Ghosts and goblins. Rattling chains. Things that go bump in the night.
It’s all part of the Halloween fun, unless you’re a bank.
As the stock market has rallied from its historic lows in March, home prices also appear to be rebounding. According to the S&P/Case-Shiller Index, home prices in 20 U.S. cities rose in August for a third consecutive month, bolstering the case that an economic recovery is at hand.
In the wake of the stock market sell-off, forecasters had projected the housing index to sink 11.9 percent from August 2008, after a 13.3 percent drop in the 12 months ending in July. In sharp contrast, the gains over the last three months have been the strongest since the last quarter of December 2005.
Only One Direction Remains
Seasonally adjusted, the average increase was about 1.2 percent in July. Based on this data, it’s easy to conclude that home prices have found a bottom.
Most industry analysts agree that rising home sales are due in part to government programs including the first-time buyer credit and efforts to lower borrowing costs. At the same time, this rising plateau in home prices may be difficult to sustain if joblessness continues to mount and foreclosure rates don’t abate.
Therein lies the rub.
Home prices like everything else are a function of supply and demand. If the supply of available homes goes up, it’s only logical to assume prices will continue either to hold at their current bottom or trend lower.
Over the past few months, home prices have been supported by a decline in inventory. These numbers are borne out by this month’s Case-Shiller report. This, in turn, has fueled the rosy belief that housing bust is near an end.
A recent study, just released by Amherst Securities, a major national broker-dealer of mortgage-backed securities, paints a very different and much darker picture.
Analysts at Amherst estimate an “overhang” of approximately 7 million homes at risk of default or foreclosure. The current consensus holds that the number of homes at risk is between 2 to 3 million.
The staggering number of at-risk homes projected by Amherst is 1.4 times the number of houses annually sold in this country each year. If Amherst is right, as these homes emerge from the shadows, their sheer volume will likely push prices markedly lower.
Amherst is not alone in its grim forecast.
Credit Suisse projects that nearly $700 billion in mortgages may be in peril over the next two years. In the view of this global financial leader, most of those mortgages in jeopardy are related to the five-year option arm home loans that originated between 2005 and 2006.
Why the Numbers Are Impressive
Until now, these borrowers have been servicing negative amortization loans requiring them to pay interest only on their notes. Analysts at Credit Suisse see trouble ahead as these borrowers are faced with the added financial burden of starting to pay down the principal on their loans.
Amherst cited three additional factors that have kept the reported number of at-risk loans artificially low.
First, banks have been slow to report mortgages that have fallen 30 or even 60 days behind. Second, as a result of low “cure rates,” fewer delinquent mortgages are returning to performing status. Finally, banks are simply taking longer progress through the foreclosure process, and holding foreclosed properties longer to avoid putting pressure on home prices.
With home and other asset prices on the rise, the Federal Reserve may also take action to prevent housing values from re-inflating too quickly.
Fed Chairman Ben Bernanke and other policymakers at the central bank have expressed growing concern about the threat relating to the formation of another asset bubble. Fed officials under Benanke’s direction are now reviewing whether recent gains in asset prices and narrowing credit spreads are justified as they try to ensure near-zero borrowing costs don’t generate future market turmoil.
At the height of the housing boom, sales of existing homes soared to about 7 million per year. Current figures show this number has dropped to a more normal 5 million.
Why Prices May Become Static
Based on the current sales rate, it would take about 9 months to clear the existing inventory of homes on the market. Under normal conditions, it would take about 6 months.
If both Credit Suisse and Amherst are correct in their projections, these additional 7 million houses in the “shadow inventory” could hit the market over the next 2 years. Even if you assume that interest rates remain unchanged for the foreseeable future, this massive influx of new inventory could slow the market turnover rate from 9 months to 16 months.
This dramatic upswing in supply could freeze average home prices near their present levels or force them lower. Home prices could be pushed lower still as the Fed slowly backs down its “quantitative easing” of interest rates in order to avert the formation of another asset bubble.
The message to home sellers is clear.
If you’re lucky enough to be ahead of where you started and have a willing buyer on the hook, take it. If you don’t, look for a renter because time and market pressures may not be on your side.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
