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The Recession Will End… When Housing Gets Sorted

Just a few short weeks ago, it felt like we were through the worst of it – jobs seemed to be improving, retail sales were strong, banks were paying back their loans to the government. But then one niggling little issue emerged: the housing market is hardly in good shape.

The big question is when to buy. Prices surged in the summer and early fall, and so did sales, thanks to a government tax credit. That credit is due to expire in April, which, coupled with rising interest rates, could put the market at a standstill. Surely prices may fall, benefiting buyers, but there may be fewer homes on the market. And who wants a mortgage at a higher interest rate – if you even qualify? Banks are becoming more stringent, recommending mortgages be capped at no more than three times one’s annual income, with no less than 20% down.

At the mid-December meeting of the Federal Open Market Committee, which sets monetary policy, there was a movement toward extending the tax credit.

Not everyone thinks that’s a good idea. Writing recently in his blog on Seeking Alpha, Cliff Wachtelchief analyst for AVAFX, offered up an interesting observation on this damned-if-they-do-damned-if-they-don’t measure:

• If the credit expires, housing demand is likely to drop off, especially because much of the prior purchases were simply pushed forward to exploit the temporary tax credit, robbing the market of future demand. Ramifications for jobs, spending would be negative.
• However, if the credit is extended, that would be a form of stimulus spending which would pound the already weak USD, which in turn could start a nasty downward spiral and double-dip/ ‘W” shaped “recovery” as it means:

1. Rising Long Term Treasury Yields: A weakening dollar hurts US Treasury bond demand and thus forces rising long term rates needed to peddle the stuff. We’re already seeing this happen.

2. Rising Mortgage Rates: That, in turn, would drive up new mortgage rates. Worse, it would mean that the waves of Adjustable Rate Mortgages due to reset would only go higher in 2010-2011.

3. Rising Default Rates and Declining Real Estate Prices: Mortgage reset rates, already set to rise, would become that much higher, bringing that many more defaults and troubles for the critical banking and housing, sectors. Note that current studies suggest the vast majority of mortgage holders, particularly those with mortgages under 15 years old, have zero or negative equity in their homes due to declining house prices. Add to this witches brew of continued job losses or even just wage stagnation combined with rising mortgage costs, and we get higher default rates, both residential and commercial, as both forced and “strategic” defaults grow.

4. Renewed Housing and Banking Sector Crisis: Rising default rates, already rising, further weaken the already troubled banking and housing sector with asset write downs and further declines in property values as more inventory hits an oversaturated market. Remember, the housing and banking sectors lead us into the crisis, into the current rally, and are essential for any sustained recovery.

5. The Feared “Double Dip Recession”: Further downturns in these sectors would thus likely send stock and other risk asset markets tumbling. Unless there are more bailouts, which in turn hits the USD again…? (Go to item 1 above and repeat).

Tags: housing, mortgage, real estate, The Recession Will End...