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Eye on the Economy
By David F. Seiders, NAHB Chief Economist

Available indicators suggest that first-quarter growth of real gross domestic product (GDP) is heading toward an annual rate of about 4.5%, even better than the final quarter of 2003 (4.1% according to the preliminary estimate released by the Commerce Department on March 1).

Despite more than two years of positive economic growth, and several consecutive quarters of downright robust growth in real GDP, the U.S. labor market refuses to improve appreciably.

The eagerly awaited employment report for February (released March 5) not only showed unexpectedly meager payroll job gains for that month, the report also revised away some of the meager growth that had been reported for the two previous months. Furthermore, the report continued to show stagnant average weekly hours and average hourly earnings. In addition, the malaise in the labor market was accentuated by further erosion in the labor-force participation rate — reflecting a distinct lack of enthusiasm by the unemployed about job prospects.

Corporate America and Bush economic policies are in the Democrat’s gun sights …

Ongoing efforts by corporate America to boost productivity (output per hour) and to protect profit margins from rising benefit costs apparently are the key factors behind stagnant job growth. And the much-publicized outsourcing of U.S. jobs to low-wage places like China and India also is taking a toll. One of the few components of the U.S. labor market that is showing persistent growth is temporary help services, a type of hiring that can easily be reversed and does not expose companies to benefit costs.

The presumptive Democratic nominee for president, John Kerry, immediately made hay out of the February employment report, decrying Bush economic policies and ridiculing recent White House forecasts for robust job growth in 2004. President Bush and his advisors could only say that things are bound to get better. Most private forecasters, including NAHB, have been scratching their heads and trimming their job growth forecasts (but not their GDP forecasts) for the rest of the year. And it’s now only eight months until the elections!

Chairman Greenspan goes off the reservation to attack the housing GSEs …

Fannie Mae, Freddie Mac and the Federal Home Loan Bank System, the housing-related government-sponsored enterprises (GSEs) have been under fire for about a year, following revelations of accounting and management irregularities that cropped up primarily at the secondary market GSEs (Freddie and Fannie). As a result, fundamental questions have been raised about the adequacy of GSE regulation and capital standards as well as about potential risks posed by GSEs to U.S. and global financial systems and to U.S. taxpayers.

On Feb. 24, Federal Reserve Chairman Alan Greenspan testified before the Senate Banking Committee on the topic of GSEs. The hearing was supposed to focus on the regulatory structure for the GSEs, but the Greenspan’s remarks were much broader than that and contained the following hard-hitting recommendations:

• A “world class” regulator should be established for the GSEs. This regulator should have authority similar to that of the federal banking regulators, including a free hand in determining the minimum and risk-based capital standards for the GSEs.
  
  
• Ironically, world-class regulation actually can strengthen market perceptions that GSE debt is federally guaranteed, expanding the “implicit subsidy” currently enjoyed by the GSEs and paving the way for unconstrained growth in their debt issues and asset portfolios. To counter this unwanted perception and market outcome, the Congress should spell out the circumstances under which a GSE could become insolvent and the position of holders of GSE debt if a company were placed in receivership.
  
  
• Limits should be placed on the volume of GSE debt (and asset portfolios) relative to the volume of mortgages securitized (and guaranteed) by the GSEs. The issuance/guarantee of mortgage-backed securities transfers interest rate and mortgage prepayment risks to the holders of the securities, leaving the GSEs with only credit risk.
  
  
• Constraints on the growth of the GSEs make sense from a housing policy point of view. The GSEs reduce mortgage interest rates by only a fraction of the borrowing cost advantage they enjoy in the markets (according to Federal Reserve research) and the mortgage rate is not an effective channel of federal housing assistance in any case. In this regard, Greenspan argued that downpayment assistance would be a more cost-effective way for the government to subsidize homeownership.

Chairman Greenspan obviously has raised enormous issues and has made highly controversial recommendations. Indeed, the issues and recommendations are so extensive that Congress and the Administration inevitably will find the task of re-regulating and possibly restructuring the GSEs even more daunting than before! It’s always tough to craft and enact major pieces of legislation in an election year, and it now seems even less likely that a major GSE bill will succeed in 2004 — barring more revelations of accounting/management problems at the GSEs.

Federal regulators give conflicting views on fixed-rate vs. adjustable-rate home mortgages …

The home mortgage market is rich in options that range from the traditional 30-year fixed-rate mortgage to adjustable-rate loans that are tied to short-term market indexes (like the London Interbank Offered Rate — LIBOR). The various mortgage options are used by home buyers with widely different planning horizons, different tolerances for interest-rate risk and different needs in terms of affordability. This flexible system obviously has been working quite well. Indeed, great financing conditions shepherded the nation’s homeownership rate to an all-time high at the end of 2003, and the quality of mortgage credit has been very well maintained throughout the current cycle.

Fed Chairman Greenspan dropped bombshells on the mortgage finance system on March 1 when he questioned the economics of the fixed-rate mortgage and argued that many home buyers had somehow been missing the boat by not opting for adjustable-rate loans — even though the ARMs would saddle them with interest-rate risk! This bizarre salvo from our central bank could have been aimed at the secondary market GSEs (Fannie Mae and Freddie Mac) that Greenspan was about to attack the following day on Capitol Hill. After all, the GSEs have been stressing the central role they play in making the fixed-rate mortgage available to home buyers at attractive rates, at all times, in all areas of the country.

In a strange turn of events, the Federal Deposit Insurance Corporation (FDIC) issued a report on March 2 that took a whack at ARMs! The FDIC warned depository institutions that ARMs not only pose risks to home owners when interest rates rise but also pose credit risks to banks that hold these loans. The FDIC is concerned about rising interest rates that could cause house values to fall and provoke mortgage defaults — resulting in net losses to banks when house values fall below mortgage balances.

Both Chairman Greenspan and the FDIC are off base on mortgage products …

By March 2, Chairman Greenspan publicly conceded that he “probably spoke imprecisely” the day before and “did not mean to disparage” fixed-rate mortgages. In fact, the chairman noted that the 30-year fixed-rate home mortgage was a “great invention” in the market. As for the FDIC, the concerns about adjustable-rate loans made by depository institutions in areas where high home prices make fixed-rate loans unaffordable to many prospective home buyers not only represents a backward step on housing affordability but also seems misplaced with respect to credit quality.

Properly underwritten ARMs with periodic rate-adjustment caps should not be a credit quality problem in the context of reasonable forecasts for the economy and interest rates. Furthermore, house values in the places the FDIC is worried about are very well founded on high land values, and theories of house price “bubbles” are retreating into the woodwork as the national economic expansion proceeds. It’s one thing for the FDIC to worry about “sub-prime” lending practices by federally insured depository institutions. But the FDIC should not sully the mainstream ARM market that supports home sales in many high-priced markets.

It’s time to review the key assumptions underpinning NAHB’s forecasts …

NAHB’s short-term forecasts for housing and the economy are grounded on a number of assumptions regarding public policy and developments on the international scene. These are the key assumptions for 2004-2005:

• The Fed holds monetary policy steady until after the November elections (possibly until early 2005) and then slowly raises the federal funds rate over the rest of the forecast horizon.
  
  
• The 2001-2003 Bush tax cuts remain in place and the federal budget deficit begins to recede in fiscal year 2005 as tax revenues rise and discretionary federal spending slows.
  
  
• World oil prices recede from current high levels after mid-2004, despite OPEC’s recently announced production cutbacks. Oil prices will be near $30 per barrel by late this year and near $26 by late 2005.
  
  
• The broad trade-weighted value of the dollar continues to weaken moderately over the next few quarters, but orderly exchange markets are preserved and the Fed will not have to combat a “dollar crisis” with higher interest rates.
  
  
• Productivity growth in the U.S. slows from the recently elevated pace, particularly in 2005 (that’s good for job growth).
  
  
• No major constraints are placed on the growth of the housing-related GSEs, and GSE status is preserved for Fannie Mae, Freddie Mac and the Federal Home Loan Bank System.
  
  
• The markets for fixed-rate and adjustable-rate home mortgages continue to function properly, without interference from federal banking regulators.
  
  
• There are no significant terrorist acts in the U.S.

If our assumptions are on target, the outlook for housing and the economy is bright …

NAHB’s forecasts for 2004-2005 currently contain the following key features:

• Growth of real GDP averages more than 4%, with relatively strong growth in 2004 as stimulus from both monetary and fiscal policy spurs the economy.
  
  
• Broad measures of inflation recede a bit further in 2004 before firming up to some degree in 2005 as the deflation threat passes.
  
  
• Payroll employment growth gathers stronger momentum before long and the unemployment rate gradually recedes across the forecast horizon.
  
  
• Fed policy and a very low inflation environment keep long-term interest rates quite low for most of 2004, but the rate structure moves up more decisively in 2005.
  
  
• Home sales, single-family housing starts and production of condo units in multifamily structures all perform strongly in 2004 and then erode modestly in 2005 as interest rates rise. The real value of remodeling to owner-occupied homes moves up nicely in both 2004 and 2005, supported by ongoing solid increases in house prices.
  
  
• Production and sales of manufactured homes (HUD-code units) crawl out of deep recession but recover only a fraction of the decline posted in the 1999-2003 period.
  
  
• Production of market-rate rental housing gives some ground in both 2004 and 2005, under the pressure of high vacancies and sizeable completions of units still in the pipeline. Total multifamily production holds up reasonably well, however, supported by the condo market and the market for federally subsidized low-income rental housing.

NAHB Chief Economist David Seiders analyzes the economy from the point of view of the housing market every other week in the free e-newsletter, “Eye on the Economy.” The preceding is a reissue of his March 10 edition. To subcribe to “Eye on the Economy,” click here.

Want more economic information? Find it in our publications.

Find more in-depth information in our three economics publications, Home Builders Forecast, Housing Market Statistics and Housing Economics. All are availaible by subscription. 

• Home Builders Forecast includes analysis of single-family and multifamily residential activities, residential remodeling and the full range of nonresidential construction as well as the macroeconomic factors such as GDP, employment and interest rates that drive construction. If your business depends on reliable estimates of housing starts, construction spending and remodeling activity, Home Builders Forecast is designed to meet your needs.
• Housing Market Statistics contains an overview of important developments and trends that serves as an executive summary of the current industry situation. It also contains annotated charts depicting movements in key indicators and tables providing monthly, quarterly and annual data for more than 250 variables.
• Housing Economics provides a rigorous monthly overview of the economy, along with monthly data for more than 100 local markets and in-depth analyses of the niches and nuances of home building markets. Available online or in print, it is written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

To learn more or to order any of these three NAHB economic publications, visit the Economics Publications Information section of the NAHB Web site or call 800-223-2665.

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