A theory on the bounce and slog housing market – Will rising home prices resurrect those negative equity home owners?
Another thesis regarding the housing market’s future path is that of a bounce and slog market. The theory focuses on the negative equity home owners and also the low inventory on the current market. This view point actually holds some solid ground. As of last count, there are over 11 million negative equity home owners in the US. This data is usually put out quarterly but with the stronger home price movement this summer, many will move out of the negative equity position. The theory proposes that many are not selling today simply because they cannot without bringing cash to the table. Out of the 11 million underwater home owners, how many would like to sell but simply do not because they would actually lose money on their sale? This is an interesting perspective on the underwater segment of the market. Yet the outcome is probably not as clean cut as one would expect.
Case Shiller will turn positive shortly
2012 has been a solid year for housing thanks to low inventory and very low interest rates:
Coupled with the above items, you also have very low down payment mortgages like FHA insured loans that have boosted the entry level market buyer by allowing maximum leverage with little money in the game. This has assisted on one front but there are still many in a negative equity positions that are paying their mortgage dutifully. To the initial theory of the bounce and slog, the idea goes that many will want to sell and are seeing that prices are going up. So they hold off inventory until they reach a tipping point where it finally does make sense to sell. In normal markets, people move for more common reasons like starting a family, up-sizing, divorce, or down-sizing. The distressed portion of the market was typically a small segment. For the last few years it has dominated.
As more of these home owners enter positive equity territory many are likely to sell based on more historical reasons versus the current leakage of shadow inventory. But think of what happens then. A larger portion of inventory will enter the market and likely put pressure on prices. After all, we know that 11 million of these homes are sitting in this exact position. It is an interesting theory and seems to be a very likely outcome on a nationwide scale especially if household incomes do not go up (and there is little evidence to show this is happening).
You also have seasonal impacts of home prices. Spring and summer are usually the best times for sellers and fall and winter usually see prices stall based on volume of sales:
Since the Case Shiller data lags the current market by a few months, you are likely to have positive news coming out for the spring and summer while the fall and winter data will not show up for a few months. It is really an interesting phenomenon because the market forces have been blunted to a large degree but you now have this pent up inventory of distressed home owners but also many more who are simply underwater. Someone that is say 5 to 10 percent underwater and has no issue paying their mortgage really isn’t a distressed home owner.
Visible inventory seemed to peak in 2008 but has moved steadily lower since that point:
With demand being increased via:
-Lower interest rates
-Banks controlling distressed inventory
-Low down payment mortgage products
Home prices have stabilized and are actually increasing nationwide. The one aspect I am cautious here about is that household income remains weak and prices have increased simply by various mechanisms of leverage. The housing bubble was created by leverage products that decoupled from household incomes. We are nowhere close to liar or NINJA loans but is a 3.5 percent down payment product something that should remain if default rates are soaring? Anyone that buys a home with an FHA insured loan (the vast majority go with the lowest down payment possible) will be in a negative equity position for a couple of years given selling costs associated with a home sale.
The premise is interesting and I think this is likely a path for housing for the next few years. A sort of bouncing along on the bottom as distressed inventory is funneled out but also, many underwater home owners come online to sell and thus pushes inventory up putting a cap on how high home prices can go up. Supply and demand on the MLS but behind the scenes, we have a potential pool of inventory that has never existed in the US housing market.
The religion of the Fed
On a side note, some seem to think that the Fed is nearly omnipotent in what they can do. Do not forget that it was the Fed with little oversight of the banking system and Alan Greenspan slamming rates lower that provided a very fertile ground for the housing market to expand. Also, let us use Ben Bernake’s words from 2007:
“(Fed Reserve, 2007) All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.”
Does that sound like a central bank that can predict deep into the future? Only a few months later the economy started to implode. The danger with the very generous monetary policy of the moment is that people are now conditioned to insanely low rates and low down payment loans. Black Swans are common because people act irrationally and we do not have full transparency in current markets. The vast majority even openly admit that banks are sitting on millions of properties yet the only way to get a true measure of their price is to have them on the market! In the short-term a bounce and slog market seems to be the name of the game.