Housing Hits a Wall

Usually I don’t bother commenting on the monthly report of pending home sales, but today’s news that the index of activity maintained by the National Association of Realtors dropped by 16% in November is noteworthy. This is simply due to the fact that such a dramatic one month drop reveals to us all the distortion in real estate provided by the stimulus package. Remember: all summer long as we heard bullish reports about home sales rebounding we were cautioned that the popular first time buyer tax credit may be adding volume that would prove to be unsustainable. Add in the impact of the huge drop in home prices in most of the country and the recipe for a period of unusual activity was set well in place.

This morning’s data seems to mark the end of the distortion.

Our problem now is trying to tell whether this is a one month adjustment back down to a new ‘normal’ level of activity, or whether we will see one or two more declines before we hit that level. Given that we have just entered a very cold weather pattern and are still mired in a poor credit cycle I think it reasonable to expect a couple more poor months.

Naturally the realtors don’t see it that way. Then again those folks are perennially optimistic. Their spokesman points to the data and sees reason for hope: November may have seen a dramatic drop from October, but it is still 15.5% up from a year earlier. He expects another ‘surge’ in activity in the spring, and now assures us that the housing sector is firmly capable of growing without government life support.

I wouldn’t go that far.

Obviously housing has bounced back from the deep lows it hit last year and late 2008. That much we can all agree on. The issue we are all grappling with is its trajectory during the rest of 2010, and especially its ability to maintain a growth path without a further dose of government aid. On this latter score today’s report paints quite a negative picture.

Let’s look at the fundamentals:

Clearly home affordability has improved from the ridiculous days at the height of the bubble. Prices have dropped back into reasonable ranges from the absurdity of 2005-2007. But that improvement has come entirely from prices collapsing and not from wage growth. Without incomes growing, affordability will not continue to improve and may well decline somewhat as prices bounce up a bit in the face of strengthening demand. Longer term and sustainable recovery for housing depends heavily on income gains, and there are few signs of that occurring sufficiently this year for us to believe housing will prosper. Plus credit is still tight. We are all aware of the follies of mortgageunderwriting during the bubble – especially now that Bernanke has cast that underwriting [wrongly in my view] as the primary villain of the entire crisis. As ever, our brain dead banks are now doing their apres-frenzy lurch back to underwriting caution, and are thus overly squeezing the credit supply. This means the flow of cash into new bank loans is much slower than we need it to be in order to generate a healthy growth pattern for housing. Tight credit is likely to remain the order of the day for a while yet – certainly into the spring which is normally a hot sales season for real estate.

So I take issue with the realtors. While I don’t foresee a continued negative trend in housing throughout the year, I do not agree that we will see a surge. More likely, given current conditions, is a weaker recovery and modest growth, which is nothing to get excited over in either direction.

A word of warning: the deeper message in today’s news is the worrisome fact that the economy seems still to be heavily dependent upon government aid for its current growth. We are all expecting the first growth in jobs for many months when the government issues its report later this week. I am beginning to wonder how much of that is simply a function of stimulus and how much is sustainable beyond the unwinding of government support that will begin later in the year.

Put another way: do we need another dose of stimulus to crank the private sector? Today’s report is ambiguous in that regard at best. It certainly cannot be encouraging to have housing plummet the first month its life support is withdrawn.