Eye on the Economy: Housing Indicators Are Flashing Red
NAHB’s baseline (most probable) forecast now includes a mild economic recession in the early part of 2008. We’re currently pegging the peak of the cycle in December 2007 and the trough in August 2008.
We expect real gross domestic product (GDP) to contract modestly in the first half of this year and the labor market to deteriorate for a somewhat longer period ― a normal timing relationship.
A flurry of recent negative economic news prompted us to move a recession into our baseline forecast. This news included soaring energy prices, deterioration of our trade balance, plummeting consumer sentiment, ongoing erosion of the labor market and more negative readings on the housing market.
Downward revisions to the Federal Reserve’s economic forecasts from both the Federal Open Market Committee (FOMC) and Fed staff also encouraged us to make the recession call.
The Labor Market Is Steadily Deteriorating
Labor market conditions have been deteriorating for some time.
Employment growth started to slow early last year and the unemployment rate has been trending upward since that time.
Total payroll employment — from the establishment survey — started to fall this January, and the economy lost 232,000 jobs in the first quarter of the year.
Private sector employment actually started down in December and the cumulative contraction was 300,000 through March of this year. The unemployment rate — from the household survey — was 5.1% in March, up from the cyclical low of 4.4% a year earlier.
There’s little doubt that labor markets are deteriorating further in the second quarter. Weekly data on claims for unemployment insurance are trending upward, and surveys of consumers are showing deepening concerns about current employment conditions as well as job prospects down the road.
NAHB’s forecast now shows a downward trend in payroll employment through the third quarter of the year, and we expect the unemployment rate to gravitate upward through the year — reaching 5.7% by early 2009.
While this rate seems rather benign by historical standards, the increase from the cycle low ― 1.3 percentage points ― is consistent with a mild economic recession.
Financial Markets Remain Under Stress
A broad range of credit markets, including the home mortgage market, still are not functioning normally. Only the Treasury securities market, backed by the full faith and credit of the U.S. government, remains unscathed.
Indeed, the frenzied flight to credit quality has put downward pressure on the entire Treasury yield curve.
Some private securities markets, including those for subprime, Alt-A and jumbo home mortgages, have essentially shut down. Even the GSE securities markets, backed by “implicit” federal guarantees, have staggered, and spreads to Treasurys have widened substantially.
As a result, spreads of prime conventional home mortgage rates over comparable maturity Treasurys remain extremely wide. So do spreads of prime jumbo mortgages over prime conforming rates, even for those that recently were made eligible for purchase by the GSEs.
As securities markets have faltered, private credit demands naturally have shifted to depository institutions.
Unfortunately, many large depositories have been compelled to take substantial writedowns on portfolios of securities — particularly those containing subprime mortgage paper — reducing capital available to support new lending.
This, naturally, has contributed to the broad-scale flight to quality that now includes considerable tightening of lending standards at the depositories, particularly in mortgage markets and in the markets for residential construction and development loans.
The Fed Is Fighting on Two Fronts
The Federal Reserve is fighting desperate battles and expending a lot of ammunition on two fronts, and results to date have been limited.
On one front, the Fed is aggressively easing monetary policy in order to support economic growth, and that’s a campaign that obviously is not going very well.
In fact, the Fed’s job now is to limit the depth and duration of an economic recession that apparently is already underway. We expect the next Fed salvo to be half-point cuts in both the federal funds and discount rates at the conclusion of the upcoming meeting of the FOMC on April 30.
On the second front, the Fed has come up with a series of innovations designed to improve financial market liquidity and market functioning, apparently with only limited success to date.
Recent actions include lowering the cost and increasing the allowable term of discount-window credit to commercial banks; increasing the size of the Term Auction Facility, through which credit is auctioned to depository institutions; initiating a Term Securities Lending Facility, which allows primary securities dealers to swap illiquid mortgage-backed securities for highly liquid Treasury securities; and creating the Primary Dealer Credit Facility, which serves as a discount window for primary dealers.
In its spare time, the Fed recently took unprecedented steps to forestall the bankruptcy of the large nonbank primary securities dealer, Bear Stearns. This action may very well have prevented a full-blown financial panic.
Housing Market Indicators Are Flashing Red
Housing data received in recent weeks unanimously display ongoing deterioration of the single-family housing market. According to National Association of Realtors®, pending sales of existing homes (based on contracts signed) fell back in February following apparent stabilization in January.
For the new-home market, the Commerce Department reports that single-family starts and permits both fell by about 6% in March, closing out a very weak first quarter and pointing toward further deterioration in coming months.
NAHB’s proprietary survey of large public and private single-family builders showed ongoing erosion of both gross and net home sales in March, and sales cancellation rates remained quite elevated.
NAHB’s broad-based single-family Housing Market Index remained at a near-record low of 20 in April, based upon builders’ perceptions of buyer traffic and current sales volume as well as builders’ expectations of sales activity six months down the line.
Finally, the Mortgage Bankers Association’s weekly survey of mortgage lenders shows a substantial fallback in applications for loans to buy homes since early this year, on a four-week moving average basis.
Policy Help Hopefully Is Coming
The Fed has been easing monetary policy aggressively since last fall and our central bank presumably can be counted on to deliver additional monetary stimulus in the months ahead.
The fiscal stimulus package designed by Congress and the Administration and signed into law earlier this year should provide decent support to the economy, primarily through consumer spending, starting late in the second quarter and extending into the fourth quarter.
Our assumptions on monetary policy and on the effectiveness of the stimulus package already on the books are key to the “mild” nature of the recession that’s now part of our baseline forecast.
But there are considerable downside risks to this forecast, and the housing and mortgage markets are most vulnerable to downside influences.
We haven’t dealt with broad-scale house price declines since the 1930s and the formidable problems in credit markets are dominated by steadily deteriorating mortgage credit quality. Indeed, we're facing a potentially disastrous feedback loop comprised of falling house prices, falling credit quality, tightening credit standards, falling house prices…
The Federal Reserve now has full appreciation of these downside risks, the Congress apparently is learning fast and the Administration seems to be facing the growing realities.
Maddening political differences may stand in the way of effective measures to spur home buying and stem the rising tide of foreclosures that dumps more inventory onto glutted markets, adding to downward pressure on house prices.
Policy makers now are debating various tax credits for home buyers and various ways to contain mortgage foreclosures. Stay tuned.
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 April 15 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.
Can't attend? Watch the conference webcast live.
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.
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.