Extending the Housing Bust Predictions

It says something about the growing irrelevance of print media that this cover of Time magazine, sitting on newsstands in late August, came to our attention only this week…

We can imagine the thought crossing the minds of at least a few readers: “Wow, maybe we really have hit bottom in housing.” You know, magazine covers as contrarian indicators – including the all-time classic…

Today, that cover stands as a monument to bad calls, coming just as the stock market launched an epic 18-year rally. Except it didn’t, really…

What people forget is that famous BusinessWeek cover hit the newsstands in August 1979…but the stock market didn’t hit bottom until August 1982. With hindsight, we could say it forecast the bear market would stick around for another three years.

So if the Time cover is a reliable indicator, we still have another three years of housing bust ahead of us. Sure enough…

“The slide in US home prices may have another three years to go,” reported Bloomberg just yesterday, “as sellers add as many as 12 million more properties to the market.”

Bloomberg cited the research of Morgan Stanley analyst Oliver Chang, who examined a phenomenon we’ve long chronicled in this space – the “shadow inventory.” That’s all the homes in foreclosure that lenders are keeping off the MLS, lest they flood the market and push down prices even further than they already are.

“The issue is there’s more supply than demand,” says Chang. “Once you reach a bottom, it will take three or four years for prices to begin to rise 1 or 2% a year.”

Coming onto the market soon – 95,364 more bank repossessions that took place during August. That’s a record high, according to RealtyTrac.

But lenders sent out 5.5% fewer default notices compared to a year ago. That means there’s even more shadow inventory backing up in the pipeline. “There is a buildup in delinquent loans that are not in foreclosure,” says RealtyTrac’s Rick Sharga. “It’s a managed slowdown more than anything else.”

So the slide in prices goes on: Home prices in July were flat compared to a year earlier, according to CoreLogic. It was the first month since January that prices didn’t register a year-over-year increase, however meager. In 36 states, prices outright fell – the highest number since last November.

The number of home sellers who cut their prices grew in August for the third straight month, according to the real estate website Trulia. 26% of sellers cut their prices, the highest percentage since last October. The average price cut was 10%.

What could turn this around? “When we see job growth across America,” says Trulia CEO Pete Flint, “we can begin to discuss stability in the housing market.” (Good luck with that: First-time jobless claims fell a paltry 3,000 last week, to 450,000. That total needs to be at least 100,000 less to signal economic growth.)

Even people who don’t worry about their jobs are giving up on the American Dream. Last weekend, the San Francisco Chronicle profiled a couple who qualified in 2006 for a $625,000 mortgage…yet was priced out of the market.

Fast-forward four years and prices are down… but now the couple qualifies for a mortgage of only $280,000. “Our incomes haven’t changed, but the rules have changed,” the husband says, “so we don’t really talk about buying houses anymore. We’ve shelved it.” We suspect they’re not alone.

There’s another problem facing the housing market this fall, one that a sharp-eyed reader reminded us of recently…

“Do you have a ‘we are here’ plot of the Alt-A/subprime, etc., [coming up soon]?” the reader asks. Ah, the famous Credit Suisse chart of adjustable-rate mortgage resets.

“I think Alt-A is going to spike in September-October, so it would be nice to see that one again in an updated form.”

Ask and ye shall receive. And the reader is right: We should hit a peak in resets next month…with an even-higher peak coming late next year.

“The government’s mortgage modification programs have been a complete failure,” says Strategic Short Report’sDan Amoss, assessing Uncle Sam’s attempts to prop up the market. “They have not addressed the problem of negative home equity.

“The level of home equity is the leading predictor of mortgage defaults and foreclosures,” Dan explains. “With housing prices set to weaken once again, we could see several months of self-feeding downward spiral: In an environment of weak housing demand, selling adds pressure to prices, which begets more selling… There’s still more room to the downside for prices to return to pre-housing bubble levels.

“In banking, they often say, ‘The first loss is the best loss.’ With a renewed downturn in housing prices, we could see a rush to liquidate the ‘real estate owned’ that’s been sitting on bank and GSE balance sheets waiting for a rebound.”

So the trickle of shadow inventory hitting the market now could soon become a flood.

Dave Gonigam
for The Daily Reckoning