When Will the Housing Market Recover?

For the Housing Market, the Worst Is Still Coming

The Fed's interest rate cuts in January have lifted the stock market somewhat, and gotten investors hopes back up, but those cuts are like trying to plug a dam with chewing gum.  Some key questions that investors and policy makers are asking themselves during these trying times:

• Will American spending continue?
• Will banks continue lending or will their hands be tied by mortgage defaults?

The recent optimism has helped the homebuilder stock index recover a whopping 49% in the last couple weeks of January.  The problem with this optimism?  It's a heck of a lot more likely that the housing market is still nowhere near recovering.  Here's why.

Economic growth is still slowing

Home construction is falling at an annual rate of 24%.  On January 30th, the government announced that economic growth slowed to a mere 0.6%.  It's very possible that home prices will continue to drop, some analysts say as much as 25 - 40% over the next couple years.  The fact is that they still have plenty of room to fall.  It's uncanny how similar the optimists' arguments supporting the housing boom today are to those that supported the tech movement of the late 90's just before it all came crashing down.

Home prices are still way above their long-term trend

Since 2000, home prices have skyrocketed above and beyond their long-term trend, and despite the recent drop are still nowhere near returning to normal.  Such a spike has never been seen in U.S. history - looking at data all the way back to 1890.

Would a 25% drop help the housing market on its road to recovery?  Hardly.  Putting long term growth back on track does not erase the turmoil (credit crises, unemployment, etc.) that the bubble started.  There are simply too many potential scenarios that could dip the economy into recession, and therefore prevent the housing marketing from recovering.  Let's take a look at some of them.

Is housing a fail-safe investment?

Government, real estate, and media alike had homeowners believing that their homes were as solid an investment as you can find.  And for those that bought and sold, it was.  But the average person isn't out there flipping houses, and is now stuck with a  home that will potentially lose a large chunk of its value over the next couple years.  This is especially the case for homeowners that purchased towards the peak of the boom.  So it's no longer a question of when will the housing market recover, but rather when will it completely collapse and how is that going to affect the economy?

How will a housing market collapse affect the economy?

If the housing market does collapse, it will definitely tip the economy into a recession.  Why?  Because over $5 trillion dollars in wealth will be chopped off the balance sheets of households and banks.  That's about the size of the drop in stock market wealth during the tech crash.  Where else has a housing decline led to a recession?  The housing decline that began in 1925  and ran through 1932 weakened banks and contributed to the mother of all recessions - the Great Depression of 1929.

Why will the housing market continue to decline?

One problem with the current investor sentiment in relation to the housing market is that investors are factoring in the amount of home equity loans - $700 billion annually - that are still being withdrawn.  Once this slows, as it's bound to if prices keep falling the way they are, it will put massive downward pressure on the economy.  What will a further decline in prices mean?  If prices decline another 20%, two-thirds of people will owe more than their homes are worth. 

A one-two punch to the economy - housing and finance

The second blow will come from the financial sector.  Massive mortgage and mortgage-backed securities losses have spilled red ink all over financial statements.  What's worth is the amount of leverage bank impose on themselves - they've borrowed way too much money to fund their investments.  As a result of real estate losses they'll need to cut lending way back - an action that has already taken hold, as it's now harder to get a mortgage than it has been anytime in the Federal Reserve's history of surveying loan officers.

Residential construction losses spread to other industries

The drop in residential construction that took a full percentage point hit out of our economic growth will spill over into other industries, wiping out jobs in carpentry, real estate, mortgage broking, and furniture sales.  Meanwhile, American consumers are realizing that homeownership is turning into the same nightmare investment experience that investors of the tech boom at the turn of the century felt.  The bottom line?  Homeownership was way oversold, and we still have a ways to go before realizing the full extent of the coming correction.  Housing market recoveries may be making headlines, but so were tech drop recoveries eight years ago before the worst was over.

What can I do to hedge against a recession?

While we state clearly in our terms of use that we're not giving explicit financial advice, I can say that we're definitely backing our share of shorts in the financial and housing sectors to hedge against the coming housing market drop.  Just click on shorts in the menu above to see what we've evaluated and stay tuned to Quick Stock Picks for more info on the housing market.

Reference - Business Week