Housing's Woes Will Linger and Cost Us More

04/15/2010 11:07 am EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of INSIGHT, says the housing market has structural weaknesses that will keep prices down and frustrate any proposed solutions for Fannie and Freddie.

House prices have risen a bit in recent months, but probably because of the $8,000 tax credit for new home buyers that is scheduled to expire in April.

More importantly, the $47-billion federal Home Affordability Modification Program has forced a widespread moratorium on foreclosures while mortgage modifications are considered, even though delinquencies have leaped.

As the modification attempts play out, many mortgages will be foreclosed and houses dumped on a market already overburdened with excess inventory. Estimates are that five million of the 7.7 million delinquent residential mortgages will be foreclosed in the next few years.

The inventory of new and existing houses listed for sale has run a fairly steady 2.5 million. That number leaped to almost five million in 2007 and still is 3.8 million, suggesting there are 1.3 million in house inventories over and above normal working levels.

But wait! There’s more! There are 992,000 housing units that were built between the peak in the first quarter of 2006 and the fourth quarter of 2009, but can’t be accounted for by those listed for rent or sale. This hidden inventory number, almost one million, is in addition to those that will be foreclosed and sold as mortgage modification attempts are abandoned.

As noted earlier, excess inventories are the mortal enemy of prices, and we expect house prices to fall another 10%, bringing them to the 35% to 40% peak-to-trough decline we forecast back in 2008. At that point, we said, about half the homeowners with mortgages would be under water with their mortgages exceeding their houses’ values.

Under water houses mean that the biggest asset for most Americans, their home equity, has disappeared. So, they consume less as they attempt to recoup their losses by saving more. Furthermore, the previous stampede into homeownership is being reversed as foreclosures mount and falling prices discourage home ownership.

Fannie Mae and Freddie Mac are in dreadful financial shape, but they are convenient vehicles in Washington’s attempt to at least stabilize housing.

Some, predictably the National Association of Realtors, want these GSEs to be permanent wards of the state, converted to federally owned nonprofit corporations. At the other end of the spectrum are calls for the demise of Fannie and Freddie, with the government playing no role in supporting “affordable” housing or guaranteeing residential mortgages.

Regardless of the final destinies of Fannie and Freddie, they will no doubt continue to be used by Washington to bail out troubled homeowners.

Regardless of earlier inept regulation, imprudent private lenders, and home buyers who believed in free lunch, home ownership is too politically sensitive to allow free markets to correct the present imbalances. So, the workout process may drag on for years and ultimately cost the taxpayers close to $1 trillion.

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