Washington & Wall Street: Bernanke's Housing Bubble is Unsustainable

Home prices rose last month by an average of 10.9%, according to the Case-Shiller index.  The good news is that home prices continue to recover from the lows seen in 2009.  The bad news is that increasingly frothy conditions in the housing market are neither normal nor sustainable.

“Home prices are still down by 28% from their 2006 peak and have returned to levels last seen in late 2003,” writes Nick Timiraos in the Wall Street Journal. “One year ago, home prices were 35% below the 2006 peak.”  Timiraos notes that the largest gains in average home prices have occurred in the West, “including many markets hit hardest by the foreclosure crisis.  In March, prices were up by 22.5% in Phoenix from one year earlier, and by 22.2% in San Francisco.”  Markets such as New Jersey, New York and Connecticut, on the other hand, have barely moved or are actually down.

The rally in the US housing market is largely an illusion.  If you take sales of distressed properties out of the Case Shiller data, for example, average home prices are up about 5% over the past year.  And much of the upward move in home prices is due to short supply rather than a groundswell of real consumer demand for homes.

Almost half of all home owners with mortgages owe more than their properties are worth or had less than 20 percent equity in the first quarter, according to Zillow.  Those people probably are locked in to their residences.  Listing a house and purchasing a new one generally requires equity of at least 20 percent to meet costs, Zillow said.

“The effective negative equity rate nationally —where the loan-to-value ratio is more than 80%, making it difficult for a homeowner to afford the down payment on another home — is 43.6% of homeowners with a mortgage,” says Zillow. “While not all of these homeowners are underwater, they have relatively little equity in their homes, and therefore selling and buying a new home while covering all of the associated costs would be difficult.”

Since the largest percentage moves in average home prices is in CA and other western states, the supply constraint in these markets will likely continue to push home prices higher, but this is not good news.  Home prices in CA are moving five times faster than the underlying growth in the job market.  Indeed, there is already evidence of manic behavior in many of the hottest western housing markets.

Homes in desirable areas of CA, for example, are going in a matter of days and at 120% of the “broker price opinion” or BPO.  Some of the buying interest comes from investors, who are creating a feeding frenzy in some markets not seen since the bad old days of 2006-2007.  Multiple bidders for homes in the $300k, $400k and $500k range and higher are not unusual.

Part of the reason that measures such as Case-Shiller are showing such strong increases in prices is due to the disappearance of any discount for bank-owned, distressed real estate, also known as “REO.”  A report just put out by the Federal Housing Finance Administration notes that REO sales have significantly increased the apparent rebound in average home prices nationally.

The agency notes that "distress-free" home price indices for 12 large metropolitan areas generally report lower quarterly appreciation than do the purchase-only indices.  In 11 of the 12 areas the new indices, which remove the direct effect of short sales and bank owned or REO properties, shows lower appreciation than traditional series such as Case Shiller. 

For example, in Atlanta the purchase-only four quarter index appreciation was 17.62 percent vs. just 10.3 percent excluding distressed sales.  For Chicago the numbers were 4.26 percent versus 2.9 percent, respectively.     

Bottom line is that the Fed’s efforts to boost home prices are working, but not for the reasons most people want to believe.  Instead of a steady flow of newly formed households and first time home buyers, what we see is a speculative frenzy driven by the Fed’s zero interest rate policies.  A limited number of American families are competing with highly leveraged institutional investors for an even more limited supply of properties.  And mortgage rates, no surprise, are rising.

When the music stops, look for some of the same big investors who are now paying 120% of BPO to come under pressure to sell homes into a declining market. Indeed, smart managers at institutional funds and commercial banks are selling right now into Bernanke’s housing bubble.  So when your stock broker calls to talk about investment opportunities in single family homes, just put down the phone.

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