May 13, 2009 (Housing Market Monitor)

Still No Green Shoots in Housing

By Dean Baker

May 13, 2009

Record rates of foreclosure ensure that rapid house price declines continue.

There continues to be no sign of any turning in the housing market. The Mortgage Bankers Association’s Purchase Mortgage Applications Index remains near its low for this downturn, suggesting no uptick whatsoever in demand.

The Refinance Index fell sharply for the third consecutive week, indicating that the refinancing boom is over. Households will still see some boost in their discretionary income as mortgages that they applied for 3-4 weeks ago come through, but the incremental lift will dwindle quickly. Also, the fees and jobs generated by the refinancing process will be lost. While the Fed presumably intends to keep interest rates near their current level, there will not be another burst of refinancing unless it pushes interest rates to near 4.0 percent.

While there is no evidence of any uptick on the demand side of the market, it looks like the supply of houses on the market will continue to be boosted by a large number of foreclosed properties. The April foreclosure data showed a further rise from March’s record level.

Foreclosure activity had slowed somewhat in January and February, largely due to moratoriums put in place by many of the major lenders. The jump in foreclosures in March could have been a one-time increase as banks sought to work through a backlog, but the even higher April numbers suggest that we are likely on a still higher trend.

There were 342,000 foreclosure notices issued in April, a rate of more than 4 million a year. At an average of 2 notices per home, this rate implies that more than 2 million foreclosed homes will be coming onto the market over the next year. This is more than 40 percent of the current sales rate for new and existing homes.

There continues to be huge differences in foreclosure rates across states, with Nevada, Florida, and California leading the country in rates of foreclosure. In Florida and California, the rates of foreclosure are 1 in every 135 and 1 in every 138 households, respectively. In Nevada, the rate is an incredible 1 in every 68 households. These extraordinary rates of foreclosure will guarantee substantial downward pressure on prices in these markets throughout 2009 and into 2010.

In Michigan and Ohio, foreclosure activity appears to be slowing. In Michigan the April rate was 12.8 percent below the March level and 11.8 percent below the year ago level. In Ohio the April rate was 2.3 percent below the March level and 4.3 percent below the year ago level. However, this falloff may not indicate an improvement in the market – it could just mean that banks see little profit in carrying through foreclosures in a market that is already glutted with unwanted properties.

Freddie Mac reported losing another $10 billion in the first quarter, bringing the total cost of its bailout thus far to $51 billion. Its losses will undoubtedly climb much higher, both because of the bad mortgages that it still has on its books and also due to the fact that it continues to purchase mortgages on which it is likely to make large losses.

Just as they did throughout the run-up phase of the bubble, Fannie and Freddie continue to buy mortgages on homes that were purchased at bubble-inflated prices. When these prices deflate to trend levels, many of these mortgages will go underwater, creating a very high risk of default.

As has been noted in the past, this problem could be easily avoided by using appraisals that are based on rental prices rather than sale prices. Since rents never diverged far from trend levels, if the home’s underlying value was treated as a multiple of the appraised rent (e.g. 15 times annual rent), it would have been easy to avoid acquiring mortgages that were especially likely to go underwater.

Fannie and Freddie’s failure to adopt rent-based appraisals was an important factor in allowing the bubble to expand to such dangerous levels. Their continued willingness to buy mortgages on homes bought at bubble-inflated prices will add tens of billions more to the cost of their bailouts.

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