Households not favoring idea of taking on new credit
We can spend all the resources possible to underpin the financial system but the reality is that the experiment with massive doses of leverage from 2002 to 2007 has left the household sector, at the margin, in complete disgust, if not fear, when it comes to taking on new credit. This is evident in the Fed flow-of-funds data showing the first net consumer debt paydown ever, the Fed loan officer survey, the record-low NACM index and of course, as we saw yesterday, the 2.6% slide in mortgage applications for new home purchases in the February 20th week – and down a whopping 30% from year-ago levels despite record low mortgage rates and record-high affordability levels. Housing turnover down 5.3% in January (to a 12-year low) and median home prices down 15% YoY (and down 26% from the peak) tell the tale that housing today is about as desirable a consumer asset as the
Lincoln convertible was back in 1973. People are content renting and forgoing the risk of taking on a mortgage – or the experience of investing in an ever-deflating asset for that matter.

Relentless declines in home prices continue
The Case-Shiller home price index for the 20 largest US cities fell by 2.5% M/M in December, for the 29th consecutive monthly decline. This was in line with BASML expectations but slightly worse than consensus estimates. Relative to a year ago, prices fell by 18.6%, while the three-month annualized change was a steeper drop at 24.5%. Deflation intensified across all markets, bringing the total decline to -27.0% relative to the peak in July 2006. Indeed, all 20 markets fell for the fourth straight month. Markets that have been hardest hit by pervasive subprime lending also reported the largest monthly and annual declines in December. The National Association of Realtors reported that 45% of existing sales over the month were foreclosure related, specifically citing activity in California, Nevada and Arizona. Such properties, selling at steep discounts, continue to drive prices lower, as was seen in the sharper declines reported in Phoenix (-5.1% M/M and -34% Y/Y), Las Vegas (-4.8% M/M and -33% Y/Y) and San Francisco (-3.8% M/M and -31.2% Y/Y).

National home prices (which are only released quarterly by Case-Shiller) in the 4Q fell by 7.2% versus the 3Q, or -26% at a quarterly annualized rate. This compares to a lighter 13.3% annualized quarterly drop in 3Q and reflects a marked acceleration in the pace of decline. Clearly, a broader number of
markets are sharing the pain as the economic downturn weighs on sales and foreclosure sales grab more of the activity. Relative to the peak in mid-2006, the national index is now down by 21%. Depressed demand, tight credit, rising default rates and excess inventories can be expected to continue to lead prices lower in the quarters ahead. We estimate that an additional 15%-20% in downside is still in store.

Further surge in the inventory-sales ratio
What really caught our eye in this week’s new home sales data, which showed another decline to a new record low, was the further surge in the inventory-sales ratio – we are now measuring the oversupply in years, not months! The backlog of unsold homes surged to an all-time high of 13.3 months’ supply from 12.2 months in December and 9.8 months’ a year ago. Problem is that prices do not stabilize until we break below 8 months’ supply – and they tend to deflate 3% per quarter until that happens. So as impressive as it is that the builders have taken single-family starts below underlying sales, their efforts are just not sufficient to prevent real estate prices from faltering further – indeed, it would now take 17 years to fully absorb the excess inventory even if the builders were to keep starts at their current depressed levels; and even if the builders were to declare a moratorium immediately, that is taking starts to ZERO, demand is so weak and the unsold inventory so intractable that it would now take over 3 years to achieve the holy grail of price stability in the residential real estate market. And recall that the ‘real’ unsold inventory in the resale market is 11.2 months’ supply, not 9.6 (which is bad enough) and that 45% of the sales activity are foreclosure sales. And increasingly, all cash deals (since we know that mortgage applications are down more than 40% from a year ago) so we have some ‘punters’ who are going to be looking to sell into any uptick and hopefully (for their sake) get a capital gain on the deal.