Rosy Housing Numbers Have Many Thorns

The number of Americans who signed contracts to buy a home jumped considerably last month, surprising many forecasters. Pending home sales, as the indicator is called, increased 8.2 percent in May. Compared to a 11.3 percent drop in April it is a considerable swing.

But what does it mean?

In some regards there is a bit of a pendulum swing going on. The April decline was a historic drop and way outside the norm, even in the bubble deflation. The increase also means that we’ll have stronger existing home sales numbers in the coming months, assuming all the pending transactions close. However, most people want to know if this means we’ve hit the bottom of the housing markets decline.

We haven’t.

To start, we’ll likely see pending home sales numbers fall again in the coming months since mortgage applications fell by 3 percent last week to the lowest level since February, according to MBA. You also can’t really gauge the future of the market based on one month of data.

Most importantly, though, are other housing sector indicators.

New home sales fell 2.1 percent in May and existing home sales also continued to fall, sliding 3.8 percent last month. In context these numbers for housing sales are essentially some of the lowest since we began keeping records. The rate of decline was even faster than after the drop off falling a surge of sales temporarily inspired by the expiration of a home buyer tax credit. But unlike the ability to reboot the Superman franchise after the last film failed to turn out an audience, the housing market does not just get a new director and costume change. There are four core elements of the housing market right now that need to be addressed in one way or the other.

First, housing prices are off their historical trend and need to fall further before we can see any recovery start. Much of the past few years has been spent on efforts to prop up prices, but that has only meant keeping the bubble inflated–and I’m pretty sure we all agreed the housing bubble was bad. Right? Prices need to fall anywhere between 5 percent and 25 percent depending on who you ask. According to Case-Shiller data released yesterday, housing prices dropped 4 percent from last year. But there is more to come. (See the third chart in our April issue of Ahead of the Curve.)

Second, housing inventories need to be worked out. There is a massive supply glut of homes today (about 4 million) that needs to be sold before the residential construction industry can fully return. But what is worse is there are about two million homes in the shadow inventory, i.e. stuck in the foreclosure process for one reason or another and not officially on the market to be sold. The larger the shadow inventory, the more price signals are screwed up. Once those homes do finally hit the market they will add downward pressure to housing prices. Until this happens borrowers are either buying at inflated prices or uncertainty on the future of prices is keeping buyers out of the market (like myself).

Third, state attorneys general and federal banking regulators have been waging a war on mortgage servicers, the companies that process mortgage payments and distribute the money to investors or whoever owns your mortgage. Mortgage servicers screwed up en masse last year by foreclosing on some homeowners they did not have legal authority to evict. Instead of just levying a fine on these companies for provable legal misdeeds, the state AGs have sought to force a new, universal set of servicing standards on the mortgage companies and are trying to extract a pound of flesh from the companies to create mortgage assistance programs. The effectiveness or ineffectiveness of these programs aside, the process has gotten muddled and overextended. The longer this process takes, the more uncertainty there will be for mortgage investors considering jumping back into the market. Furthermore, the process has delayed foreclosures and added to the shadow inventory.

Finally, the fourth matter to address is the inexplicable continued existence of Fannie Mae and Freddie Mac. Not only do these gigantic subprime elephants still dominate the market, but Congress has barely moved any legislative reform past the subcommittee level in the House. Plenty of ideas are on the table for how to deal with them, but little action has been taken.

For more, see this short Free Market Housing Finance Reform Primer that I wrote up earlier this month. The main points on what we can do are:

  1. First, put Fannie and Freddie on a five year path towards sunsetting their charters.
  2. Second, end Making Home Affordable Programs (including HAMP) to declog the foreclosure pipeline and unwind the shadow inventory of homes.
  3. Third, end the Fed’s artificially low interest rate policy to let the cost of mortgages rise to their actual market pricing.
  4. Fourth, end the Mortgage Interest Deduction and capital gains exemption for housing investment returns.
  5. Fifth, pass legislation that would allow a covered bonds market to function in the U.S., as well as other new forms of mortgage financing.
  6. Sixth, have state AGs finish their investigation of mortgage servicers,
  7. Seventh, create a market-organized Mortgage Underwriting Standards Board (MUSB) on a model like FASB to have the industry establish guidelines and definitions for types of mortgages and securitization so that investors have better awareness of what they are purchasing when buying mortgage securities (and so the government doesn’t try to define mortgage quality itself, like it is trying to do through QRMs).
Also see my testimony on near-term changes to help the housing market recovery take hold.