Eye on the Economy: Affordability Is Improving, But Other Forces Rule
On Dec. 1, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) identified December 2007 as the end of the previous economic expansion and the beginning of the current economic recession.
This means that the previous expansion was a little more than six years long and that we’ve been in the current recession for about a year.
The NBER business cycle experts rely on a variety of monthly indicators of domestic production and employment to figure out cyclical peaks and troughs in the U.S. economy.
As usual, payroll employment growth was crucial to identifying the transition from expansion to recession. Employment peaked last December and has declined every month since then.
The cumulative decline through October came to nearly 1.2 million jobs, and the monthly pattern of decline generally has been worsening as the year has progressed.
The Recession Is Deepening as 2008 Draws to a Close
The recession definitely is deepening at this time. Rapidly rising claims for unemployment compensation point toward further large losses of payroll employment in both November and December, and the unemployment rate is bound to rise further from the 6.5% level reported for October.
With respect to overall economic output in the U.S., the third-quarter decline in real gross domestic product (GDP) recently has been revised to -0.5%.
Furthermore, the composition of that report, particularly a major downshift in consumer spending, has negative implications for the final quarter of the year.
We now expect real GDP to contract at nearly a 5% annual rate in the fourth quarter, the deepest decline since the first quarter of 1982.
We still expect the trough of the current recession to occur around the middle of 2009, assuming a lot of help from the Federal Reserve and a large fiscal stimulus package early next year.
There is a high probability that this recession will turn out to be the longest of the postwar period, surpassing the 16-month recession in 1973 to 1975.
The Contraction in Housing Production Is Weighing Heavily on the Economy.
Housing production in the GDP accounts (residential fixed investment) and employment in residential construction (builders and specialty trade contractors) have been contracting substantially since the early part of 2006. Furthermore, there’s no apparent letup on either front for the balance of this year or early 2009.
Starts of new housing units still are tumbling downward from their early-2006 peaks, particularly in the single-family sector.
Single-family starts fell by 3.3% in October to a level that was down by 71% from the peak in January 2006. Single-family starts for the month were also the lowest since October 1981.
Issuance of single-family permits declined even more sharply in October, leaving the level 74% below the cyclical peak in the fall of 2005 and the lowest since the early 1980s.
Not surprisingly, the value of residential construction put-in-place declined by 3.5% in October (nominal terms), paced by a whopping 4.6% contraction in the single-family component.
All this adds up to another major hit to real GDP from residential fixed investment in the fourth quarter of this year, contributing heavily to the steep decline we’re now projecting for the overall economy in that period.
New-Home Demand Still Is Weakening
Sales of new homes continued to trend downward in October, falling by 5.3% for the month and by 40% on a year-over-year basis. Indeed, new-home sales now are down by 69% from their cyclical peak in July 2005.
NAHB’s single-family Housing Market Index (HMI) fell to 9 in November, a new record low 9. The series was begun in January 1985.
The November reading was five points below the previous low in October of this year and was down from 72 at the cyclical peak in June 2005.
All three HMI components — current sales, sales expectations and buyer traffic — were at record lows in November and new lows also were posted for all four regions of the country.
Preliminary tabulations point toward further broad-based erosion of the HMI in December.
Sales of existing single-family homes were down by 3.3% in October, although this series has essentially been rattling sideways since late last year.
However, foreclosure-related sales of existing homes have been rising sharply during this period, creating more and more cut-rate competition for home builders as those units have come onto the markets.
House Price Declines Still Are Deepening
National average house prices continued downward in the third quarter of the year, according to prominent repeat-sales price measures, and the rates of decline actually were larger than during the second quarter of the year.
The S&P/Case-Shiller national home price index was down by nearly 17% in the third quarter on a year-over-year basis, the largest such decline on record.
The month-to-month decline came to a seasonally adjusted annual rate of 14%, a bit deeper than the second-quarter setback but still short of the declines registered in the final quarter of 2007 and the first quarter of this year.
The national purchase-only house price index that’s based on the conforming mortgage market — served by Fannie Mae and Freddie Mac and produced by the Federal Housing Finance Agency — showed a 6.02% decline on a year-over-year basis in the third quarter, the largest such decline on record. Furthermore, this price index fell at a 7.12% seasonally adjusted annual rate in the third quarter, also the largest decline on record.
The downward momentum in national average house prices is bound to extend through the balance of this year and into 2009. The fundamental weakness of housing demand, the rising tide of foreclosures and the persistently large numbers of vacant housing units on for-sale and for-rent markets will be putting downward pressure on house prices for some time.
Housing Affordability Is Improving, But Other Forces Rule
The stunning declines in house prices, combined with reasonably favorable prime home mortgage rates, have been boosting standard measures of affordability even as median family income has stagnated in a contracting economy.
For example, the National Association of Realtors® Housing Affordability Index for September was up by 17% from a year earlier, and all four regions showed substantial gains during that period.
Of course, the standard measures of housing affordability do not capture shifts in mortgage lending standards, and we know from the Fed’s quarterly surveys of senior bank lending officers that standards have been tightening considerably on all types of home mortgage loans — prime, subprime, Alt-A and “nontraditional” adjustable-rate contracts, including interest-only and payment-option varieties.
Nor do affordability measures capture household expectations of future house price movements or household perceptions of their own economic prospects.
Recent measures of consumer confidence definitely are in classic recession territory, and the recent NBER announcement that the U.S. has been in a recession since the end of last year can only further darken the mood of the American consumer.
While a variety of surveys show that Americans generally believe that house prices will grow nicely over the long term, the recent sharp declines in many areas undoubtedly have damaged shorter-term price expectations for many prospective home buyers.
The Fed Is Prepared to Deliver More Help to Financial Markets and the Economy
On Dec. 1, Federal Reserve Chairman Ben Bernanke delivered a wide-ranging speech, “Federal Reserve Policies in the Financial Crisis,” explaining what the Fed has done so far on three major fronts — interest rate policy, liquidity policy and policies designed to stabilize the financial system.
While citing degrees of success on all three fronts, Bernanke stressed that the nation continues to face substantial risks to both financial stability and economic growth.
Looking forward, Bernanke conceded that, with the target federal funds rate already down to 1%, the scope for using conventional interest rate policies to support the economy is quite limited in the near term.
We still expect the Fed to drop the funds rate target to 0.5% at the Dec. 16 Federal Open Market Committee meeting, but that may very well be the low point for this cycle. Furthermore, the Fed seems committed to keeping the effective funds rate close to the announced target, rather than letting it run below target for extended periods of time.
Bernanke actually saw more potential for “the second arrow” in the Federal Reserve’s quiver, i.e., the provision of liquidity to the private sector to support the functioning of credit markets without dropping the federal funds rate.
The Fed has virtually unlimited capacity for such “quantitative easing,” and there’s virtually no limit to the size of the Fed’s balance sheet.
In this context, Bernanke spoke about Fed purchases of longer-term Treasury and agency securities in the open market, serving to force down market yields on such securities. He noted that the Fed had recently announced plans to buy both government sponsored enterprise (GSE) debt and GSE mortgage-backed securities, and that mortgage rates had fallen substantially by about half a percentage point after that announcement.
On the liquidity front, Bernanke also talked about direct support to specific financial market components — as recently done for the commercial paper market — allowing the Fed to sidestep banks and primary dealers and deal directly with borrowers or investors in key credit markets.
The Fed conceivably could deal with the conforming home mortgage market through such a purchase facility, putting further downward pressure on mortgage rates in the process.
The Fed also intends to move ahead with policies to stabilize the financial system, working with the Treasury, the FDIC and other agencies to take all steps necessary to minimize “systemic risks.”
Bernanke said that capital injections into the banking system, the FDIC’s guarantee program and the provision of liquidity by the Fed have already greatly reduced the risk that a “systemically important” financial institution will fail.
Policymakers obviously will continue to pursue that important objective during the difficult period ahead.
Fiscal Policy Will Heavily Determine the Performance of the Economy and Housing in 2009
The Fed, Treasury, FDIC and other federal agencies can do a lot to support the economy and improve the functioning of the financial system, and many foreign central banks are pulling out the stops on their fronts.
But massive fiscal stimulus is urgently needed to limit the dimensions of the deepening economic recession in the U.S. and to get the economy back on a positive growth track at some point during 2009.
As dismal economic data have piled up recently, the estimated size of a fiscal package sufficient to stabilize the situation has been growing by leaps and bounds.
It’s now become commonplace to talk about a fiscal stimulus package in the $500 to $700 billion range, around 4% of GDP. This, of course, is in addition to the previously enacted $700 billion Troubled Asset Relief Program (TARP) that’s supposed to stabilize and strengthen the financial system through capital injections to financial institutions, primarily banks and other means.
The market “consensus,” including NAHB, is looking for an aggressive combination of tax cuts and spending increases to be delivered early next year when the economy will be extremely vulnerable to a downward spiral in the absence of powerful fiscal stimulus.
There are a lot of candidates for inclusion in a fiscal stimulus package, of course, and high priority presumably will be given to unemployment insurance benefits, food stamps, aid to state and local governments and infrastructure spending.
Temporary tax cuts to help lower- and middle-income households and small businesses probably are in the cards as well. And the current marginal income tax rate schedule probably will be maintained for some time, avoiding rate increases at higher income levels.
The housing sector sorely needs targeted fiscal stimulus to bolster sales, limit foreclosures and keep home prices from seriously overshooting on the downside. Indeed, the overall economy will not stabilize until the housing sector hits bottom.
NAHB is aggressively promoting strong tax incentives for all home buyers, sizable federal buy-downs of home mortgage rates — possibly by the Fed — and maintenance of the FHA/GSE loan-size limits at $729,500 beyond the end of this year.
NAHB 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 the Dec. 3 edition. To subscribe to “Eye on the Economy,” click here.
Construction Forecast Conference Webcast Available
An on-demand webcast of the 2008 Fall Construction Forecast Conference is available for purchase.
The webcast fee includes access to the webcast archive and electronic copies of the conference handout and presentation materials. Multiple viewers in one office can purchase the webcast for one fee.
The on-demand webcast also gives viewers complete flexibility in their viewing experience — pause, skip forward and backward, or jump directly to your topics of interest.
To purchase and download the webcast, 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.