Will the U.S. Housing Market Double Dip?

I am often asked why I, a commercial building sales broker, pay attention to the residential housing market. It is because we landed in this recession due to stresses in the housing market and the roads leading out of the recession will run through the housing market as well. During the summer, that road seemed to be heading toward recovery.

Over the past few months, there have been some signs that the U.S. housing market had begun to stabilize. Some economists have even said that the market bottomed as early as the spring of this year. Let’s look at the reasons for the optimism.

Industry experts were cheering October’s new-home sales figures, which easily beat estimates by climbing 6.2%. Prices, which had been in free fall, dropped by the smallest margin in nearly a year. (The S & P Case-Schiller Index, which only tracks 20 markets suggests prices have been increasing for 5 months running). The National Association of Realtors reported last monday that sales of previously occupied homes in October jumped 10.1% from September to a seasonally adjusted annual rate of 6.1 million, the highest level since February 2007. The number of home listed for sale nationally was 3.57 million at the end of October, down 3.7% from a month earlier. Much of the sales activity was driven by buyers who rushed to claim the first-time home buyer’s tax credit before it was to expire on November 30th of this year. The number of homes for sale in September was 3.63 million, down 15% from a year earlier.

Mortgage rates have been at historically low levels. Mortgage backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae rose to their highest level of the year last week buoyed by strong investor demand. Risk premiums on the bonds, which measure their yield (moving inversely to the price), fell as low as 1.24 perceentage points above the yields of comparable Treasuries last Wednesday. The previous narrowest level was 1.29 in May. These dynamics have created an average rate on 30-year fixed rate mortgages at only 4.78%, which matches a record low from April. That rate was down from 4.83 the previous week and 5.97% a year ago.

If we look at the housing market dynamics more closely, however, it appears there is a good chance that government intervention may be creating a bubble of its own, artificially and unsustainably propping the market up.

Consider this: The average single family home price in the United States is $178,000. Most mortgages made today are guaranteed by the Federal Housing Administration which requires only a 3.5% downpayment (less in several circumstances) which is $6,230. With the $8,000 first-time home buyer’s tax credit, the government (the taxpayer) is paying people to buy houses (It has been estimated that 80% of the purchases that occurred using the credit would have occurred anyway so the “real cost” of the economic incentive to create a sale is $40,000, not $8,000). Buyers are utilizing artificially low interest rates as the Fed is buying a significant percentage of offered Treasuries to keep rates down. Without this quantitative easing, mortgage rates would be much higher. The Fed is also buying much of the residential mortgage-backed securities that are being sold. Between Fannie, Freddie and the FHA, the government( the taxpayer) presently guarantees 92% of all home mortgages in the country. To top it off, the government (the taxpayer) is also purchasing a substantial amount of these very mortgages that we, um – I mean the government, guarantees.  Does this sound vaguely familiar to you? Isn’t this type of shell game that got us into this mess in the first place?

We must not forget that the catalyst for most of the stress in the housing market was government policy aimed at increasing the homeownership rate through lowering mortgage lending standards. These policies began in 1977 with the Community Reinvestment Act (CRA) which targeted banks and encouraged them to increase lending in low- and moderate-income communities. From 1977 to 1991, $9 billion in CRA lending committments had been announced.

In 1992, congress passed the Federal Housing Enterprises Financial Safety and Soundness Act, also known as the GSE Act (ironically, the name sounds so benign). The objective here was to force Fannie and Freddie to purchase loans that had been made by banks; loans that were made as part of the CRA. The GSEs had to do this to comply with the law’s “affordable housing” requirements. Since then, Fannie and Freddie have purchased over $6 trillion of these mortgages. The goal of community groups, of forcing Fannie and Freddie to loosen their underwriting standards in order to facilitate the purchase of loans made under the CRA, was achieved. Congress inserted language into the law encouraging the GSEs to accept downpayments as low as 5% or less, ignore impaired credit if the blotch was more than a year old, and otherwise loosen their lending guidelines.

The result of these loosened credit standards, and a mandate to make “affordable-housing” loans, created a massive pool of high risk lending that ultimately drowned the GSEs, overwhelmed the housing finance system, and caused an expected $1 trillion in mortgage loan losses by the GSEs, banks, and other investors and guarantors. Most tragically, there is an expectation that, at the end of this cycle, the U.S. will have seen 10 million or more home  foreclosures.

The refundable tax credit, available even if a family has no taxable income, will enable many more purchasers to buy a home, even if they are not qualified. But it could also bankrupt the FHA and, by doing so, would damage an already weak housing market.

This credit was initially available only to first-time buyers with a combined income of $150,000 or less ($75,000 for individuals). In 2009, about 40% of all first time buyers used the credit, so extending it was strongly supported by residential real estate brokers, home builders and their congressional allies. The recently passed extension (until April of 2010) makes the credit available, not only to first time buyers but, also to those who have owned a home for at least five years. In addition, it raises the maximum income for a qualified buyer to $225,000.

The first-time home buyers tax credit is expected to cost the Treasury about $15 billion in 2009, more than twice the projected cost when Congress approved the stimulus package (is it really hard to believe that the government could underestimate the cost of the programs it implements? – watch out healtcare reform!).

The problem here is that, as we discussed above, the FHA insures mortgages with such low downpayments that it can be funded completely by the refundable tax credit. Owners who don’t invest their own money into a house are much more likely to default on the mortgage. The FHA is already looking at a number of serious problems. Two weeks ago, the agency reported that its cash reserves, which are federally mandated to be no lower than 2% (down from 3% last fall) of its portfolio, had dropped to 0.53%.

The deteriorating quality of the FHA’s mortgage portfolio is a critical challenge to the housing market and the federal budget. A recent government audit concluded that the FHA would run out of money in 2011 and need a federal bailout if a recovery is not swift.

Presently, the percentage of U.S. homeowners who owe more on their mortgages than their properties are worth swelled to about 25% according to a report in the Wall Street Journal. Moody’s.com pegs this percentage at nearly 33%. Either way, this dynamic threatens prospects for a sustained housing recovery. These so-called underwater mortgages present a roadblock to a housing recovery as these properties are more likely to fall into foreclosure and get placed on the market, adding to an already bloated supply.

Over 40% of borrowers who took out a mortgage in 2006, when home prices peaked, are under water. In some parts of the country, home prices have dropped so much that borrowers who purchased homes five years ago now have negative equity. Even recent bargain hunters have been hit as 11% of borrowers who took out mortgages in 2009 already owe more than their homes are worth. Borrowers with negative equity are more likely to default and, today, about 7.5 million households are 30 days or more behind on their mortgage payments or are in foreclosure.

This level of negative equity has some economists projecting that housing won’t really bottom out until 2011. There are additional factors that lead to their conclusions.

The home sale statistics that are presented by the NAR and Commerce Department exaggerate activity as they double count some sales. If a foreclosure occurs and the bank sells the property to an investor at an auction who subsequently resells the house to someone who intends to live there, that counts as two sales. Additionally, “seasonally adjusted” numbers also will exaggerate the real level of activity.

Moreover, most of the sales activity is taking place in the areas which have been hit the hardest such as California, Southern Florida, Arizona and Las Vegas where we see the highest level of distress and very cheap condos, co-ops and single family residences.

Home prices are measured in three different ways: 1) median income to median sales price, 2) the cost of owning versus the cost of renting, and 3) the total housing stock value as a percentage of GDP. If we consider these three different methods of measuring home prices and affordability, it is possible to conclude that home prices have another 10% – 15% to adjust before the market actually hits its natural bottom.

All of the government intervention has prevented the market from hitting its natural bottom. No one wants to see people displaced but artificially propping the market up only makes things take longer to correct and simply delays the inevitable. The American consumer has had a long-held taboo against walking away from their home, but this crisis seems to be eroding that.

The Fannie and Freddie bailouts have already cost us $112 billion (and counting). How much will the FHA bailout cost? If housing values don’t recover, or the FHA cannot outrun its problems, the government audit suggests that FHA could ask for $1.6 billion by 2012. judging from history, that is probably a low-ball estimate.

Congress probably doesnt mind, however, because these liabilities are technically off budget, until they aren’t. i certainly hope the housing market recovers quickly but there appear to be many hurdles to overcome before this can happen.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,000 properties in his career.

29 Responses to “Will the U.S. Housing Market Double Dip?”

  1. 1 jsawicki November 29, 2009 at 10:39 am

    That is a great write up. The first time home buyer credit is definitely creating its own little bubble that is giving the illusions of a recovering market. It will be interesting to see what happens in 2010, I’ve heard that a large batch of option ARMs will be readjusting upward at that point which should trigger another wave of foreclosures and short sales. I see so much negative news on the horizon that I think hoping for a recovery starting in 2011 is optimistic, I’m thinking 2013….

  2. 2 rknakal November 29, 2009 at 11:26 am

    Hi Jsawicki, Thank you for your post. Most bubbles are the result of well intended policies, the economic impact of which were miscalculated. Alan Greenspan keeping interest rates too low for too long was one policy and it appears that the government’s handling of the housing market is another one. Let’s hope it is not as much of a problem as the statistics indicate.

  3. 3 rknakal November 29, 2009 at 11:30 am

    Additionally, housing recovery is important based upon the impact that it has on the “wealth effect” of U.S. consumers. If homeowners feel like they have more equity in their homes, they are more likely to spend a little more.

  4. 4 Todd Roesler November 29, 2009 at 12:27 pm

    Great insight to current home sales, the truth and potentially what is looming.

    It seems to me the very people running the Treasury, SEC, HUD and many Federal agencies, all came from Wall Street and Banking. Knowing what happened in 2008, knowing what happened when we sold out America to NAFTA, 401K’s versus a Pension system, our current leaders in office are likely to fail as well. The very well educated “advisory committees” they all rely on are working for the very company’s who all thrive on greed.
    Many financial elements one can agree we made significant wealth, however it is all built on speculation and a house of cards. When will commercial fall to the same levels and porfolios adjusted? When stocks reflect the ability to write down to current values?

    Love your blog………

  5. 5 rknakal November 29, 2009 at 12:45 pm

    Hi Todd, thanks for your post. The commercial market has not been helped by government policy to the extent the residential market has been so the bottoms we are approaching will be a more real indication of an inflection point. Jobs are really the key to many of the nation’s problems. Jobs will allow consumers to regain confidence and get our economy moving again. 70% of our GDP is consumer driven and employment drives the consumer. With regard to stocks, the equity markets and bond markets are in violent disagreement, and at some point, this is going to be resolved by a sell off in the stock markets. We must not forget that, although we can print as much money as we like, at the end of the day you have to pay interest on your debt….

  6. 6 hummbumm November 30, 2009 at 9:55 am

    I believe the bulk of bubble in residential real estate cause by loan growth in explicitly non-conforming loans (those that do not qualify under GSE standards) Look at market share of GSE in 2005-2006. The $6T number you refer is the $ amount of conforming loans guaranteed, these have the best credit statistics of any residential loan group vs jumbo, sub prime, alt A etc…. and not on balance sheet assets at GSE. GSE purchased loans were about $800B each and included AAA tranches that were stupid purchases. however the affordable housing aspect of things was a bit player in the demise of GSEs and housing bubble.

  7. 7 Chris T November 30, 2009 at 4:46 pm


    Its interesting to hear your opinion on this matter as more and more investor advocates from different areas of investment seem to be reaching the same conclusion. In a recent blog Bill Gross of PIMCO states the following

    “The legitimate question of the day is, “Is a 0% funds rate creating the next financial bubble, and if so, will the Fed and other central banks raise rates proactively – even in the face of double-digit unemployment?”

    The Feds current policy is designed to artificially prop up asset prices to regain stability in our financial markets. With Armageddon no longer on the horizon (I hope), it seems the issue now is will the Fed’s policies create a future situation of deflation/inflation of hard assets, and if so, which will occur first? I don’t believe we can determine which will occur until markets are allowed to act out naturally free of artificial insemination.

    With interest rates at near zero (0%) the recent run up in the stock markets could be a direct result of speculation by investors accessing cheap capital, not to much different than before June 2007 with the then ease of access to capital. As you point out in your article a similar situation is occurring in the sale of homes with the use of negative down payments through the application of the housing tax credits, add to this inexpensive interest rates, and we have a similar situation pre June 2007. We have created a “New Normal” situation, a cocktail of financial combustion.

    Whether this combustion fizzes for our enjoyment or explodes in our face seems to be the question. If the future is a deflationary economy then we have created the potential for future loan defaults. If the future is inflationary then we will see all tides rise. Which future you see depends on whether you believe we will see a V recovery or a W recovery.

    Regardless of the type of recovery actually occurs, as a commercial real estate professional I can only hope our markets (real estate as well as others) are allowed to reach equilibrium on their own merits sooner rather than later. Our current and future earnings depend on it.


  8. 8 rknakal December 1, 2009 at 7:11 am

    Hi Hummbumm, Thanks for your post. I understand your position. The main point I was making is that there are too many artificial factors propping up the market and FHA is, essentially, a subprime lender today creating a significant chance of another bubble in housing caused by not allowing the market to hit its natural bottom.

  9. 9 rknakal December 1, 2009 at 7:14 am

    Hi Chris, thanks for your post and your well made points. Bill Gross is one of the smartest guys out there and I agree with his position. I believe our commercial markets will hit equilibrium sooner than the residential markets because of the relative lack of government intervention in our markets. A reversal in the trend in unemployment would go a long way towards getting us there.

  10. 10 wrc December 1, 2009 at 12:50 pm

    In response to jsawicki’s comment.

    I have a loan that was fixed for 5 years and has now rolled over to one that refixes every year.

    My new rate after it refixed is 3.25%.

    People are not defaulting because the rates have jumped; they are defaulting because the original underwriting was flawed due to loose underwriting standards, i.e. liar loans which allowed unqualified people to get these loans.

  11. 11 Carl Todd December 1, 2009 at 8:38 pm

    The home is occupied by the consumer. Our National economy is 2/3rds. consumer driven. If the consumer continues to afford to buy their homes it definitely is a positive sign of recovery.

    Well pointed out is how much of the current homes sales are stimulus based. My worry is the huge under and unemployment base.

    If employment turns positive and housing sales continues to increase It would certainly ease my concerns about a commercial RE bust beginning this time in 2010. To me the tenants in the non-trophy office buildings and non-national chains in the retail properties are critically dependent upon the local population’s ability to be able to pay for their services and merchandise.

    FDR expressed my most reliable economic indicator when he said: “The can be no prosperity until the man (person – today)has money in their pocket”, and that money can only be regularly put in their pockets from steady middle income jobs not one shot gimmicks that are usually followed by political sound bites tell us not to worry as what they just announced will solve all our financial problems.

  12. 12 Gabriella December 2, 2009 at 11:40 am

    Very true and very scary! So what can we hope for?

    First, these buyers purchased their homes at very discounted prices. Second, they can afford to service the debt.

    Otherwise, I don’t even what to think of the alternative.

    Good discussion anyway.


  13. 13 dgaines December 3, 2009 at 1:08 am

    Great column as always
    It is clear you and I are of the same mindset

  14. 14 rknakal December 3, 2009 at 7:43 am

    Hi Carl, thanks for the post. Its all about jobs. I completely agree.

  15. 15 rknakal December 3, 2009 at 7:44 am

    Hi Gabriella, thanks for your post. A natural bottom would be a good start to the recovery in housing.

  16. 16 rknakal December 3, 2009 at 7:45 am

    Hi David, thanks for the response. I hope things are moving well in Chicago!

  17. 17 Tim Gallen December 3, 2009 at 10:01 am

    Robert: While you are obviously one of the best real estate bloggers in the market right now, this latest missive is placing you on another level – which used to be called investigative reporting in the journalism business. That is a straight forward factual analysis of a situation sprinkled with facts to support your premiss. So, just a note to encourage you to keep this kind of clarity coming. Your industry needs you right now.

  18. 18 rknakal December 4, 2009 at 6:29 am

    Hi Tim, Thank you very much for your post. I truly appreciate your kind words. I believe it is important for all participants in our market to be aware of issues so that our perspective and concerns can be expressed to people who may be in a position to alter the direction when we are off course. Using elected officials as an example, too often, from the moment our legislators get elected, getting re-elected seems to be the main objective with disregard for what actually would be best for our cities, states and country. If any of the information provided on StreetWise helps, even in the smallest way, I would feel like I am contributing to our collective cause. Thanks again for your feedback.

  19. 19 David Bahr December 4, 2009 at 12:44 pm

    I strongly disagree on the reasoning for a possible double dip.

    The average credit score of an FHA loanee is actually increasing, the quality of their portfolio is improving. With no one lending, a lot of reputable customers, who wouldn’t have otherwise, walked in their doors…so to speak. They do have the high delinquency rate but that’s fraud. 100K+ loans of no payment or one single payment before defaulting. With no one lending, the shysters had to go somewhere, too.

    FHA can easily deal with defaults and other stuff. They are govt sponsored loan sharks. They don’t deal with accounting, just money in and out. Last year, they made money when all accounting based firms lost. They only count physical money and send money back to treasury over their regulatory requirements. If they expect a need for money, budget accounts for them.

    The exaggerated blow-up of the FHA is a last ditch effort to justify that armageddon may be upon us.

    As far as the premiums paid for GSE’s MBS’s, who else is initiating new rMBS’s? PLS’s showed clearly how they could be extremely abused and the model doesn’t work. There is no meaningful demand.

    With the coming of FAS rules 166/167, every issuer of MBS’s will be penalized since everything will remain on the books, even if the issuer no longer “owns” the security but merely guarantees it. This defeats the liquidity purpose of the secondary market.

    If banks are going to be forced to adopt the GSE’s model, they won’t be initiating any new PLS’s even when the economy does return. The days of passing 100% of the credit risk on down the line are over.


  20. 20 Cornelia Netter December 4, 2009 at 1:34 pm

    Today’s blog is the most accurate report of the events that one by one got us into the current housing mess. This disconcerting thing is Congress’s unwillness to accept responsiblity for the results of their meddling in the housing market. And they are still at it, allegedly “for our own good”.

    Thank you for your blog and keep up the good work! You are a voice for sanity in an insane world.

  21. 21 Brent December 5, 2009 at 12:21 pm

    Incomes are not rising and jobs are not coming back rapidly (if at all). These are the two dynamics that propel people into the housing market.

    The author makes a number of salient points, although one would never know about the extent of trouble based on official pronouncements from the organizations and media involved. Banks and financial institutions with toxic mortgages and foreclosed homes have a slower-than-molasses mentality about acknowledging their poor lending practices, responding to offers for the purchase of these properties, and generally dealing with business in an expedient way. Talk to anyone seeking to purchase a short sale or foreclosed property, along with the realtors who try to put the deals together, and one will quickly appreciate the banks who want government bailouts employ the most imperious practices in disposing of failed loans and the properties supposedly supporting those same loans.

    We don’t really know the extent of financial institution losses because the financial institutions will not make a full and fair accounting of current values, nor will they place properties on the market for fear of losing yet more money based on the current marketplace. Financial institutions, in league with the Federal government, employ accounting practices no honest business would ever consider. FASB has caved in to political demands and eased reporting requirements still further.

    With taxes rising precipitously to pay for profligate spending, bloated public pension expenses and defense costs in other countries who have no requirement to shoulder their own military expenses, we cannot hope for recovery for years, if ever.

    We cannot hope for recovery because our governments refuse to accurately report inflation, unemployment, underemployment and GDP numbers when they massage those statistics to satisfy their own perpetuation in office/power.

  22. 22 noel lange December 5, 2009 at 10:29 pm

    Bob, excellent recap of a topic I am very nervous about. I will bookmark your blog and make sure I read it regularly. This is one of the most well written blogs out there. Thanks for sharing your knowledge.

  23. 23 ben alkemade December 6, 2009 at 12:52 pm

    Bob, good insight and well thought out.
    I agree.
    This kind of government-interference gives a smokescreen
    and blurs market forces.
    Of course it is a very unpleasant situation for a lot of
    homeowners. On the other hand it was too long too nice to be true.There were ( early) warning-signs all over the place!
    But- as is common in business- everybody went to the same side
    of the ship.That’s what happened.
    The way back/up is through the jobs and than the housing market,as long as it takes. ben

  24. 24 rknakal December 6, 2009 at 10:51 pm

    Hi David, thanks for your post. You make some good points. Naturally, most loans remain good but even if 90% are performing, a 10% default rate is significant. FHA is implementing a shell game similar to what got us into this mess in the first place. Social benefits aside, it simply makes no sense to pay people to buy houses. Many of these buyers default without even making a single payment.

  25. 25 rknakal December 6, 2009 at 10:52 pm

    Hi Cornelia, thank you for your post. Your reputation preceeds you and I am honored by your remarks. I hope all is well with you.

  26. 26 rknakal December 6, 2009 at 10:54 pm

    Hi Brent, thank you for your post. You make some great points. Asking for unbaised reporting from the government, under any party, is wishful thinking.

  27. 27 rknakal December 6, 2009 at 10:54 pm

    Hi Noel, thanks for your post and your kind words.

  28. 28 rknakal December 6, 2009 at 10:56 pm

    Hi Ben, thanks for your post. Yes, clearly the answer is jobs, jobs, jobs. It is about time Washington is focused on them.

  29. 29 Bruce Valentia December 12, 2009 at 8:09 pm

    Bob, Thank you for the wealth of information you have provided!

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