Is the housing market turning around?

After a few months of recording slightly optimistic economic indicators, the US economy hit a bump last week with release of existing home sales, new home sales and durable goods orders. In August, existing home sales went down by 2.75%, new home sales missed expectation by 16,000, median existing homes sales prices went down by 3% to $177,700 and median new home prices went down by 9.5% to $195,200. While people are still debating that the worst is behind us and we would continue to see rally in these numbers, I think it is very important to take a deep breath and look at the biggest asset class (mortgages) of the US in the context of fundamental economic indicators and the impact of the government intervention.

In my opinion, we still haven’t reached the turn around on the pathway. I don’t know if the journey will be short, but as a pilot will say the journey is going to be bumpy and we should keep our seat belts fastened. The fundamental factors that I think will impact the housing prices are- unemployment, credit availability, mortgage rate, inventory and foreclosures.

As is widely expected, we will see the unemployment going up to double digits (10-11%) from current 9.7%. Most of the firms are restructuring and trying to stay afloat by cutting costs. This unemployment is also going to be sticky and especially the jobs lost in the financial services and automobile sectors. As of August 2009, we have had more than 5 million jobs lost in this recession (unemployment 9.7%). In past recessions, on average, this number was 2.5 million (average unemployment 7%). In past recessions, it took around 2-3 years to create the lost jobs. In this one, we can easily see that it will take more than 5 years. Given the unprecedented unemployment and the sticky nature of it, I don’t see enough people having growth in their income to propel the demand for houses.

As microeconomics suggests, demand and supply meet each other in the markets to determine the price. In the case of housing, usually the equilibrium is achieved with 6-7 months of inventory. Higher inventory means an increase in supply and given that the demand hasn’t changed, the price will go down. In the current market we have more than 9 months of inventory. This is publicly known and the government is trying everything to sop the extra inventory. Two most prominent steps taken by government are: i) a tax credit up to $8000 for first time home buyer and ii) a plan to purchase mortgage backed securities to keep the mortgage rate low (increases affordability). So the most pertinent questions are how long will the government keep running these programs and do we have only 9 months of inventory?

Tax credit for first home buyer ends on 1st December 2009 and the mortgage purchase plan ends in the first quarter of 2010. If these plans truly end on the above mentioned dates, I can confidently say housing prices will hit a new bottom. As a student of depression, Ben Bernanke knows that when a country is coming out of recession, the price depreciation of any asset class is not good and that of the biggest asset class of the US, not at all. So I believe that these plans will be extended but will these plans be good enough to bring down 9 months of inventory to 6-7 months of inventory? This is where market has lot of noise and disagreements. Many experts believe that banks are holding 1-1.5 million houses in foreclosed and other lenders are waiting for prices to firm up before they enter the market. Based on the recent reports published by Laurie Goodman of Amherst Securities Group, there is more than 7 million of shadow inventory ready to enter the market and this is around 16 months of inventory. This will put a huge pressure on the housing market and despite the government’s attempt to stimulate the demand, the demand will never be able to match such a big supply and prices will come under tremendous pressure.

Based on what we have talked about so far, the path forward for the government is pretty clear: continue with incentives to encourage people to purchase homes (not refinance), keep mortgage rates low by continuing to buy the mortgage based securities, provide other subsidies to promote home ownership till the industry manages to regain its health. These steps will serve as the seat belt and Fed needs to implement them tightly and boldly to alleviate the pain we will face in the bumpy ride and to make sure the injuries don’t become fatal.

Changes in missile defense system for Eastern Europe - a Perspective

The latest strategic move by US to replace the missile defense system planned for eastern europe, with a more cost-effective, sea-based system intended to defend against short and medium range missiles launched from Iran, has caught many by surprise. The rationale given by Robert Gates(Def Secy) to back this decision is that their intelligence suggests that the long-range missile threat from Iran is negligible, and not as advanced as feared earlier in the Bush era. Thus the new version provides a more appropriate defensive response in a cost effective fashion.

This is where we start peeling off the rhetoric. In my opinion, although the missile defense system was supposed to have been inititated to counter Iran, there is a greater benefit it provides to US, in terms of securing a base right next to Russia, and provide a logistical support in the strategic eastern europe region, and effectively keeping the Russians on the defensive.

Obama's foreign policy, of what we have seen so far, seems to be placing a much bigger focus on diplomacy, and he started it with calls for greater alignment with the muslim world, talks with Iran as well as annouce the closure of Guantanamo, and getting the Attorney General to lead a probe against alleged malpractices done by the CIA. Clearly, he is seeking to improve the American image, by distancing his administration from the Bush one, and giving such signals to the world. Only a closer look would reveal that in terms of foreign policy, nothing has truly changed from the previous administration, but such is the nature of subterfuge that policymakers have to make use of, to mould public opinion, the imperative for any ruler.

In this context of Obama's foreign policy so far, we can analyze the ramifications of this move. On the surface, it is a clear call to the Russians for an era of greater reconciliation, and this missile strategy change, was also followed quickly by a call by NATO Secy Gen to the Russians for greater involvement and cooperation with NATO. This begs the question, what do the Americans hope in return for this allowance. The obvious would be greater support for a unilateral action against Iran, as Russia has clearly aligned itself with Iran over the matter.

Obvious constraints usually do not work, and Russia is not in a position to change its stand on Iran. However, this makes the US look conciliatory and consensus seeking in the eyes of the key NATO allies, notably Germany and France. Support of Germany and France is getting more and more important for US, especially in Afghanistan where it is fighting a losing battle. Most of developed Europe has issues with Islam extremism, as they are on the hit list themselves, and I suspect, their leadership would like to provide greater support to the Americans in this War on Terror, as it serves their self interest as well. Muslim immigration is one of the biggest challenges facing developed Europe, and I think they have started formulating appropriate responses to counter this.( Cue Sarkozy and his recent aggression against institutionalized signs of Islam, some other notable european nations like the scandinavians, Dutch and UK also keep dropping feelers pointing to the same sentiment). With this move, I feel this just might herald the return of NATO to global significance, and redeem their image, after the disastrous war in Georgia last year.

Thus to summarize, this move is based on providing the allies in Europe with talking points to tone down the anti americanism reflected in european public opinion, and returning to the american fold as key allies in the War on Terror, a war which is critical for the entire western world (not just US), to retain its cultural hegemony on the world. Additionally it provides relief for the European nations with a more relaxed Russia, along with the cost savings it provides to US ( especially in these days).