Are We There Yet?

The bottom in the housing crisis is nowhere in sight, according to data released today. Take your pick, the stats are all bad:

* Foreclosure filings: up 112% in the first quarter compared to 2007.

* Home prices: down 12.7% in one year (Case-Shiller index).

* Vacant homes: up 5.7 % in 2007.

* Owner-occupied homes: stuck at 68%--and headed lower.

The vacancy rate is the one that really gets me. It is a capsule summary of the colossal, almost obscene misallocation of capital (aside from war spending) that took place in the U.S. over the past decade.

Let's look at the vacancy numbers more closely. In 2007 the number of vacant homes increased by one million to a record 18.6 million. If we take out seasonal homes, we are left with 13.9 million vacant homes that are suitable for year-round occupancy. Of those, 4.1 million are for rent (over 10% of the total rental stock). Another 7.5 million are off the market for one reason or another; they may be second homes, homes in foreclosure, or homes in undesirable locations. Bottom line: there are 2.3 million vacant homes awaiting buyers, an overhang that is nearly double the usual.

How did it happen? The Federal Reserve helped with its loose monetary policy, encouraging risk-taking among lenders and borrowers alike. Artificial demand was created as homes (particularly at the high end) morphed into something else: fungible assets that investors could swap in and out of. In other words, these homes were not built for occupancy. Wall Street fueled the boom by securitizing home loans and hence increasing the velocity of all that easy money.

Many (most?) of these home loans were structured to serve quick flippers, not long-term occupants. These so-called "exploding ARMs" (adjustable rate mortgages) came with low introductory interest rates good only for two or three years before resetting much higher--no problem if you can get out before the reset. Oh, wait, you mean you actually want to live in that house? Then you had better be ready for higher monthly payments. Hybrid ARMs worth $362 billion will reset in 2008 and will devour a lot of those IRS rebates going out in the mail starting this week. Unless these loans can be reworked, many will fail.

Vacant homes lose value in many ways. Not only do they have to be repriced (downward) according to the law of supply and demand, but they are beset upon by squatters and vandals. The physical deterioration, in the words of a Boston attorney, is "like Katrina without the water." And it will get worse before it gets better.