Bottoms Away

David Leonhardt proves a tease today, with a piece which opens with a chart showing home price to income ratios returning to normal for most markets and closes by telling readers that prices are going to keep falling. His evidence for this comes, in part, from a bit of auction watching:

The winning bid on the first home auctioned off, a two-bedroom townhouse in Virginia Beach, was $115,000. Just last July, it sold for $182,000, according to property records. A four-bedroom brick house with a two-car garage in Upper Marlboro, Md., went for $375,000. Last year, it sold for $563,000.

Leonhardt says such bids won throughout the auction, and I'll take his word for it. Still, you have to wonder whether someone who decided to buy in mid-2008 and who then defaulted almost immediately was bidding scrupulously. I also think it's not necessarily correct to think that prices at these auctions are indicative of the underlying values of the homes. Leonhardt continues:

As is often the case at these auctions, the seller of the condo -- Fannie Mae -- retained the right to refuse the winning bid and keep the property. But Mr. Houtkin told me he was optimistic his bid would be accepted. An R.E.D.C. employee suggested to him that $30,000 wasn't much below the minimum price that Fannie Mae had hoped to receive.

How could that be? Because Fannie Mae, like many banks, is inundated with foreclosed properties. In recent weeks, banks have begun accelerating foreclosures again, after having held off while waiting to find out which homeowners would be eligible for the Obama administration's assistance program.

This is basically forced selling into a frightened market. As Leonhardt says, this makes for a bad dynamic, where markets are overwhelmed generating rock bottom prices, which pushes some new homeowners into default while encouraging potential buyers to hold off on a purchase since prices are still falling. Obviously, banks don't feel like managing and maintaining huge holdings of single-family homes, but this behavior is very costly -- must as asset fire sales during crisis are costly -- and it's likely that if they could be avoided, everyone would be better off.

But to return to a point discussed yesterday, consider this:

Last week, JPMorgan's chief financial officer told Eric Dash of The New York Times that JPMorgan, and presumably other banks, would be under pressure "until home prices stabilize and unemployment peaks." As long as home prices are falling, foreclosures are likely to keep rising and the toxic assets polluting bank balance sheets are likely to stay toxic.

I'm of the opinion that we're actually pretty close to the point at which local fundamentals begin to reassert themselves, and some cities with less inventory overhang see prices stabilize while others continue to see declines for some time. Unfortunately, the places where prices stabilize earliest are not likely to be the places that have been hit hardest by foreclosure -- the real bubble hotspots:

Six of the nation's top 10 metro foreclosure rates in the first quarter were in California, according to RealtyTrac. Merced ranked second with 4.2 percent of households in some stage of default. Stockton was fourth at 3.7 percent and Riverside-San Bernardino-Ontario was fifth at 3.5 percent. Modesto, Bakersfield and Vallejo-Fairfield ranked sixth through eighth...

Florida's jobless rate jumped to a record 9.7 percent in March. The state's Cape Coral-Fort Myers area was third on RealtyTrac's foreclosure list with 3.9 percent of households receiving a notice. Port St. Lucie ranked 10th.

At ninth on the list was Phoenix-Mesa-Scottsdale, Arizona...

The question is this -- if home prices and unemployment stabilize in most markets in the near future (within a year, say), but deterioration in the worst markets continues, adding to ever greater rounds of defaults and foreclosures, then what will the effect on Wall Street be? Do we need not simply the national housing market, but specifically the California and Florida housing markets to right themselves before banks can be sure that they're out of the woods?

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/contributors/Ryan-Avent