Apr052012

Despite optimism, signs point to ongoing market weakness

Everyone seems to believe the market bottom is in. Investors are buying up cheap homes in beaten down markets, Calculated Risk called the bottom, sentiment among realtors has turned positive, and the mainstream media is flooded with optimistic spin about housing. But have we really hit the bottom?

Grim Housing Data Shows We Have Not Hit Bottom

By MICHELLE HIRSCH, The Fiscal Times — March 29, 2012

A new string of grim housing data confirms what economists and analysts have long predicted: the housing market has yet to hit bottom, and once it does, it will be a long slog back to health and stability.

The nation’s heap of completed foreclosures remained steep, barely budging to 65,000 in February compared to 66,000 one year earlier, according to new data released by CoreLogic Thursday.

The percentage of American homeowners more than 90 days delinquent on their mortgage payments, including those in foreclosure, rose to 7.3 percent in February compared to 7.2 percent a month earlier. …

According to today’s report, 3.4 million properties have gone into foreclosure since the financial crisis in September 2008. About 1.4 million, or 3.4 percent of all properties with a mortgage, were in the foreclosure process in February …

Delinquency and foreclosure rates remain well above historic norms.

That follows new data from the S&P/Case-Shiller Index that U.S. home prices sank in January for the fifth straight month to the lowest level since 2003.

Additionally, separate reports from the National Association of Realtors and CoreLogic show existing home sales and previously owned homes under contract shrank in February. The number of bank-owned homes either in the foreclosure process or seriously delinquent—the so-called shadow inventory—remained unchanged from six months earlier at 1.6 million units.

Shadow inventory may be unchanged from six months ago, but it is currently growing (see red below).

We’ve still got millions of foreclosed homes waiting to come on the market, so we’re not going to see any dramatic rebound in house prices,” cautioned Paul Ashworth, chief economist at Capital Economics. He predicts over the next few months that home prices will slowly start to rise, which will slowly nudge homebuyers back into the market and lead banks to start loosening lending criteria. “But property is a slow-moving asset, unlike stocks or equity where things can go up or down ten percent in a day. We’re not going to get a rapid rebound after the housing bust we just went through.”

… “Our view is that foreclosures, excess supply, and weak demand will drive home prices as measured by the Case-Shiller indices down at least another 5 percent,” said Patrick Newport, a U.S. economist with IHS Global Insight. …

To foreclose or not to foreclose, that is the question.

Consider the current set of circumstances and how the banks are going to move forward. First, banks want their money back. In a normal lending environment when a borrower stops payment, the bank forecloses and gets back the outstanding loan balance plus lost interest, fees and costs, and they then loan that money to someone else. For lenders even a non-performing loan generally becomes profitable in the end — at least until the housing price crash. Now lenders are desperate to get back whatever money they can as soon as they can. They can’t make good loans with capital they don’t have, so their desire is to sell foreclosures as quickly as they can to get their money back. However, lenders learned painfully in 2007 and 2008, if they foreclose as quickly as they can, prices crash, and they recover smaller and smaller fractions of their outstanding loan balances, and their lending capital becomes depleted to the point they are no longer solvent.

This is the quandary facing lenders, and how they manage these competing forces will determine the fate of the housing market. If they foreclose and liquidate on the MLS too quickly, prices will go down. If they do not foreclose and liquidate quickly enough, they might go down — at least the banks that aren’t too big to fail.

Lenders are united in their actions right now. They are withholding inventory to reverse the downward momentum of house prices. Once prices turn, they will speed up their liquidations and sell into the resulting rally thus diminishing its impact. With the delayed feedback from the market, lenders may find they have released to many properties and prices start to fall again. If so, they will restrict the inventory once again. This process of releasing inventory, evaluating the results and making corrections will be ongoing until all the delinquent loans are resolved through short sale, loan modification, or foreclosure.

So why not withhold all product and make prices go back up to the peak? That would certainly please loan owners and lenders, but it won’t happen. The lending cartel is still a cartel, and each member has a strong incentive to foreclose and get their capital back. Remember, they need that money to cover their operating costs and make new loans. Each member of the cartel who cheats will sell properties to recover capital. Other cartel members will see this behavior and copy it for the same benefit. In short, lenders don’t have the discipline to withhold enough product to force prices to move significantly higher.

Over the next several years, the market will chop around. We will see rallies and drops as lenders liquidate. We may bottom this year, or next year, or any of the next several. It all depends on how lenders release their REO, and luck. Timing the bottom won’t be a big deal. The bottom won’t be a single buying opportunity. We will bottom over and over again over the next several years, which bottom will be the lowest drop is anyone’s guess. I predict they will all be pretty close.