This month, we focus on the government’s impact on housing.
Paulson-Bush Plan — Much Ado About Nothing
We can’t find anyone credible who believes the Paulson-Bush plan that was announced on Dec. 6 will significantly help the housing market. According to UBS, as many as 340,000 borrowers would be eligible for avoiding an ARM reset, which is only a small percentage of the borrowers who will have difficulty making the mortgage payments on their homes. Most of these homes are or will be worth less than the mortgage anyway, so who is really getting helped in the long run?
I am not hoping for any kind of federal assistance other than dropping interest rates to the levels they were at several years ago. This will help homeowners stay in their homes and help banks continue lending. Both seriously and sarcastically, I just hope that Congress doesn’t make things worse, like they have done in so many past downturns, by passing laws that look great on the surface but exacerbate the problem.
Flurry of Land Activity Spurred by the IRS
There is a flurry of year-end land-buying activity that is spurred by tax incentives. While sellers and buyers still disagree on a fair price for the land, sellers who paid a lot of taxes in 2005 (principally large home builders) have a tremendous incentive to sell land before year-end. The graph below of the S&P Super Homebuilding Index shows how rapidly the publicly traded builders grew during the boom market, which means they were paying a lot of taxes.
The incentive to sell land and generate cash is so large that it is helping close the gap in value. To the extent a company loses money in 2007, the IRS allows the company to file for a refund of taxes paid during the prior two years. Although asset impairments are losses for accounting purposes, the IRS does not allow these losses to be deductible because they are not cash losses. If you don’t recognize the loss this year by selling the land, you can never recoup the taxes paid in 2005. (This is my layman’s understanding. Contact your tax advisor if you need real advice.)
Our grading system of the economy and the housing market is a “bell curve” model, with statistics at an all-time high receiving an “A,” statistics near the long-term average receiving a “C,” and the worst times ever receiving an “F.” In this grading system, it is OK to be a “C” student.
Here is our current report card:
Economic Growth: C
Overall, the economy is performing near its historical average. Backward-looking indicators such as GDP indicate that the economy performed at a stellar pace in the third quarter, evidenced by a 4.9 percent growth rate. That said, we anticipate a much weaker growth rate for the current quarter, most likely below 1 percent. Employment growth continues to weaken, with November ushering in the softest annual growth rate since April 2004. Unemployment remains low, though mass layoff events did experience their second consecutive month-over-month increase, due largely to continued softening in such industries as mortgage and construction. Retail sales improved this month, while personal income experienced a marginal decline. Core CPI — a key inflationary gauge — increased slightly this month to 2.2 percent.
Leading Indicators: D+
The leading indicators of the economy softened this month, and are performing below their historical average. Every leading indicator has deteriorated significantly since last month, weighing down on the overall economic outlook. All four major stock indices reported sequential declines in November. As such, year-over-year gains have dropped to within the single-digit range. Uncertainty surrounding the broader economy continues to spur risk aversion, leading to a drop in yields for 10-year and 2-year Treasury bills. Home builder stocks fell in November, with the S&P Super Homebuilding Index down 58 percent over the last year, clearly one of the worst-performing sectors for 2007. Lastly, the price of crude oil climbed further in November, soaring past $94 per barrel, its highest level since May 1981. In general, higher oil and gasoline prices act as a tax increase, resulting in consumers having less to spend on other products and amenities.
Mortgage Rates: B
Mortgage rates continue to perform at an above-average level, as both fixed and adjustable rates continue to fall. In December, the Federal Reserve cut its benchmark interest rate by a quarter-point to 4.25 percent, equating to its lowest level since January 2006. The 30-year fixed mortgage rate ended the month of November at 6.1 percent, while the one-year adjustable rate stood at 5.43 percent. As reported by the Mortgage Bankers Association, the percentage of mortgage loan applications with an adjustable interest rate remained relatively unchanged in November at 14.6 percent. The subprime credit market continues to worsen, as evidenced by the still-declining ABX 06-2 BBB- series, which has fallen roughly 81 percent year-to-date.
Consumer Behavior: C
All three gauges of the consumer once again weakened on a sequential basis. Consumer confidence remains in a state of freefall, dropping to 87.3 in November, with consumer sentiment and consumer comfort also continuing to decline. New data from the Federal Reserve indicates that total owner’s equity in residential real estate precipitously declined during the third quarter, due largely to falling home prices and rising mortgage debts. Specifically, U.S. households lost a record $128 billion in real estate equity in the third quarter.
Existing-Home Market: D
Our grade for the existing-home market remains weak, with prices still declining and supply increasing. Prices in the third quarter posted their biggest declines on record — down 4.5 percent year-over-year, according to the S&P/Case-Shiller index. In addition, annualized home sales fell to 4.97 million in October, equating to the lowest level since December 2000, with the existing-home sales volume now down 21 percent over the last year. The level of existing-home inventory now stands at 10.8 months, equating to a precipitous 64 percent increase over the last year, with no signs of abating. The only bright spot this month is pending home sales (based on contracts signed, thus a leading indicator of existing sales), which rose for the second month.
New-Home Market: D-
The new-home market remains weak, with builder confidence still at an all-time low, evidenced by the NAHB’s current Housing Market Index measure of 19. All new-home metrics indicate a continued softening in prices, with October’s 13 percent year-over-year price decline the biggest drop since September 1970. On the positive side, new sales volume increased to an annual rate of 728,000 in October, while the supply of unsold new homes declined to 8.5 months.
Housing Supply: D
Housing supply continues to remain an issue. Permit activity has fallen to a 1.178 million-unit annual rate, with single-family permits declining to 807,000. Single-family permit activity is now at its lowest point since November 1991, while total permit activity is at its lowest level since July 1993. Starts rose sequentially to 1.23 million in the last 12 months, while completions increased to 1.44 million. Though up sequentially, both starts and completions remain down over the last year, falling 16 percent and 25 percent, respectively.
John Burns is the founder of Real Estate Consulting in Irvine, Calif., which monitors changes in real estate market conditions and provides consulting services, including strategic planning, market research and financial analysis. He can be reached at jbrec@realestateconsulting.com.
