Jan012009

Predictions for 2009

On January 1, 2008, I wrote a post titled Predictions for 2008. You can go back and review it to see how well I did.

As a recap, I would like to share with you a couple of charts from 2008 for Irvine and OC:

original_versus_actual_2013

 

original_predition_2007

Click for larger image

Most of the macroeconomic conditions I made in 2008 are still operative, and several of the predictions I made which came true will likely repeat in 2009. These are:

  1. 2008 will see the worst single-year decline in the median house price ever recorded
  2. One or more of our major financial institutions and one or more of our major homebuilders will fail
  3. A severe local recession
  4. I predict we will see many more angry homedebtor’s troll the blog

I do not believe 2009 will see median house prices decline as much as 2008, but I do believe they will drop significantly, particularly in high-end neighborhoods. The low-end neighborhoods are closer to the bottom than to the top, so 30%+ declines in these neighborhoods are not likely. The high end neighborhoods will experience big drops. Most did not drop 30% last year, so they have more room to drop. The unemployment rate is high, and the economy is in recession which will put pressures on home prices. The dreaded ARM problem is not going away, and these loans will start blowing up this year and on through 2011.

However, there is one bright spot for the housing market that will blunt the declines in 2009: ultra-low mortgage interest rates. We will see properties at rental parity in 2009. The low interest rates are going to reduce the cost of borrowing to the point that many properties will reach rental parity this year. This does not mean we will be at the bottom. These interest rates are artificially low due to the “quantitative easing” by the Federal Reserve. This policy may persist for some time, but it is not likely that sub 5% interest rates will be around for buyers 7-10 years from now when 2009 buyers go to sell their property. That creates the issue with Your Buyer’s Loan Terms.

With the low interest rates, and with the foreclosures resulting from this year’s loan resets being a year away, we are in a good position to see our first bear market rally. This summer, we might see two or three months of sustained appreciation. This will bring out all the bottom callers. Everyone will be cheering the Federal Reserve, and many will believe the worst is over for the housing market. This will cause some major emotional gyrations for desperate homedebtors. Those who had moved from denial to fear will likely move back to denial for a time.

Remember, the loans that reset this year will take a year or more to become foreclosures. The real problems caused by all the resets will not be apparent this summer. We will likely see a large number of short sale listings, but as we all know, these rarely consummate a transaction. It is only the presence of these short sales listings that will remind us of the impending disaster when the ARM reset problem becomes a tsunami of foreclosures. When these foreclosures start hitting the market in larger numbers, and the market rally is reversed, all of those who call the bottom this summer will act surprised. Ignorance is bliss.

Not to get too far ahead of ourselves, but 2009s bear rally will be wiped out by the first wave of foreclosures. I foresee 2010s bear rally being knocked back by continuing foreclosures and the much-anticipated rise in interest rates when the FED stops quantitative easing as the recession abates. The rally in 2011 will be tepid, but at least it will be for real. For 2012-2015, appreciation will be less than 5% each year as the overhang of foreclosures and a sputtering California economy keep prices in check until Californian’s lose their minds again and inflate another housing bubble.

In my opinion, these artificially low interest rates will simply guarantee that house prices overshoot fundamentals to the downside because the fundamentals in this instance are illusory. The low interest rates will prompt some people to buy, and this increased buying activity will stop prices from falling as much as they would have without the subsidized interest rates. However, very few people currently qualify for these loans. Loan terms are getting tighter all the time, and the buyer pool is very restricted. People talk about the conservative lending terms as if they are too tight. This is nonsense. We are still not at pre-bubble loan terms (20% down, 28% DTI, high FICO, etc.) and until we get there, loan terms will continue to tighten. The diminished buyer pool when combined with increased foreclosures creates an imbalance between supply and demand which will push prices lower.

Many people erroneously believe that low interest rates are going to save the housing market because the loan resets are not going to lead to foreclosures. As I outlined in the ARM problem, the payments are going to increase even if the interest rate remains the same due to the amortization recast.

Last year I predicted that we would see banks and homebuilders go under. We did see several banks including WAMU bite the dust. This trend will continue. All of our banks are basically insolvent. Only creative accounting practices and huge amounts of borrowing from the Federal Reserve is keeping them afloat. Even the huge infusion of money through the TARP program is not going to save them. There will be many more failures and consolidations in 2009.

One surprise from 2008 was the lack of bankruptcies and consolidations in the homebuilding industry. Ordinarily, during a recession, the weak companies go out of business or are absorbed by stronger ones. In my opinion, the reason we have not seen this yet in the homebuilding industry is because there are no strong ones, and there is no reason to consolidate or expand while housing starts and sales continue to decline. I think 2009 will be different. In the second half of 2009, the homebuilders will start to rebound. If past history is any guide, the recession will bottom when housing starts bottoms. This is when the industry will begin to consolidate.

I believe we will see massive consolidation in the homebuilding industry. During the 80s and 90s the homebuilding industry was dominated by small, private builders. Many of the small fry were wiped out during the recession of the 90s. During the 00s, we witnessed the rise of the national homebuilders as the dominant market force. I believe we will see consolidation into an industry dominated by a few big names with a few small privates picking up the scraps in various markets.

Last year I predicted a severe local recession. I did not have the courage to predict a severe national recession. Perhaps I should have…