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Kass: Housing Market Still Drowns in Debt

This blog post originally appeared on RealMoney Silver on May 10 at 7:34 a.m. EDT.

Higher rates of negative equity are creating a lot of latent vulnerability in the housing stock, where if the household then encounters some economic shock, like the loss of a job or divorce or death, then that household is much, much more likely to go into foreclosure. So it just means that with higher rates of negative equity, we are going to see elevated rates of foreclosure for the net two to three years.

-- Stan Humphries, Zillow

The U.S. housing market is in worse shape than it even appears -- a weakened residential real estate market will serve as an important headwind to domestic economic growth in the years ahead.

Moreover, any additional shock or weakness to domestic economic growth and/or employment will have a further adverse impact on housing.

According to Zillow, homeowners are drowning in negative equity, with an all-time high of 28.4% of all single-family home mortgages suffering this plight. The problem is especially acute in Atlanta (55.7% negative equity rate), Denver (41%) and Chicago (45%).

But, in the aggregate, the situation is worse than meets the eye for several reasons.

According to Mark Hanson:

The above statistics rarely include second mortgages or firsts that were refinanced after the purchase, where cash out was pulled and the loan amount was increased, as most negative equity estimates are based on the original purchase price of the house itself. Zillow, for example, uses original purchase prices.

Hanson also points out:

W ith respect to negative equity as it relates to the housing market and repeat buyers, effective negative equity is far greater. This is because to rebuy, a homeowner has to sell, which means paying off the first and second mortgages, paying a realtor 6% and putting 10% to 20% down on the new purchase. When you lower the negative equity thresholds to real life, effective negative equity is epidemic and will keep the organic buyer -- especially at the mid to high end -- at bay for a generation.
I expect the housing market to scrape around the bottom, as affordability is at a multi-decade high, mortgage rates remain low, new-home production is negligible (and housing expenditures as a percentage of GDP is at an all-time low), normal population and household formation growth create latent demand for homes and the benefit of home ownership over renting has widened.
"We see something close to stability at these much-reduced home prices in the medium to lower part of the housing market."

-- Warren Buffett, May 2, 2009, at the Berkshire Hathaway (BRK.A - Get Report)/ (BRK.B - Get Report) Annual Meeting

Many have prematurely called for a recovery in the housing market. (See above Buffett quote made two years ago.)

Unfortunately, they were far too optimistic.

Reflecting the above, foreclosures and badly delinquent loans will serve as a drag upon the industry in the months (and maybe years) ahead.

I now expect another leg down in home prices of at least 5% this year.

I would avoid any housing-related equities, many of which have had their shares rise in expectation of a housing turn, which has not occurred and is not likely to occur anytime soon.

Doug Kass writes daily for RealMoney Silver , a premium bundle service from TheStreet.com. For a free trial to RealMoney Silver and exclusive access to Mr. Kass's daily trading diary, please click here.

At the time of publication, Kass and/or his funds were long BRK.B, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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