Is declining Housing Inventory a bad thing?
“Geez, it’s almost there. If we could just get another 851,489 houses for sale in the market, we’ll have it juuuuuust right…”
We released our February National Housing Report yesterday – “US Home Prices Already Climbing in February,” in which we highlight the role of declining active market housing inventory in this year’s home price stabilization.
Ironically, Jonathan Miller (author of Matrix Blog) wrote on Monday – “The Decline In Inventory Right Now is NOT a Good Sign.” Jonathan and I disagree on this point, which we delightfully and civilly discussed via email this morning.
Here’s the way I see it: It wasn’t long ago that the world was worried about millions and millions of foreclosed homes hitting the open market and crashing home prices another 30%. Now we’re worried there’s not enough supply. Huh?
The problem with the housing market in the first place was too much supply at bubble prices and demand levels. Because housing supply is difficult to destroy or spoil (Greenspan’s suggestion to burn down houses and rotting REOs aside…), I’d much rather be in a place with very low supply – even a shortage in terms of “homes for sale relative to demand” – that causes prices to rise in the short-to-intermediate term. Trying to fine tune the “right” supply level is very dangerous.
Plus, other factors are influencing active market inventory:
1. Short Sales: Some of the “lowness” in the active market inventory is due to the shadow/distressed inventory which will leak out this year via the continued short sale push from the GSEs and banks. These institutions have very large NPV functions and are concluding that a short sale at today’s price > 6-36 month foreclosure process in many cases. This will nag home prices to the dismay of non-distressed home sellers, but it’s a realistic way to handle the problem. Much better than foreclosing on another 6-10mln people behind on their mortgage. You can’t have it all…
2. REO-to-Rental: Bulk REOs on the GSE/bank balance sheets are converting to rental housing with recent program announcements from Freddie Mac, Fannie Mae, the FHFA, and Bernanke. This means that this subset of inventory won’t hit the active listings in the short-to-intermediate run. Investors buy and convert these properties to rental. Eventually when home prices rebound significantly, investors may attempt to re-sell into the market, especially if price-to-rent ratios make it economically sensible for renters to enter or re-enter the marketplace, but that is 5-7 years down the road.
3. Supply & Demand: One can use either an upward-sloping supply curve or a vertical/no slope supply curve to depict active market inventory. An upward sloping housing supply curve says that as prices rise, the quantity supplied along a fixed supply curve will also rise. However, in this scenario, prices will also drop because a rise in supply creates a surplus gap at a given quantity demanded along a fixed demand curve.
The good news is that the opposite also happens – when prices fall, the quantity supplied falls along the fixed upward-sloping supply curve, as home sellers and firms withdraw or stay out of the market. This is the argument that Jonathan makes as to why supply that is “too low” is a bad sign for the market – low supply is due to low prices.
But… if that happens for a prolonged period, then a shortage develops in the market which causes prices to rise. This is what we’re seeing now. Then, home sellers and firms will re-enter the market as suppliers when they see prices stabilize and rise. Part of this supply re-entering will be home owners on the underwater mortgage margin. They’re current on their mortgage so they don’t qualify for a short sale or modification in most cases. They want to sell but can’t sell because they are LTV=101 to 120 and don’t have the cash on hand to bring to closing. If the market pops 5-10% because of a supply shortage, then it becomes feasible to enter the market.
(Personally, I assume a vertical/no slope supply curve and a fixed demand curve. On the supply side, there are a discrete number of homes for sale at any one point in time, and there is a baseline number per year with seasonal fluctuations that enable the supply curve to move more nimbly back and forth. Principally, demand curves are fixed and are very hard to shift, though the market is seeing the demand curve shift downwards with a preference change to rentership – both by choice and by force – as the homeownership rate falls back into the mid-to-low 60%, and heads lower every quarter.)
In either an upward sloping supply curve or vertical supply curve, the supply curve moves back and forth on expected future prices (i.e. market conditions) and the number of firms (i.e. individuals, homebuilders). When these market suppliers sees a sustained recovery and expect future prices to rise, then a chunk of sellers enter the market and homebuilders start building homes.
It’s dangerous and Keynesian (worse) to think that anyone can decide the “correct” amount of active inventory, particularly when using history as a guide. Looking backwards too much for too long got us here in the first place. I’m not advocating a free-for-all in the housing market – it’s way too screwed to extract the government programs now. And it seems that HARP II might actually be working.
I do think that the market is responding appropriately right now with low supply and I’d really like to see the current situation play out in 2012 before a bunch of politicians or lobby groups decides on the optimal housing supply that should be available to buyers.
“Or maybe it should be 853,109 more homes…”