The Housing Chronicles Blog: Economists dissect the current housing market

Monday, April 28, 2008

Economists dissect the current housing market

There were three different economists opining at the NAHB Spring Construction Conference. All are hoping that the worst is behind us, but that builders need to adapt, Congress needs to act and sales need to increase so inventory levels are reduced; From the Nation's Building News:

The outlook for housing and the economy should be gradually brightening within a few months, but before there can be any assurance that the worst of the downturn is over, there needs to be a pickup in home sales, according to panelists at NAHB’s Spring Construction Forecast Conference on April 24 in Washington, D.C.

Residential production and sales this year have declined “more sharply than anticipated,” said NAHB Chief Economist David Seiders, and the situation for the U.S. economy “definitely has darkened,” with more than an even chance that it has lapsed into a “mild” and brief recession in the first and second quarters.

Seiders said that he continues to believe that new single-family home sales will stabilize during the middle of this year, paving the way for an upturn in late 2008 and in 2009 and leading to improvements in housing starts next year. However, “the sales side has to be off the deck before starts stabilize and move up,” he said...

Through March, Seiders said, NAHB surveys of 30 large builders accounting for 25% of sales nationwide, showed “no signs of stabilization, although the rate of the decline may be slowing.” Likewise, the NAHB/Wells Fargo Housing Market Index, which polls builders to gauge their opinion of current sales conditions and demand six months down the road, remains close to its record low recorded in December and “shows no recovery yet, implying further deterioration of sales.”

“We need demand to revive to turn around the market,” Seiders said, and he suggested that a temporary tax credit for home buyers, an approach being considered in housing and economic stimulus legislation on Capitol Hill, could help provide the impetus to boost sales and end the downward spiral in home prices that is the biggest concern for the health of the nation’s economy.

As home prices have declined, he said, “underwater” mortgages with balances exceeding the value of the home have been adding to the deterioration of loan quality that began in the subprime sector last summer. This is “bad for the financial markets,” he said, and could result in further tightening of lending standards, yet more foreclosures and even softer housing demand.

Economists participating in the conference were fairly optimistic that the downward turn in housing prices, while substantial, will taper off before it takes a toll on the longer-range outlook for the economy, but nobody can know for sure, they said...

Nariman Behravesh, chief economist for Global Insight, cited a “sizable risk,” perhaps 30%, that the U.S. will experience a double-dip recession in 2009 because the fiscal stimulus enacted by Congress will pull growth into 2008 that otherwise would not have occurred until next year.

However, the current recession, like the one that occurred in 2001, is far different from those preceding it in the 1970s and 1980s, which were precipitated by high inflation, tightening by the Federal Reserve and rising interest rates.

In 2001, he said, “manufacturers were hammered, but housing was doing okay.” Today, just the opposite is happening, with U.S. export growth strong. Core inflation remains “reasonably stable” at 2.25% and looks headed back into the Federal Reserve’s 1% to 2% tolerance range.

The financial crisis precipitated by the subprime meltdown last summer “is off the front pages,” he said, “and things are calming down a bit; the worst may be behind us.”

The financial markets “woke up last August to the fact that there was a lot of toxic waste out there,” he said. Of the estimated $400 billion in global losses caused by the subprime problem, about $270 billion to $280 billion has already been declared, leaving about $100 billion in write-downs that the markets will have to face and probably be able to handle.

Behravesh added that he is “a little skeptical” of talk about the U.S. today facing the worst financial crisis since the Great Depression. At the height of the S&L crisis 20 years ago, 2,700 financial institutions failed, he said, compared to “very few” so far today.

Also, the Fed “has really cranked things up to calm the financial markets,” including its rescue of investment bank Bear Sterns and stimulative interest rate cuts, which most likely will include an additional one-half percentage point reduction in the federal funds rate before this summer. “I would have to give high marks to the Fed for crisis management,” he said...

Behravesh did, however, cite downside risks to his relatively upbeat forecast for the economy. Among signals that are “flashing yellow or red,” housing remains “a long way off from recovery,” consumer spending “has come to a halt” and will remain weak next year, and, most worrisome, the recovery will be “tepid” once it starts.

Housing sales should start turning around during the second half of this year, he said, concurring with Seiders, and house prices will continue to decline in the next year or so even as housing production improves...

Jim Glassman, managing director and senior policy strategist with J.P. Morgan Chase & Co., noted that the three out of four Americans who now believe that the nation has entered into a recession may well be correct if by that they mean that the economy is “not so great. But if you mean that the wheels are coming off the wagon, I don’t think so.”

If the economy were really falling apart, he said, job layoffs would be accelerating to 500,000 to 600,000 a week; they recently have been in the mid-300,000 range.

“The elephant in the room,” Glassman said, “is what’s going on with home prices,” which is still causing “a lot of stress in the financial markets.”

Home prices are down about 12% since the height of the housing boom in 2005 and incomes have grown 14%, bringing “prices relative to income to about where they were in 2003” during this year’s first quarter, he said. “We have flushed out most of the excess.”

Glassman said his guess is that home prices will decline 5% or so further, but gloomier forecasts foresee another 15% to 20% drop, and what will actually happen is probably somewhere in between those two views. “By fall, we will start to see that most of this is over,” he predicted, but he conceded that he wished he knew “where home prices would settle out.”

Once the economy does show signs of stabilizing, Glassman said it would be a mistake for the Fed to quickly reverse course on interest rates, as some have suggested it should do, because the financial markets will be going through a difficult transition for some time, and this will require a “different monetary policy.”

Last summer’s financial crisis was precipitated by investors discovering that they had assets with exposure to credit risks they hadn’t been thinking about, and this has challenged the concept of securitized finance that has taken hold, he said. It will take a decade to restructure the system and restore the confidence of investors and provide them with the transparency to see where the risks lie...

Glassman also said that prospective home owners will have to return to how their parents bought homes and start saving more money for a downpayment.

“The customer you have known for the past 20 years is not the customer you will know in the next 10 years,” he said, as the economy transitions into a new era that “won’t feel like it has as much oomph.”

The best news for the economy, he said, is that the emerging economies, largely in Asia, are doing fine and providing strong demand for U.S. exports and providing U.S. companies with “spectacular levels of profits.”

“The world has never seen such great economic performance since the dinosaurs,” Glassman said, and as a result, the winds are shifting in favor of regions of the U.S. that rely heavily on exports, including Michigan.

In NAHB’s latest housing forecast, new single-family home sales are projected to decline 21.8% this year, to 605,000, before climbing 18% in 2009 to 714,000.

Total housing starts are forecast to decline 29.5% to 948,000 in 2008 and rise 10.8% to 1.05 million next year. Most of this year’s decline will be concentrated in single-family production, which is expected to drop by 37.1% to 653,000 homes.

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