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To Shore up the Recovery, Help Housing

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To Shore up the Recovery, Help Housing ECONOMIC & CONSUMER CREDIT ANALYTICS May 25, 2011 SPECIAL REPORT To Shore Up the Recovery, Help Housing Prepared by Mark Zandi Chief Economist +610.235.5000 To Shore Up the Recovery, Help Housing BY MARK ZANDI he five-year-old housing crash continues to threaten the U.S. economic expansion. Home sales and hous- ing construction remain weak, while house prices are falling again in many parts of the country as foreclo- T sure and short sales are ramping up. It is hard to be enthusiastic about the Although none of these steps are particu- Nationwide house prices are falling again. economy’s prospects as long as house prices larly satisfying or likely to be popular, the The Fiserv Case-Shiller national house price are declining. A house is usually a household’s outcome will be worse if policymakers stand index has dropped by a third since peaking in most important asset; many small-business by while a weakening housing market under- the first quarter of 2006. The fragile stabil- owners use their homes as collateral for busi- mines the economic expansion. ity in prices that prevailed for most of the ness credit, and local governments rely on past two years was broken in recent months property tax revenues tied to housing values. Five lean years as more distressed properties were sold. In Most worrisome is the risk that housing The housing crash is more than five a well-functioning housing market, prices will resume the vicious cycle seen at the years old. Sales of existing homes—a mea- should rise nearly 3% per year.3 depths of the last recession, when falling sure of housing demand—languish near prices pushed more homeowners under an annual rate of 5 million units, of which Economic fallout water—their loans exceeded their homes’ about a third are foreclosures and short Although housing is not the drag that it market values—causing more defaults, more sales. Sales of new homes are even bleaker, was during the worst part of the recession, it distress sales, and even lower prices. That running at a record low rate close to remains a significant weight on growth. This cycle was broken only by unprecedented 300,000 units per year. In a well-function- is particularly disappointing since housing is monetary and fiscal policy support. ing housing market, about a million more often a major source of growth early in an The gloom in the housing and mortgage new and existing homes would change economic recovery. markets notwithstanding, there are reasons hands per year, and less than a tenth would Falling house prices and the resulting to be optimistic that housing’s long slide will be distress sales.1 hit to household wealth remain a serious come to an end soon. While a mountain of Housing construction—the marker for problem. Some $6.5 trillion in homeown- distressed property remains to be sold, inves- housing supply—is even more depressed. tor demand appears strong. Prices have fallen Single- and multifamily housing starts are 3 House prices should grow somewhere between the rate of enough to allow investors to profitably rent out running at close to 550,000 units annual- household income (4% per annum) and overall price inflation (2% per annum). Prices are ultimately determined by their these homes until the market recovers. Rental ized, and manufactured home placements replacement cost, which is equal to the sum of the cost of land vacancy rates have fallen meaningfully over the barely reach 50,000 per year (see Chart 1). and the cost of construction. The cost of land is determined by the opportunity cost of that land or GDP per developable acre. past year, suggesting that new construction is This is the weakest pace of residential con- The growth in GDP per acre is equal to the growth in house- slow enough to let builders work down the still- struction since World War II. A well-func- hold income (assuming that the profit share of GDP remains constant). Construction costs will grow at the rate of overall considerable number of excess vacant homes. tioning housing market would be producing inflation (in the long run, as material and labor costs can vary Nonetheless, the risks remain uncomfort- closer to 1.75 million units annually.2 substantially in the short run). Since the proportion of house prices that are accounted for by land costs varies considerably ably high. Policymakers may thus want to from place to place (a very high percentage in San Francisco and consider taking additional steps to support a low percentage in Des Moines), the growth in house prices will 1 A housing market is considered to be functioning well when also vary considerably. For the past quarter-century or so (the housing temporarily. These might include fa- the broader economy is at full employment and growing at recent boom-bust aside), house prices have been growing at cilitating more mortgage refinancing, delaying its long-run potential rate over the course of the business a rate closer to household income. As the incentives for hom- and housing cycles. eownership steadily increased (pecuniary and non-pecuniary), a reduction in conforming loan limits, and sup- 2 This housing supply is supported by an average annual 1.25 mil- households spent as much of their income on housing as pos- porting more mortgage loan modifications— lion household formations, the obsolescence of 300,000 hous- sible. As these incentives have likely peaked and may very well ing units, and the construction of 200,000 vacation homes. decline, households will devote less of their income to housing, with principal reductions—more aggressively. and prices are likely to grow more closely to the inflation rate. MOODY’S ANALYTICS / Special Report: Mark Zandi / Copyright© 2011 1 ANALYSIS �� To Shore Up the Recovery, Help Housing www.economy.com Chart 1: The Housing Crash Continues Chart 2: Homeowners’ Equity Is Halved 2,400 200 14,000 175 2,000 12,000 Homeowners’ equity has fallen by 150 $6.5 tril from the peak and $1 tril over 10,000 1,600 the past year 125 8,000 1,200 100 6,000 75 800 4,000 50 400 Housing starts, ths units (L) 25 2,000 Case-Shiller® Home Price Index, 2000Q1=100 (R) 0 0 0 75 80 85 90 95 00 05 10 55 60 65 70 75 80 85 90 95 00 05 10 Sources: Fiserv, BEA, Moody’s Analytics Sources: Federal Reserve Flow of Funds, BEA, Moody’s Analytics ers’ equity has been lost in the housing There are other serious but harder to quan- current on other debt obligations—has crash, approximately $1 trillion of it just in tify effects from falling house prices such as risen and now accounts for approximately the past year (see Chart 2). Given our esti- a reduction in labor mobility—an important one-fourth of all defaults. mate of the impact on consumer spending way for the economy to adjust to shocks—and Decisions to default depend critically on from lost housing wealth, this will shave the erosion of retirement savings for low- and expectations about future house prices. If almost a half percentage point from real middle-income homeowners. homeowners think prices will rise, they are GDP growth this year.4 The loss is particu- more likely to hold on; if they believe more larly hard on middle-income households, Vicious cycle price declines are coming, they are likely to which have benefited less from rising Falling house prices could threaten the eco- give up. This can quickly become a vicious stock prices than their higher-income nomic expansion if they become self- reinforc- cycle, as occurred during the depths of the neighbors have. ing, pushing more homeowners under water, recession. Only a massive policy effort broke Shaky house prices have also made it dif- prompting more mortgage defaults and more it. The federal government put Fannie Mae ficult for small-business owners to use their distress sales and thus more price declines. and Freddie Mac into conservatorship and homes as collateral for loans. Bank lending With an estimated 14 million hom- the FHA aggressively expanded its lending. to small businesses has picked up over the eowners underwater, half by more than Even now, the federal government originates past year, but it is hard to see how credit 30%, this is a real possibility (see Chart 3).5 more than 90% of new mortgages. will flow freely until house prices rise again. Adding to the concern, the average under- In addition, conforming loan limits were Since small businesses are a key part of job water homeowner’s debt exceeds market increased and three rounds of housing tax creation, this is a significant impediment to value by nearly $50,000. It does not take credits were enacted as part of the federal a stronger job market. much to induce many in that situation fiscal stimulus. The Federal Reserve pur- Strapped local governments are also to turn their keys over to their lenders; a chased $1.25 trillion in mortgage securities struggling with the impact of falling house leaky roof or broken air conditioner might to bring down mortgage rates as part of its prices on property tax revenues. Despite ris- be sufficient, particularly if rental housing first round of quantitative easing. The gov- ing millage rates in many parts of the coun- is available nearby for less than the cost ernment also took part in the mortgage-loan try, tax revenue is growing near its slowest of the mortgage. Studies based on credit modification effort via the HAMP plan and pace on record.
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