Tuesday, August 18, 2009

Why July's Decline in Housing Starts is Good News

The Census Bureau, along with HUD, today released it's monthly update on various measurements of new housing construction and related indicators. I'd direct readers to focus on the housing starts figure, as this data series is arguably the most indicative of the future direction of the US housing market. For July, new starts for all categories of residential housing logged in at a seasonally adjusted, annualized rate of 581,000. That number represents a 1% decline from the prior month, and a 37.7% decline from the rate reached in July 2008. Despite being what can be described as the continuation of a sharp decline in new housing activity, today's figures should be construed as positive news for both the economy and the housing market.

Economists talk a lot about the need for an "equilibrium" to be established in the housing market. Basically, this means that excess inventory must be removed from the market so that the supply of housing can be reduced to meet current levels of demand. An equilibrium can also be reached by stronger demand, but in order to remain realistic I'll focus on the supply side of the equation. Clearly, in order to reduce the supply of something, you have to stop producing so much of it. Based upon the chart above, the period between 1959 and the present contained a relatively reliably level to which starts needed to drop in order to compensate for subdued demand. For the most part, housing starts have rarely remained below the 1 million annualized rate for any extended period of time. The current recession however, introduces a destructive wild-card to the equation: foreclosures. There may be some estimates out there, but nobody truly knows just how many foreclosures are sitting on bank's balance sheets. Further exacerbating the problem is that bank's are releasing these toxic properties onto the market in a way very similar to the slow drip of medication from an IV. Moreover, the rate at which this shadow inventory will be released back unto the market is roughly commensurate to the speed at which financial institutions are able to increase earnings growth.

The bottom line is, the faster and further that housing starts fall, the sooner the market will be rid of it's excess inventory. I'd really like to see housing starts drop to the unprecedented annualized rate of between 350-400,000. I'm fairly confident that at that point, we could begin the process of reducing inventory levels that is an obvious pre-requisite to a sustained recovery. The best stimulus measure that the government could have instituted for housing was to purchase vacant homes on a widespread basis, and literally demolish them. For now though, we'll just have to wait for the market to perform the functional equivalent of that idea on it's own. Sphere: Related Content

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