S&P/Case-Shiller Home Price Index (trademark Fiserve, Inc.)

Here's the most recent data released 1/27/09 for November, 2008 prices: SP Case-Shiller Index of Home Prices (TM Fiserve, Inc.) for November, 2008 Prices.  Home prices in the 10 largest cities are down 19.1% from their August, 2006 peaks, and the prices in the 20 largest metropolitan areas are down 18.%.

On Balance:

Those who expect or hope for a significant recovery in residential housing values any time soon will most likely be very disappointed.  Largely irreversible factors have been both causes and consequences of the housing slide, namely, a withdrawal of easy mortgage credit, and impairment of lender balance sheets.  In addition, another irreversible factor, adverse demographic trends, will likely keep housing prices low for many years.  In addition, the homeownership rate reached a record high of 69% of households in 2006.  The higher the portion of households that already own a home, the smaller the pool of qualified propsective buyers.  It will take an unknown period of time to build up the pool of buyers.  Last, but not least, is the fact that there is no economic megatrend in sight that is comparable to the computer and internet revolution to drive vigorous long term economic growth and support higher incomes.  It's possible that the current crises can be stabilized quickly with a large scale federal government loan program such as the All Streets Bailout combined with a protracted period of low mortgage rates.  If the program succeeded in stopping the housing downturn and reversing the economic downturn, housing values might return to a more normal gradual long term inflation path, but it wouldn't be anything sudden or dramatic.  Properly conceived loans can rescue borrowers and lenders from excessively leveraged properties, or prevent them from becoming over leveraged due to additional loss of values, and can shore up demand by replacing some important loan programs that have vacated the free market.

Favorable Factors:
   
    Interest Rates:  Short-term interest rates of all types are very low, so there's little room for significant reduction.  A significant question is whether that lower mortgage rates.  For the past several months the spread between mortgage rates and comparable interest rates in the banking system have been at historic high levels.  So, for example, for several years until recently one could accurately estimate the par wholesale rate on a conforming Agency 30-year fixed mortgage as being about 1.5% added to the yield on 10-year U.S. Treasury Notes.  So, during the early 2000's with the 10-year note hitting 3.5% on several occasions, the par for 30-year fixed rate mortgages bottomed at about 5.00%.  As of 1/2/09 Now, with the 10-year notes yielding 2.46%, the par 30-year fixed rate is right at 5.00%, which is a spread of 2.66%; that spread has been in force for several months.  If the previous spread existing now, the par 30-year fixed rate would be 4%!  One guesses that the mortgage market thinks the yields on U.S. Treasury securities will be increasing substantially in the near future, or the new risk premium will persist until the market is convinced all interest rates will be low for a long time.

It's possible that the par 30-year mortgage rate could stay near 5% for a long time if there's no dramatic economic recovery (most likely incur view).  However, if the economy continues to worsen, or if short rates stay low for whatever reasons, and the mortgage market begins to take a different view of the risk premium, 3.5-4.5% 30-year fixed mortgage rates would not be out of the question (that's what prevailed in the 1950's.)  On December 16, 2008 when U.S. Treasury bonds peaked in price and bottomed in yield, we actually observed one wholesale lender price the 30-year fixed rate at 4.5% better than par.

All interest rates should continue to be low, with fluctuations, of course, until a substantial economic and housing recovery can be clearly anticipated.  That could take a long time unless Congress takes dramatic action to stem the many crises that have developed, with mortgage alleviation as the focus, such as our All Streets bailout plan.  Rates remained low for a prolonged period in 2002-2005, until a modest economic recovery had developed and a housing boom was apparent in 2005.  Then short rates increased from 0.8% to 5.3% in two years.  Circumstances are very different this time around.  Even with reasonably low mortgage rates we think it's unlikely there will be any housing boom or economic boom.  So even with a bailout, rates could remain relatively low for a long time.  

   Lower Housing Prices:   There is a point at which housing prices become low enough to balance supply and demand.  One hopes we are close to that point, however, there's no evidence of that yet, and, given continued adverse economic and credit trends the number of qualified buyers (demand) will keep shrinking and excess inventory will continue due to foreclosures and short sales.

   Federal Economic Stimulus Plan of January, 2009:
The plan includes a tax credit of $8,000 for a first time homebuyer purchasing a home.  That will provide a new incentive for some to enter the market, however, we don't rate it as an overwhelming one since it will only affect a small number or new buyers, and $8,000 isn't a lot when you consider that many home prices have dropped that much in one to three months.

   Homeowner Affordatility and Stability Plan:
That's the plan announced February 18, 2009 by the U.S. Treasury and President Obama.  We rate this as being very ineffective in stopping the housing collapse or supporting prices.  It will help very few who are upside down owners, the main problem in the market.  It won't help at all anybody with a jumbo mortgage, second home or investment property.  It might stop or delay some foreclosures.  It will have little or no effect to create or encourage future demand.  We have detailed comments in our article about the plan About the New Homeowner Affordability and Stability Plan.

    All Streets Bailout:  A program like the one we advocate to relieve consumer mortgage debt and provide comparable benefits to non-owners would be a huge positive factor that would operate quickly over a period of one or two years.  We believe it would stabilize the economy and return it to a growth path.  (See summary on our website The AllStreets Bailout Plan, and more details on this blog.) 

Unfavorable Factors:

   Shrinkage in Available Mortgage Credit:  Since the slide in residential housing values began in early 2007, there has been a radical shrinkage in the availability of mortgage credit, which has paralyzed refinances and reduced the pool of qualified buyers, due to the following factors:

1. major reduction in the variety of the types of loan programs available,
2. pronounced tightening of lending standards for most remaining loan programs (except FHA, VA, USDA Rural Development, which, however, all have fairly low loan limits; the temporary increase in FHA loan limits hasn't worked),
3. increases in mortgage rates (especially for ARMs); the large rise in short-term interest rates in 2005-2007 magnified the initial subprime ARM crisis that started in 2006 due to mortgage rate resets; the resulting series of financial crises has caused huge record spreads between mortgage rates and government security rates, by at least 2% for most types of mortgages,
4. increases in the price of any given rate due to new or stiffer pricing charges for various characteristics of loans (credit score, LTV, subordinate financing, investment property, etc.),
5. drastic reduction in the number of brokers and wholesale lenders, about 300 major lenders out of about 1200 at the end of 2006 (more about this at a very popular website, The Mortgage Lender Implode-O-Meter, at http://ml-implode.com/).

The available selection of mortgages is now almost as limited as any time since Fannie Mae and Freddie Mac were converted to government sponsored enterprises ("GSE"S") in 1968 and 1970, respectively (Fannie was actually created in 1938 as a government agency but was converted to a GSE in 1968; for a brief article about them click http://hnn.us/articles/1849.html).  The list of readily available programs has shrunk down to almost nothing other than conventional mortgages insurable by Fannie or Freddie (these are known as "agency" mortgages or "conventional" loans), FHA, VA and USDA Rural Development, and home equity loans or lines of credit at no more than 80% loan-to-value ("LTV").  There has been a  virtual elimination of entire segments of mortgage loan programs:

• Subprime loans are practically gone (many are cheering).  There are very few lenders left, and remaining loans have mostly high fixed rates, only reasonable at low LTV's and with higher credit ratings.  Investors in subprime mortgage securities scarce or non-existent.  Contrary to popular belief, subprime stated income loans required documentation of employment, and a check by the underwriter of probable income via public salary data for various types of jobs.  Even stated income loans required documentation of debts, real estate owned, and assets, if needed to qualify (usually a couple of months of housing expenses in liquid reserves).  Regrettably, many borrowers with prime credit used these easier-to-get subprime ARM loans to speculate on property values.  If subprime loans ever come back, they should be subject to regulation along the lines recommended in the article in our blog.
• Alt-A loan programs pretty much eliminated from offerings by most sources, or carry prohibitive rates.  This category included loans with "stated income," "no ratio" and "no doc" processing, and up to 100% financing programs, including second mortgages and lines of credit.  This was a major source of lending for those with good to excellent credit histories and credit scores, but either didn't meet the much more stringent requirements for Fannie and Freddie loans, or didn't wish to document income (stated income), or didn't meet strict debt ratios (no ratio loans), or didn't wish to document income, employment or assets ("no doc").  Contrary to public belief, these "low documentation" types of loans were restricted in loan-to-value, and required much better credit than full documentation loans.  This category might revive to some extent at the point when investors have confidence that housing values have stopped falling.
• Home equity loans and lines of credit for more than 80% total loan-to-value.
• "Portfolio" loans;  these are loans of any type that are unique to a particular lender, intended to be held by that lender instead of being sold to an investor; there used to be a fairly large universe of such loans, and they usually had more relaxed guidelines and sometimes unique features compared to "agency" loans.  Now there are very few lenders still offering their own portfolio loans.  
• Loans for investment properties; these are greatly restricted as to the types of loans available, loan to value, and carry stiff rate pricing "hits."  Investment purchases could represent an important source of housing demand in the upcoming adverse demographic environment, but the available loan programs will need to expand significantly to open it up.
• Low documentation loans of any kind.  Many blame such loans for the housing debacle, but they have served well a very significant portion of the populace for a long time.  Lenders knew how to set guidelines and rates to maintain acceptable levels of risk based on historical performance levels, but that didn't take into account a once-in-a-century implosion of the housing values due to a unique combination of factors, and neither did guidelines for any other types of loan programs.

    Shrinkage in Pool of Qualified Borrowers:  Taken together the loss of loan programs and tightening of lending standards alone means that probably no more than about 50% of potential borrowers who would have qualified at the end of 2006 are now qualified for a mortgage.  It's unlikely that easy qualification guidelines will return for many years, if ever.  In addition, a very significant proportion of borrowers who would otherwise qualify for loans are upside-down on their property (mortgage principal totals more than it's worth) and, therefore, can't refinance or move without a short sale, so they are effectively no longer prospective buyers unless their property value recovers enough to pay off the mortgage(s).  Based on estimates for September, 2006 and subsequent drops in property values at least 25% of all U.S. residential properties are now either upside down or have no equity (article in Business Week).

A further stubborn problem on the consumer side preventing any rapid recovery in the pool of qualified buyers, is the weak condition of consumer balance sheets.  The asset side of consumer balance sheets has dramatically collapsed.  In just several months, housing equity has disappeared and the value of any stock investments have collapsed dramatically.  On the debt side, obviously consumers have too much mortgage debt.  But they also have too much auto, credit card, and student loan debt.  So even if there wasn't an economic collapse in progress, it would take a few years for consumers to pay down debt enough to begin making large purchases.  The income statement doesn't look promising either.  With the collapse of employment opportunities, and the likely drop in wages, that makes it even harder for consumers in aggregate to reestablish enough net worth to drive a housing recovery.

The drastic shrinkage of the pool of qualified borrowers is the main reason the housing slide has been so dramatic and persistent, and housing values cannot recover quickly.  As housing values declined credit availability shrank, and that put more pressure on housing values, etc.  The outlook for recovery in the values of residential housing is extremely poor as long as so many borrowers are now shut out of the market for loans.  Unfortunately, it's unlikely that any of the factors that shrunk credit will reverse in the foreseeable future.  Those who expect any significant rebound in values any time soon will be very disappointed.  The housing values will flounder for at least several years awaiting a sufficient combination of reduced inventory and a replenished pool of qualified borrowers via improved consumer credit qualification or higher incomes, or restored diversity in loan programs or population growth.  At a minimum it would be necessary for inflation (if any!) to restore the values of homes enough to enable owners to refinance or move without losses.  But inflation might be very scarce in absence of vigorous economic recovery.  

    Adverse Demographic Trends:  Another big strike against the prospect for significant recovery in housing demand or values in the near futures the aging of the population and the expected forthcoming reduction in the ratio of workers to retirees for several years.  A growing proportion of the populace is older and retired.  Retired folks are more likely to sell and downsize than to purchase or upgrade.  Furthermore, there isn't enough increase in the number of young working families who qualify for mortgages to absorb the sales of properties by retirees.  The worker to retiree ratio will continue to shrink for many years.  Another problems is that most of the folks who qualify to finance a property already own one or more.  One of the reasons the housing market turned, is that so many households already owned a home and were not interested in buying or upgrading.  According to the census bureau, home ownership reached a record high of 67.3% in 2006.  When almost everybody who is able owns something, at some critical point there aren't enough qualified buyers left to maintain a sellers market and keep prices high.

This moment in history is unlike any other in the last seventy years.  The dynamic factors that permitted housing recoveries in every cycle since the 1950's simply don't exist.  Since it's so unlikely that there can be any significant recovery in housing values due to normal economic processes, in order to stabilize the economy it's essential to relieve a significant portion of excess mortgage debt to restore a measure of health to both consumers and lenders.  We think the best dramatic solution is one such as our All Streets bailout plan.  Even if it wouldn't necessarily restore housing values, at least it should stop the slide and replace lost home equity with long term low interest loans that can give the economy and housing more time and a better chance to mend without a catastrophic collapse.

    Adverse Economic Megatrends:  In the period of 1950-1998 the population explosion of the baby boom combined with explosive technological progress (microchip, computers, software, biotech and internet) drove a megatrend of economic growth and increasing productivity.  There is precious little on the horizon to drive underlying economic growth or productivity in a similar manner.  The next ten years at least will be more or less a maintenance economy as the demographic changes play out and the economy waits significant technological developments.  We can think of only two major factors that might be significant: the generational transfer of wealth from baby boom parents to their heirs, which might help restore savings and investment levels, and the inevitable general increase in energy prices that could form a rising baseline for technological investment.  Regarding oil prices, we think the current collapse may be directly analogous to what happened to the stock market in the early seventies leading up to the 1987 "crash."  Then, in a five year period the stock market had decisively broken out of a 20 year trading range and rocketed up by a factor of 400% or so.  Then it crashed back slightly below the top of the range.  From there it rallied for twelve years and went up by a factor of 10 or so.  Oil made a similar move, rallying from the $15-35/barrel range to 147, about seven hundred percent in five years.  Recently it touched $35/barrel, and has since rallied to $47.  We think that it will slowly rally for several years and then spike to a top near $350.  Of course, by then there could be a general increase in price levels so that $350 wouldn't be all that remarkable.

-END-