Giving away money fixes everything!

In my last post I illustrated that much of information that you need to plan your financial future is either distorted or isn’t discussed in appropriate detail.  I will continue on this theme by looking at how the government giving away money has given the false appear that our economy is recovering.  I will illustrate this point by looking at the “stabilized” housing market.

I pose to you the following question: Has the housing market hit the bottom or have we merely seen the biggest step down?  Below I will argue that while housing may have hit bottom regionally or locally, the national housing market isn’t even close to hitting bottom.

First, let’s look at the historical cost of housing.

The above figure shows you that the cost of housing peaked at around 200.  However, the long term historical average is roughly 105, and as of November 2009, the index sits around 134.  (For details see the data in this Excel File [1].)

Clearly, housing prices have corrected, but prices normally will fall back near historical average which means housing prices should fall a minimum of another 20%.   A way to check this estimate is to look at ratio of the median home price to the median household income.  Historically, it takes between 2.5 and 3.5 years of the median household income to purchase a home.  Using a little data from the Census Bureau, I find the median home price (November 2009) is $215,000 and the median household income (2008) is $52029.  Doing a quick calculation, we can see the ratio stands at ~4.1.  Furthermore, this calculation confirms that home prices should fall significantly from here.

So why does the chart show home prices have stabilized around 134?  It has stabilized here because giving away money fixes everything!   At least that is what the government would like you to believe. The government’s credit for first time home buyers has brought people to the market at these prices, and delays in processing foreclosures have stopped thousands of homes from coming on the market [2]. However, the inventory of homes entering foreclosure continues to grow [3], [4]. Therefore, the obvious conclusion is that home prices have been artificially held up by temporary stimuli.

Can this last? Of course not! There are simply too many factors working against prices holding here.  As of January, 13.68% of Fannie Mae and 8.52% of Freddie Mac loans were delinquent [5].  As of February, ~10.5% of all homes were delinquent or in foreclosure [6], and these numbers are continuing to grow [7].   With the latest numbers showing that 7.9 million home owners are not paying their mortgages [8], the outlook for home price is anything but rosy.

As if this isn’t bad enough, several factors will cause the foreclosure numbers to hold at these high levels. First, the banks will eventually have to process the foreclosures they have delayed. Second, at these price levels, approximately 1 in 4 homeowners is underwater on their mortgage, and continued price declines will lead many people to simply walk away from their home. Third, mortgage interest rates will likely rise from these historically low levels. Finally, thousands of Alt-A [9] and Option ARM [10] loans will reset of over the next several years and lead to higher mortgage payment for these homeowners.

Obviously, these factors will help push home prices down further, and, therefore, the outlook for U.S. home prices is downward until these issues clear out of the system. When the unprecedented number of foreclosures is considered along with high employment, it would not be surprising if home prices fell another 40% to near to their historic lows seen during the Great Depression.

For another brief review of the problems facing the housing market, please look here [11].
For anyone considering the purchase of a home, I would recommend you listen to the recent Mark Hanson interview [12] at King World news.



Links:
Online historical housing market data [Excel File] - Robert Shiller [1]
RealtyTrac Reports 2.8 Million Foreclosures In 2009, "Would Have Been Worse If Not For Delays In Processing Delinquent Loans" - Zerohedge [2]
More Ugly Housing Data - Safehaven [3]
Foreclosure rates surge, biggest jump in 5 years - AP [4]
As GSE Delinquencies Hit All Time Highs, What About The Monolines? - Zerohedge [5]
Hosing, I Mean Housing... - The Market Ticker [6]
Foreclosure Activity Increases 7 Percent in First Quarter - RealtyTrac [7]
Mortgage Defaults May Be Driving Consumer Spending - CNBC [8]
Alt-A: "Here It Comes" - The Market Ticker [9]
More Homeowners Struggle As OptionARMs Reset Higher - CNBC [10]
The Next Leg Of The Housing Crisis In Five Simple Charts - Zerohedge [11]
Mark Hanson Interview - King World News [12]