The housing bottom consensus could have been wrong

Economists are correct in their forecasts less often than weathermen. Some of the better ones have learned how to make their predictions vague enough so nobody notices, and the best ones revise history and make people believe they were right all along. Right now, the consensus among economists is that the housing market has bottomed. Perhaps it has, but there is also good reason to believe it has not.

First, although delinquency rates are dropping, they are still almost double their historic norms. Delinquency precedes foreclosure, and foreclosure rates are still 10 times historic norms, and these rates are not dropping. In fact, we have not yet turned the corner on foreclosures.

The reason foreclosure rates are so high and likely to stay there is because lenders are yet to empty the enormous reservoir of shadow inventory.Until these delinquent borrowers are removed from these properties through short sale or foreclosure, these sales will continue to pressure home prices.

It isn’t only delinquent borrowers who will contribute to distressed inventory sales. Until the ocean of underwater loanowners is drained, each of those borrowers who wants to sell will become a short sale. People won’t be willing to stay trapped in their underwater homes for a decade or more. Sellers who have no equity and want to move really don’t care about the resale price, so they are more likely to price a property aggressively to sell as quickly as possible. If the bank won’t let them sell, most will strategically default and become a foreclosure.

Lenders believe they can correct the negative equity problem by raising prices. With the dramatic slowdown of lender liquidations of late, they have been making some progress, but unless they are going to let millions of delinquent borrowers squat until prices rise back up to the peak, the liquidations of REO from processing their previous bad loans will keep prices from rising to far too fast. How does a market bottom in the face of such a large quantity of short sales and foreclosures?

Perhaps lenders are counting on resurgent demand? The only problem is this demand does not exist. Look carefully at the graph of purchase applications. Do you see an increase in demand?

So think about what these eminent economists are saying. Because inventory has been withheld from the MLS by bank artifice and prices have ticked up slightly, we should all ignore the problems with high delinquency rates, high foreclosure rates, an enormous reservoir of shadow inventory, and weak demand. Hmmm… Does that make sense to you?

Groupthink is the problem

One of the defining features of groupthink is a self-reinforcing consensus. Economists are among the worst at succumbing to this form of fallacious thinking. As you read through today’s featured article, notice the pattern of self-reinforcing delusion and squelching of other opinions. Just like 2007 when the consensus completely missed the collapse of the housing bubble, and like 2010 when the consensus called the first bear rally the bottom, groupthinking economists are often wrong. Few economists have carefully looked at the evidence pointing to continued declines, and of those who may see the problems, even fewer have courage to stand alone and state all the reasons the housing bottom may not be as durable as projected.

Housing Passes a Milestone

Updated July 11, 2012, 7:51 p.m. ET

The housing market has turned—at last.

The U.S. finally has moved beyond attention-grabbing predictions from housing “experts” that housing is bottoming. The numbers are now convincing.

Are the numbers now convincing? Let’s take a closer look.

The indices have still not turned positive (see chart on left). Further, the current price improvement is of a smaller magnitude than the bear rally of 2009 and 2010 that fooled the economists last time. If you look at the existing home sales chart on the right, you see that sales volumes are still about 10% lower than 2000 and about 35% below the sales volumes at the peak. Sales have not surpassed the tax-credit induced nonsense of the bear rally.

The chart on the left above is single family home starts. In 2009, single-family starts fell to the lowest level recorded since 1958 when records were first tallied. Since 2009, starts have remained in the doldrums. The nearly indistinguishable uptick in 2012 has not surpassed the bear rally of 2010, and is still nearly 50% below the lowest low recorded over the 50 years prior to the collapse of the housing bubble.

Ask anyone looking for work in the homebuilding industry, and they will tell you very little has changed. Perhaps homebuilding is contributing something to GDP again, but until employment picks up in the industry, we won’t see a broader economic recovery.

In short, nothing about these numbers looks particularly bullish, and they certainly do not conclusively prove the market has bottomed.

Nearly seven years after the housing bubble burst, most indexes of house prices are bending up. “We finally saw some rising home prices,” S&P’s David Blitzer said a few weeks ago as he reported the first monthly increase in the slow-moving S&P/Case-Shiller house-price data after seven months of declines.

Since this is July, a season uptick in prices is normal and expected.

Nearly 10% more existing homes were sold in May than in the same month a year earlier, many purchased by investors who plan to rent them for now and sell them later, an important sign of an inflection point. In something of a surprise, the inventory of existing homes for sale has fallen close to the normal level of six months’ worth despite all the foreclosed homes that lenders own.

It was a surprise that lenders abruptly changed their policies and stopped taking on new REO. What isn’t a surprise is that lenders are manipulating the market.

The fraction of homes that are vacant is at its lowest level since 2006.

The reduced inventory of unsold homes is key, says Mark Fleming, chief economist at CoreLogic, a housing data-analysis firm. For the past couple of years, house prices have risen in the spring and then slumped; the declining supply of houses for sale is reason to believe that won’t happen again this year, he says.

For the past couple of years? How about every year without fail. Perhaps Mr. Fleming is right and the total lack of inventory will prevent prices from dropping this fall and winter. There is no real reason to believe that will happen other than wishful thinking.

Builders began work on 26% more single-family homes in May 2012 than the depressed levels of May 2011. The stock of unsold newly built homes is back to 2005 levels. In each of the past four quarters, housing construction has added to economic growth. In the first quarter, it accounted for 0.4 percentage points of the meager 1.9% growth rate.

“Even with the overall economy slowing,” Wells Fargo Securities economists said, cautiously, in a note to clients, “the budding recovery in the housing market appears to be gradually gaining momentum.”

Economists aren’t always right, but on this at least they agree: A new Wall Street Journal survey of forecasters found 44 believe the housing market has reached its bottom; only three don’t. (The full results of the Journal’s July survey will be released at 2pm ET)

Economists are right about 50% of the time, and on many occasions they have all agreed and been terribly wrong. The quick change to form this new consensus is a classic example of groupthink.

Housing is still far from healthy despite the Federal Reserve’s efforts to resuscitate it by helping to push mortgage rates to extraordinary lows: 3.62% for a 30-year loan, according to Freddie Mac’s latest survey. Single-family housing starts, though up, remain 60% below the 2002 pre-bubble pace. Americans’ equity in homes is $2 trillion, or 25%, less than it was in 2002 and half what it was at the peak. More than one in every four mortgage borrowers still has a loan bigger than the value of the house, though rising home prices are reducing that fraction slowly.

It’s worth pointing out here again that most economists who quote the percentage underwater figures use Zillow’s estimate based on the current value as compared to the original first mortgage. Zillow does not take into account subsequent refinances or second mortgages, nor does it allow for transaction costs to get out of the property. The true percentage of underwater loanowners is closer to 50% with beaten down markets having much, much higher rates.

Still, the upturn in housing is a milestone, a particularly welcome one amid a distressing dearth of jobs.

Has common sense prevented economists from asking how the market is supposed to bottom with such low demand due to the “distressing dearth of jobs?”

For some time, housing has been one of the biggest causes of economic weakness. It has now—barely—moved to the plus side. “A little tail wind is a lot better than a headwind,” says economist Chip Case, the “Case” in Case-Shiller.

From here on, housing is unlikely to drag the U.S. economy down further. It will instead reflect the strength or weakness of the overall economy: The more jobs, the more confident Americans are about keeping their jobs, the more they are willing to buy houses. “Manufacturing had led growth and construction had lagged,” JPMorgan Chase economists said last week.”Now the roles are reversed: Manufacturing growth has slowed as private construction comes to life.”

Plenty could go wrong. The biggest threat is a large shadow inventory of unsold homes, homes which owners won’t put on the market because they are underwater, homes that will be foreclosed eventually and homes owned by lenders. They have been trickling onto the market, slowed in part by government efforts to delay foreclosures; a flood could reverse the recent rise in prices. Or the still-dysfunctional mortgage market could get worse. Or overly zealous regulators or a post-election change in government policy could unsettle mortgage lenders or home buyers.

He acknowledges the elephant in the room, but proclaims this elephant won’t do any damage. Crazy.

But the housing bust is over.

Bullshit. This writer’s proclamation does not make it so.

Perhaps we have seen the bottom tick in nominal prices, but perhaps not. All the problems I outlined at the beginning of this post are still in play. Wishful thinking does not make a market bottom. It makes economists who indulge in it look like fools.