U.S. Housing: Drop Bounce but Bottom Still Not Reached, No Recovery Until It Does

Doom Boom & Gloom Marc Faber recently pronounced that if you want to buy a house in USA; or (presumably) also figure out a way to not walk away from the one you got, this is an OK time.

…if you can find a house you like, it may not be a bad time to buy a house in the U.S. It may not go up in value, but it may preserve its value.

That’s pretty much in line with the "BubbleomiX" view, he said 10% to go, and that said 15%.

Of course the longer the market is "supported" by the recently nationalized State Housing Bank [formerly known as Freddie (FMCC.OB) and Fannie (FNMA.OB)], plus the handouts of money borrowed by the Treasury from the Fed to pay people to buy houses, the longer the pain can be drawn out.

It's starting to look like the "splat" part of the cycle may go on for some time, and that the efforts of all concerned may prevent any "serious" declines from here on in.

Here is the S&P Case-Shiller 20 City Index with the MIT National Apartment Index, to tell the story.

(Click to enlarge)

Interesting the MIT apartment index has a "painful" bottom, but it bounced; perhaps that had something to do with the way multi-family residential homes are financed, and the fact that the "heavy lifting" of the improvised financial rescue was not directed so much in that area (i.e. the not TBTF banks got hung out to dry).

I figure the bounce there is because people are moving out of owner-occupier houses into rentals, interesting also how prices tracked homes, but the bust came later. Home prices got "supported" and as such the efforts were clearly "successful" in that the alternative would have been the grey line.

Success in managing government meddling in markets is of course relative, if market clearing had been "allowed" house prices would be recovering now.

The way the "Home" part of the chart works, is as follows:

First, the "fundamental" line is an "opinion" (mine) on what International Valuation Standards calls "Other Than Market Value", i.e. it’s a valuation that estimates what the price "ought" to be if the market was not in disequilibrium.

The logic for that line is explained in an article I wrote mid-2008 which has two components. The first is it says an owner-occupied house generates "virtual" income and that income on average for the whole of America is equal to about 22% of Nominal GDP divided by the number of houses in America.

The second is that in reality the discount factor that you need to apply to that income stream to do an income capitalization valuation (i.e. as an alternative to a sales comparison), is a function of long-term interest rates, which is an "S" curve (pretty much linear in the middle).

The validation of that model is (a) plot the model against reality going back to 1920 and you end up with a 98% R-Squared, in other words the model explains (on average) 98% of changes in US prices from then to 2000 (the start of the current bubble).

As a check and for "calibration" (b) there is "Bubbleomics" which says that when there is a bubble, you can predict the bottom of the trough that follows the "pop" from the extent to which the market got out of equilibrium (i.e. above the "fundamental"), at the height of the bubble.

So for U.S. housing on my model, the peak was 1.4 x the fundamental, so the bottom of the trough "ought" to end up at the fundamental at that time, divided by 1.4.

Well it doesn’t - but that doesn't mean it's wrong, in that no one can predict what governments will do.

Turning that around, if you know the value of the top of the peak and the bottom of the trough, and the fundamental doesn’t change much over that period, then you can figure the point at which the price crosses the fundamental from the square root of the "peak" multiplied by the "trough", that’s the red circle calculated assuming that the bottom was in Q-1 2009 and that gets you to the grey line.

Which line is right?

The thing is that once the market started to collapse, the "government" (in the broadest sense of that word) did everything it could to hold back King Canute’s tide, by providing:

• TARP and TALF to allow debt collateralized by U.S. housing to be put into cold-storage.
• Ditto nationalization of Fannie & Freddie to allow them to "trade insolvent".
• Forbearance to do the same thing, helped along by the suspension of "mark-to-market" accounting.
• (More) subsidies for people to buy houses (as if the subsidy delivered via cheap mortgages thanks to Fannie & Freddie over the past ten years was not enough).

The good news is that it looks like the "pain-relief" was very effective, if you don’t mind the huge amount of (extra) debt that was piled on so as to forestall the inevitable.

According to me that’s why there was a "Splat" instead of a sharp and short dose of pain, followed by a bounce. Putting that into "Austrian," the mal-investments are going to have to get "cleared" at some point, the choice is do you take "drugs" to prolong the agony, or just "take your medicine" and move on.

America is a democracy, 70% of the population live in owner-occupied housing, after they quit complaining that "it" was someone else’s fault (as in "Fannie & Freddie made me buy this house that is now underwater, I pay my taxes, so someone should DO something"), "the majority" voted for pain relief.

But at some point, the "Bottom Line" has to be breached, that’s the inevitability of BubbleomiX; once that is in, there will be a recovery.

But don’t hold your breath.

There again, if you see a house you like – buy it, you won’t make any money on it for a few years, but you will enjoy living in it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.