Home Sales Going Up, but Prices Should Continue to Drop

Recent reports that home sales may have bottomed out appear to have stirred some optimism that the worst of the housing crisis could be over.

Unfortunately, house prices and loan performance are lagging indicators in a recovery and this downturn has seen the biggest price drops and the worst loan performance since the Great Depression.

Historical patterns show that house prices will fall and defaults and foreclosures will continue to rise until there is an improvement in the job market. If the employment numbers start to increase in mid-2010, as many expect, the turnaround in prices and delinquency rates may not come until the first quarter of 2011. Nevertheless, sales are expected to trend upward and that is an important development, according to David Berson, chief economist for the PMI Group Inc. in Walnut Creek, Calif. "It is the precursor to everything else improving. Sales had to go up first and that is happening now," Mr. Berson said.

The National Association of Realtors reported a 2.9% increase in existing home sales in April and the trade group is forecasting a major jump in sales during the last three quarters of this year. NAR economists expect home sales will rise to a 5.5 million seasonally adjusted annual rate in the fourth quarter, up 19% from the first quarter, as the $8,000 tax credit for first-time homebuyers boosts sales.

Federal Reserve Board chairman Ben Bernanke even told Congress that he is seeing "some signs of bottoming" in the housing market. And he expects overall economic activity to "bottom out, and then turn up later this year."

Despite the improvement in sales, the PMI chief economist says house prices will continue to fall this year. "It will go down 9% to 10% this year and it will be roughly flat next year," Mr. Berson said. "There are just too many homes for sale," he said, and too many vacant homes.

The PMI Group uses First American Loan Performance data in forecasting house prices, which shows prices have declined by 22% since the peak in the third quarter of 2006. From the first quarter of 2008 through the first quarter of 2009 prices have fallen 11.7%.

Meanwhile, the Census Bureau reported that only 345,000 full-time employees lost their jobs in May, compared 700,000 during the winter months. But the unemployment rate jumped to 9.4% from 8.9% in April.

"It is a good sign and it bolsters the argument that the housing market should bottom in terms of sales and perhaps in (housing) starts" possibly in June or July, according to Scott Anderson, senior economist at Wells Fargo & Co. However, the yield on the 10-year Treasury note has risen sharply in the past few weeks and the Federal Reserve is struggling to keep mortgage rates low. The average rate on 30-year fixed-rate mortgages hit 5.59% during the week of June 12, according to Freddie Mac. This has already impacted refis. The Mortgage Bankers Association refinancing application index has plummeted to 2,600 from 6,800 on April 3.

"Just as we are hitting bottom in the housing market there is a lot of uncertainty about how strong the recovery will be," the Wells Fargo economist said. "The risk factor is mortgage rates," Mr. Anderson said, which could keep home sales stuck at "moribund levels."

His forecast calls for house prices to drop 5%-10% from April 1 through February 2010. He expects the unemployment rate will peak around 9.7% in the fourth quarter of 2009 or the first quarter of 2010 and remain at that level for most of the year. Defaults and foreclosures won't "top out until some time in 2010," Mr. Anderson said.

Meanwhile, declining house prices undermine homeowners' equity and make it difficult to modify mortgages, especially if the owner losses their job.

A Mortgage Bankers Association delinquency report shows there were 600,000 foreclosure starts in the first quarter. And foreclosure starts on prime loans jumped ahead of subprime loans for the first time this decade.

Defaults on prime loans are the "hardest to fix" because they mostly reflects the loss of a job or other life event, according to MBA chief economist Jay Brinkmann. "Since the mortgage performance lags improvement in the job market, that would put us to the end of 2010 or possibly the first quarter of 2011 before we see a nationwide improvement in the performance of mortgages," Mr. Brinkmann said.

He made his comments in releasing MBA's delinquency report, which shows the serious delinquency rate on all single-family loans (90 days or more past due or in foreclosure) hit an all-time high of 7.38% in the first quarter.