by Jonathan Foxx
Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is the President and Managing Director of Lenders Compliance Group, the first full-service, mortgage risk management firm in the country.
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I don't think anyone can doubt that the recession of mid-2006 through early-2009 - euphemistically now known as the Great Recession - was the worst downturn in the U.S. residential real estate market since the Great Depression. It's effects linger.
Record-low mortgage rates have encouraged housing affordability and supported home prices. While a high level of housing affordability would reduce downward pressure on home prices, several market indicators still highlight growing weaknesses in the U.S. housing market.
What is contributing to the weakening housing market?
Declining mortgage applications for home purchases,
Fewer existing home sales following the expired tax credit,
An elevated level of distressed and short sales,
A large backlog of distressed "shadow" inventory, and
A high unemployment rate.
About that "shadow" housing inventory, if a flood of shadow inventory does come onto the market over the next few quarters, I think it's axiomatic that home prices might fall further because distressed sales usually involve significant price discounts. Distressed properties are currently selling for an average of 25% to 30% less than non-distressed properties. The major mitigating factor to reducing the impact of the "shadow" inventory are the government programs aimed at keeping homeowners in their homes.
Some factors contributing to deflationary pressures are:
A significant rise in distressed home sales,
An elevated unemployment rate, and
Tighter lending standards.
The Direction of Affordability
Housing affordability is on an uptrend, obviously a positive sign, conditioned as it is by low interest rates for mortgage loans as well as the drop in home prices. In some instances, these factors and others have led to home price volatility and pushed home prices down, on average, to 2003 levels. Some homeowners who bought properties before 2003 have seen their investments actually appreciate, at least on average, based on the S&P/Case-Shiller Indices.
Overall, however, a quick check of the U.S. housing futures indicates that home prices will decline an additional 4% or more over the next 12 months. Home prices are key economic trend indicators, and it's simply not credible to assert that the financial markets can recover fully until and unless the housing market recovers.
On the other hand, prices in the S&P/Case Shiller Indices are now at late-2003 levels. Parts of the country have ruinous and morose housing markets. For instance, prices in Detroit are even below their 2000 levels!
It took about three years from late 2003 for home prices to reach their mid-2006 peak, and then another three for prices to fall back again.
So what is the trend?
Standard and Poor produced the chart above which, if followed logically through its trend lines, would indicate an expectation that it will take roughly nine years from now for home prices to climb back to their mid-2006 peak - and that is assuming a home price appreciation rate that is in line with a 4% household income growth rate - meaning that home prices will not be back at their prior peak until closer to 2020!
Affordability and Trends
Home price behavior can affect mortgage interest rates and the availability of mortgages. In my experience, declining home prices act inversely to the LTV ratio - that is, the ratio increases, thereby reducing the availability of refinancing and home equity borrowing options. At the same time, however, lower home prices generally act inversely to the number of home buyers in the market - that is, the lower the price of the home, the larger the pool of potential buyers. And any real volatility in home prices will obviously drive up the cost to borrow (i.e., through higher interest rates), because investors and lenders will require a higher return on their mortgage-related investments.
Comments or Questions?
I would welcome your comments or questions.
Please feel free to email me at any time.
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Lenders Compliance Group is the first full-service, mortgage risk management firm in the country, specializing exclusively in mortgage compliance and offering a full suite of hands-on and automated services in residential mortgage banking.
