Economic Issues - Part III

Current Conditions

Current market conditions can be described by a fairly simple demonstration of supply and demand. Supply (the number of homes on the market) conditions are being influenced by the increasing amount of foreclosures and defaults, new construction, natural home sales (not attributed to default), and a slowing purchasing rate.

Demand factors (the number of buyers consuming the supply) include low interest rates, home price depreciation, a borrower’s ability to obtain a loan, unemployment rates, income levels, and perception of market conditions.

Low interest rates typically increase demand. The Fed has been consistently dropping its target rate since September 2007. Although rates are low and money is cheap, this is having very little effect on demand due to liquidity problems. Banks are simply unwilling to take on risk by lending out cash. Banks are utilizing all the liquidity they can get their hands on to cover losses from poor lending decisions in the past. This increases the gap between the target fed funds rate and the actual lending rates. As banks are forced to raise their lending standards the pool of qualified buyers significantly decreases, further decreasing demand. The same problem exists with decline in home prices. Other macroeconomic factors such as unemployment and perception further decrease the pool of potential borrowers.

Foreclosures from sub-prime and option ARM borrowers are flooding the housing market with new inventory every day. Just a small amount of new home construction contributes to building inventories, currently at a seasonally adjusted rate of just 625,000. This indicator is at its lowest level since the US Census Bureau started tracking it in 1959. Inventories are building as demand continues to plummet.

The problem continues to grow. The current situation is bad. Adding in the potential $600 billion, or more, defaults yet to come has the potential to throw our economy into the worst depression it has ever seen.

Buyers and sellers are failing to come together in a way that makes the home purchasing transaction possible. Sellers can’t afford to take the loss of making up the difference between a realistic selling price and the value of their home, so they walk away and let the bank take care of it. Potential buyers can’t qualify for a loan because banks are simply unwilling to take more than a small risk in lending. Although the prospect for a resolution seems minute, there is a solution.