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Buyers won't borrow money until they know prices won't fall further
By Caroline Baum
Bloomberg News
Published on Tuesday, Jan 22, 2008
Maybe, just maybe, housing is stabilizing.
That was the hope at year-end 2006, based on a plateau in existing home sales. After falling 13.6 percent from a peak annualized rate of 7.21 million in September 2005, sales of existing homes treaded water from September through December 2006 and came up for air in January and February before submerging again.
Home sales manifested the same pattern a year later, stabilizing from September through November at a pace 20 percent below that of a year earlier. (Existing home sales for December will be reported Thursday.)
There is hope once again that housing has bottomed — hope that's as audacious as it is misplaced.
''People do not like to borrow money to buy depreciating assets,'' said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, N.Y. ''Until potential buyers can plausibly believe prices will not fall further, home sales will continue to decline.''
Prices are the mechanism through which supply and demand find equilibrium. There are too many homes for sale — those newly built and old ones owners would like to unload — relative to demand. Prices will have to fall farther, with potential borrowers running into tighter credit standards and rising costs associated with buying a home.
Wait a second. Haven't interest rates fallen in the last six months?
Yes, they have. The real cost of buying a home is a function of the actual cost (mortgage rate) less the return (house price appreciation). When home prices are falling on a national average basis, as they are now for the first time since the Great Depression, the real cost of borrowing goes up.
Using the S&P Case-Shiller Index, home prices nationwide fell 4.5 percent in the third quarter of 2007 compared with the same quarter in 2006. With the 30-year mortgage rate at about 6.17 percent, the real cost of buying a home is over 10.5 percent.
If this year is anything like last year, a prospective homeowner can't expect to defray the added cost with gains in his stock portfolio. A broad basket of U.S. equities rose 3.8 percent in 2007, less than the rate of inflation.
The good news for the residential real estate market is that home builders have finally gotten the joke and are slashing production, Shepherdson says.
''In recent months, the inflow (of homes for sale) has been slower than the pace of sales,'' which has the effect of reducing the inventory of new homes, he said. ''In the three months to November, the gross inflow of new homes onto the market plunged at a 60.7 percent annualized pace compared with the previous three months,'' a cutback comparable to one last seen in the housing bust of 1981.
Residential construction
might be a small share of the U.S. economy — 4 percent in the third quarter — but it has a big footprint. Construction activity ripples through a whole host of manufacturing industries: half of the 18 NAICS codes (the system used by the North American Industry Classification System to define industries) tracked monthly by the Institute for Supply Management, according to Norbert Ore, chairman of the ISM Manufacturing Business Survey Committee.
The nine manufacturing industries affected by housing are: Wood Products; Furniture and Related Products; Textiles; Petroleum and Coal Products; Plastics and Rubber Products; Transportation Equipment; Primary Metals; Fabricated Metal Products, and Nonmetallic Minerals.
Maybe that's why the manufacturing group's December snapshot was so glum. The ISM Index fell 3.1 points to 47.7, the lowest in almost five years and the result of big declines in the indexes of new orders (45.7) and production (47.3). Only five of the 20 industries reported an increase in new orders last month. Even orders for exports, the economy's strong suit, showed less of an increase than in the prior month: The export index fell 6 points to 52.5.
So where's the incentive to buy a home if the real cost is high, inventory is plentiful, prices are falling and credit is harder to come by?
There isn't one, at least not yet. Interest rates and prices are apt to fall farther, the expectation of which will keep qualified home buyers at bay. The effect of new federal and state regulations for mortgage lenders, while ensuring that the most recent housing free-for-all doesn't happen again, will be to depress lending in the near term.
The word ''housing'' warranted 20 mentions in the minutes of the Federal Reserve's Dec. 11 meeting, and none of the references were positive.
Policy makers acknowledged the ''intensification of the housing correction,'' said it was ''likely to be both deeper and more prolonged'' than they anticipated, admitted to ''some spillover'' to consumer and business spending, and warned that stresses in mortgage finance could further weaken the housing market.
The Fed staff expects the drag from housing to weigh on economic growth throughout 2008 and 2009. Hopes for a bottom dashed again.
Maybe, just maybe, housing is stabilizing.
Get the full article here.
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