U.S. housing slump: Six years and counting
Just as Americans begin to regain some hope that the housing sector might be on the mend, we get another batch of data showing the sector’s not quite there yet.
Groundbreaking on homes fell unexpectedly in March to an annual rate of just 654,000, down from 694,000 in February and well short of the 705,000 Reuters consensus forecast. Some context: permits peaked above 2.2 million in early 2006, at the apex of the housing bubble. On the bright side, permits for future construction rose to their highest level in 3-1/2 years.
In other housing data this week, homebuilder sentiment deteriorated again after posting a pretty decent rebound from the very depressed levels seen in 2011.
Housing healing
More than six years after its spectacular collapse, the U.S. housing market – the laggard of the struggling economic recovery – may be poised for pickup, driven in part by an upswing in remodeling, Bank of America-Merrill Lynch economist Michelle Meyer thinks.
Gains are likely to be modest at first, and are subject to volatility since overall economic growth may well slow in the second half of this year. Also, given the deep hole housing has fallen into, the market is still far from a robust recovery, Meyer wrote in a note to clients drawn from recent research.
Still, some evidence points to the beginnings of an upswing. For one, data already indicate a rebound in spending on renovations. Remodeling will pick up steam as investors convert foreclosed properties into rentals, and homeowners who have held off doing repairs or additions decide the time is ripe, Meyer said.
Stronger housing markets are also likely to be supported by a reversal of declines in household formation, which slowed dramatically as graduates opted to live at home or as people who lost their homes through foreclosures went to live with relatives or friends, she said.
Meyer and her colleagues also see an unleashing of pent-up demand for homes among homeowners who have put off the voluntary move up to a larger or more expensive home:
The long-awaited recovery in one of the most depressed sectors in the economy has begun, but it will be a long journey.
from Lawrence Summers:
It’s too soon to return to normal policies
Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future. Shifts in the economy are rarely forecast and often not fully recognized until they have been under way for some time. So judgments about the U.S. economy have to be tentative. What can be said is that for the first time in five years a resumption of growth significantly above the economy's potential now appears as a substantial possibility. Put differently, after years when the risks to the consensus modest-growth forecast were to the downside, they are now very much two-sided.
As winter turned to spring in 2010 and 2011, many observers thought they detected evidence that the economy had decisively turned, only to be disappointed a few months later. A variety of considerations suggest that this time may be different. Employment growth has been running well ahead of population growth. The stock market level is higher and its expected volatility lower than at any time since the crisis began in 2007, suggesting that the uncertainty hanging over business has declined. Consumers who have been deferring purchases of cars and other durable goods have created pent-up demand. The housing market seems to be stabilizing. For years now, the rate of family formation has been way below normal as young people moved in with their parents. At some point they will set out on their own, creating a virtuous circle of a stronger housing market, more family formation and demand, and further improvement in housing conditions. Innovation around mobile information technology, social networking and newly discovered oil and natural gas is likely, assuming appropriate regulatory policies, to drive significant investment and job creation.
True, the risks of high oil prices, further problems in Europe, and financial fallout from anxiety about future deficits remain salient. However, unlike in 2010 and 2011, it is probable that these risks are already priced into markets and factored into outlooks for consumer and business spending. There has already been a significant escalation in oil prices. The European situation is hardly resolved but is unlikely to deteriorate as much in the next months as it did last year. And market participants report great alarm about the deficit situation. So it would not take great news in any of these areas for them to actually contribute to upward revisions in current forecasts.
What are the implications for macroeconomic policy? Such recovery as we are enjoying is less a reflection of the natural resilience of the American economy than of the extraordinary steps that both fiscal and monetary policymakers have taken to offset private-sector deleveraging -- a process that is far from complete. A convalescing patient who does not finish the full course of treatment takes a grave risk. So too the most serious risk to recovery over the next several years is no longer the possibility of either financial strains or external shocks but that policy will shift too quickly away from maintaining adequate demand toward a concern with traditional fiscal and monetary prudence.
On even a pessimistic reading of the economy's potential, unemployment remains 2 percentage points above normal levels; employment, 5 million jobs below potential; and GDP, close to $1 trillion short of potential. Even with the economy creating 300,000 jobs a month and growing at 4 percent, it would take several years to reattain normal conditions. So a lurch back this year toward the kind of policies that are appropriate in normal times would be quite premature.
Indeed, recent research on what economists label hysteresis effects suggests that slowing could have highly adverse consequences. Brad Delong and I argue in a recent paper that it is even possible that premature and excessive movements toward fiscal contraction by shrinking the economy risk exacerbating long-run budget problems.
How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the eventual return to normality in a world where policy credibility is essential? The right approach is to pursue policies that commit to normalize conditions but only when certain thresholds are crossed. The Federal Reserve might commit to maintain the current Fed Funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a financing mechanism such as a gasoline tax that would be triggered when some level of employment or output growth has been achieved. Tax reform could phase in new rates in pace with the rising economic performance.
You state “Economic forecasters divide into two groups: those who cannot know the future but think they can, and those who recognize their inability to know the future.”
From the tone of this article you apparently belong to the first group.
Lenders still overvaluing properties, Fed study finds
The Fed calls it an “apparent misunderstanding.” Whatever term you prefer, a new Cleveland Fed study makes one thing clear: lenders are still overstating home values. The study focuses on real-estate-owned or REO inventory, which covers properties that are now owned by lenders.
We analyzed sales data from Cuyahoga County, Ohio, and found signs that appraisers, lenders, and investors could be routinely overestimating the property values of foreclosed homes there. We suggest some simple identifiers that can help lenders better estimate home values in weak housing markets. And though we have focused on one county, we believe the situation could be the same in other places. The factors we identify as possible causes of overestimation in Cuyahoga County are likely to be found in many other weak housing markets around the country.
The two Fed economists who wrote the report identify an array of reasons for such overvaluations, ranging from the perfectly innocent to the potentially dodgy:
Lenders may be overvaluing properties because their valuation methods—which they use because they work well in most markets—don’t happen to work well in weak ones. The evidence supports this explanation, since it is not only lenders that overestimate the value of properties acquired in the sheriff’s sale, but all parties, including federal agencies and investors. Proper valuation methods would substantially discount the appraised value of homes in weak markets, bringing the estimates of value more in line with what the property will sell for on the open market. It is important to remember that lenders usually cannot legally enter the home and inspect the interior prior to foreclosure, which would prevent them from detecting hidden defects. But even when they are allowed to inspect the interior, it may not be feasible to inspect each property prior to foreclosure, given the number of foreclosures initiated every year.
Finally, there may be incentives that encourage lenders to overvalue foreclosed properties. Doing so would allow them to shift accounting losses from their loan portfolio to their REO portfolio. Solvency tests and supervisors of financial institutions place less emphasis on REO portfolios than on loan portfolios. This is a function of banks having relatively small REO portfolios in normal times, but always having an active loan portfolio that can be analyzed.
Distress signals from U.S. housing
There was something for everyone in the January existing home sales report. Bulls could point to the level of sales, which reached a 1-1/2 year high, and the decline in housing supply, long an impediment to the sector’s recovery. Bears might focus on the sharp downward revisions to prior months that suggested conditions were improving but from considerably more depressed levels.
But one nugget in the report was unequivocally bad: the proportion of distressed sales surged to 35 percent from 32 percent, a considerable one-month rise. For Michael Meyer, economist at Bank of America-Merrill Lynch, this means existing home sales numbers have become less reliable:
We think that simply looking at existing home sales is an insufficient way to gauge underlying housing demand since the data are heavily affected by investors and distressed sales. The best measure for demand from primary homebuyers is to look at mortgage purchase applications, which have remained sluggish. In addition, we think it is prudent to wait for the spring selling season before making conclusions about underlying housing demand. The winter is typically the slow season for home sales, making the data less reliable. We expect the spring selling season to show some improvement, but we believe it risks disappointing relative to market expectations.
There is also reason for caution about the apparent progress in bringing down high inventories, the glut of supply resulting from the overbuilding of the boom years. Zach Pandl, economist at Goldman Sachs writes:
The ‘months supply’ of homes on the market has declined to the lowest level since April 2006. Although we consider the drop in this measure of inventories a modest positive, we also think it exaggerates the improvement in excess housing supply.
Active listings — which are what the existing home sales report measures — decline if a house is sold, but also if a current homeowner pulls their home off the market. They can also be held down by prospective home sellers who decide not to sell due to weak demand conditions. Available data suggest that the latter two factors may have been an important reason behind the improvement in existing home inventory and months supply.
We continue to think that the appropriate way to measure the overhang in the housing market is through excess vacancies: the number of homes currently sitting empty above and beyond the normal frictional or seasonal level of vacancies. Here we see some improvement, but progress looks much more gradual.
In Bernanke’s schedule, a hint of housing-linked QE3
Federal Reserve Chairman Ben Bernanke has made clear the central bank is considering another round of monetary stimulus. Fed officials have also suggested that if they were to embark on a third round of quantitative easing via bond purchases, or QE3, they could favor mortgage-backed securities in an effort to boost housing.
Not to read too much into anecdotal evidence, but it’s hard not to see some symbolism in Bernanke’s next public appearance, announced late on Thursday. On February 10, Bernanke will be in Orange County, California, one of the epicenters of the U.S. housing crisis. His chosen forum? The National Association of Homebuilders International Builders’ Show. The topic: Housing Markets in Transition.
Two cheers for financial innovation
Protests against Wall Street and the U.S. financial system are hanging over an annual gathering of economists and social scientists in Chicago. Yale economist Robert Shiller offered two cheers for capitalist finance, saying that while the U.S. free market system has contributed to higher living standards, the vehemence of the recent public outcry points to a need for greater democratization. This is how he put it in a speech:
Occupy Wall Street … was something that in some sense you could see coming. I think we have increasing concerns about inequality, which is getting worse, about the distribution of power.
But rather than throw the financial system out, Shiller called for tinkering. Financial institutions and structures such as insurance or mortgage securitization have a role in improving social and human welfare, Shiller argued. U.S. economic success is due to a financial system that has evolved over centuries and helped improve the quality of life, he added. A shortcoming of the Occupy Wall Street movement is that it doesn’t accept those contributions, he said.
Changes in financial structures could make the financial system more responsive to people’s needs, said Shiller. For example, a new type of corporate entity that is allowed in six U.S. states – the “benefit corporation” – could provide incentives for firms to link success more closely to improvements in social welfare. This charter allows the for-profit companies to explicitly pursue a social purpose as well as its business goal. By law, regular corporations have a fiduciary responsibility to their shareholders to be profitable, while a benefit corporation also has some accountability, overseen by a third party, to perform a public good.
Shiller also wonders why there can’t be a mortgage that has automatic work-out provisions built in. Such a mortgage could require changes to terms and conditions if the borrower experienced job loss or other financial strains. The lender would price in the possibility of such losses at the beginning and cautious borrowers might be willing to pay a higher price for the insurance, Shiller said. In effect, a 30-year fixed rate mortgage is a similar instrument, since it allows lenders to pay a higher interest rate for a long-term loan that that they can refinance.
To contain income disparity, there could be a tax indexed to inequality, the Yale professor suggested. When the income of the top 1 percent of U.S. wage earners exceeds a certain multiple of the nation’s median income, the tax would kick in. In 2006, that multiple was 36, up from 12.5 in 1980, he said.
Shiller was not subject to the “mic check” interruption that the Occupy movement uses to disrupt some public officials’ speeches. But some thought he was taking too rosy a view of the benefits of the financial system and the public’s willingness to view financial executives sympathetically. Reynold Nesiba, an economics professor at Augustana College in Sioux Falls, South Dakota, said:
Conflicting signals for U.S. economy
As 2011 draws to an unspectacular close, U.S. economic data are sending thoroughly mixed messages about the near-term path of the recovery. That’s not particularly reassuring given the still enormous risks emanating from Europe – but it’s better than the unequivocal weakness that prevailed during the first half of the year.
Consumer confidence offered some reassurance, jumping to an eight-month high in December and showing other encouraging signs as well as Eric Green of TD Securities explains:
The better than expected consumer confidence numbers (64.5) put confidence, like most measures of economic activity, back to the levels of early spring. Views on the labor market, however, look to be rising at a much better clip. The labor differential (between jobs plentiful and hard to get) continued to improve. That measure tracks the unemployment rate very well. It rose in December from -37.4 to -35.1. That remains exceptionally weak, but it is the trend that matters. That trend has improved decisively over the past several months and is now well above the spring levels that averaged closer to -39, and is the highest since the end of 2008.
Still, a much sharper-than-expected fall in U.S. home prices for October, while relatively stale as a data point, was enough to remind the Wall Street crowd that this fundamental source of growth remains in a rut with no end in sight. U.S. home prices peaked in mid-2006 and have since dropped by about a third nationwide, with much steeper plunges in the hardest hit parts of the country.
Nomura’s Aichi Amemiya reminds clients of the foreclosure glut still to hit housing:
The recent positive momentum of home sales data has not carried over into housing prices. The Case-Shiller house price index showed a continued decline on a month-over-month basis in October. The monthly rate of change was -0.62% in October, following -0.66%% in September (Consensus:-0.34%). The pace of the decline was faster than the market expectations. […] An expected surge in foreclosure activity will likely become a burden on prices. Realtytrac, a private online marketplace for distressed properties, said in the recent foreclosure report, ‘November’s [foreclosure] numbers suggest a new set of incoming foreclosure waves, many of which may roll into the market as REOs or short sales sometime early next year.’
Making sense of bounce in U.S. housing starts
Surprise! There’s some life in housing after all. U.S. construction starts and building permits jumped to a 1-1/2 year high in November as demand for rental apartments rose, suggesting a downtrodden housing market may be entering a tentative recovery. But will this be another in a long string of bottom-bounces? Or is it the start of a trend?
Starts surged 9.3 percent to a seasonally adjusted annual rate of 685,000 units last month, the highest level since April last year and well above the Reuters consensus forecast of 635,000. Stephen Stanley at Pierpoint Securities was reticently enthusiastic:
Could it be? Is the housing sector finally beginning to stir? It is a little premature to declare victory, but the data are starting to point to some stirrings in residential construction activity. To be sure, we should not be entirely surprised. New home inventories are far and away lower than they have been in decades.
Still, Stanley was all too aware of the sector’s worst kept secret – a stalled foreclosure process has the potential to delay a broad-based recovery for a while to come.
Of course, there is that nasty little overhang of existing homes associated with the ongoing foreclosure wave. While home buyers are slowly chewing through this problem, much more remains to be dealt with. Nonetheless, as time goes on, foreclosed homes are becoming an increasingly less appealing substitute for a new home. Some folks simply want to live in a new house, and for them, a foreclosed home won’t do. As a result, I am not surprised that housing starts, new home sales, homebuilders’ sentiment, etc. are starting to move somewhat higher even though the foreclosure problem is not yet completely resolved.
Another caveat on the rosier-looking figures, from JP Morgan analyst Daniel Silver — the key sources of improvement in the report came from multi-family starts, which he says tend to be more erratic. Some more details from Silver’s research note to clients:
These increases were largely driven by sizable gains related to multifamily starts and permits, but single-family starts and permits increased as well during the month. Although single-family starts and permits remain depressed by historic standards, there has been some modest improvement in the data over the past few months. […] Other data on mortgage purchase applications and homebuilders’ sentiment (reported separately) signal that we could see some more improvement to come; however, the November gap between permits and starts in permit-issuing areas points to a slowdown in single-family starts in the very near term. Multifamily starts and permits have trended higher throughout most of the recovery, though the monthly readings are often volatile.
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Falling home values adding to local budget woes: Cleveland Fed
The U.S. home price drop is adding a further drag on local budgets by shrinking the property tax base, according to a new study from the Federal Reserve Bank of Cleveland.
That sets the current episode apart from other recessions, where rapid housing rebounds alleviated some of the budget pressures naturally associated with periods of contraction. The report’s authors, economists Thomas Fitzpatrick and Mary Zenker, explain:
During and after earlier recessions, home prices remained flat or increased. Stable home prices provide stable tax revenue, which is used to fund many critical city services, such as the local police force, fire department, public education, and infrastructure projects. The fall in property values that began in the recent recession — and that continues in many markets today — may be amplifying the budget crises across the country because of the decline in property taxes it is causing.
Regardless of the fact that the housing market is at pathetic levels historically, the builder data showed the rebound off the lows to be on track. http://bit.ly/IYSxuj
The headline number indicated an annualized decline of 44,000 for total starts, or a monthly rate of decline of 3,666. Most of that was due to multifamily starts, which are wildly volatile. Drilling down into the data, single family starts actually rose by 7,300 units in March, which is a far cry from the headline number implication that the housing market is falling apart. Single family starts normally increase in March and this March was weaker than usual, but is that a bad thing?
It seems that Wall Street analysts forget the law of supply and demand. Fewer starts mean reduced supply, especially considering the incipient rebound in housing demand, however small. Reduced supply versus increasing demand eventually leads to equilibrium, and ultimately to rising prices if those trends continue.
http://bit.ly/HVHH50