We have not reached the bottom of the housing market. I hate to say it. I really do hate to always be the pessimist. And I don’t say this because I’ve been steeped in a couple decades' worth of bitterness as a Red Sox fan. The numbers are just not adding up to recovery.
It is all the rage these days to talk about how we are finally seeing recovery in the housing market, and that pretty soon we’ll be back to home price growth. Analysts point to the decline in housing inventory, lower rates of unemployment, higher rates of affordability, increases in housing starts, and even growing stock values for publicly traded homebuilders.
But this optimism will disappear faster than the enthusiasm for Kony2012 once the next wave of downward home price pressure hits. Describing the current housing market situation as being in the eye of a hurricane is not exactly accurate, but it is fair to say there is another storm gathering that will hit housing hard in the next few years—and it is impossible to stop.
The storm is a mix of delayed pressure as a result of the quantitative easing of the shadow inventory, and a troubling historical trend.
The first pressure system comes in the form of rising mortgage rates. The Fed’s quantitative easing has succeeded in pushing down long-term interest rates and subsequently mortgage rates over the past few years. (QE1 had more to do with this than QE2, but who’s counting.) But whether you think this is a good thing or not, with mortgage rates in the 3 percent to 4 percent range, the only direction they really can go from here is up. A 30-year fixed-rate mortgage at 2 percent is just not worth the risk of lending. It might be several more years before the Fed eases off the quantitative gas pedal, but when it does so interest rates, and with them mortgage rates, will rise. And when mortgage rates rise that puts downward pressure on housing prices since more expensive mortgages mean reduced demand and the need to lower home prices to compensate.
The second element of the coming storm is that while today’s inventory of homes has indeed declined to a much more manageable level, the shadow inventory of homes remains high. While there are currently around 3 million homes for sale in America, once you factor in the homes that are in serious delinquency (i.e., more than four months past due), homes in the foreclosure process, and homes that banks have seized but not put on the market yet, the housing inventory is closer to 10 million homes. Estimates on this do vary, but even the most recent National Association of Realtors data shows a 35-months supply of homes in Florida, and a 41-months and 65-months supply of homes in New York and New Jersey, respectively. The challenge is that once all these other millions of homes hit the market, they will also add downward pressure to housing prices.
The third thing to consider is that history looks to be anti-recovery right now. It is true, as a number of analysts have pointed out recently, that real housing prices (meaning inflation adjusted) have fallen to their long-term trendline. If you discount the most recent housing bubble as fueled by a host of poor policy choices made in the 1990s (such as homeownership goals, Fannie Mae and Freddie Mac’s attempts at dominating the market and advancing taxpayer guaranteed mortgage-backed securities, and the Community Reinvestment Act of 1995), then the historical trend since World War II would suggest that housing prices should be where they are at today. But even if indicators say this should be the bottom, the historical trend has also featured multi-year long “over corrections” after housing bubbles.
In the below graph, you’ll notice that after a housing bubble peaked in 1978 it slowly declined and hit the historical trendline in 1981. But it continued falling and didn’t come back up to the trendline until 1986. Similarly, the housing bubble that peaked in 1989 declined a bit faster and hit the average trendline in 1991, but it wasn’t until 1998 as the massive 21st century housing bubble began to build that prices got back to their trendline.
We should not expect this coming bubble and bust to be any different. Especially with the downward price pressures from quantitative easing and the shadow inventory waiting to smash in on today’s relative calm.
To borrow a phrase from our president, let me be clear: Lower housing prices are not necessarily a bad thing—we need prices to be at the level the market demands. But they will mean higher levels of negative equity and more pressure put on the huge stockpile of homeowner debt. And that is not a recepie for recovery in the near-term.
The dark side of low interest rates is that they discourage savings. And without much incentive to save, household debt levels have not fallen very far from the 2008 peak, and in fact began growing again in mid-2010. This high level of debt contributes to the weakness in economic growth, as it constrains consumption and deceeases demand for housing. And with the years of household deleveraging up ahead it doesn’t matter that affordability is increasing as prices fall: The buyers that do exist will continue to demand lower prices.
There are optimists who argue that declining unemployment means a stronger labor market and this will provide a host of new buyers entering the housing market (this trend is very exciting for mom and dad who just want their college graduated child to stop mooching off them for free rent). But those who praise a rate of 8.3 percent unemployment are willfully ignoring that we have shockingly low rates of participation in the labor market, and that if the Bureau of Labor Statistics also counted those workers who’ve just stopped looking for a job in the past month, the headline unemployment figure would be closer to 9.5 percent.
There is nothing wrong with hoping that we truly have reached the bottom of the housing decline and the beginning of recovery. Personally, I choose to indulge in the fantasy that the Red Sox have a chance to win the American League pennant despite the fact that we have only three pitchers, all past their prime, in our rotation. But when you face facts and consider the numbers, all those rosy news stories about an improving housing market look about as credible as the claim that home prices would always—always!—go up.
Anthony Randazzo is director of economic research at the Reason Foundation. This commentary first appeared at Reason.com.