The housing rot is still eating the US economy from the inside
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Associate Editor
David Stevenson May 27, 2010
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Amid the current market mayhem, where in the financial world is still safe? The answer, it seems right now, is the United States.
The economy looks more than OK, according to the latest statistics. Wall Street is faring better than other major stock markets. And the US government is, for now at least, able to raise money to fund its debts at record low interest rates.
So is everything's fine? Sadly not. Property is still looking very sickly indeed. And that could bring the whole pack of cards tumbling down again…
The US economy isn't as healthy as it looks
Durable goods orders are a handy gauge of how well the US economy is doing. And yesterday's figures were again better than expected.
Total orders increased by 2.9% in April and have now risen in four of the last five months. In addition, American businesses are spending heavily on capital equipment.
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And at first glance, even the latest numbers on the property front don't look too bad. The S&P/Case-Shiller 20-City home-price index is generally seen as the bible for US housing. Residential values were up 2% in the first quarter. Further, April's new home sales rose by 15% compared with March. That adds up to an eye-catching 49% gain in such sales in just two months.
So does this mean the long bear market in US housing is finally coming to an end?
No, it doesn't.
US house prices have been falling for six months
Look at the full details of the S&P/Case-Shiller index and they're nowhere near as reassuring. March actually saw a 0.5% dip in prices. Also, on a non-seasonally adjusted basis – i.e. on the real figures – US house prices have been in retreat for the past six months. As for those apparently spectacular new home sales, again everything isn't quite as it first appears. The figures were ramped up by the government's tax credit programme, which subsidises buyers. So there was a rush to sign contracts – before the scheme finished at the end of April.
So we've just seen "the last hurrah for new home sales", says Paul Dales at Capital Economics. And as he also points out, applications for loans to buy a new home have since dropped to a 13-year low, despite falling loan rates. "So far in May, this proxy for new housing demand has absolutely cratered at a 99.96% annual rate (yes, that's correct)", says David Rosenberg at Gluskin Sheff.
"High unemployment, heavy indebtedness and tight credit may mean applications remain weak for some time", says Dales. "It will only be a matter of months before a double-dip in the housing market starts to act as a modest drag on economic activity".
In other words, get ready for plenty more downbeat property news. This wouldn't be so bad if the underlying state of the market weren't already so dreadful. But it is.
One in seven American mortgages is in trouble
In fact, it's truly scary. For one thing, the excesses of the last housing boom remain. There are still more than four million unsold houses in the States, 3% more than a year ago, and equal to almost 8.5 months' supply at current sale rates.
The percentage of US homeowners behind on their mortgage payments has multiplied more than five times between 2006 and 2009, according to Federal Reserve figures. By the end of March, one in every seven US households with an outstanding mortgage was either behind on payments or in foreclosure, says the latest report from the US Mortgage Bankers Association.
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What's more, although government measures have temporarily slowed down the pace of foreclosures, this may well not last. That's because more and more borrowers are getting further and further behind with their payments. Mortgages that are at least 90 days overdue or in foreclosure account for a record-high 68% of all problem cases.
"It's like shutting off the oil leak", says Jay Brinkmann at the MBA tells Reuters. You might stop the flow, "but you still have a lot of oil in the Gulf to deal with".
Worse still, it might be premature to suggest even that the 'leak' has been plugged. Despite the US government's best efforts to fiddle the figures by hiring extra workers for the national census, America's dole queues still aren't really shrinking. If job losses start mounting again, loan payment problems can only worsen further as more adjustable-rate loans 'reset' to higher repayments. That's when initial 'teaser' rates, which are set as low as possible to entice buyers, are hiked after – normally – five years.
It all means that if you're thinking about snapping up that 'condo' in California, you can probably afford to wait for a while.
Why there could be more carnage in the US banking sector
But the biggest concern is what all this means for the banks. Lenders may have thought the "credit cycle" was going their way, and that their losses from bad debts were about to come down. But it isn't. And they aren't.
"Consumer borrowers are free to chose what bills they pay, but that only lasts so long", says Annaly Capital Management. "Soon they won't be able to pay their credit card bills. The worst of the credit cycle is not behind us."
So the bankers will be left to pick up the tab – if they can. But many can't. No wonder US banks have been going bust in droves. That's because the capital on their balance sheets has been completely eaten up by all the bad debts they've had to book, leaving the businesses worthless.
In 2010 to date, 73 US banks have gone bust. That's more than double the pace of 2009. And last year's total of 140 failed lenders – the highest annual tally since 1992 - is bound to be beaten as the overall bad debt problems get worse.
We wrote a couple of weeks ago about how commercial property losses would hit lenders in Europe. (Commercial property: the worst could be yet to come). And how US banks are in a worse mess on this score too.
For now, the spotlight is on Europe. But once the glare fades from that side of the Atlantic, there'll be plenty of bad news stories coming out of the US to fill the gap. It's yet another reason why your portfolio needs to be positioned defensively. We invited a group of investment experts into the MoneyWeek office to discuss where the value lies in US stock markets this week. You can read their stock picks in the next issue of the magazine, out tomorrow.
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