Higher Inflation Expectations? Higher Mortgage Rates Coming

Speaking of higher inflation (see previous post) ... there are so many bad outcomes that could come from this especially in an economy which needs its life blood of "cheap money" to exist (solve problems).... I cannot even begin addressing all the myriad issues but let me throw one out - long term rates will be going up as inflation expectations pick up; and you know what is tied to long term rates - mortgages. So what happens to home prices when mortgage rates go up? They must go down - because higher rates means it costs more to own a home. Oh dear. Housing recovery of spring 2008, err summer 2008, err fall 2008, err spring 2009, here we come. But never fear the statistics show a "surprising increase in home sales" in certain areas - they forget to look behind the curtain and mention that these are in large part foreclosures - at prices that people who actually live in a home are not even close to offering. So yes we will see spikes of home sales here and there, especially in areas with huge foreclosure rates - but these are not transactions between human to human - they are bank to human. And with higher rates it only makes the process of market clearing prices, and inventory reduction take that much longer to play out.

• The Sacramento Association of Realtors says that a whopping 65.5% of 1,654 homes sold by Realtors in May were bank-owned, foreclosed, homes. The median sales price in Sacramento County and the City of West Sacramento May was $230,250, down 34.2% from a year ago.

• Realtor sales overall in Sacramento in May were up 76% from a year ago and up 14% from April, the local trade group said.

• But as housing economist Thomas Lawler pointed out in a recent research note, “non-distressed home sellers found little solace” in the Sacramento sales “boom.” The banks appear to be offering bargain basement prices that mom-and-pop home sellers can’t stomach.

• In Las Vegas, for example, about half of recent sales have been lender sales. according to The Greater Las Vegas Association of Realtors. The lenders are finding buyers there also. Sales of single-family homes in April were up 30% from a year earlier.

So let's remember this reality when the Kool Aid begins about how sales are "recovering" and the stock market skyrockets up on the news sometime later this summer or fall. When prices are 30,40,50% below what people who actually live in homes believe their home is worth, we are still not recovering - we need a functioning marketplace where buyers (humans) and sellers (humans) can agree a price is fair. We are currently in a market (in some states) where buyers (humans) are picking off inventory (to flip?) from sellers (banks) who just want out of inventory. Now the main problem is, each and every day new inventory (new foreclosures) are coming into the banks hands - and I believe in certain states will be doing so for at least another year, at an increasing pace. We're still in the 4th inning, not the 7th-8th inning of the housing bust. Yet another creation of unregulated banks, and easy money Federal Reserve. It's amazing how low prices must go when you don't use exotic mortgages.... it actually has to reflect a person's income (shocking).

In [Dec 6: What Should Median Housing Price be Today?] I calculated that to reach the traditional ratio of homes costing 2.6-3.0x median income, median home prices would need to fall to $135K. That would be down from the bubble $230K at the peak (summer 2006). We already had fallen to $208K by last October and now are in the $190Ks. As more and more foreclosures happen and people are able to buy product at prices they can afford, this will only be putting more pressure on those who have stubbornly stuck in their homes, wanting to sell but still expecting 2005 prices (they've finally come to the conclusion that they won't get 2006 prices).

Now with the credit markets still frozen for many, lending requirements swinging from "you have a pulse? Here is $600K" to "I want to know the color of your great grandfather's eyes before you even get $1 from my scrawny banker hand", and on top of that a potentially RISING rate environment for mortgages? Did I mention how expensive it is getting just to drive around on a Sunday looking at open houses? Did I mention how 3500 -4500 sq foot McMansions that were just dreamy in the era of $1.50 gas, and natural gas and coal prices 50% lower than they are now, are going to fall out of favor due to cost of keeping heated/cooled? Did I mention all the homes in the far off suburbs far from workplace are going to fall out of favor, also due to high gas? Did I mention that people still need to afford to eat while they are in said new home? Well, let's just say we could have a long way to go - those of you who got a mortgage in the 1970s will be able to relate to how "little" house one could buy at 11%, 12% mortgage rates. We've been at still historically low 6% mortgage rates, but now rising quickly as inflation pressures mount... 6.2-6.3% last I checked in past few weeks. If we do get to 7-8% type of mortgage rates, I'll have to move us BACK from the 4th inning of the housing correct, back to maybe the 3rd.

Conclusion: This is all priced in with market participants who have carefully thought out all the implications, and still come to the conclusion that the 2nd half recovery is alive and well; further their idea of long term is "next week" hence why the "long term" is always rosy for them. Buy stocks.

Long the first Kool Aid stock market rally on "better than expected" home sales data; coming to a theater near you (within months)