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Bankers Are Still Wrecking Housing Market Fundamentals

(photo: Images of Money/flickr)

Regardless of the recent bullish stories on the housing market (examples here, here, here and here), housing market fundamentals are lousy. Demand in the last decade was wildly distorted by banker abandonment of underwriting and appraisals. Now bankers are worsening the crash they created. As a result, prices will just keep falling, and foreclosures cannot lead to clearing the market (regardless of what some say). Foreclosures can only make the problems worse.

Market Distortion From Excess Demand in Bubble Years

As a first step to seeing the problems, let’s get real about how profoundly market-distorting that lender-inflated bubble was. People who could not afford to buy homes, period, were nonetheless given loans, artificially expanding the number of people expressing demand. In addition, people who could have afforded a house, if not the house they purchased, expressed their natural demand in the ‘wrong’ segment of the market. Both distortions combined to spike prices far higher than natural demand would have driven them.

To see the price spike, consider the median and average home prices, nationally, in 1976, 1986, 1996, and 2006, using August values in each year, in constant 2006 dollars:

1976 Median: $156,603 Average: $171,838
1986 Median: $168,306 Average: $208,221
1996 Median: $176,031 Average: $205,198
2006 Median: $243,900 Average: $317,300

That is, across twenty years the median home price increased by about $20,000 and the average by about $35,000. In the next decade–the bubble decade–the median and average prices each grew about three times faster. That’s more froth than Starbucks puts on its biggest latte. And it’s a strong signal of just how far prices have to fall to get to where natural demand would have pushed them.

Excess Supply

But the price peak isn’t the full measure of how far prices need to fall, because supply didn’t remain constant. The price spike drove home builders to add supply beyond what they would have to meet natural demand. This chart from the National Association of Home Builders shows that from 1978-1997 sales of new homes oscillated between approximately 0.4 to 0.8 million homes a year. For twenty years, demand pressure was never great enough to sell more than that in a year. From 1997 through 2007, however, sales went from about 0.8 million to nearly 1.3 million a year and back down to about 0.8 million. That’s 11 years of sales volume that dwarfed the preceding 20.

We’re seeing that part of the market correct, because in 2010 and 2011 more like 0.3 million new houses sold, and that’s roughly the pace this year. But it’s not obvious that three years of below normal sales is enough to balance out that decade of excess. Moreover, all those extra new houses are only one part–a relatively small part–of our current supply excess. Foreclosures have brought far more homes to market, and worse, have far more yet to come, than that new home bulge.

More Foreclosures (Supply) to Come

RealtyTrac data shows foreclosures are increasing again, after slowing down last year. In New York it looks like 100,000 new ones may be coming, based on notices sent in the first quarter of 2012 alone. They’re also on the rise in Pasco County, Florida. But you needn’t look at these stats to understand we’re nowhere near out of the foreclosure crisis yet.

According to the Federal Reserve, about 12 million people owe more than their homes are worth, and CoreLogic reports that falling prices mean their ranks include even new buyers. Being underwater is a strong predictor of default and foreclosure because when life happens (job loss, divorce, illness), the homeowner can’t sell to get out from under the suddenly unaffordable mortgage. In addition, some people will strategically default, like the very wealthy who don’t care about their credit, and people who can otherwise make it work for them.

And then there’s the millions trying to get their loans modified. Banks are forcing far too many of those people into foreclosure even when modification is in everyone’s financial interest. One of many ways the banks turn potential modifications into foreclosures is by wildly overvaluing the home, which skews the critical “net present value” calculation. [cont’d.]

Banks Are Manipulating Inventory

Given the grim reality of too many houses at crazy high prices, how come we’re seeing a spate of good housing news stories? Well, those stories reported supply had shrunk so much, prices were rising. One of the most comprehensive was by Nick Tiramos for the Wall Street Journal, detailing that shrunken inventory was leading to some bidding wars in several markets. Local pieces, this Arizona Republic story, continued the theme. Both articles noted that the bidding wars didn’t mean prices had recovered much compared to the bubble years. Nonetheless, if the decreased inventory is for real, the optimism’s justified, right?

Too bad the inventory decrease seems artificial, the result of bank manipulation. Take Phoenix: RealtyTrac identifies 6,611 “bank-owned” properties there. An Arizona realty website lists only 275 for sale. Similarly, Yahoo real estate claims there’s over 8,000 foreclosure properties in Phoenix, but Realtor.com lists less than 4,000 homes of any type. AZHomeonline.net lists a bit over 4,000, plus 312 foreclosures and shortsales. So are the foreclosures in Phoenix on the order of 300 or 6,600? Makes a wee bit of difference when the non-“distressed” market is about 4,000, don’t you think?

(To Tiramos’s credit, his piece acknowledges the good news may not last because of the bank owned backlog; the more cheerleading articles don’t.)

Phoenix isn’t the only place where banks are holding properties off the market. In Portland, Oregon, banks aren’t selling 80% of the homes they own, The Oregonian reports. All the bank owned inventory statewide represents more than a year and half’s supply of houses all by itself, according to a RealtyTrac executive quoted in the piece. If the housing inventory is that distorted in Oregon, what’s it like in the hardest hit states?

By holding off inventory, the banks provide temporary support to prices, but for how long? The inventory will make its way to market–there’s just too many houses held in reserve for the banks to manage and maintain the properties in a market-price optimizing way. Moreover, this artificial control of inventory means foreclosures do not help a market to bottom; foreclosing cannot “clear” the market.

Where Will Future Demand Come From?

The last aspect of our housing market’s broken fundamentals is on the demand side. Specifically, who can buy a house now?

Not many young college graduates and their young families, normally the quintessential first time buyers. By 2008, over 200,000 young people had over $40,000 in student debt each, and given the explosive growth in debt, many more have that much now. In fact, the 1,781,000 students in the class of 2012 average over $25,000 each. Nope, young people won’t be buying homes for a decade or two. Millions of underwater homeowners can neither trade up nor down. Foreclosed former homeowners don’t have the credit or the cash to re-enter the housing market. In short, current and future demand for housing is likely to be substantially less than historically normal demand, even as prices keep falling and interest rates hover at historic lows. And that’s still true even if the job market comes back, not that there’s any sign of that.

The banks could substantially boost demand by writing all the underwater mortgages down to market value. People would be able to sell, and buy, and millions of foreclosures would be averted. But the chance the banks will take such drastic action is nil. Not essentially nil, like Powerball odds, but nil.

And nil is also the chance that housing is headed toward a broad based recovery, even if some local markets, unhampered by massive bank-owned inventory and large numbers of underwater homes, show sustained improvement.

CommunityThe Bullpen

Bankers Are Still Wrecking Housing Market Fundamentals

Regardless of the recent bullish stories on the housing market (examples here, here, here and here), housing market fundamentals are lousy. Demand in the last decade was wildly distorted by banker abandonment of underwriting and appraisals. Now bankers are worsening the crash they created. As a result, prices will just keep falling, and foreclosures cannot lead to clearing the market (regardless of what some say). Foreclosures can only make the problems worse.

Market Distortion From Excess Demand in Bubble Years

As a first step to seeing the problems, let’s get real about how profoundly market-distorting that lender-inflated bubble was. People who could not afford to buy homes, period, were nonetheless given loans, artificially expanding the number of people expressing demand. In addition, people who could have afforded a house, if not the house they purchased, expressed their natural demand in the ‘wrong’ segment of the market. Both distortions combined to spike prices far higher than natural demand would have driven them.

To see the price spike, consider the median and average home prices, nationally, in 1976, 1986, 1996, and 2006, using August values in each year, in constant 2006 dollars:

1976 Median: $156,603 Average: $171,838
1986 Median: $168,306 Average: $208,221
1996 Median: $176,031 Average: $205,198
2006 Median: $243,900 Average: $317,300

That is, across twenty years the median home price increased by about $20,000 and the average by about $35,000. In the next decade–the bubble decade–the median and average prices each grew about three times faster. That’s more froth than Starbucks puts on its biggest latte. And it’s a strong signal of just how far prices have to fall to get to where natural demand would have pushed them.

Excess Supply

But the price peak isn’t the full measure of how far prices need to fall, because supply didn’t remain constant. The price spike drove home builders to add supply beyond what they would have to meet natural demand. This chart from the National Association of Home Builders shows that from 1978-1997 sales of new homes oscillated between approximately 0.4 to 0.8 million homes a year. For twenty years, demand pressure was never great enough to sell more than that in a year. From 1997 through 2007, however, sales went from about 0.8 million to nearly 1.3 million a year and back down to about 0.8 million. That’s 11 years of sales volume that dwarfed the preceding 20.

We’re seeing that part of the market correct, because in 2010 and 2011 more like 0.3 million new houses sold, and that’s roughly the pace this year. But it’s not obvious that three years of below normal sales is enough to balance out that decade of excess. Moreover, all those extra new houses are only one part–a relatively small part–of our current supply excess. Foreclosures have brought far more homes to market, and worse, have far more yet to come, than that new home bulge.

More Foreclosures (Supply) to Come

RealtyTrac data shows foreclosures are increasing again, after slowing down last year. In New York it looks like 100,000 new ones may be coming, based on notices sent in the first quarter of 2012 alone. They’re also on the rise in Pasco County, Florida. But you needn’t look at these stats to understand we’re nowhere near out of the foreclosure crisis yet.

According to the Federal Reserve, about 12 million people owe more than their homes are worth, and CoreLogic reports that falling prices mean their ranks include even new buyers. Being underwater is a strong predictor of default and foreclosure because when life happens (job loss, divorce, illness), the homeowner can’t sell to get out from under the suddenly unaffordable mortgage. In addition, some people will strategically default, like the very wealthy who don’t care about their credit, and people who can otherwise make it work for them.

And then there’s the millions trying to get their loans modified. Banks are forcing far too many of those people into foreclosure even when modification is in everyone’s financial interest. One of many ways the banks turn potential modifications into foreclosures is by wildly overvaluing the home, which skews the critical “net present value” calculation.

Banks Are Manipulating Inventory

Given the grim reality of too many houses at crazy high prices, how come we’re seeing a spate of good housing news stories? Well, those stories reported supply had shrunk so much, prices were rising. One of the most comprehensive was by Nick Tiramos for the Wall Street Journal, detailing that shrunken inventory was leading to some bidding wars in several markets. Local pieces, this Arizona Republic story, continued the theme. Both articles noted that the bidding wars didn’t mean prices had recovered much compared to the bubble years. Nonetheless, if the decreased inventory is for real, the optimism’s justified, right?

Too bad the inventory decrease seems artificial, the result of bank manipulation. Take Phoenix: RealtyTrac identifies 6,611 “bank-owned” properties there. An Arizona realty website lists only 275 for sale. Similarly, Yahoo real estate claims there’s over 8,000 foreclosure properties in Phoenix, but Realtor.com lists less than 4,000 homes of any type. AZHomeonline.net lists a bit over 4,000, plus 312 foreclosures and shortsales. So are the foreclosures in Phoenix on the order of 300 or 6,600? Makes a wee bit of difference when the non-“distressed” market is about 4,000, don’t you think?

(To Tiramos’s credit, his piece acknowledges the good news may not last because of the bank owned backlog; the more cheerleading articles don’t.)

Phoenix isn’t the only place where banks are holding properties off the market. In Portland, Oregon, banks aren’t selling 80% of the homes they own, The Oregonian reports. All the bank owned inventory statewide represents more than a year and half’s supply of houses all by itself, according to a RealtyTrac executive quoted in the piece. If the housing inventory is that distorted in Oregon, what’s it like in the hardest hit states?

By holding off inventory, the banks provide temporary support to prices, but for how long? The inventory will make its way to market–there’s just too many houses held in reserve for the banks to manage and maintain the properties in a market-price optimizing way. Moreover, this artificial control of inventory means foreclosures do not help a market to bottom; foreclosing cannot “clear” the market.

Where Will Future Demand Come From?

The last aspect of our housing market’s broken fundamentals is on the demand side. Specifically, who can buy a house now?

Not many young college graduates and their young families, normally the quintessential first time buyers. By 2008, over 200,000 young people had over $40,000 in student debt each, and given the explosive growth in debt, many more have that much now. In fact, the 1,781,000 students in the class of 2012 average over $25,000 each. Nope, young people won’t be buying homes for a decade or two. Millions of underwater homeowners can neither trade up nor down. Foreclosed former homeowners don’t have the credit or the cash to re-enter the housing market. In short, current and future demand for housing is likely to be substantially less than historically normal demand, even as prices keep falling and interest rates hover at historic lows. And that’s still true even if the job market comes back, not that there’s any sign of that.

The banks could substantially boost demand by writing all the underwater mortgages down to market value. People would be able to sell, and buy, and millions of foreclosures would be averted. But the chance the banks will take such drastic action is nil. Not essentially nil, like Powerball odds, but nil.

And nil is also the chance that housing is headed toward a broad based recovery, even if some local markets, unhampered by massive bank-owned inventory and large numbers of underwater homes, show sustained improvement.

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David Dayen

David Dayen