Is Deflation in the US Housing Sector Accelerating?
May 23, 2011
IRA co-founder Chris Whalen will be on a panel with Josh Rosner, Michael Lewitt and Gretchen Morgenson of the New York Times, talking about the GSEs. By no coincidence, Morgenson and Rosner will be releasing their new book, "Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon." You may sample the book in the New York Times Sunday Business Section.
After reading the book excerpt, non-bank lender NovaStar Financial certainly seems to be an outlier, does it not? The aggressive management practices and financial statements certainly make the company seem to be a very noisy subject -- but this assumes that somebody is watching for red flags. Indifference is the operative posture in Washington and no time more than the present, even when the housing market is still melting down.
In a presentation at the REthink conference sponsored by Housing Wire, John Burns walked the participants through the current situation in the US housing sector and the outlook for a recovery in prices. The bottom line: Even though affordability has returned, new home sales are likely to remain depressed for years to come due to massive inventories of unsold homes, dwindling finance and weak employment markets. Now you know why IN governor Mitch Daniels would rather see Barack Obama spend another four years in the White House -- held captive to a Republican controlled Congress. But even Obama may not want the POTUS job by next year.
The stark presentation by Burns provides a reminder that it took most of the 1990s right through to 2001 before the US real estate market recovered from the S&L crisis of the late 1990s. Given the far larger degree of movement over the past five years in terms of metrics such as demographics and home ownership, as well as available financing and home prices, it seems reasonable to ask whether the cure period this time around will not take a bit longer.
One of the key points made by Burns is that new home construction is not likely to recover until a substantial dent is put in the backlog of unsold homes. He sees the backlog going out four years or more. With the degree of price contraction experienced in many markets, starting a new home construction project does not make any sense. Even though home selling prices have dropped by low to mid double digits, the cost of building a home has not dropped significantly. Indeed, costs such as project overhead have gone up 10-20% since 2006, according to Burns Real Estate Consulting.
As crazy as home prices had behaved in the past several decades, the sad fact is that the rate of inflation for many of the inputs that go into building a new home today were galloping along at double digits. The true, underlying rate of inflation in the US during this same period has been several times higher than the officials statistics suggest -- both in terms of rising costs and compression of real wages -- making the replacement cost for many existing homes far closer to current market than home owners and policy makers appreciate. We can call it real margin compression, perhaps a new economic metric?
Channel check: Call your insurance broker and review the replacement cost assumptions in your home owner's policy. Then send us a note and give us (1) your current valuation for tax purposes and (2) replacement cost for insurance purposes. We face the strange prospect of a market where many homes are trading at or around true replacement value, but remain unsold due to a lack of financing and also a shrinking home owner population. Homes are still not affordable vs. available consumer incomes.
Consider this thoughtful comment we got from one long-time reader named Gary, who for decades has worked along the US-Mexico border as a banker and businessman. Note what he says about the nature of the housing market and also the potential role that community banks can play in rebuilding the market for residential home finance on sane terms:
The factors discussed above are just some of the "sources of friction" we see slowing or retarding a recovery in the US housing sector. One of the members of our continuous online housing study group, Alan Boyce, told the attendees of REthink that the credit spread for prime collateral going into private label securities is +100bp to the GSE curve, but that the spread for the bottom 90% of borrowers is "incalcuable." More, the veteran mortgage market observer predicts that in the futrure spreads on private label collateral will widen during times of market stress or interest rate ease by the Fed, even as Treasury paper and GSE obligations tighten. "That super 'procycality' cannot be allowed to happen," Boyce argues.
On Wednesday this week, IRA's Chris Whalen will be addressing a luncheon in Manhattan sponsored by BNY ConvergEx. We will be discussing the outlook for financials given the prospects for the housing sector, EU defaults and the scheduled end of the Fed's quantitative easing operations. Please contact your ConvergEx representative for details.
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