Eye on the Economy: Subprime Mess Threatens Home Sales
The dramatic housing market correction has been a major factor in the evolving macroeconomic picture since early last year — exerting strong drags on growth of both real GDP and payroll employment while putting strong upward pressure on measures of core consumer price inflation through the imputed “owners’ equivalent rent” components.
Federal Reserve estimates show that the pronounced slowdown in house price inflation during the past year is taking a toll on household balance sheets. In this regard, holding gains on homes slowed sharply as 2006 drew to a close and losses presumably are not far down the line.
At the same time, maintenance of strong growth in mortgage debt has impinged on home owner equity positions, and the Fed’s financial obligations ratios for home owners now are at record highs.
Mortgage Credit Problems Have Moved Center Stage
The slowdown in national house price appreciation, already involving absolute declines in some metro markets, is helping to expose lax mortgage underwriting standards that developed during the earlier housing boom.
The “subprime” mortgage sector has been in turmoil during the past month, and the “Alt-A” market — that financed a lot of investors/speculators during the boom — also is under substantial stress.
Mortgage credit quality deteriorated badly as 2006 drew to a close, particularly in the subprime ARM market, and further increases in delinquency and default rates are inevitable. Lending standards already have tightened up quite a bit in subprime and Alt-A markets, and Federal Reserve surveys suggest that a broad-based firming of mortgage lending standards is underway at commercial banks.
The evolving mess in mortgage markets threatens home sales and housing production through two major channels: reductions in gross and net sales due to tighter mortgage lending standards, and increases in unsold inventories due to a rising tide of mortgage foreclosures.
Furthermore, both factors will put additional downward pressure on house prices, pointing toward further deterioration of household sector balance sheets — with sobering implications for residential remodeling and consumer spending.
The Fed Changes Its Tune on Housing — Again
As widely expected, the Fed held monetary policy steady at the March 20-21 meeting of the Federal Open Market Committee (FOMC). The FOMC statement recognized recent mixed signals on the economy and noted that “the adjustment in the housing sector is ongoing” — in sharp contrast to the “stabilization” judgment expressed in the Jan. 31 FOMC statement.
While the March statement continued to highlight inflation risks, it’s clear that the Fed’s confidence in the ongoing economic expansion has eroded and our central bank now apparently views the risks to growth and inflation as essentially balanced.
In this regard, we’re still expecting a quarter-point rate cut at mid-year, assuming that core inflation recedes about as expected by the Fed, and more cuts may be in the cards.
Fed Chairman Ben Bernanke testified last week on “The Economic Outlook” before the Joint Economic Committee of the Congress. He noted that “the principal source of the slowdown in economic growth that began last spring has been the substantial correction in the housing market.”
Bernanke also said that “the near-term prospects for the housing market remain uncertain,” that “developments in subprime mortgage markets raise some additional questions about the housing sector,” and that “the correction in the housing market could turn out to be more severe than we currently expect.”
Indeed, he fingered housing as the key downside risk to the Fed’s forecast of moderate economic growth over coming quarters.
There Are Partial Offsets in Mortgage Markets to the Subprime Mess
The subprime mortgage mess naturally has helped generate a flight to quality in financial markets, and this phenomenon has put some downward pressure on the Treasury yield curve. Prime mortgage rates — fixed and adjustable — also have come down in the process as spreads to Treasury rates have held firm. Consequently, we have trimmed our forecasts of rates on long-term Treasury securities as well as prime fixed-rate home mortgages across the 2007-2008 forecast horizon.
The Federal Housing Administration (FHA) mortgage insurance program, which lost a lot of market share to subprime during the 2003-2006 period, apparently is helping to fill the financing gap created by the abrupt withdrawal of subprime lenders.
Furthermore, Congress may very well “reform” the FHA program to help refinance distressed home owners and bolster the flow of credit to higher-risk buyers — by lowering downpayment requirements, raising loan-size limits and creating a risk-based premium structure that would allow FHA to dip deeper into the credit risk pool.
But the Net Impacts of Mortgage Market Developments Definitely Are Negative
The net impacts on home sales from subprime-related tightening of mortgage credit conditions and offsetting benefits in prime and FHA mortgage markets definitely will be negative for the balance of 2007 and possibly in 2008 as well.
NAHB’s forecasts for both home sales and housing production have been trimmed recently, and we now expect single-family housing starts for 2007 to be the lowest since 1997.
We’re still looking for some recovery in 2008, although our current forecast for housing starts is well below our estimate of the sustainable trend level of production. In these terms, the major “correction” process that began in the fall of 2005 will extend at least through 2008.
And Forecast Risks Now Are Formidable
The ranges of uncertainty around our recently-revised baseline (most probable) forecasts for home sales and housing production are extremely wide because of the subprime debacle and related effects in mortgage markets. Indeed, the key downside risks to the overall economic outlook now reside in the mortgage and housing markets — a point made last week by Fed Chairman Bernanke.
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 28 edition. To subscribe to “Eye on the Economy,” click here.
Is the Housing Correction? Attend Construction Forecast Conference
Will housing demand outweigh affordability hurdles, inventory overhangs and the retreat of investors? Where are home prices headed?
Get the answers 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 Your State’s Starts Forecast for 2008?
Find out in HousingEconomic.com’s State Starts Forecast (sample). The starts forecast includes downloadable Excel tables of total, single-family and multifamily starts by region and state.
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.