Housing has likely bottomed. New bubble forming?

I hate to be the bearer of bad news, but as I'm sure you're already aware, almost all data seems to be indicating a bottom in housing.

Despite the claims of the Calculated Risk blog (which I have echoed), the bottom appears to have occurred simultaneously in permits, starts, sales, and prices.

The bottom also appears to have occurred simultaneously in nearly all parts of the country. The S&P/Case-Shiller seasonally-adjusted home price index shows month-over-month increases in price for 15 of the 20 metropolitan areas it tracks, including here in the Washington, DC area.

The bottom in housing is coinciding with the bottom of the economic cycle (i.e. the end of the recession).

Housing permits:


Housing starts:


Housing prices (via Rebecca Wilder):

There is a somewhat strong possibility that the $8,000 first-time home buyer tax credit, which ends November 30, is creating a false housing bottom.

By transferring wealth from some taxpayers to others (apparently a Democratic Party specialty), the tax credit is creating artificial housing demand. As confirmation of the effect of this wealth transfer, we can observe a similar pattern in auto sales due to the Cash For Clunkers program. Cash For Clunkers artificially stimulated auto sales by rewarding gas guzzler owners with a $3,500-$4,500 tax credit to buy slightly less gas guzzling vehicles. (We fuel-efficient car owners get to pay the tab via our taxes.)

Low mortgage rates are also stimulating housing demand. Mortgage rates today are lower than they were earlier in this decade when they helped fuel the housing bubble. These historically low mortgage rates are likely to remain low for some time, as the Fed and Treasury do everything they can to strengthen the economy.

Just as the Fed happily encouraged a housing bubble to stimulate the economy after the 2001 bubble burst-caused recession, I fear it will happily encourage another bubble to stimulate the economy after this one. As the stock market demonstrated earlier this decade, a new bubble can form before the previous one completely deflates.

Stock market double-bubble:


The big question is, what is the primary driver of current housing activity? Is it the $8,000 tax credit, which will go away soon, or is it the historically low interest rates, which won't?

The Cash For Clunkers program, and the fact that housing activity is much stronger at the low end of the market, suggest that perhaps the $8,000 tax credit is the primary driver. Low mortgage rates should equally encourage sales of all conforming mortgages, regardless of price. By contrast, the tax credit should heavily favor low-end sales. This is because an $8,000 tax credit is 10% of the cost of an $80,000 house, but only 2% of the cost of a $400,000 house. The fact that new home buyers are currently making up a disproportionately large percentage of home buyers is further evidence of the first-time home buyer tax credit's effect.

That said, as the tax credit stimulates housing activity and prices, it may change market psychology. Rising prices and low mortgage rates may then encourage others to jump on the bandwagon, causing yet another housing bubble before the current one has fully deflated. I can't predict the future, but this is a possibility that worries me.

What could prevent such a scenario? If Nouriel Roubini's warning that the economy may experience a double-dip recession comes to pass, then that will likely knock the wind out of the housing market a second time. However, the upward sloping Treasury yield curve—the most reliable and far-sighted leading economic indicator—suggests this will not happen.

Rebecca Wilder expects home sales to surge in the next few months as the end of the tax credit nears. Due to data lag, we likely won't know until spring 2010 whether home prices continue falling after the tax credit expires.