News from California Association of Realtors that this market might be short lived

Bottom's Up: This Real-Estate Rout
May Be Short-Lived

By JONATHAN R. LAING

This real-estate rout has been more painful than prior ones, but it may be shorter-lived. Indeed, there are early signs of recovery.

<form enctype="application/x-www-form-urlencoded" action="/public/search/results.html?mod=ba_authorsearch" method="post" accept-charset="UNKNOWN"> </form>

<script type="text/javascript"></script> <script type="text/javascript" src="/b2-button.js"></script> <script type="text/javascript"></script>

IA FEW YEARS AGO, AN ACQUAINTANCE SENT Wellesley College economist Karl "Chip" Case a T-shirt depicting a cartoon of a smiley-face house surrounded by soap bubbles, called "Mr. Housing Bubble." But it was the words captured in a comic-book cloud on the shirt that gave this otherwise goofy image its bite: "If I pop, you're screwed!"

The dark humor hardly was lost on Case, co-creator along with Yale economist Robert Shiller of the now-canonical S&P/Case-Shiller Home Price Indices. In pairing recent sale prices of U.S. homes with the prices those same homes fetched previously, the index is substantiating what every sentient American knows: The U.S. housing market is in a deep funk, probably the worst in 50 years, according to Harvard's respected Joint Center for Housing Studies.

Home prices are down nearly 18% from the market's peak, according to Case-Shiller, and inventories of unsold homes are at near-record levels. Foreclosures are mushrooming on "subprime" properties, or homes whose purchase was financed with subprime debt. Blowback from the crisis has left mortgage-finance giants Fannie Mae (ticker: FNM) and Freddie Mac (FRE) financially strapped, while many other lenders lack the stomach -- or money -- to offer new mortgages. Noted market experts such as Pimco bond-fund manager Bill Gross and economist Mark Zandi of Moody's Economy.com predict the meltdown in housing will continue for many months, with home prices declining by 10% or more from today's depressed levels.

Yet, such pessimism appears overdone, based on much recent data. Sales of existing homes are showing tentative signs of increasing, while the plunge in prices likely is nearing an end. Total inventories fell in May to 4.49 million existing homes for sale, or a 10.8-month supply at the current sales pace, down from an 11.2-month supply in April, according to the National Association of Realtors, in just one statistic emblematic of the nascent trend.

YES, THE SUPPLY OVERHANG still is humongous, but at least the numbers are moving in the right direction, as even Treasury Secretary Henry Paulson noted last week. Speaking at a Federal Deposit Insurance Corp. conference, Paulson declared that "we are well into the adjustment process." Inventories of new single-family homes are down 21% from a 2006 peak, he observed, while "existing-home sales appear to have flattened over the past several months, indicating that demand may be stabilizing."

Still other numbers suggest prices are close to bottoming. The S&P/Case-Shiller Index for April, released just last month, showed the biggest year-over-year price decline yet, of 15.3%. Buried in the numbers, however, and widely ignored in the media, was the news that home prices actually rose, albeit slightly, between March and April, in eight of the 20 markets covered by the index (Boston, Charlotte, Chicago, Cleveland, Dallas, Denver, Portland, Ore., and Seattle). This was in sharp contrast to the readings for March, which showed prices falling in 18 of the 20 surveyed markets. Also, the pace of monthly price declines is starting to slow in most of the markets with negative readings.

"Other than Larry Kudlow of CNBC, none of the journalists who interviewed me after the latest release seemed at all interested in any of the positive developments," says David Blitzer, chairman of the S&P Index Committee. "They seemed focused on the bad year-over-year number."

In general, transaction-based home-price indexes, including S&P/Case-Shiller, may be painting a bleaker picture of price trends than warranted. That's because subprime housing, though less than 10% of the total U.S. housing stock, accounts for a far larger share of current sales volume, owing to spiraling defaults and distress sales. In the San Francisco area, expensive homes ($721,548 and up) have suffered a peak-to-trough drop in price of only 10.7%, compared with low-priced homes ($473,711 and under), down 40.9%, and mid-range homes, down 28.3%, according to the latest Case-Shiller numbers. The surge in low- and mid-range sales has been sufficient to push average peak-to-trough prices down by 24.6%, despite the index's valuation-weighting.

Help for the housing market also may be on the way in the form of proposed congressional legislation that would allow the recasting of some $300 billion in troubled subprime mortgages through the Federal Housing Administration. The bill, which some have derided as a bailout, would demand sacrifices by both lenders and borrowers, and could help to ease conditions in the subprime market.

Of greater importance, a government takeover of loss-ridden Fannie and Freddie -- the subject of widespread speculation late last week -- would ease concerns about the continued availability of credit in the housing market. Fannie and Freddie, which buy mortgages from banks and repackage them into mortgage-backed securities, are the biggest source of financing for the U.S. mortgage market.

SURPRISINGLY, CHIP CASE, whose knowledge of the housing market goes back decades and is based on the voluminous collection of data, is among those who think home prices may be nearing a bottom. Case notes, among other things, that new housing starts fell to 975,000 in April from a peak rate of 2.27 million in January 2006, and that three declines of similar magnitude -- from more than two million to less than one million -- have occurred in the past 35 years. "Every time this has happened before, housing-market activity has rebounded within a quarter and caught experts by surprise," he says. "In many areas, particularly outside the overbuilt markets of Arizona, Florida and Nevada and the huge bubble market of California, home prices may well stabilize" and begin to recover before the end of this year.

Case acknowledges history might not repeat, as the U.S. could be on the cusp of a painful recession. Unlike the three prior dips of a million-plus starts -- in the first quarter of 1975, the second quarter of 1982 and first quarter of 1991 -- the latest slide was triggered by insensate speculation and suicidal lending practices rather than the traditional factors of rising unemployment and interest rates and slowing economic growth. Thus, he says, a protracted dip in the economy would temper his optimism, though the official measures of economic growth don't indicate a recession yet.

Jim Paulsen, chief investment strategist of Wells Fargo's primary investment unit, expects home prices to steady by year end, with the pace of foreclosures slackening shortly. Most of the subprime debt at the center of the current crisis already has been written down by financial institutions, he notes, while many subprime borrowers who lost their homes are returning to rental units. "Folks who compare this home-price cycle to the one that occurred in the early '80s obviously have short memories," Paulsen says. "In the 1980s the economy was in a deep recession, mortgage rates were at 17% or more, and unemployment [was] hitting a post-Great Depression high of nearly 12%."

THE STEEP DECLINE IN HOME prices -- Case prefers to study the ratio of sale prices to per-capita income in various locales -- already has improved affordability. The change in such ratios varies by market, with Florida, Arizona and Nevada typically tracing short boom-and-bust cycles because any surge in speculative demand quickly is followed by overbuilding, due in part to the abundance of cheap land. The ratio in Phoenix, for example, has been reverting to a more typical six times home prices to income, after soaring to nine times in 2005 and '06.

Most volatile are popular metro areas, such as Los Angeles and Boston, where housing demand is high, along with restrictions on development. Los Angeles' affordability ratio doubled from 2001 to 16 times at the height of the housing boom, before dropping back to around 11. The Boston market never grew so frenzied, perhaps because it was far from the center of the subprime-lending business in Southern California, where an array of bad business practices flourished. Boston's housing-affordability ratio peaked at 12, and since has returned to a more normal nine times prices to income.