The Housing Market: Cautious Optimism

In 2013, there is no economic reason why the housing rebound shouldn’t continue.

By Christopher Thornberg

The massive bubble that ripped through the markets in the middle of last decade left a mountain of bad mortgage debt, a large excess supply of housing, and a consumer sector that was disinclined to get back into the market — and even if willing, credit was tight. The Obama administration tried a few policy tricks to get the market back into growth mode over the past few years, but with little success. Predictable since the problems were so fundamental. Policy maneuvers, done on the cheap, were bound to fail.

The ultimate cure was always time — time to allow population growth to use up the excess supply of homes, time for the banking sector to clean out its supply of foreclosed homes, and, of course, time for the public to forget the excesses of the last cycle. In 2012, the number of REO units fell below 400,000 for the first time since 2007, even as the “months supply” of existing homes for sale dropped below six months. And inventories of new homes for sale have been low for years.

Combine this with a record level of housing affordability that was created by low interest rates, and it was only a matter of time before the market gained traction. Prices, which had languished since hitting bottom in 2009, have been rising. Case Shiller, median prices from the National Association of Realtors and the Core Logic price index have all reported increases in nominal prices in recent months.

It is important to note that the recovery, while real, is still “small”. Although inventories are tight relative to sales, sales are still low. That is to say that a large portion of the housing market is not in play. There are still an excessive number of units in the foreclosure process — though considerably lower than a few years ago — and an even larger number that are underwater on their current loan implying they will neither sell nor buy.

Also the number of owner-occupied households has remained flat for four years. The growth has instead been in renting households. Here, investors have filled in the gap.

Indeed, investor demand has heated up to the point that in recent months there has been a startling drop in the sale of foreclosed homes—in favor of short sales. Banks do not want to deal with the new regulatory requirements of a full foreclosure if avoidable, and investors prefer to get ahead of the curve rather than waiting for an auction.

And builders are beginning to enjoy the results of higher demand. Permits for new units hit an annual rate of 900,000 late in 2012, still far short of the 1.5 to 1.6 million that should be supplied in a normal year, but on the right path.

There is little reason to think these trends shouldn’t continue into 2013. The small recovery will become larger as rising prices free many homeowners up to get into the market. The fundamentals of the private sector economy are fine, implying that the economy continues to expand, albeit at a slower than hoped for pace. Incomes are rising, corporate profits are solid, the stock market has bounced back nicely, and consumer credit is becoming more available.

There is a major, looming risk to the housing recovery, and that is the Federal budget of 2013. At this writing, there is still no resolution to the so-called ‘fiscal cliff’ that will occur when taxes increase and spending falls on January 1. In Beacon Economics’ estimation there is not likely to be a bargain before the end of the year, despite the fact that both sides seem to be inching towards middle ground. The slow pace of the negotiation has left the economy is slow growth mode — as businesses and individuals wait to make critical investment decisions until after they better understand the lay of the fiscal land.

And finally, while the Fed continues to loosen its monetary policies, it is also clear that some of the massive liquidity they are injecting into the system is starting to leak into the money supply. While real inflation is years away, it is still possible that the Fed will have to start reversing course late in 2013 or early in 2014. This will cause rates to rise, which will be another slowing factor for the housing market.

So while the current housing recovery is on solid footing, it continues to face stiff resistance as officials move to unwind the many policies they put into place in 2008 and 2009. Cautious optimism should be the guiding principal for 2013.

Christopher Thornberg PhD, is founding partner of Beacon Economics, LLC and widely considered to be one of California’s leading economists. He is an expert in economic forecasting, regional economics, real estate and industry analysis, employment and labor markets, and economic policy. For more information, go to

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