Eye on the Economy: Near-Term Housing Outlook Has Darkened
Real gross domestic product (GDP) growth for the second quarter has been revised downward from 3.3% to 2.8% — still a respectable pace. Of more importance, key sectors of the economy weakened considerably during the third quarter and the economy is entering the final quarter of the year in troublesome condition, despite recent declines in oil prices.
The housing sector continues to pull the U.S. economy downward. Housing-related weakness is progressively spreading to other sectors, and credit-market constraints are weighing on virtually all components of spending except for outlays by the federal government.
Consumer spending, accounting for about 70% of overall GDP, has been flagging badly as the special stimulus from the personal tax rebates has run out of steam, as job losses have accumulated and as wealth losses in housing and the stock market have weighed on consumer confidence and discretionary spending.
Indeed, real disposable income has been declining in recent months and it’s now pretty clear that real personal consumption expenditures contracted in the third quarter — the first quarterly setback since 1991. Plummeting auto sales are an important part of that story.
The confidence of nonfarm nonresidential businesses also has been shaken badly and recent indictors point to a manufacturing sector in recession and systematic declines in commercial construction as well.
It’s now likely that nonresidential fixed investment, in total, will slip into the red zone in the third quarter of the year and that overall GDP growth will be around zero for that quarter — a percentage point below our most recent baseline forecast.
Stutter-Steps on Financial ‘Bailout’ Plan Roil the Markets
Panic gripped equity and credit markets two weeks ago as a series of major financial institutions either went under or were “rescued” by the federal government. Some relief was provided the following day when news leaked out that the Treasury and the Fed were crafting a big plan to rescue the U.S. and global economies from financial Armageddon.
Both the Treasury Secretary Henry Paulson and the Fed Chairman Ben Bernanke, joined at times by the SEC Chairman Christopher Cox, spent much of last week on Capitol Hill and at the White House, and President Bush made a series of public statements to stress the extreme seriousness of the situation and to rally public support for the plan that had been presented and defended by Paulson and Bernanke.
Unfortunately, the financial rescue plan was quickly dubbed a “Wall Street Bailout Plan,” an incredibly inaccurate and inflammatory handle.
This characterization not only made it virtually impossible to rally public support for the plan, it also cleared the way for political wrangling in Washington over self-serving issues or ideological principles — just weeks before the national elections.
As a result, the proposed $700 billion financial rescue plan that apparently had broad bipartisan support went down in flames in the House of Representatives on Sept. 29, provoking another massive stock market contraction and a deep freeze in credit markets here and abroad.
Equity markets staged a partial rebound the next day as battered House members in both parties held open the possibility of a near-term compromise on an amended package. Meanwhile, the Senate actually went ahead with passage of a similar plan on the evening of Oct. 1, effectively handing the ball back to the beleaguered House, which agreed to the plan two days later.
The bill's enactment certainly will not ensure immediate repair of credit markets or quick economic recovery, but outright failure in the House would have ensured a deep recession and a major financial market meltdown.
New-Home Sales Shift Down Again
Sales of existing (previously owned) homes have been essentially flat since late last year, prompting suggestions that housing demand has already “stabilized.” But a large and rising proportion of existing-home sales are sales of foreclosed homes (or short sales) at fire-sale prices, especially in previously overheated markets where prices have fallen dramatically.
While it is good that many foreclosed homes are being taken off the markets, the foreclosure surge is hardly a sign of housing market vitality.
Competition from foreclosure sales actually is a major negative for the new-home market. In fact, new-home sales still are heading downward, falling by a whopping 11.5% in August to the lowest level since the depths of the 1990-1991 recession.
Furthermore, NAHB’s proprietary survey of 30 large single-family builders showed ongoing erosion of both gross sales (new orders) and net sales (accounting for cancellations) in August, on a seasonally adjusted basis.
NAHB’s single-family Housing Market Index (HMI) perked up a bit in September, rising by two points from record lows posted in July and August, and the rise primarily reflecting a better outlook by builders for future home sales.
However, that survey was taken before the incredible events in financial markets after mid-September and it’s entirely possible that the HMI will fall back in our October survey.
House Prices Continue Downward, Eating Away at the Financial System
Falling house prices are a deadly cancer that’s eating away at the national and global financial systems — and making the financial rescue plan absolutely essential for survival. Unfortunately, recent news on the house-price front only accentuates the urgency of the situation.
All major measures of U.S. house prices are retreating rapidly. OFHEO’s purchase-only House Price Index (conforming market only) fell at a 7.5% seasonally adjusted annual rate in July while the S&P/Case-Shiller composite index for 20 large metro areas fell at a 12.2% pace for the same period.
While these rates of decline are somewhat slower than earlier this year, the breadth and depth of the declines still are highly destructive to mortgage credit quality and the financial system.
The median price of existing homes sold (not controlled for compositional shifts) fell by 9.5% in August (year-over-year), with a 9.7% decline in the single-family market and a 7.2% decline in the condo market. In the West, single-family prices were down by 24.8% while condo prices were off by 17.9%.
The Fed Pulls Out (Most of) the Stops
The Federal Reserve has been pumping massive amounts of liquidity into the financial system during the incredible round of turmoil that erupted around mid-September, including a huge injection on the heels of the failure of the financial rescue plan in the House of Representatives on Sept. 29.
These extraordinary efforts by the Fed, in conjunction with steps by foreign central banks along the same lines, certainly have helped to maintain some order in short-term credit markets here and abroad.
Even so, a seemingly irresistible flight to credit quality has virtually strangled interbank markets as well as securities markets for short-term credit, including the commercial paper market in the U.S.
Prompt enactment of the financial market rescue plan presumably will boost confidence in the financial system, although credit-quality spreads in money and bond markets figure to remain quite wide for an extended period of time.
The Fed has been holding the federal funds rate target at 2.0% throughout the recent period of turmoil. However, our central bank has allowed its special liquidity injections to push the effective funds rate below target for most of this period — rather than “draining” bank reserves through open-market operations to keep the funds rate on target.
We believe the Fed will cut the federal funds rate target after the financial rescue plan is enacted. We expect cuts of 50 to 75 basis points by the end of the year, and we do not expect any upward adjustments before mid-2009.
The Probability of Recession Has Risen Considerably
NAHB’s most-recent short-term forecasts for real GDP and payroll employment are being marked down at this time, despite our new monetary policy assumptions, and the forecasts are being fully revised following enactment of the financial rescue plan.
Recent evidence of economic weakness, substantial wealth losses in equities and housing, and stubbornly tight credit market conditions are likely to take enough additional toll on the economy to justify an official recession “call” by the experts at the National Bureau of Economic Research.
We’re now looking for a medium-sized U.S. recession in 2008 and part of 2009, with a peak unemployment rate around 7% — compared with 6.3% in our most-recent baseline forecast. We still expect the global economy to maintain positive growth throughout this period, and that’s an important call.
The Near-Term Housing Outlook Has Darkened
Fixed-rate home mortgage credit remains available at reasonable rates through the FHA/VA/Ginnie Mae system as well as through Fannie Mae and Freddie Mac — the GSEs currently under federal conservatorship.
But the shortage of mortgage credit outside these market segments is quite serious and the weakening economy inevitably will be taking a toll on home buying as we move ahead.
Furthermore, increasingly tight credit conditions in the markets for land development and construction loans — markets that are served primarily by depository institutions — inevitably will sap the strength of the early stages of recovery in housing production.
With respect to our baseline (most probable) forecast, we’ve essentially kicked out the projected troughs in new-home sales, housing starts and residential fixed investment by one calendar quarter and deepened the declines modestly in the process.
The projected peak-to-trough declines easily stack up as the deepest since the 1930s.
However, there is good news ― most of the projected decline is behind us, and the growth potential from the cyclical trough is immense.
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 Oct. 2 edition. To subscribe to “Eye on the Economy,” click here.
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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.