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The housing bubble is deflating -- but gently
So far, there is no resounding POP to the bubble. But a closer look at home-sales numbers reveals danger signs in a few markets.
By Jim Jubak
As Edward G. Robinson said in "Little Caesar," "Mother of mercy! Is this the beginning of the real estate bust?" (Well, he would have said that if he wasn't playing Rico, a Depression-era gangster.)
Sure looked that way Wednesday. Sales of existing homes dropped by almost 6% in December from November's pace, according to the monthly survey by the National Association of Realtors. That's the third straight monthly decline in sales of existing homes. The median price of a house fell by almost 2% from the previous month.
As you'd expect -- especially since the drop to an annual sales rate of 6.6 million was worse than the 6.9 million annual sales rate that economists had been expecting -- the news knocked the stuffing out of housing stocks. The Ryland Group (RYL, news, msgs), for example, dropped 6.4% on the day. The news also killed what had been a weak but promising rally in the stock market as a whole.
But although the data do show a continuing slowdown in the housing market, in my opinion the numbers don't add up to anything like a bust.
So far, what we're seeing is a gradual deflation of the housing bubble thanks to higher mortgage rates. The danger signs, if they do exist, are local and concentrated in what had been the hottest housing markets. And there's certainly no evidence, so far, of any national mortgage debt crisis. Nationally, borrowers are actually showing lower default rates. (In some local markets, default rates are rising, but the troubles in the local economy seem to be the culprit.)
That last point is important, because it would take soaring mortgage and home-equity loan default rates in order for any correction in the housing market to do damage to the financial markets at large.
Related news and commentary on MSN Money
A bubble deflates, gently
At the moment, in my opinion, the numbers tell us to stay vigilant and watch trends carefully. So far the Federal Reserve, which created this housing bubble, is being successful in its efforts to deflate it gently. I'm skeptical that the Fed's efforts will have a happy ending in the long run, but I don't see any reason to panic before panic is due, either.
Let's take a closer look at the data, shall we?
Yes, December sales of existing homes were down from November. But sales for 2005 still set a record at 7.1 million. That's up 4% from the 6.8 million homes sold in 2004.
We're still a long way from seeing an actual year-to-year decline in sales of existing homes, although some economists are expecting to see exactly that in 2006. David Lereah, chief economist for the National Association of Realtors, projects 2006 sales of existing homes to fall by 5% this year. A 5% drop would result in sales of 6.7 million existing homes in 2006. That's justly slightly below the 6.8 million sales in 2004 and still 8% above the 6.2 million sales in 2003.
For the gradual sales decline of the last three months of 2005 to become something more serious, the rate of decline would have to pick up in 2006. And it's certainly possible that it will: The supply of unsold existing homes moved higher in December. The inventory of unsold houses now equals 5.1 months of existing sales. That's the highest inventory level since June 2003.
The downward spiral
I think one of two things has to happen for the rate of decline to accelerate.
First, the drop in the selling price of an existing house needs to become large enough -- and the speed of decline fast enough -- to send both buyers and sellers to the sidelines. Clearly, the West, the region that has been the hottest market in the country during the housing boom, is the market to watch. Sales of existing homes in the West fell by more than 11.4% in December. That's twice the national rate.
And the median selling price of a house in the West fell by 4.5%. That's way above the 2% drop in the median sales price in the Northeast, the other hot market in the recent boom. Another few months of that kind of sales-price decline might be enough to take buyers out of the market: Who wants to buy a house today when it will be cheaper tomorrow? That would accelerate the decline in sales, which would, in turn, lead to further price drops, which would, then, accelerate the decline in sales.
Second, the economy could soften enough so that buyers would be either unwilling to buy because their own economic situation is so uncertain, or unable to buy because of lost jobs or income.
I'd look to the Midwest as a test case for how a soft economy accelerates a drop in existing home sales and exerts strong downward pressure on housing prices. After all, the region's economy is taking a huge whack from the troubles of the auto industry, the area's biggest industry. Ford Motor (F, news, msgs) just announced plans to cut 25,000 to 30,000 jobs, and competitor General Motors (GM, news, msgs) is cutting jobs and reducing hours. And as the reductions in volume ripple down the supply chain, companies such as Lear (LEA, news, msgs) are cutting work forces as well.
In December, amazingly to me, you don't see much sign of those troubles in either the numbers of existing homes sold or in the median price of those sales. Sales of existing homes in the Midwest dropped by just 2.6% in December, well below the national average of a 5.7% decline. And the median sales price in the Midwest actually climbed by 1.7% in December. The Midwest was, in fact, the only region to show a rise in median sales price in December.
That doesn't mean there isn't trouble in the housing markets of the Midwest. Just that the trouble isn't showing up -- yet -- in the numbers for sales of existing homes.
Pain in the rust belt
The pain is showing up, however, in the default rates on mortgages, credit cards and other forms of consumer debt -- especially in what are called the subprime markets, where borrowers have less than sterling credit ratings.
In October, the national default rates on credit card receivables and auto and mortgage loans fell by 11%, 2.7% and 7.9%, respectively, according to an analysis by Friedman, Billings, Ramsey. That's good news for anyone who's worried about the ability of the U.S. consumer to carry current high levels of indebtedness.
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