Foreclosure Trends Are Clouding the Housing Market Outlook

As signs of the times go, this recent headline in the New York Times Sunday magazine could not have been a welcome one for mortgage lenders:  “Just Walk Away.”  That’s the advice contributing writer Roger Lowenstein offered to homeowners with under water mortgages, telling those who are able to make their mortgage payments that it may not be in their financial self-interest not to do so. 

“Strategic default” is the term for the decision Lowenstein was proposing.  His point was not that defaulting on loans is a good idea or that it is without consequences; rather, he was complaining about a perceived double standard, where consumers are told that it is immoral for them to walk away from their debts but deemed good business for corporations to walk away from theirs.  No one accused Morgan Stanley of moral weakness when it stopped making payments on six San Francisco office buildings worth less than the outstanding mortgages on them, Lowenstein argued; why should consumers operate under a “powerful moral constraint” that doesn’t apply to corporations? 

We mention Lowenstein’s argument not because we agree with it, but because with nearly 11 million mortgages currently under water according to recent estimates, the prospect that a significant number of them might “strategically default,” as Lowenstein suggested, should give lenders pause.  Even without that risk there is ample cause for concern about foreclosure trends.   

Foreclosures Looming

More than 300,000 households – 1/417 homes – received foreclosure notices in November.  That was 8 percent below the October total but still 18 percent higher than in November of 2008, despite the Obama Administration’s intense pressure on lenders and servicers to increase their efforts to modify the loans of borrower at risk of foreclosure.  Modifications have been increasing and subprime defaults have been declining, at least in part because of those efforts.  But an increasing proportion of delinquencies and defaults involve holders of prime mortgages, who are struggling not with funky mortgage structures or questionable lending practices, but with unemployment, reduced home values, or both.

Although the freefall in home prices has slowed, some analysts are predicting that prices could decline by at least another 10 percent before the market finally finds a bottom.  The Federal Reserve’s plan to withdraw the support that has kept mortgage rates low is adding to the concern. 

“There are plenty of headwinds out there,” economist Karl Case, co-founder of the closely-watched Case-Shiller home price index, told Bloomberg Radio, recently.  “There is clearly a huge problem,” he added, noting, “the [housing] pipeline isn’t clearing.”

The Case-Shiller index was essentially flat in October, with 11/20 metropolitan areas reporting slight price gains.  Although the year-over-year price decline (7.3 percent) was the smallest in two years, the rate of improvement slowed in October, fueling concerns that the housing market may be vulnerable to a double-dip.  

Mark Zandi, chief economist at Moddy’s.com, is among the analysts cautioning against a premature conclusion that the market’s recovery has begun.  “We’re closer to the end of this [downturn] than the beginning,”  and definitely “heading in the right direction,” he told Bloomberg New, but still not “there” yet  -- “there” being a stable platform for a sustained recovery. 

The positive signals the housing market had been emitting for much of the year dimmed noticeably in November, as pending home sales – a predictor of future transactions – fell by 16 percent, ending 9 consecutive monthly gains.  Industry executives blamed uncertainty about whether Congress would extend the homebuyers’ tax credit (it did), which was to have expired in November.  The extension keeps that break (now available to existing as well as first-time buyers) in place until June and offers it to existing home owner as well as first-time buyers. 

“Sales are still comfortably above year-ago levels,” Lawrence Yun, chief economist for the National Association of Realtors (NAR), said, indicating, he believes, that “the market has gained sufficient momentum on its own.”  Yun expects “another surge” of buying activity in the spring, “as buyers take advantage of affordable housing conditions before the tax credit expires.” 

Double-edged Sword

Other analysts see the credit as a double-edged sword, spurring sales in the near term, but portending a steep drop-off later this year. “My worst fears,” Scott Anderson, senior economist for Wells Fargo, told the Wall Street Journal, “are that the housing market has been propped up by the first time buyer credit and that housing will not be getting the same boost as the year moves forward.” 

Reflecting the tax credit boost, existing home sales increased by 7.3 percent in November, beating the anemic November, 2008 sales pace by nearly 46 percent and reaching the highest annual rate (6.54 million units) in almost three years.   Clouding those results somewhat, more than one-third of the sales were foreclosures (suggesting further downward pressure on price) and more than half were first-time buyers, underscoring the impact of the tax credit, and suggesting that Anderson’s fears about a weakening market ahead may be justified.

Uncertainty about the tax credit, which buoyed existing home sales in November, apparently had the opposite effect on new home sales, which fell by 11.3 percent to their lowest level since April.  Builder confidence levels followed that trajectory, sinking to their lowest level since June, as two key components of the Home Builders confidence index – current conditions and sales expectations for the next six months –both declined. 

Despite their gloomy mood, builders broke ground on more new homes in November than in October permits for new single-family homes rose to their highest level in a year.  Unseasonably warm weather in November following an unseasonably wet October partly explained the improvement, but Frank Nothaft, chief economist for Freddie Mac, perceived a “stabilizing” trend in the data.

“The bottom in home construction has coincided with increasing home sales throughout the past nine months,” Northaft said in a recent market commentary.  Home buyers, he suggested, are responding to lower rates “and the perception that the freefall in the housing market is behind us.”

Joe Robson, chairman of the National Association of Home Builders, agreed that conditions are improving, but the pace, he said, remains very slow.  “We’re headed in the right direction,” Robson said, “but poor job markets and other economic factors are still keeping many potential buyers on the fence for the time being.” 

Economic Uncertainty

While the housing market has driven economic growth in recent years, most agree that it is the economy that will drive home sales up or down.  What analysts can’t seem to agree on is which way the economy is moving.  Some are debating whether the improvements they are seeing in some indicators have staying power while others disagree on whether conditions are improving at all. 

“The nascent recovery is ending 2009 on a high note,” Richard DeKaser, chief economist for Woodley Park Research, told Bloomberg News.  ”The consumer is doing all right, housing is clearly on an upswing, and business investment is improving.”

“We’re digging out of the hole,” Brian Bethune, senior economist at IIHS Global Insight, agreed.

The problem, other analysts suggest, is that the hole is deep and the shovel not nearly large enough to produce a sustained recovery.  “The recession isn’t over,” Martin Feldstein, former president of the national bureau of Economic Research (which determines the official beginning and end of recessions), insisted recently.  The coming year, Feldstein said, “is going to very weak.” 

Current economic reports provide evidence to support views at both ends of the mood spectrum.  On the optimists’ side:

• The Institute of Supply Management’s  (ISM) Mangers’ Index increased by 1.4 points in December to 55; it’s now up 23 points from the 28-year low reached in December of 2008.
• Factory orders increased by 1.1 percent in November, spurred mainly by non-defense capital orders – a key predictor of capital spending by U.S. businesses and a very encouraging sign, some analysts believe. 
• The Index of Leading Economic Indicators increased for the seventh consecutive month in November, rising by almost 1 percent. 
• Household wealth increased by $2.67 trillion in the third quarter, reflecting improvements in stock prices and home values.  Households have now regained about one quarter of the $17.5 trillion in wealth lost since the middle of 2007.
• Consumer incomes increased by 0.4 percent in the third quarter for the first time since May, while consumer debt declined by 2.6 percent —the largest quarterly drop since record-keeping began in 1952.  Some analysts see the debt reduction as evidence that households are repairing their finances, setting the stage for a resumption of consumer spending.  Others see it as evidence of a permanent change in consumer behavior, boding ill, they say, for an economy as dependent as this one on consumer spending.  
• Consumer confidence increased in December as Americans became more optimistic – or at least somewhat less pessimistic – about the employment outlook.  Expectations for the next six months reached the highest level in two years in the Conference Board survey, but the view of current conditions sank again in December to the lowest level since February of 1983.  Although more optimistic about the long-term outlook, “consumers remain rather pessimistic about their short-term prospects, and this will likely continue to play a key role in spending decisions in early 2010,” Lynn Franco, director of the Conference Board’s Consumer Research Center, said in her analysis of the survey results. 

Employment Concerns

The employment outlook remains the largest question mark – and potentially the darkest cloud – on the economic horizon.  It is the major concern cited by analysts who see more problems, and not much of a recovery, ahead.  Even analysts who had been encouraged by increasingly positive employment data during the past few months were rattled by the December report that the economy shed another 85,000 jobs.  Although that reflected a continued slowing in the job loss rate, it “disappointed” economists who had predicted a small gain or no loss at all for the month.  The disappointment overshadowed the previous week’s report that the number of first time unemployment claims had fallen to the lowest level in 17 months, beating predictions that the number would rise again and pushing unemployment claims almost 20 percent below where they stood in October. 

But even emphasizing the positives, the unemployment picture looks considerably less than cheery, some economists contend.  The economy, they note, has shed 8 million jobs since the recession began in December of 2007 – 4.2 million of them last year alone.  And the positive figures look a lot less  positive, these analysis say, if you include discouraged workers, who are no longer looking for jobs or who have accepted part-time work, in the calculation of the unemployment rate. 

Still, it is possible to find some encouraging numbers in the employment data, starting with an increase in the hiring of temporary workers and a decline in layoff announcements, which fell to their lowest level in two years in December, according to Challenger Gray & Christmas report.  On-line employment ads posted in November, meanwhile, reached their highest level since October of 2005, and nearly three-quarters of the employers responding to a Manpower Survey at the end of last year said they plan to keep staffing levels even over the next 12 months. 

That represents a significant change in the corporate mindset, Jonas Prising, executive vice president of Manpower, the national employment services company, believes.   “Employer uncertainty around hiring is shifting from whether to consider adding staff to when and at what rate to make the investment,” Prising said in a recent press statement, discussing the recent Manpower survey results.  “A record number of employers plan to keep staffing levels stable,” which, he noted, “is not only good news for the employed; it also means expanding opportunities for job seekers.”