April housing market reports were mixed. New home sales were up nearly 8% and were 8% above the trailing 12 month average. But permits and starts declined to slightly below the 12 month average. New home prices ticked up in April but appear to still be in a mild declining trend. Inventories of new homes for sale continue to shrink from already record low levels. This has reduced the months’ supply of new homes for sale to 6.5 which is the lowest reading since late 2006 except for several months during the homebuyer tax credit period.

Homebuilders have cleaned up the mess on their side of the fence. They have reduced prices and cut starts and inventories to approximately match the current depressed market conditions. Homebuilders will respond quickly to the improvements in demand expected in 2011-12. Housing demand growth will be modest because it is derived from the subpar economic growth. The forecast is for the pace of economic growth to rise to 3% or more in the second half of the year after a sluggish start in the 2% plus range. Hence, new home permits, starts and sales are expected to increase at a progressively rising pace through 2012.

Nonetheless, the housing recovery will continue to be slow compared to recent housing recoveries because more mess remains to be cleaned up by current homeowners, by mortgage originators and mortgage investors and by the legal system that processes defaulted mortgages. Housing starts are projected to reach 665,000 in the final quarter this year and 949,000 by the final quarter of 2012.

The restraints on starts from the existing home market, the mortgage market and the legal system worsened slightly in April and early May. The outlook for these restraints is to ease very gradually over the next two years. Until they are gone, they will partially offset the boost to starts coming from rising employment, expansionary monetary policy and the reduced inventory of new homes for sale. Existing home sales dipped slightly in April but the inventory of existing homes for sale jumped and existing home prices fell significantly after a period of near stability. This is added competition for homebuilders.

The inventory jump is the result of more defaulted homes being put on the market after clearing the necessary legal steps even though fewer defaulted homes are now entering the foreclosure process. 1-2 million more homes with troubled mortgages have yet to be sold at distress prices, at short sales or by the foreclosing lender. Also, the legal process has gotten murkier. Countless programs are in place or being proposed in legislatures or courts at all levels of government that impact the legal handling of defaulted mortgages. Generally, they slow the handling of defaulted mortgages by providing funds to financially troubled homeowners, imposing moratoriums on foreclosures are requiring added legal steps to finalize foreclosures.

In addition to causing foreclosure delays, some of the recent anti-foreclosure initiatives also demand that mortgage originators, lenders, investors and servicers pay several tens of billion dollars to atone for their sins. This is not yet resolved but has the potential to add further restraint on housing starts by siphoning off mortgage capital and prompting a rise in mortgage rates.