Out of Control Policy Blog

Barry Ritholtz On Housing Pessimism

Last Friday, Washington Post columnist Barry Ritholtz broke down the pessimist's view on the housing market. With spring comes a traditional uptick in housing data, inspiring memory challenged journalists to wax philosophical about the bottom of the housing market finally being upon us and blue skys forever to come. But here are some reasons why that view is misinformed (regular readers will note these are not new concepts to this blog).

First, the shadow inventory:

"What is shadow inventory? This is important, as lowering the total inventory of houses for sale is how prices stabilize and sales volume moves higher... It includes bank-owned real estate, distressed houses not yet for sale, short sales and delinquencies that have not yet defaulted. Foreclosure properties are also in the shadow inventory. These houses will eventually become part of the total supply for sale. Although there is no official count, estimates of potential shadow inventory run as high as 10 million.

"That’s not all. There’s also a huge overhang of underwater homeowners — whose houses are worth as much as 25 percent less than what is owed. The owners don’t qualify for a mortgage modification. They may be delinquent but aren’t in default. Two-thirds of all U.S. houses have mortgages. Of those, an estimated 21 to 29 percent of the mortgages are underwater, or up to 16 million houses. When prices finally do rise, we can expect many of these no-longer-underwater owners to put their houses up for sale. If only one in three do, that is another 5 million homes in inventory."

Second, home affordability:

"Are houses affordable? Here’s where every discussion of affordability seems to start: the National Association of Realtors Home Affordability Index. In my view, it’s worthless. Why did I come to such a harsh conclusion? The index offers little insight into how affordable housing actually is. In the biggest run up in housing prices in American history, the index never dipped into the level of unaffordable. Imagine that.

"As ridiculous as that sounds, it’s even more absurd when we look at the NAR methodology, which ignores factors such as family savings rates, cash assets, consumer credit, indebtedness, credit servicing obligations, inflation and income gains. The affordability index looks at the wrong things and ignores the important ones. The correct question is not whether the houses are affordable in theory. Rather, it’s whether potential buyers can afford to buy them."

Third, how cheap house prices are:

"Are the prices cheap? Few had forecast the steep drop in median house prices. Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or financial conventions (New York City) that mandated significant down payments and other prudent requirements and avoided much of the bloodshed. The conventional wisdom seems to be that prices have stabilized and are overdue to start rising. The data, however, suggest something else. The most recent Standard & Poor’s / Case-Shiller index of national prices (January) shows prices are still falling, about 4 percent year-over-year."

Fourth, asset prices follwing a bubble:

"How do asset prices behave following a bubble? Regardless of the asset class — stocks, bonds, commodities, houses, etc. — assets do not merely stabilize. We have never seen a stock market run up into bubble territory and then revert to fair value. Instead, we careen wildly past that level, to deeply undersold and exceedingly cheap. That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money returned to its rightful owner, the prudent investor.

For a lasting recovery, we need to see houses cheap enough that they fall into “good hands” — long-term owners who can afford their mortgage payments. Until that happens, houses will stumble along the bottom of the price range. The nation could easily see another 10 percent to the downside — assuming nothing else goes wrong. This would actually be good news. The government interventions (first-time buyer tax credit, mortgage modifications and foreclosure abatements) have prevented prices from finding their own levels. If they did, houses would be much more affordable, and buyers would come out in droves.

That is how a true housing recovery begins.

Read the rest of the piece at Washington Post here.

Anthony Randazzo is Director of Economic Research


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