Do you think you’ve hit bottom? Oh, no. There’s a bottom below. - Malvina Reynolds
To begin with after the end of a house price bubble homeowners feel that they have some sort of entitlement to the previous high value of their homes. If they can’t get it, they often won’t accept lower offers. So, previously established highs tend to be “sticky”. This is exemplified by the trend of sales shown in Berkeley, CA, multiple listing data between the late 1960’s and early 1980’s. Sales volume went down. Inventory went up. Prices didn’t drop.
There is also normally a “resistance level” in the house market at 80% of the previous high. The reasoning is that conventional loans normally require about 20% down payment. As long as properties can be sold for more than 80% of the previous high, no problem. If prices hit that level then the market gets stalled in the foreclosure process. Both sellers and lenders have a problem. “Short sales” can be quick and easy. But they cost the lenders as they recognize a loss and cost the sellers as they book a paper gain which is subject to income tax. As lenders are increasingly unable to absorb losses they try to hold out for their mortgage amount. Needless to say, the borrowers can’t afford to pay more taxes. Concessionary lending to facilitate sales at that nominal price level can obscure a further decrease. This is exemplified by Redwood Shores, Redwood City, CA, in the early 1990’s. Prices were off about 20% from their 1989 highs and about half the sales were foreclosures.
My initial take on the bubble (late 2006), was that we would about split the difference and get a 10% decline peak to trough, assuming that the economy didn’t tank. Further, I figured that the market would probably stabilize in 2009. There might even be some dead cat bounce. Well, I’m wrong. Median prices are now at about 80% of the 2006-7 high and still heading down. Part of the problem, but not all, is that the economy has gone off a cliff.
That’s probably not too surprising. I estimated the magnitude of the mortgage problem at about $1 trillion*. Goldman Sachs agreed six months or so ago. I bounded the upper limit at $2 trillion*. If correct, that’s in round numbers 10% of the GDP. That represents a pretty hefty chunk of annual gross investment. At this moment the government is in the process of trying to fill that hole. Hope the effort works. If it does, then the housing market has some chance of stabilizing in 2010.
Another way of looking at this is to consider that a lot of people who normally wouldn’t become homeowners were such at the top of the bubble. Heard an anecdote. Apparently Goldman Sachs had a small appraisal department to look at the appraisals in the loans they were packaging. The normal percentage of odd appraisals was about 5%. In 2007 that rose to 40%. G-S got out of underwriting and into the short selling business. A possible measure of this problem is the percentage of homeownership. It probably topped at about 69% in the 4th quarter of 2006. In 2000 it was more like 67%. As there are about 150 million households in the US, the difference is something like 2-3 million homes. That represents something like half a year’s supply at the usual home sales rate of around 5 million per year. As of late 2008 the rate had fallen to about 68%, so maybe half the homeowners who squeezed in for the bubble have been squeezed out. It’s taken about two years. Given that the rate of home sales, including foreclosures, is now under 5 million, it might take that long or more to get the other half squeezed out. Or you could take a look at the annual rate of sales. Between two and three million “extra” home sales happened in 2006-7, a number roughly consistent with the excess ownership percentage. At this point something less than half of all sales are foreclosures, and the rate of sales is something over 4.5 million per year, so the rest of the excess might get squeezed out this year.
Notwithstanding all the political posturing, the rate of homeownership may dip below trendline; more supply in a glutted market. The equilibrium marketing time for houses is something like four months. It’s presently more like a year. Might easily be that long this time next year.
So, what might the equilibrium house price be at the bottom? Let’s say that the 2003-4 price level was supportable by income ($180k/$60k ±) with the low interest mortgages available at the time. Let’s say, further, that for the next couple years mortgage rates will remain at least that low. But unemployment is likely to rise and incomes are unlikely to inflate enough to make up the difference. So, don’t be surprised to see the bottom somewhere around a national median price near or below $180k. That’s between 25-30% off the 2006 high. In 2006 that was a nightmare scenario.
Rising mortgage interest rates at some point are going to come into play. If they are in response to inflation, as in the 1970’s, they probably won’t stop the stampede out of money and into tangible assets. At one point in the ‘70’s a very good rate of return could have been earned on a carload of toilet paper. Further, assumable low fixed rate mortgages may add value to houses so encumbered. Back to the future for the appraisers’ argument about concessionary financing and cash-equivalence. So, a little bit of inflation not only cuts into effective indebtedness, fear of more might stimulate demand. Am told that some poisons work in a similar fashion.
All that said...
There’s a low below the low you know. You can’t imagine how far you can go...down. - Malvina Reynolds
back of the napkin notes -
*The $1-2 trillion is based on mark-to-market and present prices. The “hold to maturity/workout” value of all the junk at, say, 15% rate of return might be substantially higher, and the loss correspondingly less. Pencil it out at 50% recovery over five years assuming 100% foreclosure. Then compare with recently reported prices on CDOs. Part of the question is how much were the mortgages marked up when packaged into exotic securities? Had to be something to pay all those bonuses. The other part of the question is how low can we (the house market) go. Of course commercial mortgage backed securities are following house loans into the tank with possibly even worse fundamentals.
Above normal homeownership -
Total owned houses - 100 mil ± @69% ownership, 98 mil @67% (2000 level) 67.8% (2008), 68.9% (2006, 4 qtr). Excess - 2 million
Typical annual house sale turnover 5 mil ± Bubble turnover 6 mil in ‘07, 7 mil in ‘06 ± 2 year excess 3 mil ±
“Total housing inventory at the end of July rose 3.9 percent to 4.67 million existing homes available for sale, which represents an 11.2 month supply at the current sales pace, up from a 11.1 month supply in June. The rise in supply results from a sharp increase in condo inventory; the single family supply declined...
Existing-home sales, including single-family, townhomes, condominiums and co-ops, increased 3.1 percent to a seasonally adjusted annual rate of 5.00 million units in July from a downwardly revised level of 4.85 million in June, but are 13.2 percent lower than the 5.76 million-unit pace in July 2007.” http://www.realtor.org/press_room/news_releases/2008/08/july_ehs_show_gain