September 14, 2006
The market is suddenly assuming that since energy prices are declining and mortgage rates are drifting down, consumer spending will pick up and the housing industry decline will end. In our view this outcome is highly unlikely. Our negative outlook for consumer spending is based far more on the end of the housing boom than it is on high oil prices. In turn, it is now evident that housing is already undergoing a hard landing that can't be cured by a downturn in mortgage rates, and that the situation is likely to worsen. Here are some facts to consider.
* 32.6% of new mortgages and home equity loans in 2005 were interest only, up from 0.6% in 2000
* 43% of first-time home buyers in 2005 put no money down.
* 15.2% of 2005 home buyers owe at least 10% more than their home is worth.
* 10% of all home owners have no equity in their homes
* $2.7 trillion in loans will adjust to higher rates in 2006 and 2007.
* 70% of borrowers who took out pay-option ARMS in the past year have loan balances larger than their initial loan.
* Homeowners face higher payments as mortgages are reset. Generally, monthly payments rise between $200 and $500 depending on the size of the mortgage.
* According to Reality Trac, August foreclosures were up 23% over July and 53% over a year ago.
* The number of homes for sale is at record highs, and inventories are 59% higher than a year earlier.
* New home sales are down 22% and existing home sales down 11%.
* The NASB housing market index has recorded an all-time decline.
* The housing affordability index is at a 15-year low.
* The house price-to-income (rents) ratio is off the charts. According to HSBC, in 18 states accounting for over 40% of national home values, the price-to-income ratio is 3.6 standard deviations above the mean.
* The OFHEO index of house prices deflated by the consumption price deflator has soared to a record high of 350 from 250 in 2001. From 1976 to 1996 it never was above 220.
* According to the NAR the year-to year prices of existing homes are now flat. A short time ago they were rising at a yearly rate of 16%.
* Nationally, home prices have not declined on a year-to-year basis since 1933. Recently, however, prices have been dropping in the North East, West and Mid-West.
* Sales incentives are now estimated at 3% to 7% of selling prices.
Although new housing starts directly account for only 5% of GDP, the indirect effects are far greater. Some studies show that the housing industry and all its related activities have accounted for 30% to 40% of the entire employment growth in the current cyclical expansion. In addition it has been well demonstrated that mortgage equity extractions have been a cash cow providing home owners with hundreds of billions of dollars that have gone into consumer spending. With housing already in a hard landing, it will be extremely difficult to avoid a hard landing in the economy as well. In our view the stock market is in the same kind of denial it was in 2000 when the vast majority of strategists and economists already knew the dot-com bubble had burst, but mistakenly thought it would have little impact on the rest of the economy or on stocks.