by Calculated Risk on 7/21/2010 07:39:00 PM

Fed Chairman Ben Bernanke was asked today why he thought companies with significant cash weren't investing. His answer was that most companies currently have excess capacity.

Bernanke was also asked about small companies having trouble getting financing, and he pointed out that small companies reported their number one problem is "lack of customers", not difficulties in obtaining financing.

This excess capacity or lack of demand - and therefore lack of new investment - is a key reason why the recovery is sluggish.

One of the few sectors seeing new investment is the semiconductor equipment manufacturers - Intel, Taiwan Semiconductor and others are making new investments in equipment to meet increased demand - and Applied Material, LAM Research, KLA-Tencor, Cymer and others are all seeing a boom in business. I've spoken with companies in the semiconductor equipment sector, and they are hiring like crazy (probably all of these companies are). But this is a small part of the economy ...

Most other sectors, from autos to commercial real estate, and especially residential real estate have too much capacity. Away from equipment and software, investment is still very weak.

As we've discussed many times, usually residential investment is the key investment sector for the economy in the early stages of a recovery. But not this time because of the oversupply of existing housing units.

There is some good news:

Homebuilders are on track to deliver the fewest housing units this year since the Census Bureau started tracking housing starts in 1959 (¹see analysis below).

The U.S. population is still growing and new households are being formed. Based on normal household formation to population ratios, there would usually be over 1.1 million net new households formed per year. Because of financial distress, the number of households formed in 2010 will probably be lower then normal. But this is real pent up demand - people don't want to double up with friends or live in their parent's basement forever!

However the bad news is:

There are still a substantial number of excess housing units (my estimate is around 1.7 million as of Q1).

Usually the key sector for job creation and household formation in the early stages of a recovery is residential investment. But this sector isn't participating (as expected), and this weakness is contributing to the sluggish labor market.

Eventually this excess supply will be absorbed, and new residential investment will increase - but that will not happen until the excess inventory is reduced significantly.

¹Analysis: Housing Units added to stock in 2010

Yesterday the Census Bureau reported housing starts fell in June to a 549 thousand seasonally adjusted annual rate. As I noted yesterday, this is good news for the housing market longer term (because of the excess housing units), but bad news for the economy and employment short term.

The table below is based on the data through June, and shows an estimate of the number of housing units that will be added to the stock in 2010 (based on completions from the Census Bureau).

Housing units include single family homes (included as 1 to 4 units), apartments (5+ units), and mobile homes. Demolitions are subtracted from the stock (note: demolitions are the hardest to estimate).

(in thousands)	2009	First Half 2010	2010 Estimate
1 to 4 units	534.6	243.8	500
5+ units	259.8	86.8	150
Mobile Homes1	53	26	55
Sub-Total	848.4	356.6	705
Demolitions2	200	100	200
Added to Stock	648.4	256.6	505

¹ Actual through May 2010, June estimated.
² estimated.

Notice that the number of "5+ units" completed in 2010 is about to collapse. This is already in the works as shown in the following diagram:

Click on graph for larger image in new window.

The blue line is for multifamily starts and the red line is for multifamily completions. All the multifamily units that will be delivered in 2010 have already been started since, according to the Census Bureau, it takes on average over 1 year to complete these projects.

Since multifamily starts collapsed in 2009, completions will collapse in 2010.

In June 2010, builders started 8,200 apartment units (NSA), and completed 18,200 units. This level of starts has been steady all year, and completions should drop sharply in the next few months. As an aside, this suggests that construction employment will decline further over the next few months.

Similar logic applies to single family units, although these only take around 7 months to complete. Most of the housing units that will be completed this year have already been started. Builders completed 243,800 units (1 to 4 units) in the first half of 2010. Based on starts, builders will probably complete about the same number of units in the 2nd half of the year.

The manufactured homes data is from the Census Bureau through May (and demolitions are estimated).

by Calculated Risk on 7/21/2010 03:59:00 PM

Note: This index is a leading indicator for new Commercial Real Estate (CRE) investment.

Birmingham Business Journal reports that the American Institute of Architects’ Architecture Billings Index increased to 46 in June from 45.8 in May. Any reading below 50 indicates contraction.

The ABI press release is not online yet.

Click on graph for larger image in new window.

This graph shows the Architecture Billings Index since 1996. The index has remained below 50, indicating falling demand, since January 2008.

Note: Nonresidential construction includes commercial and industrial facilities like hotels and office buildings, as well as schools, hospitals and other institutions.

This suggests the slump for commercial real estate design is ongoing. According to the AIA, there is an "approximate nine to twelve month lag time between architecture billings and construction spending" on non-residential construction. So there will probably be further declines in CRE investment into 2011.

by Calculated Risk on 7/21/2010 01:50:00 PM

Here are two live feeds for Fed Chairman Ben Bernanke's testimony to the Senate Banking Committee: The Semiannual Monetary Policy Report to the Congress

Here is the CNBC feed.

Here is the C-Span3 Link

Prepared testimony: Semiannual Monetary Policy Report to the Congress

by Calculated Risk on 7/21/2010 12:08:00 PM

Earlier I mentioned that a normal housing market usually has under 6 months of supply. The NAR reported that months of supply was at 8.3 months in May, and the months of supply was probably be higher in June (to be reported tomorrow).

A quick estimate: If sales are 5.3 million (SAAR) in June, and inventory stays the same at 3.9 million units, the months of supply will rise to 8.8 months in June.

This is calculated as: 3.9 divided by 5.3 * 12 (months) = 8.8 months of supply.

For July, if sales fall to 4.5 million (it could be lower) and inventory is still at 3.9 million units, months of supply will rise to 10.4 months.

I think these estimates are conservative (actual will probably be higher). For reference, the all time record high was 11.2 months of supply in 2008.

This level of supply will put additional downward pressure on house prices.

Click on graph for larger image in new window.

This graph show months of supply and the annualized change in the Case-Shiller Composite 20 house price index.

Below 6 months of supply (blue line) house prices are typically rising (black line).

Above 6 or 7 months of supply house prices are usually falling (although there were many programs to support house prices over the last year).

The dashed red line is the estimate for months of supply in June and July.

This is a key reason why I expect house prices to fall further later this year as measured by the Case-Shiller and CoreLogic repeat sales house price indexes.

by Calculated Risk on 7/21/2010 08:55:00 AM

Nick Timiraos and Robbie Whelan write at the WSJ Housing Market Stumbles. A few excerpts:

The Wall Street Journal's quarterly survey of housing-market conditions in 28 major metropolitan areas shows that inventory levels have grown in many markets.

... newly signed contracts in May and June have plunged. ...

More broadly, the housing market faces two big problems: too many homes and falling demand.

A few comments:

It appears the existing home inventory is still rising, and with a plunge in sales in July and August, the months-of-supply metric for existing homes will probably be in double digits (over 10 months) later this summer. That historically means falling prices (about 6 months of supply is a normal market).

Although there are markets where there is just too much supply (like Detroit), in most markets the problem is too much supply at the current price. So falling prices will help clear the market.

The housing tax credit was a clear and unequivocal failure. Not only did most of the benefit go to people who were going to buy anyway, but the credit didn't reduce the overall supply (the total supply includes both homes and rental units). The credit just incentivized some people to move - and pulled some sales forward - and to the extent the credit went to new home sales, it actually was counterproductive by increasing the excess supply. This is a textbook example of bad policy.

The unemployment benefit extension was helpful for housing. Not only does this benefit go to people who will probably spend it, but it keeps households in place - otherwise more people would be doubling up with friends or living in their cars. This might not be the most effective policy, but at least it was helpful (as opposed to the housing tax credit).

This double-dip in housing should be no surprise. I wrote about it last summer (and many others have too).

by Calculated Risk on 7/21/2010 07:43:00 AM

The MBA reports: Interest Rate Drops Spur Refinance Applications in Latest MBA Weekly Survey

The Refinance Index increased 8.6 percent from the previous week and was the highest Refinance Index observed in the survey since the week ending May 15, 2009.
...
The seasonally adjusted Purchase Index increased 3.4 percent from one week earlier, driven by an 8.0 percent increase in government purchase applications.
...
"As rates on 30- and 15-year fixed-rate mortgages declined to the lowest levels recorded in the survey, refinance activity increased last week. The refinance index is up almost 30 percent over the past 4 weeks, but is still well below the peak seen last spring,” said Michael Fratantoni, MBA’s Vice President of Research and Economics.
...
The average contract interest rate for 30-year fixed-rate mortgages decreased to 4.59 percent from 4.69 percent, with points increasing to 1.04 from 0.96 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans. This was the lowest 30-year contract rate ever recorded in the survey.

Click on graph for larger image in new window.

This graph shows the MBA Purchase Index and four week moving average since 1990.

Although the weekly applications index increased slightly, the four-week moving average is at a 15 year low (lowest since August 1995). The four week average is off 36% since the mini-peak in April (the weekly index is off 42% since the end of April).

This collapse in the mortgage application index has already shown up as a decline in new home sales, and will show up in the July and August existing home sales reports (counted at close of escrow).

by Calculated Risk on 7/20/2010 10:08:00 PM

The Semiannual Monetary Policy Report to the Congress 02:00 PM - 05:00 PM ET

by Calculated Risk on 7/20/2010 07:45:00 PM

Tomrrow, starting at 10 AM ET, Fed Chairman Ben Bernanke will report to the Senate Banking Committee: The Semiannual Monetary Policy Report to the Congress

David Wessel at the WSJ has a preview: The View From Bernanke's Perch at the Fed

Neil Irwin at the WaPo has some comments: Why Wall Street doesn't understand the Fed

Bernanke will very likely tell the Senate Banking Committee on Wednesday that cutting [interest on excess reserves] is one of a handful of options that the Fed is evaluating should the economic recovery continue to stumble. The others ... are strengthening its promise to keep interest rates low for an extended period and buying enough mortgage securities to replace those that mature. He will indicate openness to buying more long-term assets, but only if the economy appears to be heading back toward recession.

I doubt Bernanke will mention options for further easing in his prepared statement, however he will probably be asked about what options are available in the Q&A. As Andrew Tilton at Goldman Sachs noted yesterday: "Any commentary on easing options seems more likely to come in the question-and-answer session rather than prepared remarks. One way for Chairman Bernanke to keep specific ideas at arm’s length might be to couch them in terms of a discussion of what other central banks have done."

I think Bernanke will mention the recent weak economic data in his prepared testimony, and it will interesting to see how he phrases it. As far as policy options, I think the options Irwin mentions are possible - and also possible is setting target ceiling rates for 3 to 5 year Treasury securities (he discussed this in his 2002 speech: Deflation: Making Sure "It" Doesn't Happen Here).

by Calculated Risk on 7/20/2010 04:31:00 PM

The Obama Administration released the June Housing Scorecard today. The graphs are a little hard to read, but they do provide a list of sources.

On modifications they provide a graph showing 2.95 million total modifications for Hope Now, HAMP, and FHA loss mitigation (page 3). There are also private modifications too (not mentioned) - so quite a few borrowers have had some sort of loan modification.

For housing supply (page 2 last graph), they show existing home inventory and "vacant housing units, held off market, year round, other" from the Census Bureau. I suppose they are using this number (about 3.6 million now - usually around 2.7 million) as a measure of shadow inventory. I think a better measure of the excess supply is to use the vacancy rates from the Census Bureau. The Q2 vacancy rates will be released next week on July 27th.

by Calculated Risk on 7/20/2010 01:07:00 PM

From Treasury: HAMP Servicer Performance Report Through June 2010

Click on table for larger image in new window.

About 389 thousand modifications are now "permanent" - up from 347 thousand last month - and 521 thousand trial modifications have been cancelled - up sharply from 430 thousand last month.

According to HAMP, there are 364,077 "active trials", down from 467,672 last month. There is still a large number of borrowers in limbo since only 235 thousand trials were started over the last 5 months. I expect another large number of cancellations in July.

The second graph shows the cumulative HAMP trial programs started.

Notice that the pace of new trial modifications has slowed sharply from over 150,000 in September to just over 15,000 in June (down from 30,000 in April 2010). This is the slowest pace since the program started, probably because of two factors: 1) servicers are now pre-qualifying borrowers, and 2) servicers are running out of eligible borrowers. The program is winding down ...

Debt-to-income ratios

If we look at the HAMP program stats (see page 3), the median front end DTI (debt to income) before modification was 44.8% - the same as last month. And the back end DTI was an astounding 79.9 (up slightly from last month).

Think about that for a second: for the median borrower, about 80% of the borrower's income went to servicing debt. And the median is 63.7% after the modification.

And that is the median - and just imagine the characteristics of the borrowers who can't be converted!

Summary:

Another large number of trial programs were cancelled. This will mean more foreclosures (or short sales) in the near future.

A large number of borrowers are still in modification limbo, so there will probably be more cancellations coming.

The program is winding down quickly (only 15,000 new trials started in June).

The borrowers DTI characteristics are poor - suggesting a high redefault rate over the next year or two.

Note: On page 3, HAMP added the delinquency rates for "permanent" modifications. As an example, 5.9% of borrowers are 60+ days delinquent six months after their modifications became "permanent". Over 8,800 "permanent" modifications have been cancelled, and only 195 have been paid off (probably sold property). The others probably are in foreclosure (or other distress sale).