Missing Signs of the Recovery

According to Steven Gjerstad and Vernon L. Smith,  authors of the paper “Household exhttp://www.blogger.com/post-create.g?blogID=6970246168829061655penditure  and economic cycles, 1920 – 2010”, “In the Great Depression and in every recession since, recovery of residential construction has preceded recovery in every other sector, and its recovery has been far larger in percentage terms than the recovery in any other major sector.” (WSJ Why We're in for a Long, Hard Economic Slog)

The problem is that the recovery in residential construction seems quite a way off.  The number of existing houses being sold is still declining and is now at the lowest point since the National Association of Realtors started tracking the sales in 1999.  Sales of new homes are declining even faster resulting in a problematic gap in the level of sales.   (Graph from calculatedriskblog.com)

When demand for housing declines, the price of existing houses also declines until a buyer is found or the price drops below what the seller is willing to accept.  The minimum a seller is willing to accept can be determined by a myriad of factors and can continue to drop well below what recently may have been considered the fair value.  With new housing, there is more of a price floor.  If prices drop below the level at which a builder can make a profit, finished houses may be sold at a loss but more houses will not be built until prices recover.  The increasing gap between the number of existing and new home sales is an indication that prices are falling below the floor at which new homes will be built.

So when will prices rise enough to encourage builders to start building again?  When demand starts to catch up to supply and right now there is a whole lot of supply.  According to the National Association of Realtors, in July there were 3.98 million homes for sale, representing a 12.5 month supply. Additionally “As of March, banks had an inventory of about 1.1 million foreclosed homes, up 20% from a year earlier, according to estimates from LPS Applied Analytics” was reported in the Wall Street Journal. Another 7.8 million homeowners are either in the process of foreclosure or are delinquent on their mortgage.  Real estate date provider CoreLogic estimates that 11 million homeowners are underwater on their mortgage.  It is difficult to say how many of these houses will end up on the market and eventually sold but it looks like it is going to be quite some time before excess existing inventory is reduced enough to encourage a significant increase in the new home consrtuction that is supposed to lead the economic recovery.