SERIOUS MONEY:VETERAN MUSICIAN Neil Diamond topped the album charts for the first time last week after more than four decades of effort.
His latest contribution to the annals of music history, Home Before Dark, seems to fit the bill when it comes to the US's beleaguered housing market.
Diamond's well-deserved triumph coincided with a surprising uplift in homebuilding, which offered a chink of light to homebuilders and caused many commentators to suggest that the worst real-estate downturn since the 1930s was close to an end.
The upside surprise came just 24 hours after the National Association of Realtors declared that "home sales and prices throughout most of the country are poised for improvement in the second half of 2008". The association's medium-term outlook forecasts a rise in prices that sees home values exceed their recent peak within two years.
Seasoned commentators quite rightly treat such an analysis with scepticism, since estate agents are in the business of generating home-sales activity, just as Wall Street investment banks do likewise in shares. Asking a real-estate agent what he or she thinks of home values is akin to asking Wall Street brokers what they think of stocks, and such queries are usually greeted with bullish enthusiasm.
Fundamentals do not concur with the opinion of American realtors and, for those investors who are tuned to the signal rather than the noise emanating from the data, it should come as no surprise that Diamond's enduring classic, Love on the Rocks, is far more representative of the state of affairs in the US residential home market.
The statistics speak for themselves and determined optimists will require more than single monthly numbers to convince otherwise. These are the same people who argued that a national bear market in housing could not happen simply because the data showed that national home prices had not registered a single year-on-year decline in the postwar period.
Unfortunately, such an observation is dangerously misleading. The argument that a national housing recession was unlikely has since been discredited as prices have dropped year-on-year for 14 consecutive months. Worryingly, the pace of decline continues to gather momentum, with the most recent reading showing a drop of almost 13 per cent.
Students of Newtonian physics, which underpins economic and financial theory, are aware that an action is met with an equal and opposite reaction. But such linear thinking does not apply to asset markets, as a seemingly unimportant piece of data can produce a disproportionate reaction and bring the system to its knees, just as one grain of sand dropped on top of a child's sandcastle can precipitate an avalanche.
This is an apt description of the chain of events that struck US mortgage markets and the toxic high-yielding securities that proliferated during the upturn and which found a home in many pension funds simply because the rating agencies had awarded them triple-A status.
The US Federal Reserve believes asset bubbles are almost impossible to identify until after the fact, yet surely a considered analysis could identify a confluence of symptoms that pointed towards an inevitable meltdown.
The almost 100 per cent rise in home prices in real terms from the mid-1990s to the recent peak could not be explained by demographics, increased construction costs, employment gains or wages, which have been stagnating in real terms so far this decade.
The typical Wall Street explanation is that lower mortgage rates and their greater affordability underpinned the boom. However, such analysis does not explain why the after-tax cost of mortgages almost doubled relative to rents over the past eight years, or why the US's historically stable home-ownership rate jumped 2.5 percentage points to a record high, or why the subprime segment came to command a double-digit share of new mortgages.
The number of new records registered during the boom is enlightening. The value of home sales to nominal gross domestic product, home mortgage borrowing as a percentage of GDP, and home mortgage borrowing to the market value of the housing stock all reached record highs.
The simple truth of the matter is that price increases created expectations of further gains and all interested parties jumped on board, which undermined the stability of the market.
A market dislocation was inevitable given the uniform belief in the investment merits of bricks and mortar. The aftermath is plain. Inventories of new and existing homes exceed 10 months at the current sales rate but are considerably higher at the likely trough in sales activity, foreclosures are commanding an increasing share of existing sales, and vacancy rates are at a record high.
Not surprisingly, home values are falling, but the deterioration will persist as demand continues to soften in the face of a weak labour market and tighter loan standards. The cumulative loss of household wealth could reach $6 trillion (€3.8 trillion), an amount equivalent to almost 40 per cent of nominal GDP. Pay no heed to the realtors; the US housing market is on the rocks.
