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The Bottom of the Housing Market

Why the Latest "Rescue" will Fail

Written by Brian Hicks
Posted July 24, 2008

Shill: (slang)-verb: to advertise or promote a product as or in the manner of a huckster.

Lawrence Yun is at it again and this time it's even more embarrassing than the last.

But I guess when you are the paid mouthpiece of the National Association of Realtors (NAR), you don't really have much of a choice. Either you climb to the top of the trench and make a mad dash into the machine guns or you take one from your own side. Anyway you slice it it's a no-win situation.

Nonetheless he was out again today for his monthly trip into the fifth dimension declaring once again that the phoenix was about to rise from the ashes. "I think," said Yun, "we are very near the end of the housing downturn."

More Housing Bubble Pain

Meanwhile his own statistics betrayed him as the fallout from the housing bubble grinded on.

According to the NAR, existing home sales fell by 2.6% in June to a seasonally adjusted annual rate of 4.86 million units from 4.99 million in May. That current sales pace falls 15.5% below those from June 2007 as transactions continued to shrink dramatically from their bubble peaks.

Prices, according to the group also suffered falling a whopping 6.1% over last June. As a result the national median existing home price was $215,000 for the month vs. $229,000 a year ago.

The reason for Yun's optimism? It is the latest housing "rescue"-read bail out—- making its way through Congress.

According to Yun, a tax credit provision within the bill of $7500 for first time homebuyers will be enough to end the slide, finally drawing in all of those mysterious people he insists are just hanging out on the sidelines.

Of course, the bill is full of all kinds of other goodies courtesy of the U.S. taxpayer because the list of things "too big to fail" is growing. Because when all else fails it is up to the taxpayers to socialize the losses. So much for the free markets.

But the darker truth behind cheers is no different than it was six months ago when I wrote the 6 Reasons why the Bottom on the U.S. Real Estate is Nowhere in Sight

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6 Reasons There's No Housing Bottom Here

In fact, just to review here are the six solid reasons why those all of those rescue plans will end up long on rhetoric and short on substance.

Together they add up to a market that just can't be fixed—or jawboned for that matter. They are:

1. Macro-Economic Decline - For years now those who have been housing's biggest bulls have cited a growing economy, low interest rates and low unemployment as the reasons why real estate couldn't possibly decline. Nonetheless, after peaking in 2005 housing did fall, completely blind to those same conditions.

However, some three years later, the macro-economic conditions have dramatically changed, led not coincidentally by the bursting bubble. That sets up the real estate market for its fatal blow as both a weakening economy and now job losses are beginning to accelerate. That's a nasty brew that not even historically low rates can fix. These factors alone are enough to send housing lower in the year ahead.

Mortgage rates, by the way, are actually headed higher-not lower. U.S. 30-year mortgage rates rose to an average of 6.63 percent from 6.26 percent a week ago, while 15-year mortgages averaged 6.18 percent, up sharply from 5.78 percent a week ago.

When they hit 7% it's going to be lights out.

2. The Credit Crunch - When the money to lend was sloshing all around the globe, rising real estate values were a no-brainer. In fact, those excesses were so large that they helped to turn a normally illiquid asset into a liquid one practically over night.

But with the foreclosures and defaults now off the charts in the U.S., that same pool of liquidity has suddenly gone dry. And as one lender after another has to drain their cash reserves to cover those mounting losses, their pool of deposits to lend against has dropped dramatically.

That means that what each of them can lend in the future will now fall exponentially—to the tune of 10 to 1. That's the downside of fractional reserve lending. So for every dollar that each lender sets aside for losses that's $10 that now cannot be loaned out.

It is, in short, the workings of banking leverage in reverse. In fact, according to a forecast by Washington Mutual at the end of last year, the credit crunch will lead to 40% fewer mortgage originations in 2008 as the dollar volume falls to $1.5 trillion this year from $2.4 trillion in 2007. That's huge.

3. The Fed is No Savior - A 1% Fed funds rate for over a year may have started the epic bubble, but this go round lower rates have done nothing to stop its slide. That's because try as they may, the Fed can't add any air to market, no matter how low rates go.

The reason? Lower prices now and in the future make today the worst to time to be entering the housing market—no matter what your realtor may tell you. In fact, according to a recent report by Goldman Sachs, home prices will likely decline by 15 percent nationwide from their peak. But if the United States enters a recession home prices could fall as much as 30 percent nationwide. Those aren't exactly the types of declines that will be luring buyers off the sidelines anytime soon.

Moreover, price declines approaching 20% will completely wipe out the second mortgage market. And when that happens, the mortgage market will be changed in ways that lower rates will never be able to compensate for.

Higher mortgage insurance and heftier down payment requirements as a result will further limit the ability to qualify.

4. Tougher Lending Standards - Back in the day when anyone and everyone could qualify for a loan, keeping home prices down was nearly impossible. Because when lending standards became as loose as they did, anyone and everyone that wanted to buy home did. And using a mix of option ARMs, interest -only loans, sub prime teasers, and liars loans, borrowers flooded the markets with a level of demand that will never be seen again.The result was a doubling of home values.

But as the absolute foolishness of those days has been exposed, lenders have gone completely in the opposite direction, turning back the mortgage clock a good ten years. That has made borrowing money considerably tougher, even for "good" borrowers.

In fact, according to a recent study by the Federal Reserve, banks are now raising their credit standards for mortgages, consumer loans and commercial real estate loans at a pace never seen in the 17-year history of the Fed's quarterly survey of senior bank loan officers. That means that an entire level of would-be borrowers has been locked out of the market for good, further weakening demand.

Simply put, people that can't borrow money don't buy homes.

5. Massive Oversupply - When home price appreciation was at its peak demand was so great that on average there was a 4 month supply of homes on the market. That skinny supply scenario helped to push the market into another level.

But with demand having peaked in 2005, not even good economic times could stop or slow down the build up of inventory nationwide. In fact, according to today's numbers from the NAR existing homes have grown to a 11.1 month supply. Those are figures that will continue to grow as demand shrinks and mounting foreclosures pour onto the markets.

That will push prices lower in the years to come as the laws of supply and demand continue to work in reverse.

6. The Affordability Gap - When liar's loans and outright fraud disconnected a person's ability to borrow from their income, chasing home prices beyond real affordability was easy. But now that a persons ability to actually make their payments has suddenly become the rage again (go figure), home prices will return to their traditional anchor. That is income.

The result will be lower values across the board. That's because historically, median home prices and median income have always shared a pretty consistent relationship. In fact, from the 1970's until 2001 the historical ratio between median home prices and median income was between 2.6 and 3.0.

So where are we today? Well with the median home price at $208,400 and median income at about $49,000 that leaves us at a ratio of 4.25—more than 30% beyond the historical norm. That means that in order to return to a historical level of affordability either incomes have to rise significantly or values have to fall by as much as 30% on average nationwide.

That's a gap that's hard to finesse. Here's a bet on falling values rather than rising incomes.

So it looks like Mr. Yun will be at it again next month.

By the way, if you are wondering what ever happened to our old pal David Lereah, he slipped out the back door over a year ago.

But now that he is now longer shilling for the National Association of Realtors, Lereah has changed his tune entirely. In fact, in many ways he has finally come clean.

Housing Lereah says now is not at the bottom after all.

Last month he told Newsweek, "We're not at the bottom. People want it to be near the bottom, but we're not there yet. The leading indicators are still very bad. Pending home sales are still in bad shape. Mortgage applications are low ... There's still supply out there in abundance ... This thing is going to get worse before it gets better."

Your bearish-analyst,

steve sig

Steve Christ

Chief Investment Analyst

The Wealth Advisory

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