Wednesday, December 2, 2009

Low Housing Inventories? Foreclosures continue to drive the market.

The inventory of new homes is in the ballpark of a new record low.  Almost one year ago, I posted on the topic of housing inventories (here).  Since then, the inventory of new homes has decreased to the lower end of my estimates, falling through my floor of 250 thousand; still the fall in inventories shows no sign of abating.  The pace of inventory drawdown has remained between 2.5 and 4.5 percent per month all year.  In every other recession, the end of the inventory cycle has been marked by gentle U-shape.  If true this time as well, the end of the housing correction is still far into the future. 

Why are inventories falling?  They are falling because the total inventory of housing effectively on the market is much larger than in a normal downturn.  Inventory is pushed up by the stock of foreclosed homes. 

Foreclosed homes directly compete with new homes, and they add to inventory in exactly the same manner.  A new home is empty and must be sold to maintain its value.  A foreclosed home is (generally) empty and must be sold to maintain its value.

In my view, the scale of the foreclosure problem is only beginning show.  The following chart shows the inventory of new homes, the solid blue line.  The inventory has declined from just shy of 600 thousand homes in early 2006 to almost 200 thousand in October.  Foreclosures swamp these numbers.

Fannie and Freddie alone have a stock of foreclosed houses on their books of over 100 thousand.  The red diamond in the chart shows inventories adjusted for these homes.  This addition moves the stock of unsold homes above the long-term average of the series. 

But these homes are just the tip of the iceberg.  The current number of foreclosed houses is much larger than those on the books of the two GSEs.  Even more importantly, at present, another 11 million households are in a negative equity position.  If even 10 percent of these households go into foreclosure, the true level of inventories is over 1.4 million, an inventory stock 2.5 times the previous record high. 

Since the foreclosed inventory cannot be worked off through starts alone, the adjustment will have to come through prices.  House prices are going to have to fall further.  They have to get cheap enough to clear the market.  The fall in prices will put more households under water; some of these houses will go into foreclosure, keeping inventories elevated. 

Also of note, median months for sale has continued to rise.  The graph below shows data from 1988.  Two prior recessions are shown and in neither of those recessions did the time for sale even budge.  The median new home on the market has now been for sale for 13.5 months, an increase of 4.4 months in the last year.  Most likely, this rise reflects blocks of houses that cannot be sold or at least cannot be sold at anything near the current price.