6/24/2010
By David Urani, Research Analyst

This week brought in some decisive news about the housing market, and after feeling a bit like Chicken Little over the past few months, I now have my proof that the market is now indeed in some serious trouble. New home sales for the month of May, the first month without the nationwide homebuyers' tax credit, plunged to a record low of 300,000 homes annually. It was a dismal report across the board, with sales falling more than 20% seasonally adjusted in all four major geographies, including a 53% drop in the West. We knew the tax credit was pulling forward sales, and here is the proof that it was indeed a driving factor behind home demand over the past few months.

As we showed in previous articles, falling mortgage purchase applications heralded the drop in sales. Through the first few weeks of June, purchase applications have continued to fall, indicating that home sales could continue to go lower yet. We should also note that existing home sales began to fall in May as well, although due to the way they are recorded the results so far are not as conclusive. Nevertheless, with the housing market now on its own (sans government help), it's clear we are going to have to survive through a period of very weak sales.

As bad as the home sales trends have been, that only accounts for the demand side; now on to supply side of the equation. Existing home supply in May stood at 3.9 million units. At the time of the report, homebuyers were still able to complete deals that were ordered before the tax credit expiration. As a result, there was still a relatively high amount of home buying and inventory actually fell by 3.4% from April. Nevertheless, inventory  rose by 7.8%, 2.7%, and 11.1%, respectively in the three previous months, despite there being tax credit demand boosting home sales. It's plainly obvious that foreclosure problems continue to wreak havoc on the market. As of May, foreclosure filings were still at extremely high levels, above 300,000 per month.

The good news is that the rate of new delinquencies is slowing, indicating that some stabilization in the economy is slowing the flow of troubled homeowners (albeit slowly). However, the rate at which foreclosures are being finalized and being converted into vacant inventory is rising. There are roughly seven million delinquent borrowers in America, four million of who are seriously delinquent (90 days or more). Foreclosure prevention programs such as the White House's HAMP program have been delaying the processing of foreclosures, however, such that borrowers who go delinquent are spending more than a year on average in their homes without having to make payments. We are now at a point that the massive pipeline of delinquent borrowers is being cycled through the process after a long wait. With respect to foreclosure prevention, the HAMP program has only begun to lose its influence, as new enrollments are down to approximately 30,000 per month from more than 100,000 during its peak last year. In total, only 340,000 people are enrolled in the permanent program. Even for those enrolled in the program, studies have shown that more than half of modified mortgages eventually go back into delinquency.

All told, despite some slowing in new delinquencies, foreclosure inventory is hitting the market at an increasingly faster rate, and there is still an extremely large pipeline of millions of homes waiting in the wings. Meanwhile, the rate of home sales, as we now know, has fallen off a cliff. Therefore, it is highly unlikely that current sales rates will be able to soak up the stream of new vacancies. Now for some economics 101: lower demand + higher supply = lower price. Home sellers will need to drop prices to entice buyers back into the market now that the tax credit is gone. But even then, it is apparent that the tax credit pulled forward sales such that buyers who perhaps would have bought later this year already did so. Brace yourself, prices are about to fall.

David Urani
Wall Street Strategies