Real Estate Problem

A few weeks ago, the Fed chairman appeared before Congress and essentially testified to the following:

• The economic growth is slowing
• Inflation remains the primary concern of the Federal Reserve

Never mind the Bush’s most recent assessment of the “thriving” economy. His speechwriters must have forgotten to cross check the alleged information with Bernanke’s testimony given less than four weeks ago.

Well, I sidetracked a little.

So why does Mr. Bernanke hesitate to admit the fact that the economy appears to be headed into the phase of stagflation, if it hasn’t already? Is he out of touch with reality? Does he believe that the Central Bank’s monetary policy will be able to curb the stagflation? Does it have a chance? My guess is yes. And I am guessing at the cost of inflation.

Why?

Because it is particularly difficult to curb stagflation in today’s unbalanced world economy. If stagflation continues to grow in the U.S., the U.S.’s already heavily-indebted consumers will have to cut back on their spending, which, in turn, will force the rest of the world to start spending more to keep the world economy growing. There is no chance of that happening. The Fed will be too worried about stagnation to let that happen and the central banks of other countries will be too concerned about inflation in their economies to cut rates. See The Economist, May 5, 2005. Hence, many experts bet on rate cuts starting as early as at the end of this year.

But before then…

To stay liquid and to survive the credit crunch as well as the uncertainty that lies in the months ahead, the Wall Street has virtually stopped buying mortgage-backed securities in the secondary markets. As a result, the cost of financing a home purchase in many high-valued areas of the country such as California became even more expensive. This puts many potential home buyers, who require non-conforming jumbo loans, out of the market. The implications of this could put a further dent on the already-declining housing market: home values are falling at accelerating rates; mortgages, both subprime and now even prime are defaulting by rates not seen in many decades; foreclosed homes are popping up everywhere like mushrooms.

The housing market is in pain. And the worse is yet to come since current real estate and broad financial conditions point to more trouble in the months ahead. However, real estate has been regarded as one of the best hedges against inflation; therefore, my bets are on the market rebounding by mid 2008, after the Fed starts cutting rates to curb stagnation.

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629 homes had ownership transfer in May in the San Fernando Valley region of Los Angeles, CA, 26.5 percent less than during the same period a year ago, but up 15.4 percent from the total amount reported for the month of April. Condo sales droped 37.5 percent compared to a year ago. However, Condo sales rose 15.7 percent compared to April. It looks like the San Fernando Valley residential real estate market is gaining momentum. Source: SRAR

Despite the Southern California real estate market weekness, San Fernando Valley real estate market remains strong. “Reflecting ongoing demand for housing and confidence in the local economy, the median price of single-family homes hit a record high during May 2007 even as home sales continued to soften throughout the region,” reported the Southland Regional Association of Realtors.

Mortgage rates gained considerably this week, virtually eliminating the rate declines of the proceeding three weeks, reported Freddie Mac today.

Freddie Mac said the average rate on a 30-year fixed-rate loan rose to 6.73 percent for the week ending July 12, from 6.63 percent the previous week.

Last year at this time, 30-year mortgage rates averaged 6.74 percent.

The mortgage rate increases this week were caused by a favorable job report for June and robust consumer credit growth for May.

Accordingly, both the National Association of Realtors and the Mortgage Bankers Association were necessitated to re-assess their previous forecasts of home price recovery in mid-2007 and now are looking to early 2008.

A real estate related article featured by Realty Counselors Inc. indicates that even though home prices adjusted to a more logical activity level with a modest decline, home sales activity in the San Fernando Valley came in stronger than expected for the first quarter of 2007. The data was obtained from the Southland Regional Association of Realtors. The article can be found here: Los Angeles Real Estate Market Snopshot.

As I was browing the net, I came across a Press Release entitled “California’s Real Estate Crisis Will Be Worse Than Most Analysts Realize, With Home Prices Falling 15 To 30 Percent During The Next 36 To 42 Months” released by The Norris Group.

I simply could not ignore and had to discuss it.


Here you have a two and a half page press release advancing an argument that is supported by two variables: builders writing off option agreements and the low affordability level in California. While I can neither dispute nor support the so-called forecast, it would be more credible if Mr. Norris would support it by other relevant data. A contention of this magnitude must set a proper strong foundation so that it may be given the deference it claims it deserves.

California is not the only real estate market that has seen enormous gains during the past years. Better yet, the U.S. is not alone in sharing the most recent substantial real estate market growth. The latest real estate boom is, in most part, the end result of a combination of various political and economic changes that the world had not seen before, including globalization, weakening dollar, introduction of euro, speedy growth of other economies of the world, inflationary pressures, population growth, etc.. Not too mention that the pre-boom California real estate market was significantly undervalued.

If the forecast of Mr. Norris holds to be accurate, it will not just be true for California.

While I cannot rule out the possibility of declining home prices in California, it will not be in the double digits, as indicated in the forecast of Mr. Norris.

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According to a report issued by the National Association of Realtors , despite a luck of home buyer confidence and continous tighter lending standards, home sales should remain stable in the months ahead. NAR’s Pending Home Sales Index (PHSI), a forward-looking indicator that gauges home sales activity for upcoming months, declined for the third consecutive month in May, down 13.3 percent from a year ago to a reading of 97.9. A PHSI of 100 is equal to the average contract level in the year 2001, which was the first of five consecutive years of record home sales.

The California Building Industry Association (CBIA) also anticipates a stabilizing housing market through the remainder of the year, as indicated in a recent report.

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