Eye on the Economy: The Core Problem Is Falling House Prices
Revisions in the gross domestic product (GDP) revisions for the fourth quarter of 2007 left the overall economic growth rate at a meager 0.6%, but the estimated contraction in residential fixed investment deepened to a 25.2% annual rate and RFI subtracted a whopping 1.25 percentage points from the GDP growth rate.
The housing contraction weighed on GDP growth from other directions as well, including the reeling housing finance system and components of retail sales closely related to housing market activity.
Available data, including housing starts and building permits for January and February, point toward another sharp contraction in RFI and another very weak GDP growth rate in the first quarter of this year, a pattern that skates dangerously close to recessionary conditions.
We now view a mild recession as a nearly even bet, but we also believe that aggressive actions by the Fed and the recently enacted economic stimulus package virtually guarantee stronger growth by the second half of the year.
Labor Markets Weaken on Key
Recent labor market conditions are consistent with seriously below-trend GDP growth and tepid growth in labor productivity.
The February employment report revealed the second consecutive decline in total payroll employment and the third consecutive decline in private payroll employment, and an ongoing slide in residential construction employment was a key factor in this pattern.
Slight declines in the civilian employment rate in both January and February (calculated from the household survey) actually provide little comfort since these declines reflected serious shrinkage of the civilian labor force — hardly a sign of economic vitality.
Inflation Picks Up at Exactly the Wrong Time
Surging commodity prices (primarily food and energy) have complicated the inflation picture in recent times and there’s also an inflationary impulse from the falling dollar through rising import prices.
These developments have prompted speculation about an emerging “stagflation” pattern in the U.S. economy and some observers believe that inflation pressures will limit the Fed’s efforts to revive the flagging economy.
Others argue that recent inflationary pressures contain some temporary influences and that evolving labor market conditions hardly suggest upward pressure on unit labor costs — traditionally the Fed’s major inflation concern. We’re in this camp.
Another Round of Financial Market Turmoil Erupts
Financial markets remain under considerable stress as the mortgage-induced stampede to quality continues unabated. Equity markets have been reeling and quality spreads in corporate bond and mortgage securities markets have been widening once again. Indeed, even key money-market quality spreads have widened out again.
On this round, investors have even soured on the debt and mortgage-backed securities issued by Fannie Mae and Freddie Mac, pushing out spreads between “prime conventional conforming” mortgage rates and yields on comparable-maturity Treasuries to the widest in many years.
Mortgage Credit Quality Deteriorates Further
Concerns about mortgage credit quality actually have intensified as incoming data on delinquencies and foreclosures have worsened and as evidence of serious house price erosion has accumulated.
It now has dawned on investors that home owners’ willingness to repay their mortgages is at least as serious an issue as their ability to repay when rates reset on adjustable-rate loans. This realization has directed focus to the equity positions of home owners, and that picture seems to be darkening daily.
The Fed Rolls Out Liquidity-Enhancing Innovations
The Fed is on red alert as the faltering economy and the serious financial market dislocations present an unprecedented set of challenges to our central bank.
The Fed has been fighting a two-front war, not only managing conventional monetary policy so as to reduce the federal funds and discount rates but also rolling out a series of measures to bolster liquidity in key segments of the credit markets.
On the liquidity front, the Fed has aggressively encouraged bank use of the discount window and now is using its huge balance sheet capacity to unlock portfolios of major financial institutions and improve the functioning of credit markets.
In this regard, the Fed is providing outlets for banks and primary securities dealers to “exchange” illiquid private-sector securities ― including private-label mortgage-backed securities ― for cash or Treasury securities on a term basis and at the Federal Reserve discount rate.
Monetary Policy Is Becoming More Stimulative
On the conventional monetary policy front, the Fed dropped the target federal funds rate and the discount rate by 75 basis points at the conclusion of the March 18 Federal Open Market Committee (FOMC) meeting, saying that “the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.”
The FOMC statement also stressed that “downside risks to growth remain,” even after the policy change.
We’re projecting an additional 50 basis point cut at the next FOMC meeting on April 30. That move, if implemented, will drop the nominal funds rate to 1.75% and place the real (inflation-adjusted) funds rate in the negative zone — exactly where it belongs when housing and the economy are in deep trouble.
The Housing Market Still Is Going Downhill
With respect to recent housing market developments, sales of both new and existing homes were down in January and the months’ supplies of unsold homes challenged record highs in both markets.
On the production front, single-family housing starts and permits moved down substantially in both January and February, guaranteeing another sharp decline in residential fixed investment in the second quarter as well as ongoing losses of payroll jobs in home building.
NAHB’s monthly surveys of single-family builders have yet to provide convincing signals regarding near-term stabilization of buyer demand or housing production.
Traffic of prospective buyers has revived to some degree since late last year but the quality of traffic apparently is not high. Furthermore, gross and net home sales still are eroding and sales expectations of builders have not yet improved.
The Core Problem Is Falling House Prices
It’s increasingly obvious that the core problem for the housing market, the economy and financial markets is actual and expected declines in house prices.
This problem is symptomatic of stubbornly weak home buyer demand and an extremely large supply of vacant homes on the for-sale market, and the upswing in mortgage foreclosures in piling more and more vacant homes onto the for-sale market.
This critical situation calls for government policies to stimulate home buyer demand and to stem the flow of foreclosed homes onto the market.
The Fed clearly is on the job, and major responsibilities also lie with other federal regulators, the Government Sponsored Enterprises, the Congress and the Administration.
The deteriorating market situation is forcing serious discussions on all fronts and some adjustments have been made, but the range and depth of policy responses has yet to be determined.
The Forecast Is Policy-Dependent
NAHB’s housing forecast shows major declines in house sales and housing production for 2008 as a whole, although we’re also showing turning points for sales and starts before the end of the year.
There are major downside risks to these forecasts, however, and the ultimate outcome will depend critically on the public policy responses to the destructive downward spiral in house prices and the associated impacts on 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 March 19 edition. To subscribe to “Eye on the Economy,” click here.
Attend the Spring Construction Forecast Conference in April
Plan to attend NAHB's Spring Construction Forecast Conference on Thursday, April 24 at the National Housing Center in Washington, D.C. The conference brings together the nation's premier housing economists and finance experts for an in-depth examination of the economic outlook for the housing industry.
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For more information, or to register for the conference or webcast, visit www.nahb.org/cfc.
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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.
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For assistance, call the NAHB Member Service Center at 800-368-5242.