Mr. Moderate

I hate to harp on the housing crisis but several new articles came out today and if you didn’t know what the underlying story was you might tend to believe that everything was well here in America. The housing market will not be cured for many months, and perhaps years to come. However, that does not mean that certain local markets might not experience a short-term boom on occasion. If you are “flipping houses,” there may yet be some room to maneuver if you are in the right market. But sooner or later, if you are not careful, you will get caught holding the bag and one bad deal can destroy all of your profits.

First, take a look at one symptom of foreboding:

According to a report from consumer credit reporting agency Experian, borrowers with credit scores of 620 or below are 30 days late more often with mortgage payments than with payments on bank-card debt.

In the past, people in financial trouble (i.e., those who have low credit scores) would do everything they could to make their mortgage payment and, if money was short, it would be the credit card bills that would get put off. Most states protect some amount of home equity against creditors, so you could keep your house, and all of its equity, even in bankruptcy, so long as you could make your mortgage payment. And after all, who wants to be homeless?

If low-score borrowers are letting their mortgage payments slide while paying down their credit cards, that means they have made a conscious or unconscious decision to allow the house to go back to the bank. In such a situation, they are probably “upside down” (owe more than the house is worth), realize it, and realize that it is a bad economic deal for them to continue to pay mortgage payments when they are bound to lose the house in any case. Having reached that point, it becomes their highest priority to reduce other kinds of debt, particularly high-interest credit card debt. This is what a rational person would do, and generally speaking, the market reflects the rational decisions of its participants.

The implications of this situation is that there are a lot more foreclosures waiting out there in the wings to add to the inventory of unsold homes than any market optimist would care to see. The situation cited above is highly-unusual in American economic history, and must be taken as a serious sign of severe economic distress to come.

Housing is the great engine of the American economy, and if home builders are slowing down, and if resales are also slowing down, then eventually the whole economy must also slow down. So long as nothing (like massive foreclosures) drives up the inventory, eventually the market will bottom and housing will recover. But, given the above data from Experian, can it be said that massive foreclosures aren’t in the cards?

Second, we should look at the just-released statistics:

Existing homes sold at an annual pace of 5.99 million last month, down from a revised 6.01 million rate in April, according to the report from the National Association of Realtors.

…

The glut of homes for sale on the market rose 5 percent from April to 4.4 million homes, leaving an 8.9-month supply of homes for sale on the market. The last time the group estimated that many months of inventory for sale was June 1992.

So, we’ve reached a 15-year high in terms of “months of inventory” on the market. Of course, low sales volume will drive that number up, as will higher actual inventory numbers. So, which way will sales move? Well, housing sales (and the prices at which homes sell) are largely driven by available credit supplies, and those supplies are substantially smaller due to the melt-down of the sub-prime mortgage market. If I was renting, and somebody came up to me and told me that for the same amount of monthly payment I could buy a home, I would be a fool not to jump at the chance. The only hold-back is available mortgage money. A lot of unworthy borrowers were put into homes as a result of the sub-prime mortgage market. That drove housing prices and home sales up (a lot). Now, as the creative loans used to put those people into homes come home to roost, in the form of unaffordable higher adjustable monthly payments, people are just forced to give up. And you can tell it from statistics like the Experian numbers quoted above.

The above statistics shows that nationwide we have “an 8.9-month supply of homes.” What does that really mean to the housing market? Well, one economist had this to say:

Because housing markets are intensely local, it won’t do much good to check national figures. Instead, stay alert to leading indicators of recovery in your local market, …

In markets with fewer than 6.5 months of inventory, homes tend to be appreciating faster than inflation, says Mark Dotzour, chief economist at the Real Estate Center at Texas A&M; above 6.5, prices are lagging inflation.

Above nine or 10 months, prices start to drop, creating an ice-cold market for sellers. Compare the current data with that of the previous few quarters to see whether the trend is downward or upward.

Nationwide, the trend is bad, quarter over quarter. Of course, the article is correct: not every housing market nationwide is experiencing the same bad effects. Some markets may well be already through the worst of it and on the road to recovery. But the average market nationwide is not done declining; not by a long shot.

If you are really interested in buying a home, check the number of months of inventory for your local real estate market. Pick a few houses with “for sale” signs in front of them and watch to see how long they take to sell. (I’ve been watching one home here for a very long time and it is still on the market today, in spite of “reduced price,” etc.) Or find a real estate agent you can actually trust (very difficult for most of us) and ask them for honest statistics on the local housing market. Cross-check whatever you are told, and match it to the numbers quoted above.

Yes, there may be a few markets where housing will show some strength during the rest of this year; but the vast majority of markets will remain cool, and the statistics quoted above explain exactly the reasons why. Deny these facts at your own risk!