Spurred on by a last minute rush to get in on the “first-time home buyer” tax credit, sales of existing homes jumped by 9.4% in September to a seasonally adjusted annual rate of 5.57 million, up from 5.10 million in both August and September of a year ago.

Rapidly plunging mortgage rates also played a role, with the average rate at 5.06% in September versus 5.16% in August and 6.04% a year ago. Both single-family homes and condos saw sharp increases in sales activity, with the rate of single-family sales rising to 4.89 million from 4.47 million in August (up 9.4%) and from 4.54 million a year ago (up 7.7%). Condo sales were up 9.7% on the month to an annual rate of 680,000, and they soared 21.2% from the annual rate of 561,000 a year ago.

Existing home sales are highly seasonal, as can be seen in the graph below (from http://www.calculatedriskblog.com/) and we are past the most active part of the year. However, not only were the actual non-seasonally-adjusted sales higher than the corresponding month a year ago higher for the fourth straight month, for the first time they were higher than two years ago.

Even better news was found on the inventory side, as the number of houses for sale fell 7.5% from last month to 3.63 million, which is also down 15.0% from a year ago. Combined with the higher sales rate, that put the months of supply at 7.8 months, down from 9.3 months in August.

This is a huge drop, but as can be seen in the second graph (also from http://www.calculatedriskblog.com/) we are still far above the 4 to 5 months level that was considered normal earlier in the decade. That was mostly bubble territory, so the real normal is more like 6 months of supply. We are getting there, but not there yet.

Regionally, all areas of the country did well. On a month-to-month basis the West was strongest with a 13.0% increase, followed by the Midwest (up 9.6%), the South (up 9.0%) and finally the Northeast, up 4.4%. On a year-over-year basis, though, the Northeast is actually the strongest (up 11.8%) followed by the South (up 10.8%) then the Midwest (up 7.8%) and then finally the West (up 5.7%).

The South is by far the most important region when it comes to housing, with Dixie responsible for 37.0% of all used home sales in September. However, it is not as lopsided as with new home sales, where the region is regularly responsible for more than half of all new home sales.

The one fly in the ointment for the report was that prices continued to move down relative to a year ago. Nationwide, the median price for an existing home was $174,900, down 8.5% from a year ago.

The Northeast remains the most expensive area of the country when it comes to housing with a median price of $234,700, but that is down 7.0% from last year. The West is the second highest priced regions at $219,000, even though prices are down 15.0% from a year ago. The median price for an existing house in the South was $153,500, down 7.6%. The Midwest remains the cheapest place to live in the country, with the median price for a house at $147,000, down just 1.0% from a year ago.

While the official inventories are down, I am still concerned about the “shadow inventory” out there. Banks have been slow to foreclose, in part due to political pressures, but also because if they do so, then they are going to have to book the loss. Instead, they are trying to modify the mortgages through the HAMP program, which allows them to “extend and pretend” that the mortgages are still performing just fine.

In the meantime, more and more people are falling behind on their mortgage payments. In a separate report, Freddie Mac (FRE) reported that delinquencies jumped to 3.33 percent of its book of business in September from 3.13 percent in August and 1.22 percent in September 2008. Those are not just one payment late, but delinquencies of 90 days or more.

As the third graph (from, where else?, http://www.calculatedriskblog.com/) the rise in delinquencies has been relentless and shows no signs of slowing. One of four things has to happen. Either all these folks who are behind on their mortgages will have to:

1) Come up with the cash to back to current

2) The mortgage must be modified in a way that people can afford the house, resulting in a big hit to the value of the mortgage to the bank by either cutting the interest rate and or principal on the mortgage

3) The banks and ultimately Freddie — and Fannie Mae (FNM) — will just have to let people continue to live rent- and mortgage-payment-free indefinitely

4) Or there will have to be another wave of foreclosures.

While option three seems to be very popular right now, especially among homeowners, it does not seem like a situation that can last indefinitely. The HAMP program is aimed at making modifications, but a huge number of modified mortgages later go into re-default. With unemployment at 9.8% and still showing signs of rising, the first option is not all that likely. Thus we have to expect another huge wave of foreclosures coming down the road. Those will become distressed inventory.

The first-time home buyer credit does seem to have stimulated sales. However, as we saw with the Cash for Clunkers program, as soon as the program ends, sales are likely to plummet. In the meantime, the program is extremely expensive at a time of soaring budget deficits — far more expensive than was Cash for Clunkers.

Unlike the C4C program, the tax credit does nothing to reduce the existing supply of housing units, or to encourage greater household formation. All it does is shift people from being renters to being buyers. When the rental vacancy rate is soaring, this just means that rents are going to head lower. This In turn will undermine housing prices, since the price of a house over the long term has to be related to the cost of renting an equivalent house across the street.

You can also think of rent avoided as being the cash flows you get from that asset called a house. What will happen is more commercial real estate trouble, which will cause massive problems for the smaller community banks.

In addition, the tax credit problem has been riddled with fraud, including 4-year-olds being first-time home buyers (of course he is a first-time home buyer — he didn’t want to buy that 3-bed, 2.5-bath house until he could go potty by himself).

The other even bigger government support to the housing market are the massive $1.25 Trillion purchases of mortgage-backed securities by the Fed, which is artificially holding down mortgage rates, and the FHA acting just the same way that sub-prime mortgage brokers were a few years ago. The are allowing people to use the tax credit as a down payment and then only requiring 3.5% down.

In other words, you can buy a house and walk away from the closing with a check in your pocket. In any area where house prices are still falling, this is almost guaranteed to result in massive numbers of future delinquencies and foreclosures. The coming bailout needed for the FHA will rival the size of the Fannie and Freddie bailouts.

Still, at least all this massive government support is having some effect, and this was a much better-than-expected report.
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