The Future of Higher End Housing Prices

Between government stimulus spending and zero interest rate policies, today’s business managers can’t be confident that price and profit signals are valid. Even if your business isn’t tied directly to the federal budget, it’s likely that many of your customers or suppliers depend on federal spending in some fashion.

Federal subsidies are never free. One way or another, their costs are extracted out of the private sector. Yet policymakers are acting in a manner that assumes the private sector is working its way back to the economy we saw in 2006-07. The idea goes as follows: Stimulus spending is supposed to kick-start household spending. Zero interest rates are supposed to kick-start another wave of bank lending.

But this isn’t happening because many have misdiagnosed the reality we’re facing: Too many balance sheets need to de-lever, and if policy tries to stop this process, it will fail. And in the end, the public-sector balance sheet will be strained to the breaking point, which will have its own disastrous consequences for the private sector. The consequences of the attempt to “keep consumer spending up” to unsustainable levels will ultimately be disastrous.

The most-glaring recent example of the market drawing conclusions from misleading economic data is in the recent surge of stocks tied to the U.S. housing market. Investors are all of a sudden convinced that a recent blip up in seasonally adjusted housing starts will last. Mark Hanson, a widely cited expert whose opinion I’ve respected since first reading his work in 2007, summarized his view on housing in an early February note to clients:

“In the past several months (the slow season), the housing sector has no doubt benefited from a major stimulus of sorts…record-low rates; artificially low inventory; the most-favorable weather conditions in recent history; an epic backlog in foreclosure completions; [year-over-year] comps against the 2010 tax-credit hangover period; and a near-record volume of stale MLS listings being pulled off the market in order to ‘refresh’ them for the spring — right when seasonal adjustments are at their peak. In order words, a confluence of transitory factors has, in fact, caused some incremental and significant pulled-forward demand — and increased general housing- and consumer-related activity — during a time of the year when this type of activity is generally slow. But many of these factors have a high probability of reversing into the spring, meaning the payback will be much slower activity when conditions are generally busy… never lose sight of the fact that U.S. housing suffers from a narrow and finite demand foundation, which we continually focus on.

“When this housing recovery theme falls apart, the bull cases across a number of sectors will have their legs cut off over a three-month period, just like last year. And the gap between the consensus (further improvement into springtime) and the more-than-likely realization that the double dip continues is extremely large.”

In many areas of the U.S., low-end home prices are competitive with rentals. Mortgage rates are near all-time lows, and prices have already crashed. But high-end home prices will continue to drop for years to come. One’s primary residence is increasingly being viewed as a slowly consumed durable good, rather than an “investment.” Financing for more-expensive houses is also scarce. Banks aren’t interested in writing jumbo mortgages; even if they were, the traditional “move up” buyer is hard to find. If he can’t sell his existing house, he likely won’t have the down payment for a larger, more-expensive house.

This disappearance of the move-up buyer is important, especially because Wall Street is now under the mistaken belief that in early 2012, housing is in the early stages of a strong recovery.

“The next phase to the U.S. housing crisis is house price compression,” Hanson writes, “the upper price bands [will compress] on the lower. It’s already happening. The data we watch closely every day are clear. This adds an entirely new dimension to the U.S. housing crisis, one that pushes out an ultimate “recovery” a lot further into the future than anybody is forecasting, or can model.”

The excess supply of housing — especially at the middle and higher end of the market — will take several more years to clear. Prices will fall as this unfolds. After slowing foreclosure activity in 2011, most banks are set to accelerate sales of repossessed houses in 2012.


Dan Amoss