MARKET RECAP

As the economy sputters and putts along, many economists continue to look for signs the housing market is climbing out of the chasm dug by the subprime mortgage meltdown. Given the sentiment from homebuilders, some may say the housing market is finally making progress on scaling the chasm's often-slippery walls.

On that front, the National Association of Home Builders/Wells Fargo Housing Market Index rose by two points (to 16) in May, reflecting greater confidence in the newly built residential housing market. The fact that the May index continued to tick up from April’s five-point increase provides confirming evidence that the improved confidence level was no fluke.

Despite growing optimism in the new-home market, many economists remain less sanguine on the prospect of an overall housing-market recovery, given that the number of new housing starts declined 12.8% last month to a seasonally adjusted annual rate of 458,000 units, the lowest pace on records dating back 50 years. But it is worth noting that much of the decline was concentrated in apartment construction, which tumbled 46.1%. On a brighter note, single-family home construction actually climbed 2.8%.

Mortgage-market trends, on the other hand, offer a promising, tangible sign that a sustained recovery is possible. The Mortgage Bankers Association’s index of purchase applications, though falling slightly last week, continues along a higher long-term trend, thanks to investors and home buyers taking advantage of lower home prices and stable, historically low mortgage rates. On the latter, the 30-year fixed-rate mortgage remains near record lows reached at the end of March.

Not to repeat ourselves on one theme too often, but mortgage rates are unlikely to go significantly lower. Many of the government's recent economic stimulus initiatives have increased the odds of more inflation down the road. And that's not just us talking: Federal Reserve Bank of Philadelphia President Charles Plosser said prices may rise 2.5% in 2011, a rate well above central bankers’ preferred range, and cautioned against complacency on inflation – another reason we remain convinced that there is no time better than the present for getting a mortgage or for buying a home.

There has been no shortage of media coverage on the foreclosure market over the past six months. In fact, the foreclosure market seems to be the only growth market left in the country, if you listen to some accounts. The bad news is that foreclosure activity is up 32% from last year, with one in every 374 US housing units receiving a foreclosure filing in April, the highest rate yet seen by RealtyTrac, which has tracked activity since January 2005.

The good news is that demand for these homes is growing. Indeed, Housingwire.com ran an article that basically stated foreclosed homes are becoming the “hot-ticket” item in real estate. In a survey by Trulia.com and RealtyTrac, 55% of survey participants indicate they are at least somewhat likely to consider purchasing a foreclosed home in the near future, compared to the 47% who said the same in November 2008.

MARKET RECAP

There was a lot of teeth-gnashing in the media last week when news hit that April foreclosures broached a new record, with 342,000 homes receiving notices of default, auction notices or bank repossessions. RealtyTrac, an online marketer of foreclosed properties, exacerbated matters by reporting that one in every 274 homes received a foreclosure filing during the month, the highest in the company's rather scant four-years of record keeping.

The media also pounced hard on the news that the national median home price fell to $169,000 in the first quarter of 2009, due to a market flooded with lower-priced foreclosures and short sales. The punditry then began to lament that the loss of home values puts more mortgage borrowers underwater, which, in turn, could increase foreclosure rates in two ways: Underwater borrowers have no home equity to draw on should they need to pay for unexpected expenses, which makes them more likely to miss mortgage payments; and when home values fall far below mortgage balances, homeowners sometimes walk away from their loans.

We feel it's our duty to provide a little perspective. Yes, a large unexpected bill can strain family finances and the ability to service mortgage debt. But the question that needs to be asked is, how large is the expense and how often do these large expenses occur? The answer is not as often as we are lead to believe. We also feel obligated to challenge the notion that underwater borrowers walk away from their loans. Some do, but most don't. If people are working and the monthly payment is manageable, they will keep paying, even if they are underwater. Walking away has its consequences, not the least of which is making it highly unlikely the defaulted borrower can get a refinance or purchase mortgage when the economy recovers. People realize that, so they are less cavalier about throwing away their future than we are lead to believe by the media.

It's also worth noting how concentrated the foreclosure “problem” is: Ten states accounted for 75% of all foreclosure activity, and they fell generally into two categories: one-time bubble markets and the rust belt. California , not surprisingly, outpaced the competition, but even California 's foreclosure boom was confined mostly to its northern regions. Other hard-hit former boom states included Florida , Nevada , and Arizona . The rust belts states with the most filings included Illinois , Ohio and Michigan . Georgia , Texas and Virginia rounded out the top 10. And let's remember, the pick-up in foreclosures is also due to more banks accelerating the process to clear the dead wood, and that's a good thing.

Another good thing is buyers will be allowed to use their first-time homeowner tax credits as down payments when they get FHA-insured loans. Depending on the buyer's tax-filing status and the price of the home, the tax credit can be as much as $8,000.

Federal Reserve Chairman Ben Bernanke has forecast an end to the US recession, which he believes will be kaput before 2010. Bernanke also told the Congressional Joint Economic Committee that the collapse in the housing market, which began three years ago, may have bottomed out, something we've been saying for the past month.

Forecasts, especially about the future, can easily go astray, so we don't want to put too much faith in the Fed chairman's prognostication. But many signs are appearing to suggest the recession won't go much deeper. The latest comes from Mr. Bernanke himself, who said last week that “early indications” show that investor demand for the central bank’s loans to buy asset-backed securities, including mortgage-backed securities, will rise next month from May’s total, suggesting confidence in so-called toxic mortgage securities is growing.

The banks are another sign all might be well. They have been loosening their purse strings of late. Mortgages are more readily available, and so is consumer credit. This tells us that the banks' balance sheets are improving, as has their outlook for the future. Our outlook, meanwhile, has already improved.

MARKET RECAP

Recoveries are often imperceptible in their earliest stages, which has us wondering about the status of the housing-market recovery. It seems to be one that's no longer imperceptible. In fact, the prices of residential properties listed for sale rose in 22 of 26 major markets during April, with prices in 18 markets posting three months of sequential listing price increases, according to a report published by Altos Research and Real IQ,

Meanwhile, pending home sales offer hope that the sales pace will continue to accelerate through the summer months. The National Association of Realtors’ pending home sales index, a forward-looking indicator based on contracts signed in March, increased 3.2% in March, posting its own three-month sequential increase.

The one notable piece of negative housing news is the number of borrowers who are underwater on their mortgages, which climbed to 20.4 million at the end of the first quarter of 2009, according to Zillow.com, an on-line real estate information company. Thomas Lawler, an independent housing economist, stated the obvious by noting that borrowers who owe 30% or more than their homes are worth are more likely to walk away than those who owe just 5% or 10% more. It's also worth noting that the borrowers who owe 30% or more are still a relatively small percent of mortgages outstanding, and most are concentrated in Las Vegas , sections of North California, sections of Florida, and Phoenix .

The employment situation could also be viewed as a potential negative. Payrolls fell by 539,000 in April, while the jobless rate jumped to 8.9 percent, the highest since September 1983. But the fact that employers cut fewer jobs in April compared to March is viewed as a sign that the worst of the recession has passed. Granted, many economists still expect the unemployment rate to rise to 9.5% by year's end, but that suggests the rate of increase is abating

Speaking of rate of increase, mortgage rates – relatively stable for the past month – are creeping higher, which should be expected given that yields on Treasury securities have been rising at an increasing rate over the past two weeks. In fact, the 10-year Treasury note – a benchmark for the 30-year fixed-rate mortgage – jumped over half a percentage point last week, posting one of its biggest increases in months. We've been beating the drum over the past month to lock in mortgage rates ASAP. Now we are beating that drum even harder.

It's official: Our financial system isn't going to collapse after all. I think we all knew that, but the Federal Reserve went out of its way to prove everything was okay by “stress testing” the banks. The Fed's test measured bank reserves based on what's known as common equity, the value of a company's common stock and profits. The test revealed that some of the banks have sufficient reserves by traditional measures, which include other credit-related assets, but fall short by this narrower standard. The bottom line is the nation's biggest banks are regaining their health, which should translate into a greater willingness to lend.

The stress test was a part of the Obama administration's plan to fortify the financial system. As home prices fell and foreclosures increased, banks took huge hits on mortgages and mortgage-related securities they were holding. The stress test has been criticized as a confidence-building exercise whose rosy outcome was inevitable. But the information, which leaked out all week, was enough to provide a much-needed dose of market confidence.

MARKET RECAP

Sometimes bad news isn't as bad as it seems. For instance, gross domestic product dropped at a 6.1% annual pace in the first quarter of 2009, easily blowing past predictions for a 5% annualized drop. The decrease marked the weakest posting since 1958. Bad news, right?

Not so fast. It's tempting to cite the grim first-quarter GDP decline to squelch talk of any recovery in the U.S. economy, but the numbers actually contain flickers of hope. Nearly half of the GDP contraction was due to businesses slashing production in order to bring inventories in line with sales. The process, although perhaps incomplete, is well advanced, which means businesses may soon have production levels where they want them. That, in turn, could set the stage for increased business spending in the second half of the year as consumer demand increases.

In fact, consumer demand is already picking up. The monthly data on home, car, and retail sales confirm that consumption has broadly stabilized. Although home construction has tumbled, the worst is probably over: in any case, the sector is now so small that further declines mean little to overall output. The recent rise in stocks prices – arguably the most reliable economic indicator – and in consumer confidence also bodes well for businesses and consumers alike

More good news can be found in seemingly bad news on the housing front. Home prices continued to decline in 20 major U.S. cities in February, according to the S&P/Case-Shiller Home Price Index, but the rate of decrease slowed for the first time since 2007. Average prices are now down 30.7% from the housing market's mid-2006 peak. Phoenix has fallen the furthest, dropping 50.8% from its high, while Dallas has been one of the better performers, slipping a relatively modest 11.1% from its peak. Odds at this juncture favor long-term home-price appreciation over long-term depreciation.

Meanwhile, mortgage rates continue to hold steady, with 30-year fixed-rate mortgages still available in the 5% range. But again, we need to warn that rates could be approaching a low, if they haven't already reached one. Treasury yields are starting to rise, a sign of a strengthening economy and a sign that inflation could be lurking on the horizon. At this point, we think holding out for lower mortgage rates is becoming a riskier bet.

Averages are an intricate part of data aggregation and dissemination. We reference averages, such as national average mortgage rates or average existing new or existing home prices, in the newsletter. These averages are useful, because they project a large macroeconomic picture quickly.

But averages can also misinform. Picture a room with Bill Gates, Warren Buffett, and eight other people, each of whom earn $100,000 annually. If a statistician were to average the annual incomes of the 10 inhabitants, the average annual income would be several million dollars a year, even though eight of the 10 inhabitants make nowhere near that amount. It would be impossible to implement a successful sales strategy based on that average income. In other words, averages can be irrelevant.

Such is often the case with real estate. We noted that home prices in Phoenix tumbled an average of 51% from 2006 highs, while Dallas prices tumbled an average of 11%. Average these two numbers and you get an average decline of 31%, which makes the Phoenix market look more robust than it is and the Dallas market less robust. What's more, that average is even more misleading because it is based on an average of an average.

Point is, don't let national averages influence your opinion of the economy too much. Most business is local, and what's happening in one part of the country can be completely different from what is happening in another part of the country. What's happening in your part of the country is what's most relevant.

MARKET RECAP

Change is fickle: Sometimes it comes gradually, other times it comes instantaneously. One thing is for certain; change will come eventually because trends can’t last forever. With that prelude in mind, change is occurring in the housing market, and the good news is it’s the kind of change we can all believe in.

To wit: sales of existing homes stayed near a four-month average in March while prices rose from February’s levels, a sign the housing recession has at least abated if not improved. While recent numbers from the National Association of Realtors showed sales fell slightly more than forecast to an annual rate of 4.57 million, economists noted that the sales level is hovering near the level it reached in November. What’s more, prices for home resales posted their biggest monthly gains since June 2005, according to NAR economist Lawrence Yun.

Meanwhile, purchases of new homes were higher than expected in March, posting at an annual pace of 356,000, with inventories of unsold homes falling to a seven-year low. Federal Reserve efforts to bring mortgage rates down combined with tax credits for first-time buyers are expected to continue supporting new-home sales in coming months. Homebuilder confidence is another positive, having risen from a record low in January to a six-month high in April.

Low mortgage rates continue to aid recovery efforts, but for how long? Keep in mind, change will occur in this market as well. We’ve been saying for the past month that additional rate drops will be hard to come by, and that appears to be the case: Bankrate’s national survey has shown rates leveling, if not rising, in many markets. The Federal Reserve has exerted great effort to keep the benchmark 30-year fixed-rate mortgage under 5.5 percent. It can’t keep exerting great effort in perpetuity.

The Wall Street Journal reported last week that falling home prices are starting to ignite bidding wars in some areas of the country, noting several real estate brokers who say multiple offers have become more common in parts of California, Arizona, Washington, D.C. and the Minneapolis-St. Paul metropolitan areas. The Journal even reports that some markets are running into shortages of moderately priced homes in middle-class neighborhoods.

A tighter housing market seems plausible, given that the Federal Housing Finance Agency reported that home prices nationwide rose a seasonally adjusted 0.7 percent in February from January. In short, all signs are signaling that the worst has ended and that a recovery is near, if it isn’t already occurring. Many housing economists remain cautious though, believing the market will gradually recover over the next year or two, with some parts of the country stabilizing before others.

But economists are often wrong. Recoveries, or deteriorations for that matter, almost never occur at the smooth, even pace economists predict. More often, recoveries move swiftly, and before you know it sellers are getting 10 percent more for their homes this month than the month before. It’s still a buyer’s market today, but today becomes yesterday a lot sooner than most people perceive. That’s something to consider for any buyers sitting on the fence.