Job Market Stability Brings Relief to Housing Market

Since peaking at 11.0% in August 2009, Bay Area unemployment has been trending slowly downward. January's reading of 10.3% is the lowest since May of last year. Nationwide unemployment peaked at a (seasonally adjusted) rate of 10.1% in October 2009. January's reading came in slightly lower at 9.7%.

Most economists expect unemployment to remain high for the remainder of 2010. That's not good news for the housing market (especially in areas with a lot of underwater homeowners), but stable unemployment is far better than rapidly rising unemployment. Take a look at the chart, below, which shows the recent trajectories of home prices and unemployment in the Bay Area.

Bay Area home prices remained stable until the job market began to deteriorate. Prices then fell rapidly as unemployment rose, but stabilized once again when unemployment plateaued. (A similar course of events played out during the 2001 recession, although the current price decline has been far more severe.)

Some smart economists believe that the U.S. economy is not yet out of the woods, and could slip back into recession later this year. Let's hope that it doesn't work out that way. If so, then Bay Area housing prices may have reached a point of stability.

End of Fed Program Doesn't Necessarily Imply Trouble for Mortgages

The Federal Reserve has taken emergency measures to keep the recent financial crisis from spiraling out of control. One such measure, announced last March, was to purchase almost a trillion dollars worth of mortgage-backed securities from Fannie Mae and Freddie Mac. The financial crisis had severely impaired banks' capacity to provide credit, so the Fed stepped in to support the housing market.

The announced program of Fed purchases is almost complete, and is scheduled to end in March. The credit markets have stabilized over the past year, but housing market observers nevertheless are anxious about what will happen to mortgage rates when the Fed withdraws its support. The anxiety is understandable. The Fed purchased 73% of the mortgages that Fannie Mae and Freddie Mac turned into securities during 2009. Withdrawal of that kind of support seems likely to cause at least some disruption.

As I’ve pointed out in the past, mortgage rates are closely tied to Treasury rates. Take a look at the chart, below, which shows the interest rate spread between 30-year fixed-rate mortgages and 10-year Treasurys.


In the years leading up to the crisis, the mortgage spread remained close to its historical average of 1.6 percentage points. It rose dramatically as the crisis unfolded, but has since fallen to less than 1.3 percentage points. A casual analysis would therefore suggest that mortgage rates are likely to rise when the Fed program ends in March.

At least one major bond market player (PIMCO) is betting that mortgage rates will indeed increase soon. Bill Gross (PIMCO's managing partner) has an outstanding record of accurate interest rate forecasts. That's why PIMCO has become the world's largest bond fund manager; if you're looking for investment advice, take theirs. Before you decide that mortgage rates are headed for an abrupt increase, however, take a look at the chart, below, which shows a longer history of the mortgage spread.


Note: This chart uses annual averages, which smooth out some of the volatility that is evident in the monthly chart above. That’s why the maximum spread shown in this chart is lower than the maximum shown in the monthly chart.

The mortgage spread remained below 1.6 percentage points from 1991 to 1997. (It’s worth pointing out that this period coincided with the last significant housing market slowdown, and followed the S&L crisis of the late 1980’s.) The average spread during this period was 1.35 percentage points, which isn't far from the current spread. Perhaps PIMCO is correct about the likely course of mortgage rates, but I wouldn't look for a dramatic near-term increase.

(I’m not saying that you should wait to refinance. Today’s mortgage rates probably will look like a bargain a few years from now.)

Builders Are Optimistic - as Usual

On Tuesday, the National Association of Home Builders released the February edition of its Housing Market Index. The HMI rose by two points compared to January, but remains in record-low territory.


Despite the protracted downturn in the housing market, builders have remained steadfastly optimistic. Indeed, they've actually been expecting conditions to improve for the last three years. Take a look at the chart, below, which shows the 'current conditions' and 'expected conditions' components of the HMI.


The 'expected conditions' component of the HMI (which measures builders' expectations for the next six months) has remained roughly ten points higher than the 'current conditions' component since October 2006. Throughout most of the period in question, however, conditions actually deteriorated. Evidently, builders keep expecting the future to be better than the present, but the future keeps receding.

Take What "They Say" with a Grain of Salt

I love this story. Three years ago, the Mortgage Bankers Association announced plans to buy a new, $90 million headquarters building in Washington, D.C. According to Jonathan Kempner, then president and CEO of the Association, "...we have come to the inescapable conclusion that owning our own building was the smartest long term investment for the Association." The Association moved into its new headquarters in June 2008.

On February 5th, 2010 - less than two years after moving in - the MBA sold their building to CoStar Group for $41 million. In so doing, they effectively acknowledged a colossal investment blunder. Plenty of people overpaid for real estate during the boom. But the MBA was supposedly a group of financial experts, who had access to a wealth of intelligence about the real estate market. That's why I cringe whenever someone begins a sentence with the phrase, "They say..."

The Blog Is Back

The blog is back. It's been more than two months since my last posting but I expect to be posting regularly once again.

Since this is my first posting of 2010, let's start with prices. Take a look at the chart, below, which shows home price indices for San Francisco as well as the nine-county Bay Area.

The San Francisco index comes from Dataquick and includes single family homes as well as condos. The Bay Area index comes from Case Shiller and includes single family homes only.

San Francisco prices plateaued in the summer of 2005 and remained fairly stable until the summer of 2008. Then, during the six-month period ending in January of 2009, prices fell by more than 25%. They bounced back strongly in February and have remained fairly stable since then, at a level that's only about 15% below the peak.

Prices in the greater Bay Area also plateaued in the summer of 2005, but remained at peak levels for only two years instead of three. The subsequent price decline was both longer and more dramatic than in the case of San Francisco. Over the 18-month period ending in March of 2009, Bay Area home prices fell by a whopping 45%. Home prices (along with stock prices) bounced back strongly when it became clear that the economy wasn't sliding into depression. Even so, Bay Area home prices are still about 35% lower than they were at the peak.

Perhaps there's an economic justification for the strong relative performance of the San Francisco market, as compared to the greater Bay Area . I suspect, however, that the main reason why San Francisco has held up better than the greater Bay Area is that San Francisco homeowners generally have more financial staying power than their counterparts in the greater Bay Area.

35% of California Homes with Mortgages Are Underwater

According to a recent report from First American CoreLogic, 35% of California homes with mortgages were underwater as of September, 2009. Results were generally better in the Bay Area, although not in the East Bay.


There's no mystery about why so many homes in the East Bay are underwater. Prices there have fallen further than in the other regions.


Note: I don't have aggregate price indexes for the regions shown in the First American report, so I just showed the component counties.

The number of underwater homeowners continues to grow. (See this map for numbers from November, 2008.) As I mentioned in an earlier posting, the number of foreclosures is likely to continue growing as well.

Nation's Housing Prices Were Flat in September

The Case Shiller home price indexes for September were released today. The 20-city composite index was essentially unchanged from the prior month. Ten of the twenty cities actually fell during September. That represents an unpleasant reversal from the August result, when 17 of the cities rose. There are plenty of reasons to question the recent gains in housing prices. We may already be seeing signs that those gains are not in fact sustainable.

The Bay Area seems to be faring better than the nation as a whole, with September prices rising by 1.3% compared to August. Bay Area home prices are now about 14% higher than they were at their March lows, although they are still almost 40% lower than they were at the peak of the bubble.