April 9, 2008 (Housing Market Monitor)

Housing Market Monitor

Pending Home Sales Resume Downward Path

April 9, 2008

By Dean Baker

"Economists who could not recognize the housing bubble now insist that house prices are too low."

After showing a modest increase in January, the National Association of Realtors’ Pending Home Sales Index fell by 1.9 percent in February, hitting its lowest level in the current housing slump. The pending sales index, which measures contracts signed in the month, is down 21.4 percent from its year ago level and 32.0 percent from its 2005 average. The decline in contracts is less than the decline in sales, since many signed contracts now fall through because buyers can’t arrange financing.

There is an interesting regional pattern in the pending home sale index. While the other three regions show pending home sales that are at or near their cyclical lows (actually record lows – it is a new index), pending home sales in the West have bounced back by almost 20 percent from their low-point in August.

There are two factors that could partially explain this bounce. First, the decline in the summer was likely overstated somewhat. Pending sales had taken a big jump in the West in June, this probably meant that some contracts that would have otherwise been recorded in the surrounding months were instead reported in June. The other factor is that many more current contracts may not be ending in sales due to financing problems.

This view is consistent with the continuing decline in existing home sales over this period. Existing home sales are down by just under 10 percent in the West since August. If contracts are up, but sales continue to fall, then the contracts are presumably not going through. The tighter credit standards put in place by many banks likely explain this growing gap.

All signs indicate that the housing market will weaken further in the months ahead. The March jobs data means both a decline in employment and, more importantly, greater concern over job security. Many potential homebuyers who were not excluded from the market due to credit issues may now be excluded from the market as a result of fears over job loss.

On the policy front, debate has taken a bizarre turn in recent weeks. The stated goal of many of the proposals being circulated is to keep housing prices up.

This is perverse from a number of angles. First, it implies that high house prices are in some way desirable for society. Of course, if you have a lot of money invested in real estate, high house prices are good news, but there is another term for high house prices “unaffordable.” Why as a matter of public policy would we want to price young families out of the housing market? We used to try to do the opposite.

Of course, Congress is not really going to be able to prop up the housing bubble. A housing price support program that seeks to prop up a bubble will face all the problems of an agricultural price support program that seeks to maintain above market crop prices, except the market is much larger. The sums being debated in Congress, $300 billion to $400 billion in loan guarantees, cannot have much impact on a $20 trillion market. At best such programs can slow the process adjustment.

Every week that we keep the bubble from deflating we get tens of thousands of people to buy homes at bubble inflated prices, leading them to incur large losses when they sell. Perpetuating the bubble also causes more people to overestimate the equity they have in their home and therefore avoid making the necessary saving decisions for retirement. In short, propping up a bubble is really awful policy.

It is especially perverse that so many economists, who could not be bothered to look at the disconnect between housing prices and underlying fundamentals as the bubble was sending prices to record heights, are now so anxious to tell the public that house prices are falling too low. How are the same economists who insisted that they could not see a bubble (too high house prices), experts when it comes to recognizing house prices that are too low? 

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. (www.cepr.net). CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.

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