Eye on the Economy: The Economy Is Skating Close to Recession
Economic growth slowed to a crawl (0.6%) in the final quarter of 2007, according to the “advance” GDP report released by the Commerce Department on Jan. 30, and data received since then do not point toward upward revisions. The “preliminary” fourth-quarter estimate will be released on Feb. 28.
Available information for the early part of 2008 point toward further weakness in GDP growth for the first quarter of this year ― we’re currently estimating 0.3% ― and negative growth is a distinct possibility for this period.
NAHB’s baseline (most probable) forecast still says that the U.S. economy will avoid recession in 2008, although there’s a nearly even chance of slipping into the red zone during the first half of the year.
If so, the setback should be brief and shallow, due largely to the double-barreled dose of monetary and fiscal stimulus being applied to the economy.
Housing Remains a Heavy Drag on the Economy
The housing contraction continues to exact a heavy toll on the U.S. economy. Residential Fixed Investment contracted at a 24% annual rate in the final quarter of 2007, knocking off more than a percentage point from the GDP growth rate. Also, associated setbacks in related parts of the economy, such as mortgage lending, have compounded housing’s negative economic impacts.
Downward momentum in home sales and housing starts through the end of 2007 strongly suggest another heavy hit to the economy from housing in the first quarter of 2008.
Furthermore, data on housing starts and building permits for January released last week show further substantial declines in these measures, particularly in the single-family sector.
These patterns virtually guarantee another large deduction from GDP growth in the first quarter as the relentless housing contraction pushes the U.S. economy to the brink of recession.
Inflation Concerns Flare Up at Exactly the Wrong Time
By all rights, a pronounced slowdown in economic growth should relieve inflationary pressures in the economy, allowing long-term interest rates to recede as the Federal Reserve drops the short end of the yield structure.
Unfortunately, inflationary impulses are coming from commodity markets (primarily food and energy), and “core” inflation measures also have moved up recently. The Consumer Price Index for January, also released last week, displayed such patterns and caused a good deal of heartburn in bond and mortgage markets.
Upward pressure on long rates is the last thing that housing and the economy need at this time, and our central bank can’t just ignore documented upward pressures on inflation. We, and the Fed, expect the slow pace of economic activity to relieve inflation during the months ahead, although this outcome no longer feels like a slam-dunk.
Financial Market Turmoil Persists
The widespread stampede to credit quality that was triggered by the meltdown of the U.S. subprime mortgage market still is a pervasive force in U.S. and global financial markets.
Indeed, a financial system that for decades had evolved into a complex fabric of securitized vehicles now is unraveling — shutting down normal credit channels, raising credit costs for many private-sector borrowers and shifting credit demands back to depository institutions that used to carry the load.
In the home mortgage area, the securities markets for subprime, Alt-A and jumbo loans are essentially gone and yield requirements at portfolio investors are extremely wide.
Only the markets with explicit or strongly implied federal government backing are functioning well, although even the spreads between yields on mortgages saleable to the secondary-market government sponsored enterprises, Fannie Mae and Freddie Mac, and yields on comparable-maturity Treasuries have widened out a good bit since last summer.
The Fed Is Focused on Growth and Market Stability
The Federal Reserve cut short-term interest rates by 125 basis points in January, including an “emergency” cut of 75 basis points on Jan. 22 and an additional cut of 50 basis points at the regularly scheduled Federal Open Market Committee (FOMC) meeting on Jan. 30. The FOMC statement highlighted considerable stress in financial markets and downside risks to economic growth while pushing inflation concerns into the background.
On Feb. 14, Fed Chairman Ben Bernanke testified on “The Economy and Financial Markets” before the Senate Banking Committee. Bernanke made it clear that the Fed has become increasingly concerned about mounting stresses in the financial system as well as increased downside risks to growth — stemming largely from ongoing deterioration in the housing market.
We continue to believe that the Fed will cut the federal funds rate by an additional 50 basis points at the March 18 FOMC meeting and by another 25 basis points at the April 30 meeting — taking the nominal funds rate to 2.25% and the real (inflation-adjusted) rate well below 1%.
The Economic Stimulus Package Will Help Soon
The Economic Stimulus Act of 2008 was signed into law by the President on Feb. 13. The centerpiece of this short-term stimulus package is $117 billion in rebates of personal income taxes, to be distributed starting in May, along with $51 billion in business investment incentives. The bill also substantially raised loan-size limits for both the FHA mortgage insurance program and for conventional loans eligible for purchase by the secondary-market GSEs.
The personal income tax rebates and the business investment incentives figure to provide a bit of support to GDP growth in the second quarter and solid support in the second half of this year, actually pushing growth above trend in the second half. These effects naturally will dissipate early next year, making the economy vulnerable to relapse into a slow growth mode.
The temporary increases in loan-size limits for FHA and the GSEs — up to a maximum of about $730,000 — are bound to help the housing market in such high-priced areas as California to some degree.
It will take some time for the higher limits to be operational, of course, and it remains to be seen how much additional home buying will be stimulated over the balance of the year.
The expiration of the higher limits at year-end figures to be a serious problem ― in the likely event that the private secondary market for jumbo loans still is not functioning properly by then.
Glimmers of Hope for Housing?
Key data on home sales, housing starts, building permits and residential construction activity still paint a downbeat picture of the U.S. housing market. However, a few recent indicators show glimmers of hope with respect to the interest of prospective home buyers.
Falling mortgage rates (at least in the prime market), falling house prices (at least in some places) and growing income (in most places) have combined to boost standard measures of housing affordability in recent months.
Furthermore, surveys of consumer sentiment show that growing numbers of households believe that buying conditions have improved in recent times — because of lower mortgage rates and lower house prices.
The buyer traffic component of NAHB’s monthly Housing Market Index (HMI) appeared to hit a cyclical low last December. The traffic component edged up in January and made a decisive move upward in February — presumably reflecting the improvements in affordability and the brightening of consumer sentiment toward home buying.
The HMI components for current sales and sales expectations have yet to stage meaningful improvements, of course, but perhaps the essential first step toward a housing market recovery is underway.
A Second Round of Economic Stimulus That Focuses on Housing Is Needed
Despite recent glimmers of hope about the interest of prospective home buyers, the dramatic housing contraction still has substantial downward momentum and the housing market still poses major downside risks to the economic outlook.
This situation cries out for a second stage of temporary economic stimulus, directed squarely at the sector that’s at the root of the daunting problems facing the U.S. economy and the financial system.
It must be recognized, first of all, that a substantial tightening of lending standards is occurring in all components of the home mortgage market, as recently documented by the Fed, and this tightening may make it impossible for prospective home buyers to obtain financing they can afford.
Secondly, a record volume of vacant homes on the for-sale market inevitably will put persistent downward pressure on home prices, further sapping the quality of outstanding mortgage credit and making it even more difficult to refinance or restructure adjustable-rate mortgages facing payment resets. This problem, in turn, will bolster the alarming upsurge in mortgage foreclosures and dump even more inventory onto the for-sale market, stretching out the contraction in new housing production.
House prices and inventories are central to the outlook for the economy and the financial markets. Policies that stimulate home purchases in the immediate future can pay huge dividends.
The biggest bang for the buck most likely would be provided by a temporary program of tax credits for home buyers.
Indeed, the recent revival of interest among prospective buyers suggests that temporary credits could unleash a wave of home buying that would quickly restore balance to housing markets and halt the dangerous erosion of house prices and mortgage credit quality.
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 Feb. 20 edition. To subscribe to “Eye on the Economy,” click here.
Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2008 to 2009 Metro Forecast (free preview).
Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.
To learn more, visit www.HousingEconomics.com.
Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
To help members navigate the uncharted waters of this slowdown, NAHB has compiled a comprehensive “Back to Basics” online toolkit — the best of the basics, the tried and true and the truly new. To access the toolkit, click here.
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.