Commentary

Pending Home Sales Plunge

More bad news emerged on Wednesday from the beleaguered housing market. The National Association of Realtors reported that pending sales of existing homes collapsed by 12.2 percent in July. The Pending Home Sales Index, as it is known, is based on actual contracts signed, and it swooned to register 89.9- the lowest level since September 2001. To make matters worse, interest rates on popular mortgage products continue to rise.

Wall Street’s sharp-eyed economists were expecting a drop of 2 percent- woops! According to Ian Shepherdson, chief economist at High Frequency Economics, as quoted in the Washington Post, “the decline in the pending sales index in the past three months has been by far the fastest at any time since the housing market began to
slow.” And, he finished by saying, possibly for theatrical value, “this is disastrous.”

Some point to a rise in applications for home loans reported last week from the Mortgage Bankers Association as a bright spot in the downward swirl that is the U.S. real estate market. But, applications are rising due in large part to the difficulty many prospective buyers are having in obtaining mortgages, which forces them to submit to many lending institutions at once in hopes of receiving a loan.

And, more to the root cause of this evolving mess, interest rates on adjustable rate mortgages climbed to a six-year high. Remember folks, it was low interest rates- and the evaporation of lending standards- that led to the obscene bout of asset inflation that swept the real estate market into a frothy, yet unsustainable bubble. With rates rising on the housing market’s most popular financing vehicle, buyers will find American castles out of reach, and owners will find them harder to keep.

Interest rates on jumbo loans (just say “super-size me” to your local mortgage broker) have been climbing as well. These are loans that exceed $417,000, and lie outside the
guarantees of Fannie Mae and Freddie Mac- the GSEs (Government-Sponsored Entities) that purchase mortgages, and, it must be noted that Fannie and Freddie possess credit
ratings second only to that of Uncle Sam himself. This means that investors in the credit markets must purchase these monster loans. The recent, yet severe, allergic reaction to
real estate debt is causing buyers to charge a higher rate of interest in order to compensate them for the risks associated with it. This, unfortunately, means that McMansions are
becoming more expensive.

The tide of easy credit that has supported ridiculous gains in the real estate market over the past five years is flowing rapidly in reverse. That is the reason behind the
three-month collapse in pending home sales. The rising cost of mortgages is causing inventories of unsold homes to swell, which in turn, is shifting sentiment on the housing
market. A return to sanity in lending, coupled with a dramatic shift in perception will continue to cause the U.S. housing market significant amounts of pain. The excesses
built over the course of five years of lunacy will not be excised quickly. The horizon that I see for this market is one marked by a steady course of declining prices that
will probably run for at least another two years.

© 2007 Splendid Marbles.