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Eye on the Economy: Inventory Overhangs Weigh on Prices
 The Commerce Department now says that annualized growth of real gross domestic product (GDP) was only 2.2% in the final quarter of last year, down from the “advance” estimate of 3.5%. This means that the economy turned in a subpar performance during the final three quarters of last year, largely due to a dramatic contraction in the housing production component of GDP (residential fixed investment) and weakness in closely associated components of the economy. The domestic auto sector also was fundamentally weak during 2006.
The weakness in fourth-quarter GDP growth also reflected a major decline in nonfarm business inventory investment — a development that actually bodes well for economic growth further down the line.
NAHB’s forecast shows another subpar rate of GDP growth in the first quarter of 2007, followed by a strengthening process over the balance of this year and into 2008. A near-term end to the pronounced contraction in residential fixed investment is central to this forecast pattern.
Recent Volatility in Financial Markets Conveys Some Benefits to Housing Markets
Global and national equity markets have been extremely volatile in recent days, prompted by sharp losses in the Shanghai market, rising concerns about the future of the U.S. economy and statements by the former Federal Reserve Chairman Alan Greenspan about the possibility of economic recession in this country later this year. Indeed, the losses in the U.S. stock market on Feb. 27 were the largest since the setback that followed the terrorist attacks on 9/11.
The abrupt sell-off in equity markets transferred huge amounts of funds to fixed-income markets, particularly to the safe haven of the Treasury securities market. The buying pressure drove bond prices upward and drove interest rates downward, particularly on longer-maturity securities.
These rate declines were promptly reflected in the structure of mortgage interest rates — at least in the dominant “prime” components of the home mortgage market.
Subprime Mortgage Markets Are in Disarray and Mortgage Lending Standards Are Firming Up
Bad news has been coming out of the subprime mortgage market since the beginning of the year, and on Feb. 27 Freddie Mac announced that it would no longer buy mortgage securities backed by subprime mortgages with features that provoke serious “payment shock.” This announcement apparently contributed to the turmoil in financial markets later that day.
There is no doubt that lending standards in the subprime mortgage market deteriorated badly during the 2004-2005 housing boom, and even into 2006, and it’s clear that neither the investment community nor the financial rating agencies fully understood the risks associated with subprime mortgage securities — particularly the subordinated tranches.
While tightening of lending standards in the subprime market inevitably will take some toll on home buying in 2007, the adjustments now underway are essential to the health of the subprime market down the line.
The biggest issue for the housing outlook relates to lending standards in the “Alt-A” and the quantitatively dominant “prime” components of the home mortgage market. The Federal Reserve’s January Senior Loan Officer Opinion Survey — the most recent survey — showed that about 15% of domestic commercial banks (net) had tightened credit standards on residential mortgage loans over the prior three months, the highest fraction since the early 1990s.
This tightening, of course, followed three years of cumulative net easing and hardly means that mortgage lending standards at banks have become overly tight!
On Feb. 28, Fed Chairman Ben Bernanke told Congress that the current problems in the subprime mortgage market are not likely to spill over into the prime market to a serious degree, suggesting that the projected stabilization of the housing market is not likely to be derailed by an abrupt firming of mortgage lending standards.
We certainly agree, although there definitely are risks on this front.
The Demand Side of the Single-Family Housing Market Apparently Has Stabilized
Although signals are mixed to some degree, the weight of evidence shows that the demand for single-family homes has been fundamentally stable since mid-2006 and some indicators suggest that modest improvements may now be underway.
Sales of existing homes ― based on closings ― actually rose by 3.5% in January, although this increase may very well have reflected unusually warm weather conditions late last year, when the contracts were signed.
New-home sales (based on contracts signed) fell sharply in January, when weather was essentially normal. But this decline followed increases in November and December that may very well have been weather related. The new-home sales series also is subject to extreme month-to-month volatility associated with Commerce Department sampling procedures.
The Mortgage Bankers Association’s weekly series on applications for mortgages to buy homes has been all over the place recently, even on a four-week moving average basis, but this series definitely is off the lows of last fall. Furthermore, NAHB’s single-family Housing Market Index has risen systematically from the low point last September to 40 in February, showing that builders’ assessments of the demand side of the market have been on the mend following the sharp contraction from the highs of mid-2005.
Inventory Overhangs and Buyers’ Market Conditions Weigh on Home Prices
Although sales volume has stabilized, unsold inventories of new and existing homes still are quite high and affordability measures still are quite low. Under these conditions, house prices have been under downward pressure and sellers have been offering a variety of non-price incentives to support prices and sales volume.
It’s perfectly clear that house prices have decelerated dramatically from the rapid rates seen during the earlier boom period. Furthermore, prices have been falling in many previously overheated housing markets and national average home prices now are slipping into the negative range according to both sequential and year-over-year comparisons.
If non-price sales incentives were incorporated into the analysis, “true” price declines would be much more dramatic than shown by the standard measures.
The best house price measures are repeat-sales calculations that follow the same houses through time. On this basis, the relatively new S&P/Case-Shiller® Home Price Indices are the deepest and most comprehensive measures — currently providing monthly data for 20 major metro areas as well as a quarterly national home price index.
Data for the final quarter of 2006 show broad-based annualized declines on a sequential basis (-2.9% nationally) and a mixture of positives and negatives on a year-over-year basis (+0.4% nationally). More negatives are inevitable as 2007 rolls along, helping to restore better supply-demand balance in the markets.
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. 28 edition. To subscribe to “Eye on the Economy,” click here.
Is the Housing Correction Over? Attend Construction Forecast Conference
Will housing demand outweigh affordability hurdles, inventory overhangs and the retreat of investors? Where are home prices headed?
Get the answer to these and other questions at the Construction Forecast Conference — Spring 2007 on April 26 in Washington, D.C.
Panels of nationally recognized experts will discuss economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys at the day-long conference.
For more information and to register, click here.
The conference is also available via Webcast. For Webcast information, visit www.nahb.org/cfcwebcast.
 Want to Know the Housing Starts Through 2015?
Find out in HousingEconomics.com’s Long-Term Forecast.
HousingEconomics.com includes downloadable Excel tables featuring the housing starts forecast, GDP, demographics and more.
To learn more, visit www.housingeconomics.com.
 NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into the middle of the year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
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.
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