Eye on the Economy: Recession Not Imminent
The U.S. economy has been in a slow-growth mode since mid-2006 and that pattern is likely to persist during the first half of this year. The dramatic contraction in housing production (Residential Fixed Investment) exerted the strongest drag on GDP growth during the second half of last year and that pattern is sure to be repeated in the first quarter of 2007. But we expect the housing drag to ease off in the second quarter, and we’re projecting positive contributions to GDP growth from RFI during the second half of the year.
Uncertainties about the impacts of the ongoing housing “correction” on the economy, including a weaker housing wealth effect on consumer spending and fallout from the evolving subprime mortgage debacle, have energized speculation about economic recession in the latter part of this year. Alan Greenspan, the former Fed chairman, recently put a one-third probability on recession in 2007 at the same time that the current Fed chairman, Ben Bernanke, was expressing confidence in the resilience of the U.S. economy.
We stand closer to Bernanke, putting a 20% probability on recession in 2007, although uncertainties surrounding the outlook for housing finance and the housing supply-demand balance are formidable.
Subprime Mortgage Market Moves to Center Stage
The subprime mortgage market, once a small and innocuous component of the huge U.S. housing finance system, grew rapidly during the housing boom and now has stormed to center stage — spewing forth ugly images that have shocked a broad swath of financial markets.
It’s now clear that lending standards in this market deteriorated badly during the frenetic housing boom of 2004-2005 and deteriorated even further while the housing market was heading downhill last year.
Subprime lenders recently have been going out of business in rapid succession and revelations of fraudulent behavior have been surfacing. These cases often involve unregulated mortgage brokers, and the Financial Crimes section of the FBI now is on the job.
The meltdown of the subprime mortgage market definitely is a serious matter for the U.S. housing market, promising to add to a heavy inventory overhang (via foreclosures) and to reduce home sales (via tighter lending standards) at a time when lingering affordability problems still are quite serious.
But the bigger threat is spread of the infection upward — into the Alt-A and prime components of the mortgage market. Recently released data on mortgage delinquencies and foreclosures for the final quarter of 2006 show substantial deterioration in the subprime market and some deterioration in the rest of the market — presumably concentrated in the Alt-A component where interest-only ARMs with little or no documentation of borrower income/assets proliferated during the boom.
About the only saving grace in this story is a flight to quality in financial markets that promises to push rates on prime mortgages below earlier projections for 2007 — as long as credit quality spreads to comparable-maturing Treasury securities hold firm.
Economic Concerns and Financial Market Turmoil Push Interest Rates Downward
Growing concerns about the durability of the economic expansion, combined with the meltdown of the subprime mortgage market and related turmoil in the stock market, have sent huge amounts of funds to the safe haven of the Treasury securities markets.
As a result, yields on these risk-free instruments have been driven downward to levels not seen for some time. Prime mortgage rates also have come down in the process as spreads to Treasuries have been reasonably stable.
The Fed still is anchoring the short end of the yield structure, holding the federal funds rate target at the 5.25% level established at mid-2006. However, yields on short-term Treasury securities have been compressed recently, widening spreads to the funds rate.
It’s clear that market participants have just about written off any chance of Fed tightening this year, and bets on Fed easing in 2007 are accumulating.
Our forecast still calls for a quarter-point cut in the federal funds rate at mid-year. The Fed certainly could react earlier, and more often, if the shocks from financial markets — including widening of credit-risk spreads — threaten an already subpar pace of economic growth.
The Erosion of Housing Demand May Not Yet Be Over
Published data on sales of new and existing homes through January, including “pending” sales of existing homes, suggest that the abrupt downward corrections from the late-2005 peaks essentially ran their course by late last year. But it’s always tough to identify true turning points during the winter months, and some recent data for February and the early part of March suggest that further erosion of housing demand may be in store — apparently related to fallout from the subprime mortgage debacle.
The Mortgage Bankers Association’s weekly series on applications for mortgages to buy homes (available through the week ending March 9) had been showing substantial improvements from the low points last fall, but a disturbing pattern of deterioration has emerged since late January.
NAHB’s Baseline Forecast Still Shows an Unfolding Housing Recovery
NAHB’s baseline (most-probable) forecast for home sales, house prices, housing starts and Residential Fixed Investment in 2007 and 2008 has been revised downward slightly, reflecting recent housing market data as well as the anticipated net impact of tighter mortgage lending standards and lower interest rates on prime mortgages (both fixed- and adjustable-rate).
We’re now projecting 1.5 million housing starts for 2007 (equivalent to the March Blue Chip consensus) followed by a rebound to 1.64 million in 2008 — above the consensus estimate of 1.57 million.
It’s certainly fair to say that the range of uncertainty around our baseline housing forecast has widened considerably in recent weeks, and it probably will take several months to get a firm handle on the net impacts of the unfolding mortgage market saga.
We know that underlying housing demand fundamentals — primarily demographic trends — are solid, but we also know that there are major inventory and affordability hurdles to clear and that the subprime mortgage market mess is working against us on both fronts. The implications for household balance sheets must also be considered.
House Price Slowdown and Mortgage Debt Buildup Are Taking a Toll on Household Balance Sheets
The market value of homes owned by U.S. households rose by 6.3% during 2006 to a record $20.6 trillion at year end — according to recent Federal Reserve estimates. The “holding gains” (excluding net purchases) came to 4.8% over the course of 2006, down from 10.7% in 2005. The annualized holding gain for the fourth quarter of last year was down to 3.0%, reflecting the progressive deceleration of national house price appreciation from peak rates recorded in the latter part of 2005.
Home mortgage debt rose by 8.9% during 2006, down from the extraordinarily rapid rates of 2004 and 2005, but still quite robust.
Household equity in homes rose by 4.0% over the course of the year to a record $10.95 trillion at year end, although the annualized gain came to less than 2% for the fourth quarter. Furthermore, the debt-to-value ratio moved up to 46.9% by the end of 2006, continuing the upward trend of recent years.
The weakening of house prices is likely to continue during 2007, causing housing wealth and housing equity to stagnate, and possibly even decline, and the debt-to-value ratio is destined to rise somewhat further.
While not alarming, these developments inevitably detract from the investment aspects of homeownership and reduce the degree of support provided to consumer spending by housing wealth accumulation.
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 14 edition. To subscribe to “Eye on the Economy,” click here.
Is the Housing Correction Over? Attend Construction Forecast Conference
Will housing demand outweigh affordability hurdles, inventory overhangs and the retreat of investors? Where are home prices headed?
Get the answer to these and other questions at the Construction Forecast Conference — Spring 2007 on April 26 in Washington, D.C.
Panels of nationally recognized experts will discuss economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys at the day-long conference.
For more information and to register, click here.
Can't Attend in Person? Webcast of Conference Also Available
The conference is also available via Webcast. For Webcast information, visit www.nahb.org/cfcwebcast.
Want to Know the Housing Starts Through 2015?
Find out in HousingEconomics.com’s Long-Term Forecast.
HousingEconomics.com includes downloadable Excel tables featuring the housing starts forecast, GDP, demographics and more.
To learn more, visit www.housingeconomics.com.
NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into the middle of the year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.