2007: Another false dawn for housing

0 Comments | Oakland Tribune, Jan 6, 2008

Wait a second. Haven't interest rates fallen in the last six months?

Yes, they have. The real cost of buying a home is a function of the actual cost (mortgage rate) less the return (house price appreciation). When home prices are falling on a national average basis, as they are now for the first time since the Great Depression, the real cost of borrowing goes up.

Using the S&P Case-Shiller Index, home prices nationwide fell 4.5 percent in the third quarter of 2007 compared with the same quarter in 2006. With the 30-year mortgage rate at 6.17 percent, the real cost of buying a home is over 10.5 percent.

If this year is anything like last year, a prospective homeowner can't expect to defray the added cost with gains in his stock portfolio. A broad basket of U.S. equities rose 3.8 percent in 2007, less than the rate of inflation.

The good news for the residential real estate market is that homebuilders have finally gotten the joke and are slashing production, Shepherdson says.

Big foot

"In recent months, the inflow (of homes for sale) has been slower than the pace of sales," which has the effect of reducing the inventory of new homes, he says. "In the three months to November, the gross inflow of new homes onto the market plunged at a 60.7 percent annualized pace compared with the previous three months," a cutback comparable to one last seen in the housing bust of 1981, Shepherdson says.

Residential construction may be a small share of the U.S. economy -- 4 percent in the third quarter -- but it has a big footprint. Construction activity ripples through a whole host of manufacturing industries: half of the 18 NAICS codes (the system used by the North American Industry Classification System to define industries) tracked monthly by the Institute for Supply Management, according to Norbert Ore, chairman of the ISM Manufacturing Business Survey Committee.

The nine manufacturing industries affected by housing are: Wood Products; Furniture and Related Products; Textiles; Petroleum and Coal Products; Plastics and Rubber Products; Transportation Equipment; Primary Metals; Fabricated Metal Products; and Nonmetallic Minerals.

Incentive lacking

Maybe that's why the manufacturing group's December snapshot was so glum. The ISM Index fell 3.1 points to 47.7, the lowest in almost five years and the result of big declines in the indexes of new orders (45.7) and production (47.3). Only five of the 20 industries reported an increase in new orders last month. Even orders for exports, the economy's strong suit, showed less of an increase than in the prior month: The export index fell 6 points to 52.5.

So where's the incentive to buy a home if the real cost is high, inventory is plentiful, prices are falling and credit is harder to come by?

There isn't one, at least not yet. Interest rates and prices are apt to fall further, the expectation of which will keep qualified home buyers at bay. The effect of new federal and state regulations for mortgage lenders, while ensuring that the most recent housing free-for-all doesn't happen again, will be to depress lending in the near term.

Annual plateau

The word "housing" warranted 20 mentions in the minutes of the Federal Reserve's Dec. 11 meeting released yesterday, and none of the references were positive. Policy makers acknowledged the "intensification of the housing correction," said it was "likely to be both deeper and more prolonged" than they anticipated, admitted to "some spillover" to consumer and business spending, and warned that stresses in mortgage finance could further weaken the housing market.

The Fed staff expects the drag from housing to weigh on economic growth throughout 2008 and 2009. Hopes for a bottom dashed again.

Caroline Baum, author of "Just What I Said," is a Bloomberg News columnist. The opinions expressed are her own.