To say the news coming from the housing market is grim is an understatement. The Case-Shiller Home Price Index has dropped 33.1 percent from its July 2006 peak—more than the 31-percent drop in housing prices suffered during the Great Depression.
Like any economic good, the price of a house is driven by the economic law of supply and demand. Presently, the supply of homes on the market is elevated by the ongoing stream of foreclosures. In March, it was estimated that about 1.8 million homes were more than 90 days delinquent on their mortgages, in foreclosure or bank-owned.
This “shadow inventory” of homes is set to add to the unsold supply of 3.8 million previously owned homes already on the market at the end of April.
While the Federal Reserve’s quantitative easing program has flooded the system with money, it hasn’t spurred the kind of activity that was hoped to invigorate the economy. One view recently stated in The Wall Street Journal read, “The U.S. economy needs a borrower, not a lender, of last resort.” It’s a perplexing fact that, despite the low rates, the demand for mortgage loans is at a 13-year low.
So why is loan demand so soft? The oft-heard argument—“the banks aren’t lending”—doesn’t fairly explain the lack of loan demand. Sure, the banks are still nervous about the health of their mortgage portfolios, particularly as house prices drop further, in spite of their improved post-bailout balance sheets.
Some loan demand has been diminished by more stringent loan-qualification criteria, as lenders adjust to the heightened regulatory environment. The pendulum has swung from the easy-lending “fog the mirror” days toward substantial down payments backed by strong credit-risk profiles.
The high levels of unemployment, combined with consumers who are still busy working off existing debts, serves to dampen loan demand. And, finally, there is also that circular conundrum where a move-up home buyer needs to sell his current house before buying another home. Thus the pool of eligible and willing borrowers has shrunk since the credit crisis. This combination of high supply and low demand explains the drop in home prices.
There is some good news. New-home sales remain weak—the financial press and even some economists mistakenly view rising new-home sales as desirable. Until the overhang in inventory is markedly decreased, new-home construction only adds to the problem of oversupply.
Housing also appears undervalued when considering home prices are the cheapest they have been since 2002. One analyst even declared that, relative to disposable income, housing is more undervalued than at any time in the last 35 years. So it is an attractive time to buy a house if you plan to be a long-term owner—regardless of whether or not housing prices remain soft the next few years.
So, while our economy is sputtering, the path still appears to be toward a slow, long-term recovery. Hopeful signs include state tax revenue that was up 9 percent in the first quarter. Here in Indiana, Honda just announced 1,000 new jobs. The recovery will be uneven and take time, but lower prices, whether it is for homes or stocks, offer up opportunities to those who have a long-term view.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or [email protected]