by Calculated Risk on 1/02/2008 07:59:00 PM

Added: Flipped Graph and added possible future paths (see 2nd graph)

From Morris A. Davis (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison), Andreas Lehnert, and Robert F. Martin (both Federal Reserve Board of Governors economists): The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing

Abstract: We construct a quarterly time series of the rent-price ratio for the aggregate stock of owner-occupied housing in the United States, starting in 1960, by merging micro data from the last five Decennial Censuses of Housing surveys with price indexes for house prices and rents. We show that the rent-price ratio ranged between 5 and 5-1/2 percent between 1960 and 1995, but rapidly declined after 1995. By year-end 2006, the rent-price ratio reached an historic low of 3-1/2 percent. For the rent-price ratio to return to its historical average over, say, the next five years, house prices likely would have to fall considerably.

Click on graph for larger image.

Excerpt from Results:

If the risk premium to housing and the expected rate of growth of house prices were to return to their historical norms, we can use the rent-price ratio to gauge the size of the potential adjustment to house prices. Assuming nominal rents were to increase by 4 percent per year, about the average since 2001, a decline in nominal house prices of about 3 percent per year would bring the rent-price ratio up to its historical average, 5 percent, by mid-2012. That said, this is more of a back-of-the-envelope calculation than an actual forecast for house prices because we do not have a fully satisfactory model of the rent-price ratio.

This analysis assumes rents increase 4% per year, and house prices fall 3% until mid-2012 (a total of about 15%) If the price correction happened quicker, the nominal price drop would be greater (over a 25% nominal price decline if the correction happened by the end of 2009).

This graph shows the Davis, et al., data plotted as a price rent ratio. The red line is the author's assumed path (a 15% nominal price decline through mid-2012). The green line is a 12% nominal annual price decline for the next two years.

If this bust follows the pattern of previous housing busts, the largest percentage price declines will in 2008 and 2009, followed by some smaller declines in the bubble areas for a couple more years.

by Calculated Risk on 1/02/2008 02:59:00 PM

This morning I excerpted from Goodman and Bajaj's article in the NY Times: In the Land of Many Ifs. Here is the story in graphs (NY Times excerpts in italics):

"An era of free-flowing credit and speculation has led to a far-flung empire of vacant, unsold homes — 2.1 million, or about 2.6 percent of the nation’s housing stock ..."

Click on graph for larger image.

The first graph shows the homeowner vacancy rate since 1956. A normal rate for recent years appears to be about 1.7%. The current homeowner vacancy rate is 2.6%.

This leaves the homeowner vacancy rate almost 1% above normal, or about 750 thousand excess homes.

But this only part of the excess housing inventory story. The rental vacancy rate is 9.8% - off the 2004 record of 10.4% - but still significantly above the normal rate. And new home inventory is also near record levels.

Here is a rough estimate of the excess inventory (see this post for details):

Source	Units
Rental Units	700,000
Vacant Homeowner Units	750,000
Excess Builder Inventory	250,000
Total	1,700,000

"... economists suggest ... national home prices [will] fall by at least 15 percent from their peak. So far, prices have dropped a little more than 5 percent, according to the Standard & Poor’s Case-Shiller home price index."

This graph shows the S&P/Case-Shiller index is 5% off the peak, and the OFHEO index declined slightly last quarter.

To put this potential price declines into perspective, this graph shows 15% and 30% nominal price declines for the S&P/Case-Shiller U.S. National Home Price Index and the OFHEO, Purchase Only, SA index.

A 15% nominal price decline would take prices back to late 2004 for both indices. A 30% price decline for Case-Shiller would take prices back to mid-2003; 30% for OFHEO would take prices back to late 2002.

... default rates on loans to homeowners with relatively good credit ... are rising sharply ... This is a potentially ominous sign ... The spike in foreclosures is happening even before many mortgages have reset to higher rates, suggesting that borrowers are falling behind because their homes are worth less.

Here is a graph of the overall MBA mortgage delinquency rate since 1979.



This is the overall delinquency rate, and it is at the highest rate since 1986. As noted, delinquencies are getting worse in every category - including prime fixed rate mortgages - and getting worse at a faster rate in every category.

Through the recent era of multiplying housing prices, Americans have turned increased home values into cash via sales, refinanced mortgages and home equity loans — more than $800 billion a year from 2004 to 2006, according to several analysts. The pace of this flow has slowed sharply in recent months.

Here are the Kennedy-Greenspan estimates (NSA - not seasonally adjusted) of home equity extraction through Q3 2007, provided by Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

For Q3 2007, Dr. Kennedy has calculated Net Equity Extraction as $133.0 billion, or 5.2% of Disposable Personal Income (DPI).

This graph shows the net equity extraction, or mortgage equity withdrawal (MEW), results, both in billions of dollars quarterly (not annual rate), and as a percent of personal disposable income. As homeowner equity declines sharply in the coming quarters - household real estate equity declined $128 Billion in Q3 - combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.

And from the NY Times graphic:

"In the last 50 years, most recessions have been preceded by a sharp drop in residential investment. Some economists worry the historical pattern doesn't bode well for the economy in 2008."

This graph shows Residential Investment (RI) as a percent of GDP since 1960.

Residential investment, as a percent of GDP, has fallen to 4.51% in Q3 2007, and is now below the median for the last 50 years of 4.56%.

Although RI has fallen significantly from the cycle peak in 2005 (6.3% of GDP in Q3 2005), RI as a percent of GDP is still well above all the significant troughs of the last 50 year (all below 4% of GDP). Based on these past declines, RI as a percent of GDP could still decline significantly over the next year or so.

by Calculated Risk on 1/02/2008 02:11:00 PM

Here are the minutes to the Fed meeting on Dec 11th, and the conference call on Dec 6th.

Click on photo for larger image

Here are the headlines (thanks to Brian).

Consumer spending "slowing more than thought".

"Fed officials saw deeper, more prolonged housing decline." (you think?)

Risk of "substantial" further rate cuts (the market likes rate cuts!)

Added: From the WSJ: Fed Sees Potential for More Cuts, According to December Minutes

by Calculated Risk on 1/02/2008 01:10:00 PM

From the WSJ: National City Slashes Dividend

National City Corp. said Wednesday it will reduce its quarterly dividend by 49% and raise "non-dilutive" capital as the bank moves to shore up its finances amid the credit crunch.

National City also announced it is getting out of the wholesale-mortgage business, resulting in the cut of another 900 jobs.

And look at their forecast for 2008 mortgage originations:

National City expects mortgage originations in 2008 of approximately $15 billion to $20 billion. Through November, the company originated $24.07 billion in mortgages through its retail business and $19.87 billion via its wholesale channel, which funds loans made by mortgage brokers.

They expect less than half the total volume in 2008 compared to 2007, and a significant decline (perhaps by one third) in their retail originations alone.

by Calculated Risk on 1/02/2008 10:57:00 AM

From the Census Bureau: November 2007 Construction Spending at $1,165.1 Billion Annual Rate

Spending on private construction was at a seasonally adjusted annual rate of $860.7 billion, 0.7 percent (±2.2%)* below the revised October estimate of $866.6 billion. Residential construction was at a seasonally adjusted annual rate of $484.9 billion in November, 2.5 percent (±1.3%) below the revised October estimate of $497.1 billion. Nonresidential construction was at a seasonally adjusted annual rate of $375.8 billion in November, 1.7 percent (±2.2%)* above the revised October estimate of $369.5 billion.

Note that overall construction spending increased slightly (including public spending), but private construction spending declined in November. Once again, non-residential spending offset some of the decline in private residential construction spending.

Click on graph for larger image.

The graph shows private residential and nonresidential construction spending since 1993.

Over the last couple of years, as residential spending has declined, nonresidential has been very strong. There is plenty of evidence - like the Fed's Loan Officer Survey - that suggests a slowdown in nonresidential spending is imminent, but it hasn't shown up in the construction spending numbers - yet.

by Calculated Risk on 1/02/2008 10:46:00 AM

From MarketWatch: Factory sector shrinking in December, ISM says

The U.S. factory sector contracted in December for the first time in nearly a year as new orders collapsed, the Institute for Supply Management reported Wednesday.

The ISM index fell to 47.7% from 50.8% in November. It's the lowest reading since April 2003 and the first sub-50 reading since January 2007.
...
The new-orders index fell to 45.7% from 52.6%, the lowest since October 2001, as the nation was pulling out of the last recession. Just 15% of firms reported rising orders; the percentage has been lower only once in the past 25 years.

"Slower demand appears to be more of a problem than excessive inventories," said Norbert Ore, chairman of the ISM's survey committee.

Manufacturing (especially export related) and commercial real estate were two of the bright spots for the economy in 2007. Both are showing signs of slowing sharply.

by Calculated Risk on 1/02/2008 10:05:00 AM

From Peter Goodman and Vikas Bajaj at the NY Times: In the Land of Many Ifs. This is a look at the economy in 2008, and starts with housing:

An era of free-flowing credit and speculation has led to a far-flung empire of vacant, unsold homes — 2.1 million, or about 2.6 percent of the nation’s housing stock ...

This ... will not be whittled down to normal levels, economists suggest, until national home prices fall by at least 15 percent from their peak, reached in the summer of 2006. ...

The glut could be exacerbated if an already alarming wave of foreclosures continues to broaden, claiming even those with supposedly good credit.

Last year, the trouble in the mortgage market was largely confined to subprime loans extended to homeowners with weak credit. ...

... default rates on loans to homeowners with relatively good credit are ... rising sharply ... In November, 6.6 percent of so-called Alt-A home loans ... were either delinquent by 60 days or more, in foreclosure, or had been repossessed. That was up from 4.3 percent in August.

This is a potentially ominous sign, because subprime and Alt-A mortgages issued in 2006 together made up about 40 percent of all mortgages. ...

The spike in foreclosures is happening even before many mortgages have reset to higher rates, suggesting that borrowers are falling behind because their homes are worth less. Many are having trouble refinancing as banks tighten lending standards.

All of which explains why many economists expect national housing prices to fall by 5 to 10 percent more in 2008, and perhaps into 2009 as well, before hitting bottom.

Such a drop could ripple out to the broader economy by depressing consumer spending, which accounts for about 70 percent of all economic activity.

This touches on several key subjects: there is substantial excess housing inventory, the mortgage problem is broader than subprime, foreclosures are spiking before rates are resetting (because of falling house prices), lending standards are being tightened, housing prices will fall significantly, and Mortgage Equity Withdrawal is falling - probably impacting consumption. A nice overview.

by Tanta on 1/02/2008 09:32:00 AM

Go here, and then go here.

(Sorry, I'm in the middle of installing software. That requires attention to my dishwasher.)

. . . Install is going quite well, thanks.

by Calculated Risk on 1/02/2008 12:13:00 AM

From Bloomberg: Centro Puts Itself Up for Sale as Debt Deadline Looms

Centro Properties Group, facing a Feb. 15 deadline to refinance A$3.9 billion ($3.4 billion) of debt, will consider offers for all its assets including 700 U.S. malls.
...
Centro's largest U.S. shopping centers are Independent Mall in North Carolina and Cortlandt Towne Center in New York.

This sale will give us an idea of how far CRE prices have fallen.

by Calculated Risk on 1/01/2008 07:00:00 PM