by Calculated Risk on 10/23/2009 01:48:00 PM

"Never mistake activity for achievement."
Coach John Wooden
Normally a decline in inventory and the months-of-supply would be considered a positive for the existing home market, however much of the apparent recent improvement is related to an artificial - and likely short lived - boost in activity.

The following graph is a turnover ratio for existing home sales. This is annual sales and year end inventory divided by the total number of owner occupied units. For 2009, sales are estimated at 5.0 million units, and inventory at the September level.

Click on graph for larger image in new window.

Although the turnover ratio has fallen from the bubble years, the level is still above the median for the last 40 years. This suggests activity in 2009 is slightly above a normal year for existing homes.

The reason turnover hasn't fallen further is because of all the distressed sales (foreclosures and short sales) primarily in the low priced areas, and because of the "first-time" home buyer tax credit.

The distressed sales activity is a necessary step towards a healthy market, but the burst in activity associated with the "first-time" home buyer tax credit is "mistaking activity for achievement".

NAR chief economist Lawrence Yun argued this morning: "[W]e need a steady supply of qualified buyers to meaningfully bring inventories down ..."

Mr. Yun is making two obvious mistakes. First he is narrowly defining "inventories" as just inventories of existing homes. The total housing inventory includes existing homes, new homes, and rental properties.

If we think of a balloon that contains existing home inventory and vacant apartment units, the tax credit is like pushing a finger on the balloon - the indent makes the balloon look smaller, but the volume of the balloon remains the same (the decline in existing home inventory is offset by an increase in vacant apartments).

Note: there is some reduction in overall inventory as new households are formed, but not from incentivizing renters to become owners.

The higher rental vacancy rate is leading to lower rents, so the buy-or-rent decision will favor renting once Congress removes their finger from the balloon.

Yun also appears to be suggesting that the first-time home buyer tax credit is providing a "supply of qualified buyers". This is bubble type thinking. Did all the exotic loans during the housing bubble provide a "supply of qualified buyers"? Those buyers qualified for the loans, but they were not really ready for homeownership.

The same is true for buyers today obtaining FHA insured loans and using the $8,000 tax credit as their downpayment. Imagine a $200,000 purchase with no money down (except the tax credit). What happens in three or four years when the homeowner wants to sell? The transaction costs will be around $15,000 (about 7.5%) if they sell for the same price.

So a homeowner, who has been unable to save a down payment so far, will be expected to make a $15,000 down payment in arrears? I don't think so.

Oh wait. Haven't prices fallen significantly? Shouldn't prices just go up from here? Yun says we are returning "to a period of normal, steady price growth". So the homeowner can use their appreciation to pay the transaction costs? That is more bubble type thinking. Prices may go up. Prices may fall further. Loans should not be predicated on asset prices increasing.

“The next mistake will be a new way to make a loan that will not be repaid.”
William Seidman, "Full Faith and Credit", 1993.

Allowing buyers to use the first-time home buyer tax credit as a downpayment is "the next mistake".

Earlier post: Existing Home Sales Increase in September