The housing recovery mirage

Shares of Toll Brothers (TOL) are still lower when where they were a year ago. But the stock has surged from its March lows, helping to lead a rally for the rest of the building group. (XHB)

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NEW YORK (Fortune) -- Is the housing bust over?

Shares of Toll Brothers (TOL), Hovnanian (HOV) and KB Home (KBH) and other builders have surged. The exchange-traded fund that tracks the group has nearly doubled since March.

Home starts have risen for five straight months, while sales of new homes recently hit their highest level since last September. Prices are up as well: the Case-Shiller index of national house prices rose 2.9% in the second quarter, ending a three-year decline.

These signs -- as well as anecdotal reports about house shoppers growing more willing to write a deposit check -- have executives at homebuilding firms declaring the worst is over.

"We believe declining cancellations and more solid demand indicate that the housing market is stabilizing," Toll Brothers chief executive officer Bob Toll said this month in a conference call with investors and analysts.

But housing boosters have forecast turnarounds repeatedly since the market peaked in 2006, only to be proved wrong by plunging prices. And skeptics say they're wrong again now.

They argue that a deeply indebted consumer, a weak job market, expiring incentives and rising foreclosures spell a quick end to any housing rebound.

"We're entering the phase where the homeowner has to earn his way out of this mess," said Mark Hanson, who runs a California real estate research firm. "This summer is shaping up as the gateway into the next move down."

Hanson attributes the much-ballyhooed recent house price gains to a shift in the types of properties changing hands. Earlier this year, as many as half of all transactions nationally were resales of foreclosed properties, largely at low prices.

Since then, so-called organic sales (those not involving distressed properties) have risen while foreclosure sales have remained stable. This improved mix -- together with cheap financing and a couple of popular tax incentives -- helped to revive prices in some hard-hit areas.

Thus, house prices in California have risen for three straight months, according to data provider MDA DataQuick. Foreclosure sales there have dropped to about a third of recent transactions from a high of 57% earlier this year.

But with schools opening up again and the summer home-selling season winding down, sales by nondistressed sellers are likely to fall in coming months, Hanson said.

Adding to the pressure on prices, the end is in sight (or already here) for some popular housing subsidies. An $8,000 federal tax credit for first-time home buyers is due to sunset in December. A $10,000 California tax credit for buyers of newly constructed houses expired last month.

Another concern is that the housing woes appear to be spreading well beyond the questionable borrowers who were at the center of the first stage of the financial crisis.

While many mortgage defaults in 2007 and 2008 stemmed from frauds perpetrated at the height of the bubble, a greater share of problems now are being driven by the weak job market. That's evident in the fact that more so-called prime borrowers -- those with the best credit histories -- are falling behind on their payments.

Prime fixed-rate mortgages now account for about a third of foreclosure starts, according to the Mortgage Bankers Association. MBA chief economist Jay Brinkmann said in a statement earlier this month this is "a sign that mortgage performance is once again being driven by unemployment."

Some 44% of prime borrowers fell behind on payments last year because they lost a job or income. That's up from 36% in 2006, according to data from Freddie Mac.

Other numbers bode ill for a housing recovery as well. The inventory of houses for sale has come down from a recent peak but remains "high on a historical basis," Office of Thrift Supervision economist Sharon Stark said this month.

"The supply of homes continues to be a drag on home prices and the ability for home prices to recover," she added.

An orgy of homebuilding over the past decade has driven vacancy rates higher. The Census Bureau said 14.3% of rental and owner-occupied housing units were vacant in the second quarter, compared with 9.7% a decade ago.

And Hanson said the pace of foreclosures could soon accelerate as mortgage servicers catch up on foreclosures they have delayed while grappling with new mortgage modification guidelines.

"There could be a big wall of foreclosures once the servicers get running again," he said.

Even Toll, who was talking about housing markets "dancing on the bottom or slightly above that" as long ago as December 2006, has been saying lately that the homebuilders could use a hand -- from taxpayers, of course.

Toll said on a conference call Aug. 12 that the government should consider a Cash for Clunkers type plan for the housing market: giving consumers a rebate to scrap an old home and buy a new one.

Toll argued that a four-month program that offered people $15,000 vouchers for new home construction could "put twice as many people to work, twice as fast as what's being done with the auto industry."

It won't be a shocker if Toll finds some takers in Congress for that one, given the growing jobless rolls across the nation. But legislators might first want to consider how effective such a plan might be.

"It took 10 years to create this problem," said Hanson. "Do people really believe we can correct it all in 36 months?"

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