New Home Sales Hit Record Low, Builder Confidence Suffers

Sales of new single family homes fell to 276,000 units in July, on a seasonally adjusted annual basis. That's the lowest sales total on record, going back to 1963.

Sales in the west region came in at 44,000 units in July, on a seasonally adjusted annual basis. That's also a record low, going back to 1973. Sales had been improving until the end of April, when the home buyer tax credit expired.

Note: Sales of new homes are recorded when contracts are signed. For existing homes, however, sales are recorded when transactions close. That's why existing home sales fell only modestly in May (following the April 30 expiration of the tax credit), while new home sales fell abruptly.

Not surprisingly, builder confidence is suffering. After hitting a record low of 8 in January 2009, the NAHB Housing Market Index had risen as high as 22 in May 2010. The index has fallen back sharply since then, however, to it's current level of 13.

Evidently, builders' hopes were buoyed by tax-credit-induced sales. Did they not see the end of the tax credit coming?

Expiration of Tax Credit Hits Bay Area Housing Market

The National Association of Realtors announced yesterday that existing home sales were 27% lower in July than they had been in the prior month. The annualized sales rate of 3.83 million units was the lowest since the NAR began keeping records in 1999.

Sales had been rising rapidly as the April 30 expiration date for the home buyer tax credit approached. The subsequent drop-off in sales was therefore widely anticipated. (The same pattern was observed with the original home buyer tax credit, which expired on November 30, 2009.) Still, the scale of the decline came as a surprise. In a survey of economists by Bloomberg News, nobody had predicted such a large decline.

Housing is far more expensive in San Francisco than in other parts of the country. Consequently, the tax credit might have been expected to have a relatively small impact on demand. Surprisingly, however, home sales fell almost as much in the City as they did in other regions. Between June and July of 2010, home sales fell roughly 21% in San Francisco. The July 2010 total (452 units) was 17% lower than the corresponding figure for July 2009 (543 units).

Housing Market Slows Following Expiration of First-Time Buyer Credit

The housing market has slowed dramatically following the April 30th expiration of the first-time home buyer tax credit. Take a look at the chart below, which shows the NAR's Pending Home Sales Index.

The index tracks the number of purchase contracts that are signed in each month. It is normalized that the average for 2001 is 100.

In order to qualify for the tax credit, buyers had to be in contract by April 30th. There was some question as to how large an impact an $8,000 credit would have on buying activity. Now we know. Nationwide, pending home sales fell 30% from April to May. In the western region, pending home sales fell 21%.

Anecdotally, the San Francisco housing market seems to have slowed as well. I'll address this in an upcoming posting.

Mortgage Defaults May Have Peaked

Almost 20,000 Notices of Default (NOD's) were recorded in the Bay Area during the second quarter of last year. Default activity has fallen rapidly since then. In the fourth quarter (the latest available), the number of NOD's came in more than 30% lower, at roughly 13,600.

San Francisco County has experienced a similar decline in default activity. There were 607 Notices of Default recored in the City during the third quarter of 2009. The fourth quarter figure came in almost 25% lower, at 465.

Note: The abrupt decline in NOD's during the third and fourth quarters of 2008 resulted from lender uncertainty in the face of legislative changes. Keep in mind that the chart shows recorded Notices of Default, not actual instances of default.

Two quarters don't make a trend. But the recent stability in home prices and employment suggest that mortgage default activity will continue falling.

Bay Area Housing Market Recovery Continues

Bay Area home prices touched bottom in April of last year, and now appear to be almost a year into recovery. According to the Case Shiller indexes, single family home prices are 15% higher than they were at the bottom of the market. They've increased in every month since then, albeit at a slowing pace.

The Bay Area condo market also has bounced back, but its recovery has been less impressive. Condo prices are only about 7% higher than they were at the bottom of the market.

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.)