Our Outlook on the Housing Slump

The current housing slump is now well into its third year. Existing home sales, which peaked in June 2005, are running more than 30% below peak levels, while new home sales, which peaked the following month, are off by almost two thirds. June data from the Case-Shiller Index shows current national home prices currently sit more than 18% below the highs set in the summer of 2006. Single-family housing starts in July were 65% below peak levels set in early 2006, while total housing starts sit 58% below peak levels. Foreclosures are currently running at staggering levels and are likely to rise over the coming months, while the institutions that provide the financing for home purchases are imploding as we write. Independent investment banking as we know it may have just ceased, and risk spreads are expanding in nearly every asset category.   

In all, pretty horrendous news across the board. In fact, this housing downturn will make history as the largest decline in our data set. In terms of production, a record decline in single-family housing starts will be set in the next couple of months, and the national price declines are already the largest since at least the Great Depression, and maybe ever.

So is the country likely to face more of the same over the coming quarters, or is the worst of the current downturn behind us? Well, certainly the news flow is very distressing. The very funding mechanism integral to a functioning residential real estate market is currently on the ropes, as mortgage financing has been, and will continue to be, overly tight. Yet believe it or not, some signals are arising that may indicate the housing market is slowly healing itself.

The thesis underlying this view rests primarily on three pillars. First, affordability has been restored throughout several former bubble markets, and actually sits at above-average levels in many other regions. Second, though "for sale" inventories still reside at nosebleed levels, listings data coming out of many metropolitan statistical areas (MSAs) indicate these inventories aren't appreciably rising, and in many cases have started to decline, even in the face of severe increases in bank listings. And finally, the government is well aware that the forward path of home prices is key to the severity of the current economic slump, and is pulling out the stops to stem the decline. Both Fed Chairman Bernake and Treasury Secretary Paulson know that without a stabilization in home prices, the U.S. financial system's ability to avoid a deepening of the already colossal crisis is greatly diminished.

First, the Bad News
Before we lay out this thesis in more detail, it's helpful to examine where, and by how much, the market got into trouble. To get an idea of the amount of oversupply that existed near the top of the bubble, and also to this day, look no further than the vacancy data published by the Census Bureau. The chart below shows that the housing stock has been growing faster than households since the mid-1970s, helping to propel the occupancy rate to all-time lows (and vacancy rates to all-time highs).

Although it's difficult to determine where a true "equilibrium" occupancy level lies, it's safe to say the downward trend is unsustainable, as not everybody can afford a second home or a seasonal residence. To get back into balance, the percentage of occupied homes needs to increase, the extent to which is best illustrated on the chart below.

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