Housing Market Conditions Underscore Need for Action

MBA (9/29/2008 ) Velz, Orawin
Last week’s housing reports showed a picture of a somber market even before the renewed financial market turmoil over the past two weeks. Both existing and new home sales declined in August while inventory remained historically high. Total existing home sales fell modestly.
Since November 2007, sales have been in a narrow range of 4.8 million to 5.0 million units as foreclosure sales propped up the market. By contrast, new home sales posted a double-digit drop for the month after showing signs of stabilization over the last several months.

The relatively stronger performance of existing home sales over new home sales largely reflected rising shares of foreclosed homes that were sold through the multiple listing service. Many homebuyers found that foreclosed homes that were recently built and are being sold at deep discounts are substitutes for newly built homes. The National Association of Realtors estimated that foreclosures accounted for about one-third of the existing home market, indicating that activity would have been much weaker had it not been for distressed sales.

The months’ supply measures for both new and existing homes stayed above 10 months, which is worrisome given over two years of the housing downturn. For new homes, the Census Bureau does not revise data to account for cancellations of sales contracts, which makes it difficult to gauge the true market conditions. If cancellations are rising, inventory would be temporarily understated.

Major home builders continued to report rising cancellation rates. For example, KB Homes reported on Friday that, for the quarter ended August 31, the cancellation rate (cancelled units divided by gross orders) rose to 51 percent, up from 27 percent in the second quarter. With tighter lending standards and reduced credit availability, potential buyers have trouble selling existing homes and securing financing.

All measures of home prices released this week showed accelerating price declines. The median price for total existing homes posted the largest decline on record at 9.5 percent, compared with a sizable 6.2 percent drop for new homes. The monthly purchase-only index from the Federal Housing Finance Agency fell 0.6 percent in July from June and 5.3 percent from July 2007. The large monthly drop was disappointing as the index had shown a slower pace of decline in May and June, offering some hope that home price declines would start to moderate.

Outside of housing, the durable goods orders report confirmed a sharp loss of momentum in manufacturing and business investment spending. The report was consistent with the view that economic growth is sharply slowing in the third quarter to just half the 2.8 percent annualized pace in the second quarter. The final estimate of gross domestic product also showed a downward revision in corporate profits, which fell 3.8 percent in the second quarter, compared with a 2.4 percent drop in the preliminary report. This marked the fourth consecutive decline in profits, the first time this has happened since 1989, suggesting that businesses will likely cutback their spending significantly in the coming quarter.

Interest Rates:
Long-term Treasury yields were little changed this week as investors awaited the news on the government’s rescue plan. The yield on the 10-year Treasury note stayed around 3.81 percent by mid-Friday afternoon, about five basis points higher than the rate on the previous Friday.

Housing and Mortgage Indicators:
Total existing home sales were down 2.2 percent in August to a seasonally-adjusted annualized rate of 4.91 million. Both single-family home sales and condo sales fell 1.4 percent and 8.2 percent, respectively. Sales of single-family homes during the first eight months of this year were down 16.1 percent from those during the same period last year. The year-to-date decline has been worse for condo sales, at 23.6 percent lower than those last year.

Existing home sales fell in two regions, led by a 6.6 percent drop in the Northeast and 5.3 percent in the West. Sales were relatively flat in the Midwest and the South. From a year ago, the West was the only region that posted an increase in sales, with sales up by 4.9 percent.

The number of total homes available for sale was down 6.7 percent in August from July, led by a 15.5 percent decline in the number of condos available for sale. (The data are not seasonally-adjusted.) From a year ago, the number of total homes available for sale fell 2.9 percent, the first year-over-year drop since March 2005. Despite the slower sales pace, a large drop in inventory pushed down the months’ supply (or the inventory-sales ratio) of existing single-family homes to 10.0 months in August from 10.4 months in July. The huge drop in the number of condos for sale pushed down the months’ supply to 14.0 months from 15.3 months.

The median price for new homes was down 9.5 percent in August from a year ago, the largest on record. The median home price does not necessarily give the true picture of home price trend, however, as it can be distorted by the mix of sales. The large decline in the median home price may have been overstated since sales dropped the most in the West and Northeast regions, where the value of a typical house is more than the national average. The decline in the median home price in the West from a year ago was 23.8 percent, also the largest on record.

New homes sales fell 11.5 percent to a seasonally-adjusted annualized rate of 460,000 units, the largest decline since November 2007. During the first eight months of this year, new home sales were down 36.6 percent from the same period last year.

New home sales declined significantly in the West and the Northeast by 36.1 percent and 31.9 percent, respectively. Sales dropped 2.1 percent in the South and rose 7.3 percent in the Midwest.

The number of new homes available for sale fell 4.5 percent, the 16th consecutive monthly decline. This was the biggest drop since November 1963 and the second largest drop in the history of the series. The steady decline in inventory, which has reached the lowest level since August 2004, reflected considerable cutbacks in single-family starts, which have posted 15 declines over the past 16 months.

The length of time that houses have spent on the market continued to break record highs. The median number of months rose to 9.1 in August from 8.5 in July and from 5.7 in August 2007.

Despite the huge drop in inventory, a large drop in sales pace pushed up the months’ supply (or the inventory-sales ratio) to 10.9 months from 10.3 months in July. The median price for new homes was down 6.2 percent in August from a year ago.

Economic Indicators:
Durable goods orders fell 4.5 percent in August, the first decline in four months, led by huge drops in aircraft and auto orders. Excluding the volatile orders for transportation equipment, durable goods orders were down 3.0 percent, the biggest drop since January 2007. Shipments for nondefense capital goods excluding aircraft—a component used in the calculation of economic growth in the current quarter—declined 1.7 percent after a 0.4 percent gain in the prior month.

The report also indicated weakening future business investment spending. Orders for nondefense capital goods excluding aircraft—a proxy for business investment in equipment and software in the coming quarters—fell 2.0 percent following a 0.4 percent increase in July.

Both shipments and orders for nondefense capital goods excluding aircraft were revised downward considerably. This bodes ill for the current economic growth, which is projected to slow to half the second quarter’s pace. The outlook for the next six months has also worsened. Inflation-adjusted business investment spending growth is poised to slow significantly in the fourth quarter and will likely decline during the first half of next year.

Real gross domestic product grew at a seasonally adjusted annualized rate of 2.8 percent in the second quarter, according to the Bureau of Economic Analysis’ final estimate. This was a downward revision from 3.3 percent reported in the preliminary estimate. Downward revisions to exports, consumer spending and business investment in equipment and software reduced GDP. These downward revisions outweighed an upward revision to residential investment and nonresidential structures.

The biggest component of GDP, consumer spending, increased 1.2 percent, below the previously estimated 1.7 percent increase. Consumer spending made a contribution of 0.87 percentage points to GDP. The biggest contributor to GDP was trade, which added 2.93 percentage points, a smaller contribution than the 3.10 percentage points reported in the preliminary estimate.

The housing market continued to be the biggest drag to growth. Real residential investment declined 13.3 percent in the second quarter, a smaller drop than the previous estimate of 15.7 percent. This was the 10th consecutive quarter of contraction and the ninth consecutive double-digit decline. From its peak, real investment in residential structures has dropped about 40 percent. The declining residential investment subtracted 0.52 percentage point from economic growth in the second quarter. In the first quarter it took a bite of 1.12 percentage points from growth.

Inflation was slighter higher than earlier reported. The price index for personal consumption expenditures increased 4.3 percent, compared with the previously estimated 4.2 percent increase. The core PCE deflator (excluding food and energy items) increased 2.2 percent, slightly higher than the 2.1 percent increase in the previous estimate.

Profits were downwardly revised to $1.53 trillion annualized, a decline of $60 billion from the second quarter. This was the fourth straight quarterly decline in profits. This compares with an estimated decline in profits of $38 billion in the preliminary report.

The University of Michigan’s Consumer Sentiment Index rose to 70.3 in September from 63.0 in August. This was the biggest monthly increase since October 2006. The improvement in the expectations component of over nine points to 75.0 led the gain. Assessments of current conditions improved four points to 67.2 during the month. Both components of the index were revised downward from their preliminary readings, however.

Inflationary expectations dropped sharply in September. The expected inflation rate one year ahead dropped to 4.3 percent from 4.8 percent in August and from a peak of 5.2 percent in May. Five-year expectations dropped to 3.0 percent from 3.2 percent in the prior month.