Commentary

Mc Mansions to go

According to the Wall Street Journal, auction companies are reporting
that disposals of brand new-homes represent a growing part of their
revenue. This business ultimately comes from builders and developers
who can no longer finance the unsold homes they have constructed.
They lack emotional attachments to the properties they erect, and are
much more concerned with rising inventory levels.

Unlike new or existing home sales, national numbers are not available
to gauge how many homes are sold in this way, but the National
Auctioneers Association reported a 4.4 percent rise in this category
during the first half of 2006.

The rise in auction activity is most likely due to the increase in contract
cancellations, which are up 30 percent from a year ago. This phenomenon
is swelling the inventories of home builders across our Mc Mansion-dotted
land. And, this is causing sadness to envelope the creators of America’s
cavernous, yet poorly constructed castles. As a result, confidence among
the building set has plummeted to a 15 year low.

The deteriorating condition of the home builder mirrors that of the market
overall. As of the end of September, inventories of unsold single-family
homes registered 7.1 months supply, and 8.6 months for condos. This is
an increase of 60 percent from year ago levels. Granted, this actually marks
a stabilization of inventory levels over the past few months.

The small bit of good news in the new home market was more than offset
by the bad. Even though new home sales rose by 5.3 percent in September,
their median price cratered by 9.7 percent.

In addition, the prices of existing homes have fallen by the largest amount
in 35 years. So, as inventories stabilize at nosebleed levels, prices are
softening. It would be much healthier for the overextended builder and
homeowner to see a decline in prices that coincided with a serious drop in
the number of units for sale. Such a condition would imply that buyers
were simply waiting in the wings for the right price.

According to Merrill Lynch economist David Rosenberg, quoted in the most
recent edition of Barron’s, in order to reach equilibrium between supply and
demand, home sales, along with prices, would have to fall by at least 10
percent, and housing starts by at least 20 percent.

He estimates that the reduction in home sales, prices and starts would shave
anywhere from $2.2 to $4.5 trillion of equity wealth from America’s debt-
burdened consumers. This would dampen mortgage-financed spending.
The ripple effects from the drying up of credit lines would trigger a decline
in profits for retailers and financial firms, and a slowdown in overall job
growth. All of which would lead to a decline in economic activity, and quite
possibly a recession.

This may very well be the canary gasping in the coal mine. As the castle
owner sinks into a moat of debt, the economy that rose with the housing
bubble may collapse along with it.

Greg Strid

© 2006 Splendid Marbles.