“When is a buyers market not a buyers market?”, asked the intrepid, results-based consultant.
She surveyed the collection of blank stares in the RB Builders conference room for a few seconds. Not waiting for an answer that was not going to come anyway, she answered the question herself:
“When there are no buyers.”
“That’s what you call a conundrum”, announced a superintendent.
“Like, possibly finding yourself between a rock and a hard place?”, asked the CEO.
“That would be an analogy”, the superintendent replied.
One of the best economic and finance weblog sites is Calculated Risk (http://www.calculatedriskblog.com). It would be safe to say that CR has forgotten more about economics than I ever knew. One of the topics CR spends a lot of time on these days is the housing market. Actually, you can trace the importance of the subject on CR to before 2007, when the market was beginning to show signs of stress.
At an 11.6 month supply (August), CR says that the current inventory of existing homes is very high by historical standards, and that is going to cause home prices to fall even further than they already have fallen. I think CR is right, and I do not know what can be done to change that outcome, but, at the same time, I do not think the inventory of existing homes, measured as the number of months supply, is the core problem.
The current high-level supply of existing homes is the visible symptom of a much deeper problem, which is demand. The months supply of homes – whether new or existing – is a relative measure, not an absolute measure. It is current supply in relation to current demand. As CR explains, last month (August), there were 4 million existing homes on the market, and the seasonally-adjusted rate of existing home sales was 4.1 million – as he says, almost a 12 month supply. But, is that because of the high inventory or the paltry rate of sales?
As illustrated in a Calculated Risk graph in a post on March 23, 2007:
From 1983 until 1992, and again from 1996 until 2003, the inventory of existing homes for sale was in a narrow range of between 1.8 million and 2.2 million; during the period 1993 through 1995, the inventory hovered around 1.5 million existing homes for sale. That is a 20 year period in which the inventory of existing homes for sale was between 1.5 million and 2.2 million. The current inventory level, which is double the historic level, is a recent phenomena.
During the period of 1991 through 2003, even into 2004, the months supply of existing homes moved steadily lower, because the rate of sales steadily increased against this relatively static inventory of homes. In fact, sales of existing homes went from about 3.1 million homes per year in 1991, to about 6.8 million in 2004.
And, then, it changed. Here was the approximate annual picture for existing homes in 2005-2007, from the same CR chart:
2005 Inventory 2.7 million
2005 Sales 7.1 million
2005 Months Supply 4.6 months
2006 Inventory 3.5 million
2006 Sales 6.5 million
2006 Months Supply 6.5 months
2007 Inventory 4.5 million
2007 Sales 5.7 million
2007 Months Supply 9.5 months
It is no coincidence that, since 2005, inventory has moved inversely to the rate of sales.
Last month, David McCain (MPKA) and I were discussing this subject, and we both concluded that supply in the absence of demand is irrelevant. Which brings us to the implication for homebuilders.
Sales of new homes last month (in August, 2010) were estimated at 288,000 (and, yes, there is a lag between sales and completions, so it does not coincide precisely with existing home sales). At the same time, there was an estimated 206,000 completed-but-unsold new homes, which equates to an 8.6 month supply (high, but down from an all-time high of 12.9 months in January 2009). But – by historic standards – 288,000 new home sales is table stakes, amounting to perhaps 20% to 30% of the normal demand projections supported by demographics. At that level, there is no way new home completions, sales, or closings are contributing to the overall increase in the inventory of homes available for sale; it is doubtful that it even replenishes the stock of existing houses.
The problem is demand.
Except that, demand is not the real problem, either. Like the inventory of homes, it is both a cause and an effect, a symptom of one thing, but an outcome of something else. Go through a checklist of the factors that negatively impact demand, the factors that negatively influence the individual homebuying decisions of millions of Americans:
The decline of real personal incomes? Check. The loss of jobs? Check. The lack of consumer confidence? Check.
Those are the big factors. But, what about other factors:
The consolidation of households? Check. The availability and terms of mortgage financing, including serious-for-a-change LTV requirements? Check. The forecast short-term downward movement of home values? Check. 11 million homeowners who, according to the Wall Street Journal, are currently underwater on their mortgages, who will be joined by another 2.5 million if existing home prices decline by just another 5%? Check. The resulting lack of equity to transfer to the purchase of another house? Check. Credit scores, for many prospective homebuyers, that have been hammered a couple of hundred basis points? Check. Despite the de-leveraging, the lingering hangover from too much personal borrowing? Check. The prospect of higher income and capital gains taxes. Check. The possible discontinuation of the mortgage interest deduction? Check.
There is more:
The share of government spending as a percentage of GDP? The percentage of federal debt as a percentage of GDP? Check, all at record peace-time levels. An economy that – if it growing at all – is growing at one-third the rate that it should be growing? Check. The diminished prospect for U.S. global competitive standing? Check. Keynesian Socialist Idiots in charge of Congress and the White House? Check.
All of the above in some combination – and seemingly unending continuation – of a perfect storm? Double check. Too much for lower prices, mortgage interest rates at historic lows, and homebuyer tax credits to resolve. And – ominously for the builders, largely publicly-held, that banked on it – too much for a loss carryback provision to weather.
Generally-speaking, prices do not have much elasticity, unless supply and demand collude. So, there cannot be a real sellers market unless there is both high demand and a marked shortage of available homes. And, there cannot be a real buyers market unless there is both weak demand and a glut of available houses. If there was only an oversupply of new or existing homes, prices would not move much, and there would be no buyers market.
But, as CR points out, we do have a glut of available homes. And, we have weak demand. So, we must have a buyers market.
Until it gets so bad that there are no buyers.
I have been through every economic (and housing) recession since 1974. Whether that makes me wise, or simply a relic, I am not sure. I do know this recession is not only worse than anything I have experienced, it is much more complex. We live in a world of cause and effect. This time, the chain of cause and effect is longer and more complex.
Which is why we are going to rue the day we decided that government was smart enough to make so many decisions, decided we were smart to use government deficit spending as a stimulus, and decided we were smart enough to target so many incentives. We are going to rue the day when we decided not to allow market forces to sort this out. We are going to rue the day that we decided to let people that had never run a business decide how all businesses should be run.
It would have been painful. Companies would have failed. But, it would likely be over by now. Instead, we are four years into this mess, and we still cannot see the end.
NOTE: I ran this post by Bill McBride at Calculated Risk, before I posted it to Escape from Averageness. Bill had three observations, if I can paraphrase them.
First, he observed that when he started Calculated Risk in January 2005, the first topics were the housing bubble, obvious speculation, leverage, loose lending standards, non-traditional mortgage loans, etc, and how the housing bubble would eventually burst, leading the economy into recession. Bill said, back then housing was almost all he wrote about.
Second, he guessed that he is one of the “Keynesian Socialist Idiots”, except he thinks only a portion of what was done was “Keynesian” (he says the housing tax credit was anti-Keynesian). Bill would have argued for much more stimulus spending aimed directly at jobs. He thinks more spending should still occur.
Third, he said that we need to look at supply, demand, and price. He said that, at some price – except for a few areas with shrinking populations, like Detroit – the housing market would clear and the excess inventory would be absorbed. He said, lower prices would spur demand, but the economy (and the housing market) would still need jobs and incomes.
Bill said that they are all tied together.