Free Falling

Free Falling

Another month and another abysmal report on the housing market. How bad was it? Total December housing starts dropped to a record low for the fourth consecutive month. For the year as a whole, housing starts plummeted below the previous low water mark set back in the dark days of the early 1980s recession (1982 to be exact). Given the precipitous drop in construction activity during the past two years, one would think the supply of new homes would need to increase more rapidly in order to satisfy latent demand. Historically, 1.2 new homes have been built for every new household formed, but during 2007 and 2008 this ratio dropped to an average of 0.9.

This might suggest a modest shortfall in supply and the potential for new construction activity. However, this is clearly not the case since homebuilders see no end to the blood-letting anytime soon. All one really needs to look at is how out of whack supply was relative to real demand during the worst years of the housing bubble. For example, the ratio of housing starts to household formation averaged more than 1.6 between 2003 and 2006. Indeed, a glut of vacant new homes constructed at the height of this period still remains available in many areas. When combined with the erstwhile dubious underwriting standards and a deteriorating labor market that have caused foreclosures to spike, you have a recipe for a swelling inventory of unsold homes that minimizes the need for any meaningful level of new construction for the foreseeable future.

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