, the maximum cut off point from the program would be roughly $100K of household income with most areas actually cutting off well below in the $80K - $85K range.

As anyone who has lived in Boston for the last decade can tell you, a person needs to make quite a bit more than $85K or even $100K to afford even the most average of starter home.

Take any town within the route 95 beltway and you will find that virtually every single family home, even the typical 1200 – 1500 square foot cape or ranch with no bells or whistles are valued in the range of $450 - $550K.

Single family homes under $400K are generally anomaly’s with some fairly significant defect preventing them from “comping” with the norm.

Keep in mind that even though this is a state initiative, there is no doubt that it is really directed toward the Boston suburban and metro area with its tech industry and plentiful numbers of newly graduated students.

Even if this program is enacted, legislators will find that its effects will fall flat.

Possibly it will help some students afford some of the cheaper condos on the outskirts of town but in general most students are aware that the Boston area is significantly overpriced and that other areas of the country are experiencing faster growth, providing more opportunities and are significantly more affordable.

Additionally, Boston’s problems with affordability are now much greater than simply holding on to individual college graduates.

As we have seen many times recently, businesses are relocating due to the significant cost of operating a business in the bay state as well as the impact that low affordability and high cost of living has on employees.

The writing is on the wall. Boston’s home prices have to come down to meet some reasonable balance with what incomes in the area can afford.

The spending binge is now over and soon the state will have a whole assortment of new issues to contend with as it’s citizens struggle to make sense of the significant downward home price adjustment.

Friday, January 26, 2007

Today’s New Home Sales

Today, the U.S. Census Department released its monthly “New Residential Home Sales” report for December showing record weakness to sales in 2006 as well as continued weakness to the nation’s new home market.

The full year results for 2006 were 17.3% below the full year results for 2005, that’s just .5% below the 17.8% decline registered during the recession-led housing bust of 1990.

Additionally, there is a very likely chance that revisions to the results with next months report will drive the full year 2006 decline even higher possibly surpassing the 90’s housing collapse results.

In a notable change, there was an unusually large pickup to sales in both the Northeast and Midwest regions in December serving to buoy the national results.

It appears though that, for the Northeast, the level of confidence in the reported number was very low with a (+ or –) 70.0 confidence interval.

So, we will have to wait at least another month or so for revisions to really see what’s happening in the Northeast and in turn the national numbers.

Nevertheless, the December results are still well entrenched in the existing slowdown as show by the monthly year-over-year national sales chart shown below (click for larger version).

Look at the following summary of today’s report:


  • The median price for a new home was down 1.5% as compared to December 2005.
  • New home sales were down 11.0% as compared to December 2005.
  • The inventory of new homes for sale increased 5.5% as compared to December 2005.
  • The number of months supply of the new homes has increased 22.9% as compared to December 2005.

  • In the Northeast, new home sales were up 18.3% as compared to December 2005.
  • In the West, new home sales were down 27.1% as compared to December 2005.
  • In the South, new home sales were down 8.9% as compared to December 2005.
  • In the Midwest, new home sales were down 2.4% as compared to December 2005.

Copyright © 2007

PaperMoney Blog - www.paperdinero.com
All Rights Reserved


Talk about going out with a bang!

Today, the Massachusetts Association of Realtors (MAR) released their “home sales report” for December showing a firm completion to the largest yearly decline to single family home sales ever recorded in Massachusetts.

For December, single family home sales declined 16.6% compared to December of 2005 bringing the total yearly sales to 41,519 or a decline of 15.2% as compared to the full years result of 2005.

Additionally, in nominal terms (not adjusted for inflation) the median single family home price dropped 5.4% as compared to December of 2005 to $335,000 leaving the median price 11% below the peak set in the summer of 2005.

The new MAR president Doug Azarian had the following to say:

“Coming off record prices, brisk sales and seller’s markets of the past decade, it’s good to see the market coming back to some balance… At this point, the balance definitely tips toward the buyer, although the monthly inventory of available homes is beginning to diminish a bit. Sellers who heed their Realtor’s advice about right-pricing are doing well.”

Review the following chart:

As you can see, Massachusetts completed almost 12 consecutive months of declining sales (March showed a small gain) resulting in the sharpest yearly drop off in sales ever recorded by MAR.

The following chart demonstrates what this drop off looks like in the context of single family home sales since 1990. Click on it for a larger, more readable version.

As in months past, be on the lookout for the inflation adjusted charts produced by BostonBubble.com for an even more accurate "real" view of the current market trend.

Key Statistics for December 2006:

  • Single Family sales down 16.6% as compared to December 2005
  • Single Family median price down 5.4% as compared to December 2005
  • Condo sales down 8.2% as compared to December 2005
  • Condo median price up 1.9% as compared to December 2005
  • Single Family average “Days on Market” now stands at 138 days in December as compared to 104 days for December 2005
  • Condo average “Days on Market” now stands at 134 days in December as compared to 98 days for December 2005
  • Inventory of single family homes have risen for 22 consecutive months and now stands at 30,651 units listed on the market through MLS. This represents 10.3 months of supply.
  • Inventory of condos now stands at 16,581 units listed on the market through MLS. This represents 11.1 months of supply.

Thursday, January 25, 2007

Bulls Ease On Off The Cliff

Today, the National Association of Realtors released its monthly “Existing Home Sales” report for December along with a worn-out attempt to spin a “market easing” message.

As David Lereah puts it:

“Despite all of the doom-and-gloom stories and dire predictions over the last year, 2006 was the third strongest year on record for existing-home sales…”

Unfortunately, what Lereah forgets to mention is that the decline to home sales for 2006 was the greatest on record since 1982 dropping over 8.4% nationally.

To put this in better perspective, the 2006 sales decline has handily surpassed the sales decline set by the housing bust of the late 80’s and, on a multi-year basis, it appears that the sales declines may match or even beat the record declines set in 1982 when the economy was flagging and mortgage interest rates were in the high double digits.

Given that mortgage interest rates are at historically low levels and employment is unusually strong, the exceptional drop off in home sales in 2006 is quite remarkable.

What we are seeing is clearly NOT a typical recession led housing bust but rather a collapse of a speculative bubble that in many areas had been inflating for a decade and in most areas ran white-hot for the last five years.

The reality is that there remains an unprecedented number of both “investors” (i.e. poorly equipped speculators) as well as over-stretched homeowners who are desperately attempting to exit the market.

Although current inventory has dropped due to the typical seasonal cycle, the spring will bring a renewed rush of even greater numbers of sellers possibly producing the first true signs of widespread panic as sales continue to decline and prices begin to show more substantial downward pressure.

Below is a chart consolidating all the year-over-year changes reported by NAR in their December 2006 report.

Particularly notable are the following:

  • Sales were down across every region and for every home type with particularly significant declines seen in the west.
  • Inventor and Months Supply were again up double digits.
  • Median prices in the Midwest region showed a substantial single monthly decline.

Tuesday, January 23, 2007

Bamboozling the Bubble

Mortgage fraud has steadily been growing as a hot topic over the last year but with the recently reported (hat tip to HousingPanic) “Cash-Back” sham occurring in Arizona (as well as many other markets in the nation), the deception has taken on a decidedly different course.

As has been previously reported, scams involving a coordinated effort by sellers, brokers and appraisers are widespread and fairly commonplace occurring in just about every market in the country.

The scams vary slightly, but in most cases the “investor” buys a property (usually cheap and in rough shape) with the intent of quickly “flipping” it to an unsuspecting and inexperienced buyer that has been brought in by a rigged real estate broker.

The real estate broker proceeds to engage a rigged mortgage broker and appraiser who work together to both dramatically inflate the value of the property as well as falsify loan application documents to provide the evidence needed to justify the loan (i.e. buyers income, down payment etc.).

When the deal closes, the investor, the brokers and the appraiser all get a cut of the “winnings” and the buyer and lender get stuck in a pretty rough situation that usually results in a quick foreclosure.

The buyers credit is ruined, the lender is out most if not all their money and the scammers move on to the next payday.

Clearly, in the above scenario the buyer is most directly damaged as they now have a serious incident on their credit history as well as having lost their home and any deposit and payments that they may have made on the property.

To a lesser extent, the neighborhood is also damaged as foreclosures typically result in vacant properties that in many areas become run down and cost both the town/city valuable administrative resources as well as contributing to increases in violent crime as the Federal Reserve Bank of Chicago demonstrated in an interesting study last year.

The lender on the other hand is certainly damaged but after reading reports from both the GSE lenders (Fannie and Freddie) as well as private lenders, their take is fairly dispassionate as they have already accounted on a certain percentage of “bad loans”.

For many of the largest lenders, any single incident foreclosure generally results in a minor statistical blip in an otherwise stable loan portfolio.

But now it appears that times are really changing.

In the last few months there have been numerous examples of smaller, riskier lenders going bust because of a high percentage of bad loans. (Check out the Mortgage Lender Impolde-O-Meter for daily list of lenders going belly up!)

More startling even is that the nature of mortgage scams are now transforming to include deals that would otherwise appear to be on the level.

Many of the “Cash-Back” at closing scenarios are now showing themselves to be subtle (and sometimes not so subtle in the case of the recent wave of real estate investment clubs and “get rich quick” schemes) forms of mortgage fraud that are executed with the full and willing knowledge of the buyer.

In one scenario, a seller offers the buyer an incentive of a significant sum of money (sometimes hundreds of thousands of dollars) back at the closing table.

The buyer apparently is drawn in because not only do they get the property but out of the shoot they get a huge “equity” withdrawal that they can either sit on as a buffer or simply plunder on typical consumer items.

At first one might question why a buyer would want to purposefully overpay (i.e. have a much larger mortgage) for a property only to receive a significant chunk of money back from the seller at the closing.

But given the nature of our housing culture at the moment (“toxic” ARM loans, cash out refis, HELOCs), this scenario looks to be in-line with many of the other ridiculous activity that has recently occurred.

To the typical overly optimistic buyer, it appears to be simply a way of withdrawing equity that the property doesn’t have yet but is sure to in the near future.

Why not have fun now rather than having to wait for the equity it to build over time in order to get that HELOC or “Cash-Out” refinance?

In some sense, it’s hard to understand where the scam comes in with happy sellers moving property and happy buyers living easy.

Apparently though, many of these deals are coming with some of the same rigged mortgage broker and appraiser activity of the prior scam so that the property really appears to the buyer to be valuable and the buyer is helped in any way to qualify for such a great deal.

In addition, the overall effect on the nations housing market is sever as home prices are artificially inflated with a nearly certain outcome of price instability, especially for such illogical bubble markets such as Phoenix and Las Vegas.

Only time will tell what the total impact of these scenarios will be on an already stressed housing market but the one thing that seems fairly certain is that the varied and widespread mortgage fraud is currently hitting the wall with the resultant financial crisis bankrupting lenders on an almost daily basis.

Monday, January 22, 2007

Early Stages of Recovery = Late Stages of Denial

The National Association of Realtors (NAR) recently published an awkward series sound-byte video clips that were taken from an address given by their current President Pat Vredevoogd Combs, speaking at an NAR press conference.

In the clips, Combs is initially seen reiterating the now tired “It a Great Time to Buy” mantra as well as outlining additional details of the newly launched ad campaign that as Combs notes will be running throughout the year on both radio and television.

“Most consumers today understand that home ownership is a safe, secure way to build long term wealth.” states Combs adding “What consumers need more help understanding is how, or when to buy or sell… That’s where Realtors really make a difference in the marketplace.”

“Now may be the best time to buy a home in more than six years. In most real estate markets around the country ample inventory and near record low interest rates have created the best conditions for buyers that we have seen since the beginning of the real estate boom in 2001.”

It’s an interesting precedent to note that, at this point, NAR has declared that prices have stabilized rather than simply insinuating that they might be in the process of stabilizing.

Combs goes on to suggest that, “Realtors expertise and experience in their marketplace are invaluable in the current real estate environment of increased inventories, stabilizing prices and historically low interest rates.”

“As we enter a new year, signs that the real estate market is changing are everywhere. Sales were up in November for the second straight month, the first back-to-back sales gain since the spring of 2005. NAR Chief Economist David Lereah believes that the lowest point for the current cycle may have been reached in September and we are now in the early stages of recovery. By the end of the first quarter, with the opening of home buying season, we expect to see a new level of confidence to the real estate markets.”

In this way, the function of the NAR presents a unique scenario to say the least.

Not only do they publish some of the most important residential real estate economic indicators but after their Chief Economist conveys his “fuzzy” interpretation to a willing media (especially business media) their president then can freely blur the lines even further by interpreting the economist.

Clearly, a showdown of epic proportions is now brewing.

In the likely event that the spring market is similar or worse than last year, all this hubbub about market stabilization will be out the window and the NAR will be left looking plainly absurd and obviously in denial to virtually any sensible onlooker.

Friday, January 19, 2007

December's New Construction Report

The Bulls on Wall Street and in the real estate industry are getting ever more delirious, grabbing desperately yet confidently for any piece of evidence that might suggest that the housing decline has bottomed.

Driving to work yesterday I was surprised to hear CNBC report that the newly released “New Residential Construction Report” showed the largest monthly increases to permits and starts for a December in over 50 years.

As usual though, a closer look at the report reveals CNBC’s complete inability to simply read a report and present its findings without bias.

Firstly, EVERY year-over-year change to permits and starts both nationally and regionally were DOWN high double digits with the smallest decline being 14%!

Additionally, permits, arguably the most important indicator of the report showed declines perfectly in-line with the existing weakening trend.

It appears that CNBC had been a simply bamboozled by looking to closely at the overall permits and starts figures which appeared to be buoyed by unusually strong increases to multi-family construction.

If they had simply viewed the single family permits and starts figures they would have seen that December was completely in-line with the existing downward trend.

Here are the statistics outlined in today’s report:

Housing Permits


  • Single family housing permits up 1.2% from November, down 29.1% as compared to December 2005

  • For the Northeast, single family housing permits up 6.7% from November, down 21.5% as compared to December 2005.
  • For the West, single family housing permits down 0.4% from November, down 39.8% as compared to December 2005.
  • For the Midwest, single family housing permits down 3.8% from November, down 26.8% as compared to December 2005.
  • For the South, single family housing permits up 2.6% from November, down 25.4% compared to December 2005.
Housing Starts


  • Single family housing starts down 4.1% from November, down 24.7% as compared to December 2005.

  • For the Northeast, single family housing starts down 3.5% from November, down 14.0% as compared to December 2005.
  • For the West, single family housing starts went unchanged from November, down 23.5% as compared to December 2005.
  • For the Midwest, single family housing starts down 4.7% from November, down 26.4% as compared to December 2005.
  • For the South, single family housing starts down 5.7% from November, down 26.3% as compared to December 2005.
Housing Completions


  • Single family housing completions down 0.3% from November, down 8.7% as compared to December 2005.

  • For the Northeast, single family housing completions up 9.1% from November, down 12.4% as compared to December 2005.
  • For the West, single family housing completions down 2.5% from November, down 19.3% as compared to December 2005.
  • For the Midwest, single family housing completions down 7.2% from November, down 16.0% as compared to December 2005.
  • For the South, single family housing completions up 1.8% from November, up 0.5% as compared to December 2005.
Keep in mind that this particular report does NOT factor in the cancellations that have been widely reported to be occurring in new construction.

As further reports are released, cancellations should show an even greater effect on permitting, starts and completions.

Thursday, January 18, 2007

Leaning Against the Bubble

January is shaping up to be a pretty interesting month for interpreting Federal Reserve statements as they relate to housing.

It’s clear now that the Fed is very aware of the real possibility that we are about to experience a sharp correction in home prices and they are not only concerned about the spillover effects on consumption and economy as a whole but they are also taking “appropriate” action.

In the past, Federal Reserve Chief Ben Bernanke has argued that he does not support the “lean against the bubble” philosophy that would have the Fed practice and extra measure of monetary tightening on account of a presumed asset bubble.

In a speech given Wednesday, Federal Reserve Governor Fredric S. Mishkin reiterates this argument nearly identically except this time the unnamed and fictitious “asset bubble” of the Bernanke speech has been replaced with the very real “housing bubble”.

Both Bernanke and Mishkin argue that the central bank does not have an “informational advantage” over the free market that would allow it to better identify an asset bubble (i.e. properly price an asset better than the market can) and that, even if it did, monetary policy is far to blunt and instrument to use to control excessive price inflation for a single asset like housing.

Instead, they suggested that the Fed should only set monetary policy based on its fundamental charter of managing general inflation in the economy.

If an unusual asset bubble were to show itself to effect the economy as a whole, so be it, but the Fed is not willing to take what some would call “an extra measure of security” with extra tightening in a reaction to the presumed existence of a single asset bubble such as home prices.

Furthermore, both Bernanke and Mishkin agree that the Fed should take full advantage of its supervisory and regulatory powers in helping the nations financial institutions better cope with risks posed by sudden asset price declines.

In addition, both seem to agree that the Federal Reserve is far more effective at “mopping up” after a financial crisis than preventing one and that the Fed is prepared to fulfill its duties as a lender of last resort should institutions start to reel from sudden losses.

An important point to note here is that the Feds unwillingness to react to a single asset bubble should go both ways thus preventing them from raising rates to stave off an asset price bubble as well as cutting rates to stave off an asset price collapse.

In fact, this was exactly the sentiment noted in a speech by Vice Chairman Kohn last year when he suggested that home owners should not expect the Fed to act to preserve recent home prices gains.

Additionally, with the release of their regulatory guidelines for home mortgage lending, it’s easy to see that the Fed is executing as outlined.

Today though, Mishkin succeeded in putting the real face of the housing bubble on the fictitious “asset bubble” of the Bernanke speech.

Tuesday, January 16, 2007

Professor Case’s Jittery Eye

Karl Case, Professor of Economics at Wellesley College and co-creator of the S&P/Case-Shiller Home Price Index recently gave a series of presentations on housing to both the Federal Reserve Bank of Boston’s New England Study Group as well as Harvard University’s Joint Center for Housing Studies.

In the first of a series of policy briefs derived from those presentations entitled “The Changing Housing Market: A Bang or A Whimper?” Case recaps some of the factors that contributed to the extraordinary 15 year housing run as well as the prospects for the future.

As for contributing factors, Case includes interest rates and easy lending, Market psychology, stock market refuge, foreign demand, supply restrictions and Baby Boomer demographics.

Although, for Boomers he notes that, unexpectedly, it appears that Boomers view housing like previous generations viewed cars and other durable goods that consumers might own more than one of.

As was noted before, the 2005 National Association of Realtors Second Home Owner Survey shows that Boomers interest in second homes only just recently perked up and that the overwhelming majority of second home purchases were not for leisure but were, in fact, purely for investment.

Now though, Case notes that there has been a “sea change” in the housing market.

As for the changed factors, Case suggests that there has been a shift in the national psychology fueled by a steady stream of “popping” housing bubble magazine covers as well as the unsustainable disparity between household income and median home price, overbuilding and sub-prime mortgage meltdown.

Interestingly, Case also cites the Baby Boomer demographics as a “drag” on housing as retired “empty nesters” either downsize from higher price markets for lower or trade single family housing for urban condos.

This illustrates a point that has been made here many times, namely that many of the convenient arguments that have been promulgated in an attempt to justify the current run-up in home prices are fragile and can be argued convincingly, even by the same author, from both positions (i.e. either for or against support for the home price run-up).

Case concludes this segment of the series by stating:

“I currently lean toward the softer—though not easy—landing scenario. But it would not
take too much to make a softer landing much harder. A recession or rising long-term interest rates are among the factors that could turn a soft landing into a harder one. So too could another factor that is difficult to quantify: a continuing negative housing market psychology. Like everyone else, I’ll be watching out with a jittery eye.”

Thursday, January 11, 2007

UK’s Boom Goin’ Bust!

One of the more interesting facets of our housing boom is that it isn’t ours alone.

Simultaneous housing booms have been occurring all around the world (except Germany and Japan) and in particular the UK and Australia.

As John Talbott astutely noted in his book “Sell Now!” these concurrent booms offer some pretty compelling evidence that our home price inflation is not substantiated by the many local factors (Boomer demographics, building restrictions, immigration, etc.) some would have you believe.

Instead, it points to factors that have been experienced across all of these countries, namely low interest rates, loose banking and LOTS of liquidity.

Throw a dash of human nature into the crucible and BLAMO! Enter the mania!

This evidence should really serve as a wakeup call to anyone who has deluded themselves into believing that the many myths the National Association of Realtors has manufactured during the boom years are credible.

The key here is that local factors have certainly made some contribution but exactly what is not very well understood. See “A Second Look at Second Homes” for more details.

Today though, in a move that is sure to raise concerns about the stability of housing in the UK, the Bank of England (BOE) unexpectedly raised their benchmark rate 25 basis points; the rate now stands inline with eh US at 5.25%.

Apparently, this rate hike was so unexpected that not a single economist of the fifty two surveyed by Bloomberg predicted it would occur.

``We are already seeing a rapidly growing number of people falling behind with mortgage payments and in some cases threatened with repossession,'' Peter Tutton, policy officer at Citizens Advice, a consumer debt counseling service.

The decision ``will result in stagnation and prevent existing homeowners from moving up the ladder,'' said Philip Davies, chief executive of house-builder Linden Homes. ``Consumer confidence will be dented by this latest rise, implying the continuation of an upward trend in interest rates into 2007.''

So, it seems just as our housing markets inflated simultaneously, so too do our central bankers now struggle to gain control over our overheated economies, while walking a “fine line” between “soft landing” and financial disaster made infinitely more complex by unsustainable home prices and crushing personal debt

Copyright © 2007

PaperMoney Blog - www.paperdinero.com
All Rights Reserved

Wednesday, January 10, 2007

A Great Good Time to Buy!

As was widely reported, the National Association of Realtors (NAR) introduced a new “public awareness” campaign last November that sought to promote the idea that “It’s a Great Time to Buy or Sell”.

Initially, the “Buy Now” campaign attempted to stem the tide of buyer pessimism by targeting a selection of national newspapers in which a full page ad presented a variety of classic Pinocchio-Economic spin bits that NAR has become famous for.

But, that was just the beginning.

Along with the initial newspaper ads, NAR announced a $40 million television and radio campaign that would run all year long starting in January 2007.

Well, it’s now January and NAR just published the full campaign details including the full television commercials (watch now at BNN... buy or sell commercials), radio commercials, print and web ads, posters and even bus shelter placards.

First, it is interesting to note that NAR backed off the “Great Time to Buy” message from November instead settling for a “Good Time to Buy” slogan.

Perhaps, they realized that even a generally uninformed buyer might have a hard time jiving the “Great Time” optimism with all the recent headlines. Still though, the message is the same… buy now while you still have the opportunity!

My vote for the best “dishonest” slogan in the entire campaign reads:

“Out Realtor didn’t think the market would change. He knew it would.”

As well as hosting all the ad materials, the campaign site also includes the television and radio schedules outlining when the commercials will be airing. Currently, it shows the commercials will be running during a huge line up of primetime broadcast and cable spots as well as late night and popular sporting events.

Other underhanded tactics found in the advertisements include the following:

  • The “Good Time to Buy” television campaign includes a segment supposedly prospective buyers tout owning over renting, low interest rates, buying always being best for families as well as not missing the current opportunity to buy.
  • The “Know How to Sell” television campaign includes a seller stating that he wants to sell in 90 days whereby the Realtor purports to know how to achieve that end as well as stating that she has seen down markets like these.
  • The slogan: “It you’re still on the fence, picture yourself standing proudly next to the white picket variety”
  • The slogan: “Buyer’s market seller’s market. Either way, it’s an ‘I-Need-a-Realtor’ market.”

Monday, January 08, 2007

Downside Risk: A Mixed Bag from the Fed

The last two speeches given by Federal Reserve members Cathy E. Minehan, President and CEO of the Federal Reserve Bank of Boston, and Donald L. Kohn, Vice Chairman of the Federal Reserve shed further light on the Fed’s recent cautious yet somewhat mixed stance on the housing downturn and it’s possible effects on the overall economy.

Last Friday, Minehan offered an interestingly conflicted outlook seemingly remaining sanguine yet tentative.

Initially, Minehan frames the key concern of the “spillover” effect that the housing downturn could have on consumption quite nicely by stating:

“In the nonfarm business sector, inflation adjusted compensation growth fell short of productivity by 2 percentage points or more for several years until 2006. This slow wage growth occurred even as business profits were at historically high levels, causing worry that workers are not getting their fair share of the pie. Indeed, median household income fell in real terms in every year from 1999 to 2004, and even though it rose slightly in 2005 -- the latest year for which we have data -- it was still only at about 1998 levels. All of this begs the question -- could some combination of housing downturn and pressures on consumers produce a much slower rate of growth than now expected?”

While many local housing markets in the country saw median home prices start to diverge fairly dramatically from median household income in the 1997 – 2000 time frame, as Minehan points out, real median household income fell all the way through to the peak of the bubble in 2005.

This is important since household income is probably one of the most important fundamental long term factors that drive home prices and clearly hasn't played a key role in the price run-up seen in this cycle.

It takes only a little investigation to discover that the main impetus to the startling run-up in home prices during this period was a dramatic decline to real lending rates coupled with unparalleled access to capital through loose lending practices.

But are are unusually low rates and loose lending grounds for "fundamental" change in home prices?

Consider this, if the average 30 year fixed rate were to rise close to or even slightly exceed a 7.0% nominal rate in the next year or so, what do you think would be the outlook for the housing market then?

Not good I would imagine.

With prices in the stratosphere and income flat to declining, a simple 1% notch up in rates could easily bring affordability to its knees for most Americans.

Interestingly though, Minehan answers her own prior question with the following response:

“While possible [housing downturn putting pressure on consumption], in my view this is not likely for a number of reasons. First, a nationwide drop in house prices [as reported by OFHEO] fairly measured would be unprecedented, at least for any extended period of time. Indeed, as I noted before, there are signs that the real estate market may be bottoming out and prices firming, though residential investment growth is likely to be negative for some time. Second, employment trends remain solid, and equity markets upbeat, counteracting the impact on consumer wealth and spending from flattening or even falling home prices in some areas.”

Here, Minehan’s personal outlook seems to show some simple logical flaws.

Firstly, whether or not the OFHEO index registers a drop in home prices nationally seems to be a bit of a Non sequitur in that the OFHEO index is already showing declines to the Massachusetts, New Hampshire, Rhode Island, Michigan, and New York housing markets and significant decelerations to price appreciation in many more markets all resulting in the most dramatic deceleration in the index’s history.

Will the OFHEO index eventually register a decline for the first time in history? I think it will and sooner than many may be anticipating, but is the fact that that event is “unprecedented” grounds for adopting an outlook that the housing downturn is “unlikely” to cause significant spillover on the consumer? I don’t think so.

Additionally, Minehan supposes that the current strong employment situation and stock market gains will “counteract” the impact that rapidly deprecating home prices will have on the consumer.

On this point, I think Minehan is seriously underestimating the widespread and fundamental shock that loss of housing wealth will have on the ordinary American.

Home ownership is now at an all time high with nearly 70% of all Americans owning a home but as we all are well aware, significant percentages of "homeowners", especially in the last five years, have little to no or even negative equity in their homes as they desperately stretched to match the ever dwindling affordability by both foregoing deposits and resorting to the use of unusual and volatile lending products.

Many homeowners, who got in early and resisted the temptations presented by cash-out refinancing and HELOCs, may continue to feel confident, but with every 5% decline to home prices there are whole classes of more recent and low equity “owners” that are going underwater fast.

Furthermore, the employment picture has been strong (unusually strong) all through 2005 and 2006 and it failed prevent the massive declines to home sales and construction spending just as it will fail to support the home prices that were artificially inflated by many years of speculative mania.

Today, on the other hand, Vice Chairman Donald Kohn offers a more uncertain outlook:

“My expectations for 2007 quite naturally rest on an assessment of how recent trends are likely to play themselves out. How long will the decline in housing activity hold back overall economic growth? What about spillovers from housing to other sectors? What are we to make of the recent weakness in manufacturing activity? Will the recent good news on inflation persist? Before venturing some guesses on these questions, I need to issue two caveats. First, events will probably unfold differently than currently seems likely, and the range of uncertainty around any forecast is considerable. That uncertainty does not, however, diminish the value of having and discussing an outlook. Monetary policy must be based on our best estimate of future developments, and the effectiveness of policy is aided when the public understands the outlook of policymakers. But the uncertainty does underscore the value of monitoring the incoming information closely, as we always do, and of being prepared to adjust our expectations accordingly. Second, the views that I will express today are my own and not necessarily those of my colleagues on the Federal Open Market Committee (FOMC)”

Furthermore, Kohn adds:

“Home sales appear to have flattened out since midyear, mortgage applications have been increasing, and consumers' perceptions of homebuying conditions, as reported in the Michigan survey, have improved. Nonetheless, even if the demand for housing is leveling off, housing activity may not yet have found a floor, given the sizable overhang of unsold houses.”

Uncertainty about where we stand in the housing cycle remains considerable. In part, that is because this housing downturn has differed from some of those in the past in important ways. It was not triggered by a restrictive monetary policy and high interest rates; indeed, relatively low intermediate and long-term interest rates are helping to support the stabilization of this sector. But the current contraction in housing did follow an unusually large run-up in sales and construction and, even more so, in prices relative to the returns on other financial and real assets.

In my own judgment, housing starts may be not very far from their trough, but the risks around this outlook still are largely to the downside. Although house prices nationally have decelerated noticeably and appear to have fallen in some markets, they are still high relative to rents and interest rates. Building permits decreased substantially again in November, and inventories of unsold homes have only started to edge lower. We also do not know whether the possible stabilization that seems to be taking hold would be immune to a rise in longer-term interest rates should term premiums increase or the federal funds rate fail to follow the downward path currently built into market expectations. Even if starts stabilize at close to current levels, those levels are sufficiently low that overall construction activity would remain a negative for the growth of economic activity in the first half of this year.”

For my money, Kohn presents a more realistic outlook leaving open many opportunities for more additional downside risk for housing in 2007.

Saturday, January 06, 2007

Bernanke’s Umbrella

Flying well “below the radar” was yesterday’s speech by Federal Reserve Chairman Ben Bernanke entitled “Central Banking and Banking Supervision in the United States.

Although, this was not the type of event that could rival the day’s top headlines, even economic headlines, a closer inspection of the speech yields some uniquely relevant and timely information related to the plight of the housing market.

Namely, how the Fed and in particular, Chairman Bernanke, view the regulatory role of the Federal Reserve.

As was mentioned before, as part of it’s implementation of provisions of the Basel II accord, an international agreement which seeks to establish better management of systemic financial risk globally, the Federal Reserve recently published a series of regulatory recommendations that are to be implemented by the nations largest banking entities.

As a result, some institutions, such as New Century Financial (NEW.NYS), one of the country’s largest home lenders almost immediately implemented the recommendations.

The following is the list of changes announced by New Century in response to the Federal Reserves recommendations:

  • Tightening underwriting guidelines for its adjustable-rate mortgage programs for at-risk borrowers. This includes using the fully-indexed rate minus 1 percent as the qualifying rate for these borrowers.

  • Offering existing adjustable-rate mortgage (ARM) and interest-only customers who qualify the option of refinancing into a low fee 30-year or 40-year fixed-rate mortgage.

  • Implementing plain language disclosures that go beyond legal requirements in explaining terms such as prepayment charges, interest-only features, adjustable-payment features, escrows for insurance and taxes and other key features of a loan.

  • Enhancing its processes for confirming the income information provided on stated income loans. In addition to the closing certification currently employed, the company will introduce a new front-end confirmation early in the loan process to assist applicants in better understanding the terms of their loan.
This is no small achievement given that the new regulations could equate to a 20% to 50% reduction in loan originations, a substantial hit to their bottom line.

Other institutions, most notably, Countrywide Financial (NYSE:CFC), attempted to side-step the proposed regulations, at least in part, by applying for a change of status that would convert it to a federal savings bank unit of a savings and loan holding company.

This change, if approved, would put Countrywide under the regulatory oversight of the Office of Thrift Supervision rather than the Federal Reserve or the Office of the Comptroller of Currency.

This is where things may be heating up a bit.

Bernanke’s speech yesterday made direct reference to this type of organizational model stating:

“The Federal Reserve also serves as the umbrella supervisor of all bank holding companies and financial holding companies, which gives the U.S. central bank broad oversight responsibilities for these banking organizations. However, the bank and nonbank subsidiaries of such holding companies are often supervised by agencies other than the Fed.”

Bernanke goes on to assure that even in the case of subsidiaries of savings and loans, the Federal Reserve has certain regulatory oversight:

“At the operational level, the Federal Reserve System (including the twelve regional Federal Reserve Banks) works closely with other agencies to examine banking organizations and to ensure that they operate in a safe and sound manner and comply with the relevant laws and regulations. … I have already mentioned the Fed’s role as the umbrella supervisor, which affords it access to information (as well as direct or back-up examination authority) for all holding-company subsidiaries, nonbank organizations as well as banks.”

Bernanke then goes on to further outline the benefits of the Federal Reserve’s supervisory role as well recount some of the more notable financial crises’ and the Fed’s response.

In concluding his speech, Bernanke adds:

“I should be clear that my purpose today is not to make a comprehensive case that our current regulatory structure is ideal. To the contrary, we should always be looking for ways to make supervision more effective and less burdensome. My point today is a narrower one: that the supervisory authority of the Fed has significant collateral benefits in helping it carry out its responsibilities for financial stability.”

I think the key take away from this speech is that Bernanke has yet again reaffirmed his belief in importance of the Fed’s role as a regulator, and even went so far as to spell out in some detail the extent of it’s “umbrella” of regulation.

There is no doubt that Bernanke was suggesting that even subsidiaries of holding companies still fall under certain oversight of the Federal Reserve.

Thursday, January 04, 2007

Pending the Bottom

Today, the National Association of Realtors (NAR) released its November “Pending Home Sales” report which showed that nationally, pending home sales had declined 0.5% as compared to October and dropped 11.4% as compared to November 2005.

The National Association of Realtors developed the “Pending Home Sales” index (PHI) as a leading indicator based on a random sampling of roughly 20% of the month’s transactions for exiting home sales and indexed to the average level of contract activity set during 2001.

In typical fashion, David Lereah, Chief Economist of the National Association of Realtors attempted to spin the data to a more positive outlook while presenting yet another version of his fatigued Pinocchio-economic “market has bottomed” analysis.

“Because there is a stronger parallel between changes in the index from a year ago and the actual pace of home sales in coming months, the index is pointing toward fairly stable home sales in the near future, … That is another indicator that home sales likely bottomed-out in September.”

As usual, looking more closely at the results one might draw a less optimistic conclusion:

  • Nationally the index was down 11.4% as compared to November 2005
  • The Northeast region was down 9.6% as compared to November 2005.

    Additionally, November marks the sixth consecutive month that this region has registered activity BELOW the average activity recorded in 2001, the first year Pending Home Sales were tracked.

  • The West region was down 15.9% as compared to November 2005.
  • The Midwest region was down 11.9% as compared to November 2005.
  • The South region was down 8.9% as compared to November 2005.
Alternatively, examine at the follow Pending Home sales charts produced by NAR (these are from Octobers report, Novembers should be available later today) and see if you can find the bottom.

The top chart shows the progress of the national PHI since January of 2005 while the lower chart shows the progress of national PHI since January 2003. The left side of both charts is the PHI value, the bottom is the date.

So it appears that, year-over-year, contract activity is dropping rather sharply with ALL regions now showing significant declines.

Wednesday, January 03, 2007

Snap! Crackle! Pop!

Starting off the New Year with a “BANG!” comes today’s “Construction Spending” report showing truly astounding and ever accelerating weakness to the nations construction activity.

Most notably was the decline to single family construction and improvement spending which dropped and whopping 20.4% as compared to November 2005.

This is a particularly important report in that it is both a precursor to additional declines that will likely be seen in the “fixed residential investment” line item of the upcoming Q4 GDP report as well as representing a key indicator of the housing market in general.

Additionally, this severe down draft to construction activity should serve as a harbinger of things to come for the residential construction and related job markets.

As 2007 progresses we are likely to see a correspondingly sharp increase in unemployment as residential construction projects complete and unneeded workers are shed in the tens of thousands nationwide.

Recently, it has been reported that there are roughly two million vacant newly constructed homes in the US apparently representing one million more homes than normal.

By all accounts, it will take the home builders and investors that are holding all of these homes quite some time to work through this excess inventory which should continue to put a serious damper on construction spending and the job market as well.

Today’s report posted the eighth straight monthly decline to total dollars and the twelfth consecutive year-over-year decline as a percentage change.

Key Report Details:

  • The seasonally adjusted annul rate of private residential construction spending has now dropped 11.47% from the peak set back in December of 2005.
  • Overall private residential construction spending dropped 11.13% as compared to November 2005.
  • Single Family residential construction spending dropped an astounding 20.4% as compared to November 2005.
  • The latest 11.13% year-over-year decline is the largest percentage drop in over 12 years and the greatest drop to date for this year and for this cycle.
Review the following charts (click for larger version) to see the extent of the current decline in private residential construction:

Monday, January 01, 2007

Construction Capitulation: A Look Back at 2006

As we now know all too well, 2006 was the first complete year of a national housing downturn that is generally known to have begun its descent back in June of 2005.

Although having shown a significant pullback in sales in many markets during the fall selling season, 2005 was such a strong year for housing overall that it seemed to leave many observers with a false sense of security as to the outlook for 2006.

Many industry experts sensed a slowdown was immanent, but the existence of a bubble condition and the extent to which a resultant decline would materialize was still hotly contested even by veteran economists.

Some even suggested that with some “new math”, the housing bubble scenario could be completely reasoned away in favor of an alternative view that would assert that many of the county’s hottest housing markets were at fair value or even cheap.

But as the year wore on, many found it harder and harder to maintain any confident position that would suggest that housing was not experiencing a major slowdown and the debate gradually shifted to the impact that it might have.

Additionally, and somewhat quietly, the Federal Reserve cautioned homeowners not to expect Fed to rescue the housing market and that in fact, the tools that the Federal Reserve has at its disposal are far more effective at cleaning up after a financial collapse than preventing it from occurring.

With the housing market continuing to loose steam and home sellers on their own and feeling the strain, August arrived bringing with it the first major turning point of the year.

The results of the spring selling season were in and the story they told was as plain as day; sales had literally plummeted for new and existing homes, inventory had reached record levels, purchases of Saint Joseph statues were skyrocketing in many of the former “hot” markets, foreclosures were on the rise, and accounts of widespread new construction cancellations circulated while home builders shed land parcels in record numbers.

The traditional media was now ablaze with stories about the housing market and in particular home sellers hitting upon hard times.

Even the National Association of Realtors (NAR) had to concede before they appeared to be totally disconnected from reality.

During the NAR’s yearly leadership conference, Chief Economist David Lereah gave a presentation entitled “Reality Check” in which was covered virtually every point that could possibly be made to support the argument that a housing bubble did in fact exist and that it was in the process of deflating in a dramatic and unprecedented way.

Upon entering the fall, it was plainly obvious that the nations housing market was in for a far more significant decline than many had anticipated.

In an ironic note, it was discovered that the then president of the National Association of Realtors, Thomas Stevens could not sell his home in suburban Virginia after listing it for well over 365 days. In an embarrassing series of interviews he suggested that he would have had better luck had he just listened to his Realtor and lowered the price.

Stevens home continues to stand unsold and at the very same listing price it has had for over 460 days.

In September, The Senate Banking Committee convened a two part hearing on the housing bubble and toxic lending demonstrating at the very least that the government was aware that a real systemic risk did in fact exist.

In an unrelated event, the Federal Reserve published the first of a series of regulatory recommendations that identified specific risk in the home lending market and suggested policy changes that lenders would need to follow in order to carry out the implementation of the Basel II accord that seeks to better manage systemic banking risk.

Some large lenders like Contrywide Financial attempted to side-step the regulations by reorganizing as a thrift thus exempting it from all oversight by the Federal Reserve; others such as New Century Financial simply accepted the recommendations and implemented them verbatim. Some lenders that had already begun to face unexpectedly large numbers of delinquent and defaulting loans began to take more extreme measures.

In any case, the reports of widespread regulatory tightening of home lending were in fact coming true leaving millions of potential home buyers and refinancing home owners facing greater scrutiny and lenders facing dramatically lower loan originations.

But still, there was tremendous debate about how long the downturn would last, how deep it would drop and how hard it would hit the overall economy.

Then, after receiving some comforting words from none other than former Federal Reserve Chairman Alan Greenspan in October, the sentiment seemed to shift as he suggested that he was seeing a flattening in the purchase applications series published by the Mortgage Bankers Association (MBA).

Many credible sources lined up behind the Greenspan outlook suggesting that a bottom may have been reached and that the worst of the housing decline was in fact already over.

Then, a bomb was dropped.

Preliminary Q3 GDP came in way under consensus with a major decline to residential fixed investment.

When the final GDP revisions were eventually released it showed that the housing decline had stripped 1.2 percent from real GDP, the most significant quarterly decline in over 15 years.

The news now seemed to be getting the better of many in the real estate industry causing what appeared to be inconsistent assessments of the current circumstances and even some flaring tempers.

In November, UBS held a yearly home builder conference where the CEO of D.R Horton declared that the current housing market was akin to a “Death Spiral” while Bob Toll and Ara Hovnanian traded blows over tactics some builders used to move unwanted land.

Now it seemed that all the bad news was just too much for the National Association of Realtors to take and in November they decided to go on the offensive by introducing a $40 million advertising campaign entitled “Buy Now” promoting the idea that “It’s a great time to buy or sell”.

Ironically though, this attempt to persuade buyers and sellers corresponded exactly with the latest survey results from real estate and home builder practitioners which showed that the men and women in the field felt quite the opposite.

As the year drew to a close, there still existed some significant debate about the fate of the housing market except now the debate centered on how badly things would eventually turn out, a stark difference compared to the debates taking place just a year earlier when many optimistic real estate bulls and economists suggested housing might only experience a limited to no slowing in 2006.

As a possible harbinger of what is in store for 2007, the Federal Reserve modified their final issued statement for 2006 by adding the single word “substantial” before the following sentence:

“Economic growth has slowed over the course of the year, partly reflecting a substantial cooling of the housing market.”

Now with a new year ahead and a critically important spring selling season the stakes could not be any higher.

The new year will likely show continued slowing and even increasing declines to home sales but what will be more shocking to the average home owner this year will be the dramatic decline of home prices especially in the formerly “hot” regional housing markets.

It’s a one two punch of fantastic proportions as 2006 set up the perfect circumstances of plummeting home sales, bloated inventories and slumping sentiment leaving 2007 poised to tee-off, dropping the US housing market to the canvas for a long and debilitating ten count that may not be overcome for many years or even decades to come.