7-23 – The Housing “Supply” I See…a Decade Worth to Work Through

by Mark on July 23, 2012

Folks are overly optimistic on the housing “inventory” issue to the point of being sorely misguided;  confirmation bias is rampant with pundits obsessing on inventory but ignoring everything else.

It’s a classic story of “out of sight, out of mind”.  Each time a housing report is released and inventory prints lower or flat the pom-poms come out.  This reminds me of the “hide the rotten sausage” game the banks were playing in 2007-2009 (still playing today actually) with legacy residential mortgage loans and MBS when mark-to-market accounting was in effect. The banks would continually say they had low or no exposure, analysts and investors would accept this at face value, and each quarter the legacy loan and MBS risk hidden somewhere on balance sheet would weigh on capital.

Each 12 to 18 months when housing (on the bubble or at the margin) responds to some sort of massive stimulus effort consensus quickly jumps behind the macro “recovery” theme and forgets the granular.

To me, the “inventory” that NAR reports is absolutely insufficient for meaningful analysis.  That’s because it’s a “best-case, perfect world” scenario. Take short sales for example.  Few are ever “listed” in a traditional manner. Most are “listed” and go “Pending” in a very short period of time;  many times within a few minutes of each.  There are 600k short sales that occur per year and volume is climbing.  This “inventory” is real and short-sales reduce demand for “listed” inventory.  But you will never capture the 50k short sales per month in NAR’s inventory metric.  This smallest of examples alone means NAR’s “inventory” figure underestimates real and available housing supply by 20%.

The “inventory I see” — that has to be cleared (zombie owners de-levered) before this housing market has a shot at a “durable” recovery — could be as high as 30 MILLION units. Most likely a “bottom” can occur after two-thirds is worked through, or ~20mm units.  But no “escape velocity” can ever occur with over half of all mortgage’d households unable to sell and rebuy or rent — sitting stuck in their houses many with a 1% or 2% interest only teaser rate loan modification (sound familiar) — awaiting default or short sale.

Bottom line:   In order to permanently de-lever this housing market something must be done to address the 20 to 30 million homeowners in a negative or “effective” (lacking the equity to pay a Realtor 6% and put 20% down on a new house) negative equity position; with legacy 2nd liens; and without the credit needed to qualify for a new vintage loan. That’s because repeat buyers are the “durable” demand cohort;  not the volatile and thin first-timer buyer and “investor” cohorts that come and go with the stimulus wind like we saw in the first half of 2010 and will again in the second half of this year.

 

Years of “Supply” to Work Through Before Housing can Stabilize and Eventually Achieve “Escape Velocity” and a “Durable” Recovery

The chart below breaks down demand and supply as I see…as it really occurs in practice.

Based on 4.6 million sales per year — of which roughly 1.25mm per year are REO resales and short sales — then the supply below will take well over a decade to burn through at a 75% rate.  Coincidentally, this turns our housing crisis into a 15 to 20 year events, which is just about the exact amount of time Japan’s housing market took to de-lever.

Note, the three constituents of the “Ghost Supply” cohort are not mutually exclusive of each other meaning a homeowner in an “effective” negative equity position may also have a 2nd lien and impaired credit.

 

Undermining Fed monetary policy leaves the housing market vulnerable to years more pain

It is important to note that “stimulus-induced sales volume spurts” like we saw leading into the homebuyer tax-credit sunset of 2010 and are seeing today with rates down 150bps YoY;  institutional investors coming into the housing rental market in an effort to protect against 1.5% 10-year Treasuries and a genuine lack of top rated investable bonds;  the artificial lack of foreclosures etc is exactly the right medicine to eventually clear this housing market…if one chooses the route of de-levering less painfully over time than all at once.   In this regard the Fed has done a fantastic job “creating demand” in this housing market (the effects of Fed policy are not being analyzed here, simply “did Fed policy create housing demand…yes, it has).

However, the all-out gov’t and bank war against allowing lenders to exercise their “right” to foreclose with new/improved mortgage mod and workout programs coming out every few quarters, which have re-levered 6 to 8 million high-risk borrowers with mods more “exotic” than the loans they defaulted from in the first place, and new laws such as in NV, CA and OR — in NV foreclosure activity is down 80% from Oct of last year — has served to undermine Fed monetary policy as it relates specifically to housing.

Bottom line, the Fed created all the demand this housing market needs in order to — over many years — de-lever it from the bubble years credit excesses. But the gov’t and banks took away all the supply through modification can-kicking and new laws.  The unintended consequences are many.  But most obvious is that this housing depression will stretch out many more years than it would have otherwise and a situation now exists in which Fed monetary policy will start having a diminishing effect on housing demand going forward. This is big trouble.