The Housing Bubble

From CBS News in California. “The unsold inventory of new homes in Orange County is at the highest level since 1996, according to an economic forecast released Friday in Irvine. Through August, sales of existing homes in Orange County were off 29 percent compared to the same period a year ago, the largest year-over-year decline, according to the UCLA Anderson Forecast: Orange County Economic Outlook for 2007.”

“The rate of sales over the last five months have been ‘brutally low,’ with Southern California home sales falling to their lowest level in nine years last month, according to the forecast. The current state of existing home sales in Orange County and most of Southern California is in ‘freefall.’”

“‘The long-awaited real estate correction is under way, but there’s little agreement about how brutal the landing will be,’ the report states. The report noted there is a ‘growing notion that this year’s sales decline is the roughest, most sudden correction ever observed in the housing market.’”

“The report noted that what usually happens when a real estate market bubble bursts ‘is that sales just dry up’ because buyers won’t buy homes at the listed price and sellers are unwilling to cut their prices. It described the result as ‘the economic equivalent of Chinese water torture.’”

The Union Tribune. “Locally based DataQuick Information Systems said foreclosures totaled 171 last month, more than 10 times what they were a year ago and the highest since 1998.”

“Similarly, the number of default notices – the first step lenders take toward foreclosure, was 872, nearly triple the 334 filed in September 2005. Meanwhile, RealtyTrac, based in Irvine, reported area default notices totaled 1,236, up from 287 a year ago, and notices of trust-deed sales, the final notice before foreclosure, were at 247, up from 56 over the same period.”

“DataQuick analyst John Karevoll attributed the rise to the flattening of home prices. ‘The people who get into trouble are not able to use their homes to get out of trouble the way they were able to do when there was strong appreciation,’ he said.”

“RealtyTrac’s Rick Sharga said the recent increases reflect the ‘first wave’ of defaults and foreclosures stemming from the rise in adjustable-rate mortgages whose interest rates are rising too fast for some borrowers to afford. At the peak of the buying boom, he said, as many as 70 percent of borrowers in San Diego were signing up for ARMs, DataQuick has reported.”

“‘What we don’t have a precedent for in the marketplace is that many of that type of mortgage, especially not all that adjust at the same time,’ he said,”

The San Francisco Chronicle. “The number of homeowners in foreclosure has soared in Solano and Contra Costa counties in the past year. Foreclosure activity in Solano County increased nearly fivefold, while in Contra Costa County they almost quadrupled, according to RealtyTrac.”

“‘These are all the fast-growing regions in terms of home building, where a lot of first-time home buyers were getting into the market,’ said economist Christopher Thornberg. ‘These are the people who are most susceptible to a slowdown in market and these are the people who are the most overexposed.’”

“New construction attracted some investors who got in over their heads and buyers who relied on discount mortgages that are now resetting at higher rates, two factors that are pushing up foreclosure activity, said Leslie Appleton-Young, chief economist for the California Association of Realtors.”

“‘The majority of new construction, well over 50 percent of the new construction in Southern California, took place in the Riverside-San Bernardino Inland Empire,’ Appleton-Young said. ‘That’s where you saw the most activity in terms of people coming in and perhaps buying a few units to invest or driven by affordability issues got in at a very discounted mortgage rate.’”

“She and Thornberg both said they expect foreclosures to continue to climb. ‘The foreclosures, at least for a while, are going to keep going up and up,’ Thornberg said. ‘This is going to feed on itself.’”

The Sacramento Business Journal. “New-home sales tumbled 46 percent in the third quarter from a year ago, the latest evidence of a struggling housing market in the Sacramento region.”

“Only 1,956 new homes were sold in the just-completed quarter in the six-county area, 1,634 fewer than a year ago, according to The Gregory Group. It was the worst third quarter since the Folsom company started keeping track of the market in 2000.”

“The region’s median-home price dropped 3.9 percent to $440,240, the lowest price since the second quarter of 2004.”

“Housing inventory in the region, including lots ready for building, reached 4,598 in the third quarter, more than five times the 875 homes and lots in second-quarter 2004, the lowest point since 2000. About 20 percent of the current housing inventory is completed homes waiting on buyers, Group owner Greg Paquin said.”

“Not including incentives, the average new-home price dropped to the lowest level since third-quarter 2004 in Sacramento, Placer and Yolo counties. From the second to the third quarter, the average price dropped almost 5 percent in Sacramento and Yolo counties, respectively. New-home prices fell 3.6 percent in Placer County.”

“El Dorado home prices continued to rise as new high-end homes opened in Serrano. But overall sales in the county still dropped 59 percent.”

“Rising incentives could lure bargain hunters. The average incentive of $14,916 in the third quarter was 218 percent higher than in the third quarter of last year. The perks reached up to $50,000 for new homes and $125,000 for existing homes, according to the Gregory Group.”

Several readers suggested federal funds rate policy as a topic. “Was listening to the radio this amr. I forget if it was Bloomberg or CNBC. The announcer said that several of the big banks predict the Fed is gonna DROP rates this or next neeting. Almost all predict a drop in early to mid ‘07.”

“The responder said: (paraphrase) ‘are you kidding? retail sales are up the last 3 months. Wages have risen, gas prices are down. The consumer seems as strong as ever.’ To me, it now seems obvious that the Fed will risk inflation/hyperinflation to save housing as much as possible. Otherwise they would have raised. Instead, they’re squaking like chickens and then holding the FFR steady.”

“Perhaps the Fed actually does see housing as ‘too big to fail,’ specifically because of Fannie/Freddie, all the MBS out there, and the potential ’systemic risk.’ A little stealth inflation to steal the bailout from us, instead of repeating the obvious S&L bailout?”

A reply, “I wonder if we don’t end up like Japan with a deflation problem after this plays out. Japan tried to inflate its way out of its bubble and had interest rates at basically 0 % but no one would spend. There seems to be a consensus that this can’t happen here, but certainly the Japanese are not any less capable at solving problems than us.”

Another said. “What is a fall in mortgage interest rates suppose to do? 14+ increases from the FED and the 30 year rates have barely budged. (To my great bafflement). The money printers really want to put the brakes on RE and get things back to reality, you need to push to the mid 9’s, like Greenie did in ‘94.”

“The RE mess still boils down to a market run-up fueled by toxic loans. The fool pool has been fished out. People are being educated to the realities of being stuck with a highly illiquid ‘asset.’ Feds can do a Japan drop for all that matters. But the point still remains-average incomes cannot purchase an average house at today’s levels. FED is stuck in the mud.”

And another, “Dropping rates won’t solve the issue. The effective interest rate for purchases is below what they can sustain the dollar on due to funky financing and the total overextension of credit. It’s doomed to implosion, suckering in more buyers only extends the population who will suffer.”

One looked at the markets influence. “The Fed sets very short term interest rates. Longer term rates, like the 10-year (which is what the 30-year mortgage generally follows) are set by the market and its expectations. Obviously, the market expectation is that over the next 10-year period, rates will moderate. That doesn’t rule out a big spike in short term rates at all.”

“Now whether ‘the market’ and its expectations will turn out to be correct over the next 5-10 years, that’s a whole ‘nother story.”

One said, “People aren’t buying based on 30 yr fixed anymore anyway. One of the big causes of a housing meltdown will be when people’s ARMs reset. When they reset, they will of course reset higher. The people are in trouble because they can’t afford the new payment, they can’t afford to sell, so they foreclose.”

“Dropping the FFR will likely drop the ARM rates. Thus, as people get to their resets, their payments don’t jump as much, and thus less of a ’shock.’ This will NOT lead to increases in housing prices again. But it may slow the fall of housing prices.”

“Thus, the fed may be trying to engineer a ’soft landing.’ By allowing as many people as possible to either refinance into ARMs or by keeping their payments down upon the ARM reset. It just buys time. In the end, it’s giving borrowers more rope to hang themselves.”

“But borrowers have proven that they are stupid beyond belief. Many of them will be thankful for the gift from the benevolent fed. In the process, lowering the FFR will of course cause the dollar to start losing value. thus, we Americans will become more ‘competitive.’ Thus, our incomes (in nominal of course) will rise somewhat. Or at least not fall as far as they were falling due to global arbitrage.”

One looked at the consequences of lower rates. “Reducing the fed funds rate prematurely will cause inflation and once the bond markets realize we aren’t headed into a deflationary recession they would demand a lot more than 4.8% yield on 10 yr treasuries.”

“The other problem as you mentioned would be a significant deterioration of the dollar. This will fuel inflation as imported goods are more expensive, and will also create a glut of bonds as foreigners refuse to buy dollar denominated assets. We could see yields go through the roof, which would really put the screws to housing.”

“The only thing that can help housing would be wage inflation, and I think global labor arbitrage through offshoring and massive illegal immigration is going to keep a lid on the price of labor.”

“I don’t expect the FED to cut rates until late 2007 after negative GDP growth is reported and both stocks and housing have lost a lot of steam.”

One comment from Las Vegas. “I can see how lower rates would help homeowners who got sucked into the mania and purchased more house than they could afford, but I’m not sure how much lower rates will help folks who bought two, three, or more homes with the intention of selling quickly at a profit. How long can those ‘investors’ afford to wait before they must sell? I see lots of empty homes here (Vegas).”

One pointed out, “My husband and I are currently renting and have no motivation to purchase a home right now. Why? Housing prices are simply too high relative to incomes. We just don’t want to put ourselves at financial risk by buying a house. If we had to move a few years from now, who could afford to buy that house from us? At the current rate at which wages are (not) increasing, the answer to that question will be: No one.”

The New York Times. “Maybe the sputtering housing market will not be that big of a drag on the economy after all. Falling gas prices are leaving Americans with more money to spend, and inflation has become less of a threat in recent weeks, according to a report released yesterday by the Federal Reserve.”

“The growing trade imbalance with China was a major factor in the ballooning trade deficit. The unadjusted trade deficit for August was $79 billion. The numbers defied expectations. Economists who were surveyed before the numbers came out predicted that the overall deficit would fall in August, but it rose.”

“When the gap hit a record in July, economists said they believed that the numbers were nearing a peak. But as energy prices remained high this summer, the deficit continued to swell. Still, many economists said yesterday that they now believed that the turning point was near.”

“‘This is probably as bad as it gets,’ wrote Paul Ashworth, senior United States economist with the economics research firm Capital Economics.”

MarketWatch reports on the homebuilders. “Large home builders are dangling out more incentives to reluctant buyers as the roof caves in on the U.S. housing market. To entice customers, companies are serving up deals that include a free pool, a fancy kitchen or even a new car. But real-estate brokers say all buyers want is a cheaper house.”

“In September about 77% of home builders were offering some sort of sales incentive in response to spiking inventories, compared with 58% a year earlier, says Gopal Ahluwalia, at the National Association of Home Builders.”

“Forty-four percent of builders were reducing home prices, 4% were including a new car with the home and 5% were offering a free holiday trip. Underscoring the sharp pullback in the housing market, the NAHB didn’t even bother to poll builders on those three questions last year.”

“‘Inventories are at all-time highs,’ said UBS analyst Margaret Whelan. After the housing market peaked in 2004 and 2005, she said many large builders were caught with unsold inventories, which have bumped up even more due to cancellations. The companies that built so-called speculative or ’spec’ homes in an effort to squeeze every drop from the housing boom are now in the most trouble.”

“‘Home builders are generally using incentives now just to make sales happen,’ said analyst Todd Vencil. The more-speculative markets in recent years such as California, Florida and some other coastal areas are seeing the most incentives because inventories and cancellations are the highest.”

“‘Inventory does not ripen or get better with age, so the builders just want to move it,’ said Vencil. He said he’s heard the stories about some sellers offering free cars, which highlights how desperate some developers and builders are to attract buyers.”

“‘You see incentives in every market, they’re a marketing tool to get in front of customers,’ the analyst said. ‘However, there’s a difference between incentives for marketing purposes, and incentives to dump excess inventory.’”

“Among public builders, many analysts point to Lennar as the biggest user of incentives to protect its sales pace. ‘As we’ve continued to see weakening conditions in many of our strategic markets, we’re experiencing slower sales, higher cancellations, and greater use of incentives and discounting,’ said Lennar CEO Stuart Miller.”

“He said Lennar’s goal is to focus on cash flow at the expense of maintaining profit margins. ‘The best way to generate cash flow is to deliver our inventory..by reducing price to market pricing and converting inventory to cash,’ he said. ‘We have rigorously pursued this objective by using incentives and price reductions to sell homes and to back-fill cancellations.’”

“D.R. Horton CEO Donald Tomnitz said he thinks 2007 will be characterized by continuing incentives to move the existing inventory, which has largely been created by the speculators and investors having gotten out of the market.”

“‘Why are they out of the market? Because they can’t contract to buy a home today and resell it for 15% or 20% more,’ he said. With cancellations up and inventories growing, Tomnitz said D.R. Horton is trying to negotiate with buyers to close homes, noting ‘a bird in the hand is worth two in the bush.’”

“Delores Conway at the USC Lusk Center for Real Estate, said builders in California have gotten more creative with incentives. ‘The buyers’ expectations have changed a lot, they’re afraid of buying at the high point of the market, so they feel it’s to their advantage to just sit and wait,’ she said.”

“In Arizona, another hot market that’s pulled back, almost every builder is offering up extras to sell homes, said realty agent Edward Maddox. Maddox said one regional builder this summer offered a new Honda Civic if customers purchased a home during the month of July. ‘They’ll give you anything to sell the home,’ Maddox said. ‘It’s 180 degrees from last year.’”

“Yet Maddox and some other brokers said simple price discounts pique buyers’ interest more than gimmicky marketing incentives such as a free washer or dryer. ‘Most buyers are focused on lowering their monthly payments, and a new car doesn’t help with that,’ Maddox said.”

The Wall Street Journal. “The current housing slump is making remodeling a kitchen or bathroom or adding an addition easier and cheaper. Sluggish home-building demand is pushing down the cost of construction materials (prices for lumber are near their lowest level in a decade) and spurring contractors to take on smaller projects, and sometimes cut fees.”

“Custom and speculative builders are also starting to take on renovation jobs, picking up work they may have passed over just a year ago.”

“In Tucson, Ariz., Richard Fink, a custom home builder, used to do a few remodeling jobs as favors to former clients; now remodeling has grown to half his business. Samm Jernigan, a high-end custom home builder in Wilmington, N.C., said earlier this year he started ‘aggressively pursuing’ remodeling projects for the first time, and John Diament, a home builder outside of Philadelphia, says two months ago he started asking architects to send big remodeling jobs his way.”

“‘It’s good news for the consumer if you’ve got a lot more people seeking projects,’ says Gopal Ahluwalia, for the National Association of Home Builders.”

“Meanwhile, prices of framing lumber have fallen dramatically, says Shawn Church, the editor of an industry newsletter. The composite price per thousand board feet of framing lumber was $274 this week, compared with $375 a year earlier. Ken Simonson, the chief economist for the Associated General Contractors of America, says he expects to see a roughly 10 percent drop in prices of gypsum and construction plastics when government price data are released later this month.”

“The falloff is largely because of slowing new-home construction, which for several years had driven up the cost of materials. Growth in spending on remodeling has also slowed recently, a result of rising interest rates and homeowners who have postponed selling, along with presale renovations”

“The new environment means that homeowners are more likely to find contractors willing to take on projects quickly. ‘Rather than saying ‘call me next spring,’ they’ll be more likely to say ‘I’ll be over this week to the talk about the project,’ says Kermit Baker, at the Harvard Joint Center.”

“Contractor Don Sever in Oakton, Va., says he sees interest in remodeling starting to ease. He has trimmed prices by about 5 percent to attract more business. ‘People are much more cautious about spending that home-equity money,’ he says.”

“When Bruce Ash wanted to do a large-scale renovation at his Tucson home, he found Mr. Fink of Becklin Construction to take on the $700,000 project. ‘Normally, the market has been such that we could never get custom builders to remodel homes, but now, they are interested,’ says Mr. Ash, a real-estate manager.”

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