The Road To "Normalcy"

Recently, I had the chance to hear Lawrence Yun, the National Association of Realtors Chief Economist. He is very knowledgeable on the overall housing market and had some good thoughts I wanted to share with you all. I think it is great information!

Prior to the recent mid-term elections consumers expressed their troubling unhappiness about their situations. The index measuring confidence about consumers' present situation, which is based primarily on questions related to the economy, job and personal finances, was 23.9 in October. That is much lower than the neutral 100 mark and essentially at near historic lows-even matching the levels at the depth of the recessions in the early 1980s and early 1990s.

Of course, Americans are a tough-minded people who understand that bad events occur sometimes, but they are also always ready to pick themselves up. However, what is different this time around is that consumer are decidedly less optimistic about the future. Consider-the consumer confidence index about future expectations is currently 67.8, not as bad as the "present conditions" index, but much loser than the reading of 115 in 1983 when the economy also suffered from the same 9.6 percent unemployment rate that is occurring today.

Businesses through their actions have also expressed less confidence about the economy. Corporate profits are back up to their peak before the recession, yet business spending has been lackluster. Companies are just sitting on cash and not redeploying that cash back into the economy.

Meanwhile, the housing market is trying to scratch out a decent recovery under its own power without any federal stimulus of a home-buyer tax credit. Existing-home sales (actual closings and not contracts) rose to 4.5 million units (seasonally adjusted annualized rate) in September, a solid 17 percent cumulative gain over two months following the big tumble in July when the tax credit was no longer in effect. Home sales would need to rise to at least the 5-million unit mark to be considered "back to normal" under present circumstances where the total number of jobs is equal to that in the year 2000. Back then, existing-home sales registered 5.2 million units and so 2000 would also have been considered a very normal year without any hints of a housing bubble. The 7.1 million bubble-ish home sales of 2005 is long gone and will not return until both population and job growth over many years can rightly justify such levels.

The currently anticipated housing recovery is about returning to normalcy. All data point toward the market being back to fundamentally justifiable levels. The home price bubble has been fully deflated. The cost of constructing new homes is measurably higher compered to buying a nearly identical existing one. Home sales in relation to total jobs are back to normal. Home price to income ratio is slightly below historical trends, signaling a slight over correction.

the return to normalcy, however, will not be a straight upward path. We've seen evidence of that already. September's pending home sales (i.e., contract signings) took a step back after two consecutive months of increases. This type of trend-two steps forward and one step back-is likely to occur in the coming year as well. The underlying fundamentals of rising demand are present in the forms of compelling affordability condition and from job creation. But while investors appear eager to "get in" as well, they are being hampered by very tight mortgage availability for non-owner occupancy loan. In addition, the hiccups to recovery will also arise from market swings in economic data and from a a flow of foreclosed/REO properties reaching the market.

Yes, there was some good news on the job market in October with the creation of 151,000 net new jobs. Indeed, the job market has clearly turned the corner. Since January, about one million private sector jobs have been created. The pace, however, needs to kick into a higher gear. At the current job creation pace, the economy is just treading water and there will be no meaningful improvement in the unemployment rate.

The mortgage rates are at rock bottom, but are still likely to head higher. Even after the announcement of a second try at 'quantitative easing' by the Federal Reserve (QE2 in today's vernacular), which means more purchases of government bonds with freshly printed money, the long-term government borrowing rate rose, perhaps out of future inflationary fears. The 10-year and 30-year Treasury yields in mid-November were 2.6 percent and 4.2 percent, respectively. That is up from 2.4 percent and 3.7 percent, respectively, one month prior.

The QE2 attempt to keep long-term rates lower, which may or may not be working, is inconsequential to the market compared to the importance of returning lending standards to normal from their overly stringent rules currently. A well-known banker's axiom says that all bad loans are made in good times. Today's defaulting mortgages were invariably originated during the bubble years with lax underwriting standards. Both FHA-along with Fannie Mae and Freddie Mac-are reporting that those mortgages originated in the past two years are performing quite well. But the continuing anecdotal stories of good credit-worthy consumers being denied a mortgage probably hint at unreasonably tight underwriting standards.

We certainly don't want to return to any lax standards, but denying mortgages to those who are capable of making payments is holding back a true recover in both the housing market and the broader economy.

The baseline forecast is for existing-home sales to rise 6 percent in 2011 to 5.1 million units-up from 4.8 million in 2010. new home sales will rise to 400,000 in 2011 from 300,000 this year-a big increase in percentage therms but still well below normal yearly sales activity. Home values overall are not likely to move in any measurable way, up or down. We are lucky to be in Denver, where home prices in the metro area are up 2% from this time last year.