Issue 7 • January 14, 2009

The Cracked Foundation of Our Economy

As I mentioned in last week’s issue of Weiss Advice, the troubled banking and financial sector creates one of the biggest question marks for investors in the New Year.

An even bigger issue that continues to weigh on financial markets and the economy in the New Year is the troubled housing sector, which is undergoing its worst slump since the Great Depression. Single family home prices have already plunged an unprecedented 25% from their peak in 2006, according to the latest data from the S&P/Case-Shiller index.^[I]

That’s an unprecedented decline in household wealth, the likes of which has never been seen before — at least not since modern home sale records have been collected in the post-WWII era.

Much has been written already to describe the epic housing boom that occurred earlier this decade…and now the spectacular bust, so I’ll spare you the gory details. Instead, let’s review the highlights (or low-lights) of this sea of change in household wealth, and look ahead to some current proposals aimed at ending the housing depression.

The Epic Housing Slump Continues

Those expecting a merciful end to this epic housing depression were sorely disappointed with the most recent data, released just two days before the New Year. The S&P/Case-Shiller index of 10 U.S. cities declined 19% year-over-year in October (the most recent month for which data is available), showing that widespread losses are continuing.^[II]

That’s the fastest rate of home price declines recorded yet during the current housing bear market. And it indicates that conditions on Main Street are, in fact, getting worse, not better, as mounting home foreclosures keep pressure on prices.

In fact, if you purchased your home after March 2004 — you’re probably back to break-even on your investment — if not UNDERWATER — as millions of American homeowners are.^[III]

The problem: there are still more sellers than buyers in today’s housing market — in spite of (or perhaps, because of) the epic 25% decline from the peak.

Too Much Supply... Too Little Demand

Looking at a simple industry measure of supply and demand shows there are far too many sellers of homes and not enough buyers. The month’s supply of unsold homes tells you the number of month’s it would take to sell ALL the homes currently listed for sale. For the U.S. resale market, there is an average supply of 10.6 month’s worth of unsold homes now on the market in the U.S. — and a staggering 16.7 month’s supply of unsold condos nationwide. On top of that, there is an 11.5 month’s supply of unsold NEW homes in the housing inventory across America.

The norm over the last 10 years is an average inventory level equal to about 4-to-4.5 month’s worth of unsold homes. So the U.S. housing market is STILL about two-and-a-half times over supplied!^[IV]

On the demand side, we’ve seen a slight uptick in new mortgage applications as interest rates declined at year’s end, BUT this is nothing close to what’s needed to clear the bloated housing supply overhanging this market.

Meanwhile, both new and existing home sales keep falling at record rates, nearly every month, as prices continue to spiral lower.

Housing Sector Under Pressure

Existing home re-sales, which account for about 90% of total home sales, fell again in November, as the median-home price plunged another 13% from a year ago — that’s the most since the National Assoc. of Realtors began keeping records in 1968!^[V]

Foreclosures and short-sales (in other words, fire-sales) accounted for nearly HALF of all existing home sales in November.^[VI]

In terms of constructing a “sequence of depressing events,” it was the housing slump that triggered the sub-prime blow-up, and the credit-crunch that followed. The credit-crunch, in turn, led us into the financial sector meltdown, and began a bear market in stocks, both of which pushed the economy into recession.

Therefore, it is reasonable to assume that we’ll first need to see a recovery in housing (or at least some stabilization) as a leading indicator of recovery in the stock market and broader economy.

Investors and homeowners are looking hopefully toward the incoming Obama administration for some much-needed solutions to the housing and economic recessions.

What’s the Solution to the Housing Problem?

We’ll soon see what President-elect Obama’s stimulus plan looks like, but while Uncle Sam ponders injecting more capital into the wounded banking sector, the Fed and Treasury are also said to be considering a plan to “peg” mortgage rates at 4% to 4.5% to stimulate more demand.

Other “tax breaks” are being considered for “first-time” home buyers, but the proposal seems to fail the “fairness test.” What about all the millions of existing homeowners with higher interest rate mortgage loans? Shouldn’t they also be able to refinance at low government-subsidized rates?

Finally, nobody wants to consider a solution that would potentially “reward” homeowners who took out liar-loans in the boom years, without which they would most likely still be renters.

Whatever the ultimate solution, it seems clear that the overall economy won’t improve again until the U.S. housing market stabilizes first. So keep your eyes on incoming housing data, no matter how dismal.

If housing stability is the foundation necessary for a lasting turnaround in the economy, watch for housing data to go from dismal to less-dismal, only then will we finally be laying the foundation toward recovery.

Good investing,

Mike Burnick
Director of Research & Client Communications
Weiss Capital Management, Inc.

^[I] Standard & Poor’s: “Home Price Declines Worsen As We Enter the Fourth Quarter of 2008 According to the S&P/Case-Shiller Home Price Index”, 12/30/08
^[II] Ibid
^[III] Ibid
^[IV] Merrill Lynch economic commentary: “Focus is on the cure, not the patient”, 1/8/09
^[V] Bloomberg: “October Home Prices in 20 U.S. Metro Areas Fall 18%”, 12/30/08
^[VI] Ibid