Saturday, July 24, 2010

Housing Bubble Continues To Lose Air

If you've been holding your breath waiting for the housing market to rebound, you should exhale. The air continues to go out of the market as well.

After a 15% drop in May, housing starts fell another 5% in June, according to the Commerce Department. Housing starts are now at their lowest level in eight months and 76% below their 2006 peak.

Despite record-low mortgage rates, demand for housing remains low. For months, the housing market had been on government life support, buoyed by the federal tax credit. Now that the credit has expired, the market has fallen.

With an abundance of inventory available due to foreclosures and short sales, it's no surprise that housing starts are declining. Builders are putting on the breaks. Inventories of unsold new homes stand at 40-year lows.

That's because we are mired in the worst housing downturn since World War II.

However, the market simply isn't going to bounce back to its previous highs. Unemployment is too high to support a renewed demand for housing, and consumer credit has been decimated. A whopping 35% of Americans have credit scores too low to even qualify for a loan.

Home builders are fully aware of this ugly reality and they are very discouraged. The builder sentiment index fell back to a 15-month low in July on the heels of a large drop in June.

In the past decade, housing demand was artificially inflated due to a massive increase in the monetary base — which increased bank lending — and an equally massive cut in the federal funds rate to the lowest level in more than 40 years. Both of these schemes were initiated by the Federal Reserve.

This combination created a false prosperity, which ultimately fueled a false demand.

The deflation of the housing bubble is an ongoing process, and the air will continue flowing out of that bubble for the foreseeable future.

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