by Calculated Risk on 9/29/2006 06:00:00 PM

From Caroline Baum at Bloomberg: Think Housing's Stabilized? See Cancellations

... cancellations are rising, and they aren't being captured in the aggregate statistics because of the way the survey is designed. Hence, sales are being overstated and inventories understated.

``Once a sales contract is signed, there's no way of recording the cancellation or putting the home back in inventory,'' says Dave Seiders, chief economist at the National Association of Homebuilders in Washington. ``Builders keep track of gross and net sales; we don't have a net sales number from Commerce.''

The Census Bureau, which is one of the Commerce Department's statistical agencies, counts an initial new home sale: Sales go up and the ``for sale'' inventory is reduced. If the sale is canceled, it isn't reflected in revisions to previous months. What happens? When the home is ``resold,'' statisticians ignore that transaction.

``We don't double count,'' says Steven Berman, the survey statistician for the residential branch of the Census Bureau's manufacturing and construction division.

When the cancellation rate is changing -- in either direction -- it can distort both sales and inventories.

We know from big builders that cancellation rates are rising. Seiders says the rate ``has roughly doubled over the last year'' and is ``more serious at the big companies.''
...
The effect of higher cancellations is ``to overstate the overall level of sales and understate the level of inventories,'' Carson says. The opposite is true at the bottom of the economic cycle, when sales pick up and the resold homes aren't registered as a sale or removed from the ``for sale'' pile.

What makes the current situation so worrisome is the ``unprecedented inventory overhang, encompassing new and existing markets and many of the largest metropolitan areas,'' Carson says. ``Its sheer size raises the odds that prices will fall more and longer nationwide than they did in the 1990s.''

This is the clearest discussion I've seen about how the Census Bureau accounts for cancellations.

1) When a house is sold, the Census Bureau includes the sale and reduces inventory by one.

2) If the house is cancelled, the Census Bureau does nothing. Sales are not reduced; inventory is not increased.

3) When the same house is resold, the Census Bureau does nothing. It is not included in Sales.

So if 100K houses have been cancelled and not resold, inventory is actually 100K higher than reported by the Census Bureau. Because of the recent high cancellations rates, this means that new home sales are probably much lower than reported by the Census Bureau - and inventories are significantly higher.