U.S. housing gains momentum but recovery fragile

NEW YORK Thu Nov 29, 2012 11:44pm GMT

NEW YORK (Reuters) - The signs of life in the U.S. housing market may be encouraging, but not all money managers are convinced that rising home sales and values can provide serious momentum to the U.S. economy in 2013.

The still unresolved issue of some 10 million underwater mortgages - where the amount owed is larger than the current value of the house - remains a key impediment, said speakers at the Reuters Global Investment Outlook 2013 Summit in New York.

Also weighing on the nascent housing recovery is the possibility that the popular home mortgage interest deduction - used by millions of Americans when assessing their taxes - will be capped or otherwise reduced as part of efforts by lawmakers to avert the "fiscal cliff."

The White House and Congress are negotiating to avert the fiscal cliff or combination of U.S. government spending cuts and tax rises due to be implemented under existing law in early 2013 that may cut the federal budget deficit but also tip the economy back into recession.

The housing sector has been a point of relative strength this year in an economy beset by flagging business confidence and cooling demand from abroad.

A report last week showed a surprisingly sharp gain in home resales in October, while data this week showed prices for single-family homes have risen continuously since February. Economists expect home construction to add to economic growth this year for the first time since 2005.

"I think we're clearly in a (housing) recovery. All the metrics point in that direction," said Rick Sharga, executive vice president at Carrington Mortgage Holdings, a firm that has been buying up foreclosed homes in distressed markets and renting them out.

He quickly added: "But we're not exactly in a real estate boom, and there could be two or three years of marginal growth still to come."

Sharga pointed to positive trends in existing and new home sales, rising prices and falling foreclosures, and less tangible elements such as pent-up demand from new household formation.

HEADWINDS IN HOUSING

But the risks to the housing market's comeback are mounting.

If the mortgage interest deduction is reduced, it could crimp the appreciation in home prices as it will impact the amount of dollars would-be homeowners can borrow. The popular deduction makes it easier for homebuyers to borrow larger sums of money because interest on the loan can be partially deducted from their tax bill.

Pew Charitable Trusts has estimated that the mortgage interest deduction saved taxpayers about $80 billion in 2010, with tax breaks skewed heavily to those making over $100,000 a year.

There are other headwinds facing housing in the new year.

Difficulties in getting a mortgage despite rock-bottom interest rates remain a stumbling block, especially for young buyers who typically dominate the market for first-home buyers, strategists said.

But at least the jobless rate for younger adults, in the 25- to 34-year-old range, is starting to fall, noted Jeff Kronthal, managing partner at the hedge fund KLS Diversified, who offered a moderately upbeat housing outlook.

"Do I think housing is going to go back through the roof? No. But I do think housing is going to go up in the next couple of years," Kronthal said.

Nationally, beaten-down home prices are only getting back to 2003 levels, Sharga noted.

But the Case Shiller figures underlined how there is really no "national" housing market but a series of local markets whose fortunes are often not aligned.

The year-on-year gain in home prices in Phoenix, for example, was 20 percent as that city recovers from some of the worst losses in the 2008-2009 market slump. Certain other downtrodden cities, including Detroit, also posted brisk gains.

Some strategists and policymakers continue to look for large-scale solutions to the hangover of the housing bubble, including potential principal writedowns of underwater loans.

"Developments over the last six months may have reduced the problems, but they are still in the hundreds of billions of dollars," said Damon Silvers, a policymaker with the AFL-CIO.

"If you don't reset debt to have some relation to the current value it will be an ongoing and huge drag on the economy," Silvers said, continuing to hamper consumer demand and impair labor mobility.

But Sharga said that with most holders of underwater mortgages still making monthly payments and housing values slowly, if selectively, rising, forced principal balance reductions were too blunt a tool.

"If I'm 10 percent underwater and the market is appreciating 5 percent a year, I'm not really underwater," he said.

Data firm CoreLogic said in September that some 10.8 million U.S. houses had underwater mortgages in the second quarter, about 22 percent of all U.S. homes with a mortgage.

That was down from 11.4 million properties, or 23.7 percent, three months earlier.

The firm said about 1.8 million of borrowers currently underwater would be back to equilibrium if home prices rose 5 percent.

JOBS, JOBS, JOBS

Underwater, or upside-down, mortgages are heavily concentrated in Nevada, Arizona, Florida, Michigan, Georgia and California.

Homeowners with upside-down mortgages typically cannot refinance and thus benefit from ultra-low mortgage interest rates, which have helped millions of other mortgagees cash flow in recent years.

Bonnie Baha, senior portfolio manager at DoubleLine Capital in Los Angeles, said meaningful gains in housing still rested on bringing down the U.S. jobless rate, currently at 7.9 percent.

"We need more jobs so that people can buy homes. You see anecdotal evidence that the real estate market has bottomed, but until now it has just been a series of dead-cat bounces," Baha said.

And John Brynjolfsson, managing director of the hedge fund Armored Wolf, said that housing alone was not strong enough to create a virtuous circle of economic activity.

"A huge proportion of the lending being done is by the Federal Housing Authority, and focused on the areas with the highest defaults and highest delinquencies. That makes me wonder if the current prices are really sustainable, or if they are being propped up by mortgage lending itself which was the genesis of the 2008 crisis," he said.

Added Jason Ader, CEO of Ader Investment Management, who has invested in foreclosed homes in Arizona and sold them earlier this year for a profit, said he believes some housing markets have been propped up by institutional investors buying up distressed homes, not new homebuyers coming into the market.

(For other news from Reuters Global Investment Outlook Summit, click here)

(Reporting by Ros Krasny; Editing by Jennifer Ablan, Matthew Goldstein and Phil Berlowitz)

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