Why U.S. Housing Prices Will Fall Further

real estate marketIt’s been four years in a row now that some economists have been calling the U.S. housing bottom without success.

In any depressed market, there are always pockets of opportunity and some areas that will do well. In the housing market, I have no doubt that foreigners have picked up some beachfront property in California or Florida or some prime farmland in the Midwest.

I read an article recently that talked about the resurgence in the Phoenix housing market. From a year ago, foreclosures have dropped 20% and prices have risen 25% in Phoenix’s housing market (source: Globe and Mail, May 27, 2012).

In the S&P Case-Shiller index released just this week, the Phoenix housing market had the biggest price rise of all the major cities the index follows.

The article points out that the Phoenix housing market was one of the hardest hit in 2008, with prices falling 50%. Even though prices have recovered somewhat, they are still currently 50% below the prices reached in 2006. Also, Canadians are cited as the major players in the Phoenix housing market, helping this particular housing market find a possible housing bottom.

However, what does Phoenix possibly hitting a housing bottom have to do with the rest of the country hitting a housing bottom?

Even this week’s Case-Shiller index fell again and the economists who created the index point out that, even though the rate of the fall in home prices slowed, home prices still managed to hit a new record low!

Furthermore, Case-Shiller point to the fact that home prices have returned to mid-2002 levels on average, and that home prices have not turned up on average. Although they saw improvements in some markets, 17 of the 20 major cities they follow are still in a downtrend in terms of housing prices.

The other critical factor is the shadow inventory that will hit the housing market over the next few years.

The shadow inventory is comprised of bank-owned real estate and current homeowners who are delinquent on their mortgage payments. CoreLogic follows the housing market closely. It estimates that the shadow inventory is currently 1.6 million homes.

It also notes that the number of homeowners who are delinquent over 60 days has increased from last year. The real key is how quickly those bank-owned homes will hit the market.

What is clear is that there are a lot of homeowners in distress in the housing market and there are many homes in the hands of banks. It is also important to note that CoreLogic estimates that between 12 million and 18 million homes in the U.S. are worth less than their mortgages.

If prices were to rise, do some of these homeowners attempt to sell, further putting pressure on the housing market and home prices? And, at some point, interest rates will need to rise to combat the after-effects of too much money printing. These are unknowns, but are huge headwinds working against the housing market.

In any distressed market, there are always pockets of strength. However, these pockets do not represent all of the market. The continued risks in the housing market are the shadow inventory and the homeowners paying mortgages that are worth less than the value of their homes.

Until these issues play themselves out, I’m afraid the housing market is far from reaching a bottom here in the U.S.

Michael’s Personal Notes:

Deeper cuts are on tap for U.S. municipalities in distress.

I have been talking in these pages about the state deficits and how, since the financial crisis hit, the weakened economy would mean less revenue for these municipalities and states.

Just this month, the governor of California revealed that its state deficits situation was worse than projected. Instead of the $9.2-billion deficit estimated in January, the state deficit now sits at $15.7 billion (source: Bloomberg, May 14, 2012).

This means deeper cuts in social programs and higher taxes. The governor of California proposed a four-day work week for state employees as one of the measures to cut the state deficit. There will be layoffs, of course, as the state deficit was greater than first assumed.

The state’s MediCal program, which provides healthcare for the poor is being slashed by $1.2 billion, while schools expecting $1.5 billion have been told they are not going to get it.

In the meantime, taxes for individuals making over $250,000 per annum have been raised, while a proposed state sales tax increase of a quarter-of-one-point per year for the next four years is being tabled, in order to close the enormous state deficit.

As school nurses are not unionized, they are the first to go, because they can’t protest.

Besides California, which has already cut 13% of its nurses and is looking to cut more, Cleveland cut 55% of its nursing staff to meet state deficits, so that there are only 28 nurses to cover 45,000 students (source: Wall Street Journal, May 24, 2012).

In Philadelphia, 35% of their nurses were cut, which leaves 185 nurses for 152,000 students. These are the harsh realities since the financial crisis hit.

A total of 35,000 of Detroit’s 88,000 streetlights are broken and not functioning. The city is planning on upgrading and fixing only 46,000 of them and keeping only these 46,000 lit at night in order to save money to meet the city’s and the state deficits (source: Bloomberg, May 24, 2012).

Detroit is not the only city to darken streets at night to save money to pay for the state deficits. Cities in Illinois and California have done the same, but not to the extreme of Detroit.

Colorado Springs shut down 35% of its streetlights to meet state deficits, but, thankfully, after saving enough money, it has relit a few thousand, leaving only 14% off.

Since the financial crisis hit, there have been bizarre and unprecedented occurrences in this country. Municipal and state deficits continue to grow as revenues are reduced, since fewer people have jobs and housing prices have collapsed. (See: Public Employees Take Governments to Court—We Want Our Pensions.)

There is unfortunately going to be a lot more to come, as the stresses continue to grow on state deficits. The true financial crisis will come when all of this is brought up to the federal level to deal with.

Where the Market Stands; Where it’s Headed:

Last fall, I predicted the U.S. stock market would start to collapse on or about April 13, 2012. I apologize to my readers; I was exactly two weeks too early. The stock market didn’t start crashing downward until the end of April.

The Dow Jones Industrial Average has collapsed about 1,000 points in May (919 points to be exact as of this morning). Today’s front cover of The Wall Street Journal carries the headline, “Europe Woes Ignite Selloff.” What did investors expect, the crisis in Europe not to affect the U.S.? I have been writing since January that the recessions in Europe would hit the earnings of the big S&P 500 and the thus the stock market. (See: A Problem Seven Times Bigger Than Greece.)

What’s going on in the financial markets is nothing short of a joke. Investors are running away from Europe, taking their money out of big European banks and buying U.S. Treasuries. Because of the demand, the yield on the 10-year U.S. Treasury has fallen to a record low of 1.63%. It’s ironic. Investors are running to U.S. Treasuries backed by a debt-ridden government. But it’s a government that will not dare to hesitate to print money to pay back those bond holders.

In the end, this will all work out terribly wrong. The more money printed, the higher the risk of inflation. Then all of a sudden; bang, interest rise sharply. This scenario will not happen overnight. The yield on 10-year U.S. Treasuries could likely fall to one percent. But the lower the stock market goes, the higher the chances of a third round of quantitative easing (QE3), the greater the long-term inflationary risks.

We are near the end of bear market rally in stocks that started in March of 2009.

What He Said:

“Partying Like a Drunken Sailor: The party continues. Stocks are making new highs and people are spending like there is no tomorrow. Why? I really don’t know. Big (cap) stocks, they just continue going up. Wall Street bonuses are at record levels. Popular consumer goods are flying off the shelves. Designer clothes, fast and expensive cars, restaurants with one-hour waits…people are spending in America today at an unbelievable clip. 1932, 1933…who remembers those years? The depression of the 1930s was the biggest bust of modern history. 2005, 2006, 2007…welcome to the biggest boom of the same period. When will it all end? Soon, my dear reader. Soon.” Michael Lombardi in PROFIT CONFIDENTIAL, February 7, 2007. Michael started talking about and predicting the financial catastrophe we began experiencing in 2008 long before anyone else.