1)  Housing Prices are still too high based on Income

When I hear people saying, “The housing market will come back. It’s capitalism.”  I agree with them completely. I guess, my questions are:  When and why? Prices don’t just rise and fall “because it’s capitalism.” One of the huge factors in determining prices is based on income.

Here is a really important chart that I have not referred yet to on this site.  In a recent article by mybudget360.com, the author shows that there is a historical ratio of household income to housing prices sustainable at 2.2 over the last 60 years.

1950:  7,354/ 3,319 = 2.2

1960: 11,900/ 5,620 = 2.1

1970: 17,000/ 9,867 = 1.7

1980: 47,200/ 21,023 = 2.3

1990: 79,100/ 35,353 = 2.2

2000: 119,600/50,732 = 2.4

2010: 170,500/50,221 = 3.3   HELLO?

Based on 2010 Census, in 2010 median household income is at $50,221 and the median price for a home is $170,500. (170,500 / 50,221  = 3.3.) If 60 years of data doesn’t lie, housing prices still have some adjusting to do. However, in all fairness, this doesn’t mean home prices have to go down.  Technically, income could shoot up 30% and home prices would be at a sustainable level. More realistically, we could encourage child labor to increase our household income levels or of course, polygamy is option as well.

2) Interest Rates HAVE to Go Up

Because it is mathematically impossible for Fed interest rates to get any lower, the real question is when are they going to rise? Interest rates are based on several macro-trends and it is a complicated question to answer.  However, there are some important things to consider when contemplating this question. The most important thing to understand is the Bernanke has hands on control of the Fed interest rates.  They have been kept at near zero levels as to provide liquidity to the depressed market.  However, not only is it not real working as well as we would have hoped it would, some suspect that soon the international market will dictate interest rates as other countries begin to face the music and fear inflation.

Other countries purchasing U.S. treasuries keep interest rates low.  Basically to purchase a U.S. treasury, is like a bet on the U.S. (Similar to purchasing a note on a house.) However, as debt to GDP increases, many countries will view the bet to be a more risky one. In fact, as debt to GDP approaches 100%, it is like purchasing a note on a house that is underwater.  Even for the global “Dollar-Standard” market, this risk will require a premium return on investment.  As in, interest rates must rise.

This chart shows the current state of our national debt comparatively to our historical trend.

Since the 08’ crash, both the Fed and the European Central Bank have held interest rates low.  However, now the ECB is beginning to believe that due to uptick in food and energy costs, it is necessary to increase interest rates to subdue inflationary trends.  They are set to being increasing rates in April of 2011.  However, the Fed is still holding out…but for how long? Bernanke has repeatedly stated that inflation is not a major concern and points to the CPI as proof of this theory.  As many of you know, this government-manipulated system is not an accurate tool for quantifying the rising cost of living that Americans are withstanding.  Eventually, the Fed will come around this understanding when other countries are refusing to purchase U.S. treasuries unless their return is higher.  As interest rates increase, as the mathematically MUST, liquidity in the market is going to tighten up, putting further pressure on the housing market.

3) Rising Gas Prices Cause Downward Pressure on Housing

According to the Department of Energy, Year-to-date regular prices have risen 54 cents and will shortly hit new highs.  Like my recent post suggested, California has the highest prices in the continental Unites States averaging $4.03. Hawaii is the nation’s highest price oil at $4.21.

Look how insane the upturn in energy costs has been according to the CPI since 2000.

I have already discussed the uncertainty in the real estate markets in commuter communities, where people use a larger portion of their paycheck to pay for their transportation.  Not only commuter communities suffer as oil continues its climb. As oil prices continue to increase, the amount of money homebuyers can use for monthly mortgage payments declines, putting downward pressure on prices.

The recent uptick in both the food and energy sectors is forcing people to allocate more money away from housing and is having a really poor effect on consumer sentiment.

4) Too Much Inventory and Shadow Inventory In The Pipeline

There is a historically high amount of inventory in the market, but the shadow inventory is a new issue itself.  Around 2.2 Million houses are currently in foreclosure, with another 6.9 million delinquent loans. It appears that banks are realizing that prices are not going to be bouncing back so they are starting to get rid of their backlogged inventory.

The National Association of Realtors reports that we have close to a 9 months supply.  This is historically high as the median supply is around 5 or 6 months under normal economic conditions.

This chart does not account for the large amount of shadow inventory that banks are not pushing through the foreclosure process. While it is hard to clearly project the amount of shadow inventory poised to hit the market, the amount of seriously delinquent loans gives us warning that there are many more foreclosures to come.

Source : Lender Processing Service

Loans that are 90+ days delinquent have less than a 1% cure rate, so these numbers are looking very grim for the housing “recovery.”

5) New Lending Will Require Higher Down Payments

Throughout the years, we have never had a national housing bubble and bust like the one we are experiencing right now.  This was because historically, down payments and loan underwriting were kept relatively similar throughout the national market.

Recently, I had a conversation with a full-time real estate investor that recalled being baffled by how easy it was for him to get loans to purchase buy-and-flip properties in the 05-06’ bubble.  He was self-employed and because most of his investments were cash flow properties, he barely showed any income. The bank was still excited to give him $250,000 loans on demand for flipping houses in this height of the bubble.

Even though this type of practice was common in the bubble years, the most important reason we have had this type of housing mania is the pathetically low down-payment requirements.  As many of you know, FHA requires a mere 3.5% down payment to purchase a home.  That is why it is not surprising that FHA loans are now starting to default at the same rate as the Sub-Prime mortgages.

Certain states have relied on FHA loans for housing prices because the income to price ratio is so ridiculous it would be the only way people would be able to purchase homes.  In fact, in 2007 nearly 40% of home buyers in California put NOTHING DOWN.

The thing is, everyone paying attention knows this…especially mortgage lenders.  Why did this happen? Let’s think about the timing… The repealing of Glass-Steagall in 1999, followed closely by the dot-com bust of 2000… Wall-Street money needed somewhere to go… all the sudden politicians believe that lower down payments are good for communities…you can put it together.

- Hunter Thompson

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