Has a sufficient amount of air been expelled from the deflating housing bubble to suggest that a bottom is in sight? No. But there may be a few nascent signs of recovery amid the housing rubble. Let's start with a remarkable chart that compares the Nasdaq bubble to the housing bubble (see "A Tale of Two Bubbles").
From peak to trough during the 2000-2002 bear market, the Nasdaq lost 78% of its value. From peak to trough during the recent housing bubble, homebuilding stocks lost ... yes, you guessed it ... 78%!
Assets down, liabilities up
Though housing's woes are at the root of most of today's economic evils, the stimuli underway-fiscal and monetary-can only go so far in healing the carnage the bursting housing bubble is inflicting on millions of homeowners. Housing's black hole is the epitome of asset price deflation; it is less a gross domestic product (GDP) phenomenon, other than in its ripple effects. A recession, if we're in one (as I suspect) or we enter one, isn't purely driven by housing, of course. And the data measured to define a recession, including GDP, sales, personal income, industrial production and employment (no, a recession is not defined simply as two quarters in a row of negative GDP), don't really reflect the carnage.
We're in the early stages of a process whereby the asset side of individual balance sheets is being marked down as the liability side is being marked up. This doesn't mean massive job losses or deteriorating incomes (typical of a recession). But the psychological impact can't be dismissed just because it doesn't hit traditional GDP measures.
Inventories too high for prices to fly
Let's start with the basics of supply and demand. When I first rang the alarm bells about pending doom for housing, it was based on growing inventories, unsustainable home price appreciation, ridiculous lending practices and accelerating securitizations. Have we worked off these excesses? Well, prices have certainly come down, as you can see in the chart below.
You'd think, with a plunge like that, inventory excess would have eased. It hasn't. Measured as months' supply, inventory remains just off an all-time high, while vacancy rates are in the stratosphere. Simple economics tells us that prices are unlikely to stabilize until inventories begin to get some downside traction.
Fed and Congress getting aggressive
Indeed, we are getting some marginal assistance via lower mortgage rates and rising affordability (thanks to lower rates and lower prices). And the stimulus package component that bumps up the conforming loan limits from $417,000 to about $730,000 means larger mortgages can now fetch lower rates and easier refinancing. On top of that, the Bush administration and lenders (including some of the nation's largest banks) unveiled a plan two weeks ago giving seriously delinquent borrowers a 30-day reprieve from foreclosure proceedings while they try to negotiate more affordable mortgage terms. Finally, the NAHB/Wells Fargo Housing Market Index just showed a five-year-high surge in traffic, aided by improving affordability. These are all good signs ... but possibly only at the margin.
There's likely still too much complacency about how bad things are, particularly in what had been highly speculative areas of the country. Those borrowers more severely impacted reside in areas where lending standards were the loosest and/or where the local economies were troubled. Tops on the list remain California and Nevada. For instance, about 60% of properties on the market in Las Vegas are in foreclosure. The same is true in parts of California: 46% of homes sold in Sacramento and 31% in San Diego were foreclosure sales in 2007, up dramatically from about 4% for each city a year earlier.2
Not just a subprime problem anymore
Delinquencies and foreclosures are not just a subprime problem. In fact, the statistics for prime mortgages are alarming. To date, over 36% of foreclosures started in this country are prime mortgages (about evenly divided between fixed- and adjustable-rate). That's certainly lower than the 55% that are subprime, but disquieting nonetheless. In fact, subprime "serious delinquencies" (loans 90 days or more past due plus loans in foreclosure) have not yet topped their 12% record set in 2001, but seriously delinquent loans overall are at a record of just under 3% of all mortgages outstanding. That's as a result of pressures up the spectrum to prime that are typically not so elevated during housing downturns.
There's also a record that needs to be set straight. Many assume that mortgage rate resets are driving the elevated readings among adjustable-rate mortgage (ARM) delinquencies and foreclosures, when in fact the majority remain at their teaser rates. In the meantime, the ARM reset story is only just now really kicking into gear. There was about $300 billion in ARM loans that reset in 2007, while that will jump to an estimated $500 billion in 2008. The heart of the problem here is solvency. The Federal Reserve can lower rates all it wants and Congress can drop dollar bills from the sky ... but the "cost" of money is one thing, while the "availability" of money is an entirely different thing. The latter is our bigger problem today.
Banks shutting their windows as real mortgage rates soar
Banks are becoming stingier with a loaned buck-and not just for subprime residential borrowers (for whom the lending window is effectively shut). Banks are tightening lending standards across the board for consumer, commercial and industrial borrowers.
Let's talk incentive now. When home prices were skyrocketing, there was all the incentive in the world to borrow money to buy a home. The "real" mortgage rate is calculated by subtracting the rate of home price appreciation from the nominal mortgage rate. At the peak in the housing cycle in 2005, real mortgage rates were deep in negative territory, meaning you were being paid to borrow money ... not a bad deal indeed.
Talk about a reversal since then! The difference between today's 6% mortgage rate and a -5% home price depreciation rate results in an 11% real mortgage rate! Ouch. Today there's not much of an incentive for a home buyer to borrow money to buy a depreciating asset. In turn, it makes equally little sense for a lender to provide financing to a borrower who wants to buy a depreciating asset.
Securitization run amok
Of course, there's a bigger problem that resulted from the housing bubble, and that's securitization and the opacity around the trillions of dollars in mortgage-related securities and derivatives. Behind the ballooning supply of home loans was ballooning securitization. The share of new mortgages repackaged and sold to investors rose from less than one-third to more than one-half between 2001 and 2005. The jump was concentrated in those geographies where initially it had been most difficult to obtain mortgages ... the same locales where the supply of credit had escalated the most, yet where economic prospects had improved the least.
For a time, it was a good story-the "democratization" of housing finance meant a record homeownership rate and risk that was ostensibly spread throughout the system. But good stories can have ugly endings. The increase in delinquencies is now highest in regions where a larger percentage of mortgage loans were repackaged and sold. We're now learning that loan portfolios fitting the criteria for securitization are far more likely to default than packages of loans with lower credit scores that are less likely to be securitized.
This too shall cleanse
If there's any silver lining, it rests with prospective buyers. Foreclosures can be a boon for well-financed buyers searching for bargains. They're also a natural step in the process of working off the remaining excesses and getting back to some semblance of pricing reality. So are recessions.
