Farrell: It's Payback Time for Housing

The housing market had been doing more or less reasonably well until very recently when the world came to the realization that the $8,000 tax credit was going to come to an end. Now, it's payback time. Payback, as we all know, can be a real bitch. Wednesday morning's announcement ofnew homes purchased in May fell to a record low with the expiration of the credit. Sales collapsed 33% to an annual pace of 300,000 from April. That is the fewest since data started being kept in 1963.

Other housing data in recent weeks hasn't been any more encouraging. While new home sales are considered a more timely barometer of market prices, they only account for about 10% of the total housing market. Existing home purchases, the other 90% of sales counted at contract closing, dropped last month to a 5.66 million annual rate. It was just a few years ago that this number was routinely above 2 million on an annual basis...

Housing starts in Maydeclined the most since March 2009 to under 600,000. Mortgage applications, which are filed in anticipation of buying a house, dropped this past month to the lowest level since 1997. Homebuilder stocks have weakened as well, with the Standard & Poor's homebuilder composite off almost 30% since its May high. Joel Rassman, CFO of Toll Brothers builders , said, "Concerns about the financial crisis in Europe and escalating regional political tensions, coupled with worries about the oil spill in the Gulf of Mexico, have negatively impacted the outlook of American consumers."

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That may be, but I think it's much simpler than that.

Unemployment is high, job security is low, and credit conditions are tight.

It's hard to see a double-dip in housing prices not occurring.

The fallback in sales, as a result of the tax credit pulling purchases forward, is not a disaster, and is perfectly understandable.

You would hope sales would bounce back. But I am worried about that possibility in that mortgage applications are at a 13-year low. I may be hoping against hope, but I think a housing double-dip will not be followed by a double-dip in the wider economy, since housing is just a little more than 2% of overall economic activity.

On the good news side of the ledger, while mortgage delinquencies were up 36% in the first quarter of this year versus the prior year, they are actually down 7.5% from Q4. That's the first drop in mortgage delinquencies in well over two years. New mortgage foreclosures in the first quarter were up 18.6% to a bit over 370,000. Oddly, foreclosures going up is a good sign. There are so many houses in "shadow inventory" (homes that are delinquent on their mortgages but not yet foreclosed), that getting them into the foreclosure column starts to reduce the overhang of houses for sale. There is still a long way to go, but this looks to be clearly a beginning.

The Federal Open Market Committee (FOMC) released a dovish statementon Wednesday that leads me to believe that rates are going to be kept near zero, most probably through next year. My buddies at Capital Economics said recently that at the beginning of this year, the market had priced in an expectation of a rate increase sometime in the second half of 2010. Now the market is pricing in a mid-2011 Fed funds rate increase, and expectations are, by the end of next year, the Fed funds will only be at 0.8%. Kansas City Fed president, Thomas Hoenig, voted once again to drop the phrase "extended period" and start hiking rates. I don't know what he could be looking at.

The Fed says the economic recovery is "proceeding." Last meeting, they said the economic recovery was "continuing to strengthen." They are now saying the labor market improvement is gradual. They see financial conditions as "less supportive," and that would be because of overseas developments. The only positive note was they see commercial real estate as "weak," rather than "contracting."

It's hard for me to take any of the above news as reasons for the market to break out of its current trading range on the upside. We're in a trading range and summer is here. Thank God for the World Cup. Otherwise, we'd have nothing to do.