Near a Bottom in Housing?

One of the reasons I have been so skeptical about the staying power of the most recent
rally has been the disconnect between stock prices and the macro
environment. The rally apprears to be based on several false premises:  A
soft landing, a bottom in real estate, a mid-cycle slow down that
resumes almost as soon as it starts.

Indeed, if the bulk of the housing recession is behind us, then this would go down in post-war history as one of the
shallowest housing corrections on record.

This week, the news out of the Homebuilders belied the "Housing is Bottoming" meme. The simple truth is that 46 year low interest rates (~5.125%) created a generational boom in Housing construction, sales, investment, and speculation. Now that rates have increased as much as 40%, and home prices have nearly doubled in 7 years, all the while inventory built to record levels — the blush is off the rose.

Northern Trust’s Paul Kasriel put together a series of charts that belies this soft landing scenario:


Chart 1 shows a history of housing starts from January 1959 through September 2006. I have identified, admittedly somewhat arbitrarily, seven housing cycles prior to the current one. The average peak-to-trough decline of these seven cycles was 47.3%, ranging from minus 63.7% (January 1972 to February 1975) to minus 18.4% (December 1998 to July 2000).


In the current cycle, housing starts peaked at 2.213 million units annualized in February 2005 and reached a low of 1.674 million units annualized in August 2006 for a peak-to-trough decline of 24.4%. If the peak-to-trough decline in the current cycle were to match the seven-cycle average of minus 47.3%, the annualized pace would need to bottom out at 1.166 million units.

How likely is it that this housing correction will be milder than average? To answer this we need to first determine whether the current housing cycle is less extreme than prior cycles. If you look at the dollar-volume of single-family home sales to GDP (Chart 2), you will notice that this is hardly the case. The dollar-volume to GDP ratio reached a record high 16.3% in 2005, almost double the median percentage of the entire series dating back to 1968.


So, the current housing cycle isn’t less extreme than prior cycles, but is the correction near the bottom? Not according to the supply-demand balance. Chart 3 shows the year-over-year percent change in single-family homes for sale vs. the year-over-year percent change in single-family homes sold. In September of this year, homes sold fell 15.7% year-over-year while homes for sale increased 30.4%. The sold – for sale spread in September was minus 46.1% – the most negative spread ever except for minus 53.2%, which occurred in July.


Add to this the fact that single-family home prices are now plummeting. Charts 4 and 5 bear this out. The median price of a new single-family home fell 9.7% year-over-year in September – the largest percentage decline since December 1970. The median price of an existing single-family home fell 2.5% year-over-year in September – the largest percentage decline in the history of the series, which goes back to January 1968.



If, as indicated by the supply-demand balance, the housing correction isn’t near its bottom, then home prices still have further to fall. Falling home prices would imply much slower growth in home equity for households, which, in turn, would imply much less home equity available for withdrawal. As Chart 6 shows, mortgage equity withdrawal by households hit a record high annualized rate of $732 billion (8.1% of disposable personal income) in the third quarter of last year. As of the second quarter of this year, the annualized rate of mortgage equity withdrawal had slipped to $327 billion. Mortgage equity withdrawal, along with record corporate stock buybacks, has enabled households in recent years to spend in excess of their after-tax incomes (see "How Do Households Keep Spending More Than They Earn?").

Chart 6 shows that mortgage equity withdrawal is already slowing, and with the expected further decline in home prices, it is likely that withdrawals will slow even more in the quarters ahead.


Near a Bottom in Housing?
Paul Kasriel
November 3, 2006

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What's been said:

Discussions found on the web:
  1. Renter for Another Year commented on Nov 9

    House prices have not collapsed yet, but it’s coming. The bottom won’t be hit for another 2-3 years and it will be devastating to the economy. The Democrats will be blamed.

  2. gsinbe commented on Nov 9

    Chart 1 is interesting in that the latest build-up of housing starts is much longer in duration than all the previous build-ups (1990 to 2005). In other words, the area under the curve (total supply of new houses) is much greater than during any of the other busts. Might also suggest a greater than average drop, or possibly a much longer drop, instead of earlier busts quickly followed by another boom.

  3. ECONOMISTA NON GRATA commented on Nov 9


    A house that was purchased May05 in a fairly nice neighborhood here in Palm Beach County for 1.295M, Was recently offered at 1.1M and sold yesterday for 965K… the market is steady at lower levels.

  4. Mike_in_Fl commented on Nov 9

    I wrote a piece in late September on the housing stocks vs. housing fundamentals and the bottom/no bottom debate. I don’t think we’re coming out of this slump yet, not by a long shot. Some of the figures may be slightly outdated in the column, but here’s my take if you’re interested:

  5. T commented on Nov 9

    Great post… I only wish it was easier to extend what’s getting fairly obvious at the national scale down to the New York area, which is such an odd market it can defy gravity at times with its abundance of fast money and high percentage of renters (although the sheer number of huge residential buildings going up in Manhattan suggests to me that the turn, if anything, might be worse here.)

    Still renting in Manhattan for at least another year.

  6. CA Guy commented on Nov 9

    Will someone please explain to me why Wall St. analysts are so revered? Lehman doesn’t like to downgrade stocks? WTF? Toll Bros was graded as outperform? Again, WTF? Geographic diversity? Sure, they might be in markets thousands of miles apart, but they are THE top markets for appreciation and speculation. I can only guess the street isn’t satisfied with their $36B in bonuses and they want to keep this charade up for a while longer.

  7. Michael C. commented on Nov 9

    Call me ignorant. On the MEW chart, there are times when MEW falls just below the zero line.

    How does MEW go negative?

  8. charts commented on Nov 10

    really an excellent posting

  9. Lama commented on Nov 10

    CA Guy,
    You can drive yourself crazy worrying about Wall Street’s hypocracy and self-indulgence.
    Analysts are revered because the firms for whom they work are advertisers on the TV networks that proclaim reverence for them. That is, it’s all marketing.
    Also, there are some analysts who play the market both ways, having accomplices short a target stock or buying competitors’ stocks before a scathing report.
    At a company where I worked years ago, an analyst indicated that our company was in trouble because a huge multinational company was entering our market. He neglected to mention that the company was going to be our customer, not competitor. I think our stock took a 20% hit.

  10. BG commented on Nov 10

    Experts Predict Wave of Bankruptcies
    “The American consumer is arguably the weakest link in the credit chain,” a financial advisor says.
    Helen Shaw,
    November 10, 2006

    Most professionals involved in bankruptcy restructuring expect a rise in bankruptcies within the next 12 to 18 months, according to a survey.

    Over 70 percent of 90 restructuring pros in a survey by the American Bankruptcy Institute and Daily Bankruptcy Review expect that U.S.corporate restructurings will increase. Respondents to the July survey included attorneys, distressed-debt investors, financial advisors, investment bankers, and lenders.

    The survey participants differ on the most likely trigger for the next wave of bankruptcies. But 48 percent predict that it will be interest rates. The other triggers respondents cited were: home prices, 15 percent; commodity prices, 13 percent; global competition, 7 percent; and the equity bear market, 5 percent. Others think that a decline in consumer spending and unfunded pension plans will be possible triggers….

  11. GerryL commented on Nov 10

    Can anybody explain why Greenspan has been going around North America predicting that housing is near a bottom? I know he has made many bad predictions but this one amazes me. I dont think anybody can be sure where the bottom is but based upon the current data how can anybody predict housing is near a bottom?

  12. Richard commented on Nov 10

    housing is highly localized. what happens in a section of FL has little effect on northern NJ. the homebuilders who are building out former empty tracts of land without local job/income support will get slammed as the established communities without such concerns see little change except moving a bit with the tide.

  13. James Bednar commented on Nov 10

    The fact of the matter is, quite simply, that the financial intermediation provided by mortgage lenders on a national scale now introduces a common variable to all real estate markets. Markets are related, despite what the real estate industry would like you to believe.

    A collapse in Florida can, and most certainly will, affect the lending climate in New Jersey. I’m not sure why that is such an alien concept to some.

    We’ve already seen a taste of this in the Insurance industry. What does a hurricane in New Orleans have to do with Northeast coastal insurance premiums?

    Apparently, quite a lot.


  14. Richard commented on Nov 10

    Lending guidelines are somewhat impacted at a macro level but far more important is the level of risk of the borrower. Someone trying to borrow for a tract condo in an overbuilt hurricane area will be more stringent than less risky areas. I’ve personally dealt with this situation looking at vacation properties on the FL coast. The sky isn’t falling though it might come down off it’s lofty highs.

  15. James Bednar commented on Nov 10

    Someone trying to borrow for a tract condo in an overbuilt hurricane area will be more stringent than less risky areas.

    Can you provide evidence, other than anecdotal, that lending requirements vary in this fashion? If we were talking about construction finance, I’d agree wholeheartedly, but residential mortgages? I just can’t see it.


  16. JoshK commented on Nov 10

    I don’t always agree with your posts, but I think your analysis is very good with this one.

  17. tt commented on Nov 10

    strangely the Case – Schiller futures are still pointing to a drop of 5 (Denver) -8% (Miami) by next August , not much different than the imbedded expectations from the last 3 months

  18. CA Guy commented on Nov 10

    This is a great post, and I think you did an excellent job of charting historical performance. I think it was Mark Twain who said that history may not repeat itself, but it certainly does rhyme. You are correct, why should this cycle be significantly different than those past? I think the market optimism is directly tied to the fact that such a large percentage of the country has a lot riding on the housing boom. Nothing more. A Field of Dreams economy if you will. If we build it, they will come.

    Lama: thanks for the reply to my questions on analysts. In all honesty, I know the deal, but it just frustrates me to no end. In the end I suppose all we can do is analyze for ourselves and go with our guts. It is hard to do that however when we consider all the shennagins that companies have been pulling over this past decade or so. Anyone here know of good info sources outside of these blogs?

  19. MDDWave commented on Nov 10

    Charts 5 (NAR Median Price, existing 1-family % year-to-year change) is interesting to me as a secondary indicator of inflation rate. CPI as mentioned by others doesn’t seem to be a realistic indicator of inflation.

    The inflation rate could be indicated by subtracting US population growth rate from the % year to year change. I am assuming the US land mass is fixed and US population growth rate is 1-2%. The overall average growth rate of the housing market should be close to the US population growth rate. Generally, percentage above that growth rate would be an indicator to inflation. I know there are exceptions like “bigger and better houses”, but it is an indicator. Overall, it seems to match the high inflation of the 70’s, relative low inflation of 80’s-90’s, and the recent relative high inflation.

    If this is a good indicator for inflation, then there are some big concerns. If the recent (2002-2006) apparent inflation (6-12%) is real, then the Fed still has more interest hikes to do. But if the recent (2006) plunge (-1%) is real indicator of deflation, then the Fed seems to be “between a rock and hard place”. Raise rates to protect against non-housing inflation or lower rates/pump money to prevent housing deflation carrying over to other economies. Of course, we can trust the Fed to do the right thing.

  20. john commented on Nov 10

    Well, this may be stating the obvious but perhaps these forecasts for a deeper housing recession also tie into the earlier post of “U.S. Treasury Dept Usurping Fed Fueling Markets…”. With the FED and Treasury continuing to pump “IceBurg Sized Chunks of Cash” into our Financial System (Rob Kirby’s quote from Financial Sense) with the Repo, TOMO and POMO operations is it any wonder why the equity markets continue to rise. Maybe they’re trying to stave off a deep Housing Recession combined with the amount of money we’re spending in IRAQ, Afghanistan and a potential OIL price Spike when IRAN and North Korea become a ‘topic/issue’ once again (Now that the elections are over…).
    There seem to be forecasts just about everywhere for an economic slowdown — oil, 10yr yield, inverted yield curve, housing etc. and yet the stock market continues along its merry upward way with the Financial Media continuing to cheer it along. I guess this Liquidity Pump would obviously also beg the question as to how serious the FED really is in fighting Inflation by raising Interest rates. In my view this whole rally from ’03 on has just had a bad smell to it. Their doesn’t seem to be enough “Organic Growth” sector wide to justify this Bull Market. Everytime it looks like we’re going to get a sizable correction in the Stock Market a ‘Miracle’ seems to happen and up things go again. And the “Tech sector” certainly isn’t leading the way.
    Now one can argue the “Global Phenomenon” of the amount Global Liquidity and the rise in Foreign Equity Markets. I agree with some of that but I would also argue that in todays environment — at least for the last 4-6 years given the Global Financial Weight of our Economy, it all starts with our Econonmy, and the operations of our FED and Treasury, with the rest of the Financial World taking their cue’s from us.

  21. tdb commented on Nov 10

    Great post.

    Anyone see the ad taken out by the NAR on page C5 of today’s WSJ? It’s titled “It’s a great time to buy or sell a home.” The body of the ad lays out all of the reasons why now is a good time to buy, including: “HOUSING PRICES WILL POST GAINS IN 2007.” Interestingly, for most of their other claims they have a footnote, but not for their prediction that prices will be up in ’07. They have no idea what prices will do next year.

    This is a ridiculous ad that smells of desperation. What a joke.

  22. Sharkie commented on Nov 10

    One only has to glance at these charts to realize the fallout from two years of panic buying overpriced houses on cheap money has only begun. Greenie is always about two years off on his predictions. What you might want to consider is the emotional repercussions of recent spend-fest activity on a populace so easily led to the slaughter. So easily burned makes them re-coil in “hunker-down” mode indefinitely. Who’s going to buy this year when the charts, reporting and text say homes are going to be cheaper next? Classic deflation for the self-serving masses.

  23. BuyBonds commented on Nov 11

    Good article.
    Great graphs!
    I thought the line “Falling home prices would imply much slower growth in home equity for households,” was worth a grin.

  24. Home Seller Tips commented on Nov 14

    Wow, that is a lot of info. There is not way that in looking at these stats thsat someone can not conclude that we are at least entering a new type of housing market. The stats that are most interesting to me is the long rise in housing starts over the last few years. Who is filling these houses? The population groth has not been rising very quickly.

    Also it is interesting to see that the recent percentage drop in housing prices is not really setting a historical precedent.

    The thing that I am wondering is where the money has gone with these giant mortage equity withdrawals? And in the same vein what will happen when these homeowners sell off their home with nearly no equity left?

    Thanks for the great info!

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