39% of Housing Extremely Overvalued

A new report from Global Insight/National City (pdf) finds that a growing percentage of U.S. housing markets are "extremely overvalued" and are at risk of falling prices.

Summary:

• Overvaluation became more pervasive during the first quarter of 2006.
• Seventy-one metro areas, accounting for 39 percent of all single family housing value, were deemed to be extremely over-valued at that time. That represents an increase from 64 markets, and 36 percent of all single family market value, during the fourth quarter.
• As recently as the first quarter of 2004, overvaluation was insignificant. At that time only 3 metro areas, accounting for just 1 percent of all single family house value, were deemed to be extremely overvalued.
• The coastal states of California and Florida continue to show the highest concentration of overvalued markets, accounting for 17 of the top 20.
• Quarter-to-Quarter price appreciation is slowing in most metro areas, and is nearly flat in San Diego and Boston.
• Property price appreciation remains strongest among the most over-valued metro areas, and visa-versa (sic). Between the fourth quarter of 2005 and the first quarter of 2006, the correlation between valuation and appreciation was +0.36, suggesting that house prices are diverging, not converging, with respect to normal valuations.
  

EVP at PIMCO Thinks Housing Bubble Will Burst

Mark Kiesel over at PIMCO makes a good case for the housing bubble. He's putting his money where his mouth is: he sold his house and is now renting. Here's a summary:

With rising mortgage rates, housing is becoming increasingly less affordable



Exotic mortgages, designed to keep monthly payments low, have caused many people to buy more house than they can afford:

"Developments in the mortgage market have also increased the presence of marginal buyers in the housing market. This industry has transformed its product offerings in an effort to keep the initial monthly payments on new mortgages as low as possible. The growth in interest only (IO), negative-amortizing (Neg-Am), limited documentation and forty-year fixed rate mortgages attests to the industry’s use of “creative financing” to keep the game going. For example, IO and Neg-Am loans represented 1% of total mortgage organizations five years ago but have climbed to 22% as of 20052. Banks have been able to maintain easy lending standards, despite higher short-term interest rates, by securitizing mortgage loans and transferring the risk to foreign buyers."

What's more, house prices have grown faster than people's income:




Meanwhile, home inventories are booming:

"Housing inventories are becoming a problem. Presently there are almost 4 million homes available for sale nationwide, including 3.383 million existing and 565,000 new homes. Current inventories are at record levels, having risen 27% and 37% year-over-year for new and existing homes, respectively (chart 3). Given declining affordability and rising inventories, we expect to see homes for sale remain on the market longer and asking prices come down. The housing market should quickly transition from a sellers’ market to a buyers’ market."

He continues:

"In summary, the main forces driving housing price appreciation in the past are now softening. Declining affordability, resulting from rising prices and interest rates, has become a significant headwind facing new buyers. Despite the persistence of creative mortgage financing, prices have now risen to a point where demand is slowing. Federal regulators are beginning to crack down on risky lending practices. Speculators are shifting from buyers to sellers. Mortgage application growth is slowing. Finally, and most importantly, the supply and demand imbalance in the housing market is turning sharply for the worse as inventories soar."

And finally, the consequences for the economy overall:

"Housing is a leading indicator of the overall direction of the economy. As housing slows, economic growth will surely follow. As such, we should expect to see tighter terms on credit extension, less liquid markets and a pick-up in the overall corporate default rate over time with a slowdown in the pace of economic growth. An eventual rise in the default rate, combined with higher near-term volatility, should lead to a more challenging market environment for credit. Watch the “for sale” signs – in both the housing and corporate bond market – my sense is more of both are coming as the market transitions from a mode of risk taking to that of risk aversion."

Shortfall At Exxon: All those profits -- but underfunded pensions

I was amazed to read that Exxon has underfunded pensions (via BusinessWeek):

"The fact is, Exxon could be topping off its tank for employees but isn't. It's declining to put more money away for a rainy day while the sun is shining on the oil industry. And it isn't apologizing, either. 'We basically chose not to,' says Gardner. 'That's not an investment we want to put more into at this point. Our financial strength provides excellent security for any pension.' We'll see."

The Gathering Pensions Storm

The Gathering Pensions Storm: "The problem for financial markets is twofold: First, the underfunding in corporate and other pension funds will cause individual firms great hardship, making those with high legacy costs uncompetitive. Second, the underfunding at the state and federal government levels will cause tax hikes, which will alter regional and international competitiveness. We currently estimate that U.S. corporate pensions are underfunded by about $140 billion. Add the cost of other postemployment benefits and the deficit doubles. State pensions are underfunded by $284 billion.

Disturbing as those numbers are, the federal underfunding situation dwarfs the state and private ones. Social Security has a $4.6 trillion shortfall (based on present discounted value of the next 75 years), and the federal civilian and military employee programs are underfunded by $4.5 trillion."

Who Should Pay for the Corporate Pension Shortfall?

Robert Reich, a former secretary of labor, argues that the corporations that created pension plans are responsible for funding them. President Bush agrees with him:

"The President wants a law that forces companies to fully fund their pension obligations to their employees. He’s right."

How big is the shortfall, you ask? And shouldn't the PBGC ensure underfunded pensions are safe? More than 450 billion dollars. Oh, and the PBGC is short on cash, too:

"Corporate pension plans don’t have nearly enough money to pay what the companies have promised their workers. We’re talking big money here -- a shortfall of over $450 billion. And if companies can’t pay up, you know who’s left holding the bag? Not only 44 million Americans who won’t get the monthly pension payments they were promised. You and I and every other taxpayer will also be on the hook.

You see, there’s a government agency called the Pension Benefit Guarantee Corporation that’s supposed to insure most of these promises. But the PBGC itself is already deep in the red, to the tune of almost $30 billion."

Some lobbyists don't agree with the president:

"Lobbyists for big companies argue they shouldn’t be required to fully fund their pension promises. They say that such a requirement will discourage them from setting up pension plans in the first place. That’s like saying drivers shouldn’t be required to stop at stop lights because that might discourage them from driving. If companies aren’t funding their pension promises, they shouldn’t be making pension promises to begin with.

The lobbyists also argue that forcing companies with low credit ratings to pay up faster -- as is only logical, since their underfunded plans are at greater risk -- will push these companies into bankruptcy. But no one is talking about placing new obligations on them. They already owe their retirees this money. Why should retirees be treated differently from the company’s creditors and suppliers, who get paid what they’re owed?"

Let's all hope tax payers won't be the one bailing out underfunded corporate pensions.

The Pension Pinch [American Prospect, June 1, 2006]