Signs point to the emergence of a degree of stability in the next 12 months. Gordon Fowler Jr. is CIO of Glenmede Trust Company, an independent wealth-management firm based in Philadelphia.

Summary

Conditions in the housing market are still deteriorating. Prices are falling and foreclosures are beginning to pick up.
There are, however, some interesting signs that we could see some stability in the next twelve months.
By some measures housing costs have gone from being highly unaffordable to somewhat of a good buy.
A more stable housing market would lessen concerns over the quality of mortgage debt collateral and could set the stage for a stronger consumer.

Review and outlook

The heart of problems in the stock and credit markets is issues with housing. Housing-market conditions are going from weak to weaker. But there are some interesting indicators that offer the hope that stability is within sight. By one measure housing costs have gone from highly unaffordable in 2006 to more or less affordable recently. Bubbles collapse when prices can no longer be sustained by hopes and dreams that prices will continue to soar to ever higher levels. Price rallies start when values reach a point where the opportunity to buy an asset at a good price overcomes the fear that prices will fall further. A stable housing market would also stabilize the collateral behind much of the problem debt in the credit markets. A bounce in housing turnover from severely depressed levels should also help the consumer economy.

The housing market is anything but stable right now. As shown in the two charts below, housing starts and existing home sales are in free fall and close to levels last seen in the early 1980s and 1990s when interest rates spiked and the economy went into a recession.

HOUSING STARTS(Seasonally adjusted, 1969 through 2007) |image1| Sources: Glenmede Investment Research and Haver Analytics

EXISTING ONE FAMILY HOME SALES BACK TO 1990(Seasonally adjusted) |image2| Sources: Glenmede Investment Research and Haver Analytics

Not surprisingly, home prices have fallen by more than 8% a year since the peak in the market according to the Case Schiller home-price index. Andy Leperriere at ISI argues that prices could easily fall by 21% from the peak by year-end. The price declines have been particularly intense in some of the hottest markets. Florida, Arizona and Las Vegas, where aging baby boomers have purchased property in anticipation of putting aside stressful careers and retiring to relaxing environments, have all seen noticeable price declines.

CASE SHILLER HOME PRICE INDEXYear over year change (1988 through present) |image3| Sources: Glenmede Investment Research and Haver Analytics

This doesn't add up to a healthy picture for a major segment of the U.S. economy. There are some interesting signs of life however. The supply of U.S. existing homes on the market seems to have peaked at over a ten months supply and receded, recently, to about nine and a half months.

U.S. EXISTING HOMES FOR SALEMonths supply on the market |image4| Sources: Glenmede Investment Research and Haver Analytics

Mortgage refinancing has picked up too. We are back to levels last seen in the post-Internet-bubble period when the Fed lowered interest rates to stabilize the economy. Much of this volume may be related to holders of short-term adjustable-rate mortgages, choosing to lock in rates at relatively low fixed rates.

MORTGAGE REFINANCE APPLICATION VOLUME |image5| Source: Mortgage Bankers Association

The best news of all may be that housing is becoming more affordable. The National Association of Realtors (NAR) estimates housing affordability by comparing the median income for the typical U.S. family with the amount of money needed to qualify for a 30-year mortgage with a 20% down payment. As the chart below shows, housing affordability spiked downward in 2005 and 2006 as speculation took hold of the market. Since then however, affordability based on our latest estimate, has risen back over historical median levels, and is now approaching the point where housing is, arguably at least, a "good" buy. If prices fall by another 10% from here and current mortgage rates hold in place, the NAR's Housing Affordability Index would reach a near record level of 145 -- last reached in the early 1970s.

HOUSING AFFORDABILITY INDEX |image6| Sources: Glenmede Investment Research and Haver Analytics

To be sure, if home prices do drop that much, equity markets might not be all that happy. And the life of a CIO could become a bit more stressful. Don't worry about me though. We have set aside time and have already planned our summer vacation to rest, unwind and, perhaps, shop. I booked the tickets to Arizona last week. -FWR

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