Eye on the Economy - 12/19/2007 (Plain Text Version)By David F. Seiders, NAHB Chief Economist
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E-mail Our Editor The Economy Enters a Serious Danger ZoneThe U.S. economy performed remarkably well during the first three quarters of this year in the face of a stunning downswing in home sales and housing production that lopped big pieces off economic growth. Indeed, GDP growth came to nearly 5% in the third quarter despite a 20% contraction in the housing production component (residential fixed investment) that subtracted a full percentage point from the overall economic growth rate.
Residential fixed investment figures to contract at an even faster pace in the fourth quarter, and other key sectors of the economy are weakening at the same time. NAHB’s forecast shows GDP growth of only 0.5% in the current quarter — virtual stall-speed — and we’re estimating only 1.5% growth in the first quarter of 2008. This near-term growth pattern leaves the economy highly vulnerable to negative economic surprises, such as another surge in energy prices or another round of turmoil in the credit markets. We figure that, in such a danger zone, the probability of outright economic recession is about 40%. Credit markets at home and abroad have been rocked by increasingly serious rounds of turbulence since early this year. A really serious round erupted in August followed by restoration of relatively tranquil conditions by October. But another serious round erupted in November that still plagues the markets as the year draws to a close. Revelations of deep credit quality problems in the U.S. subprime mortgage sector have served as triggers for successive flights to quality in the credit markets, and the global investment community now imagines serious credit risk around virtually any corner not guarded by government guarantees. The stampede to quality has shut down or seriously crippled major components of securities markets ― not only subprime, Alt-A and jumbo mortgage securities markets in the U.S., but also asset-backed commercial paper markets and interbank markets for short-term funds in the U.S. and abroad. At the same time, quality spreads have widened out considerably in corporate bond markets and many lower-rated corporations have lost access to external funds. [return to top] The subprime-induced tightening of credit conditions in home mortgage markets now is being joined by tightening in credit markets where builders and developers raise funds — the markets for land acquisition, land development and construction loans (AD&C). Some tightening in AD&C markets has been virtually inevitable in view of the major downswing in home sales, the major upswing in inventories of unsold homes and associated weakening in prices of both homes and buildable land in many parts of the country. NAHB surveys of single-family builders show some recent deterioration in the availability of AD&C credit. For example, 40% of respondents to a December survey said that the availability of single-family construction loans had deteriorated since mid-2007. This deterioration most commonly showed up as a reduction in allowable loan-to-value ratios. We’ve also surveyed builders about changing terms on land loans taken out during the past two years. About one-fifth of respondents said that they had been asked to pay down portions of their land-acquisition loans because the appraised value of the land had been marked down since loan origination. This response was most common among larger companies and in the West. [return to top] As we had expected, the Federal Reserve enacted quarter-point cuts in both the federal funds rate target and the discount rate at the conclusion of the Dec. 11 meeting of the Federal Open Market Committee (FOMC). These changes put the funds rate at 4.25% and the discount rate at 4.75% ― one percentage point below the recent highs in mid-September. The Dec. 11 FOMC statement highlighted “intensification of the housing correction” as well as increasing “strains in financial markets,” but refused to take a position on the balance of risks to the U.S. economy. Failure of the FOMC to stress the obvious downside risks to economic growth, and to downplay upside risks to core inflation, left the markets cold — as did maintenance of the half-point penalty rate on funds raised by banks at the discount window. This double-barreled dose of disappointment rocked the stock market and called the decisiveness of the Bernanke Fed into serious question. [return to top] There apparently was some method to the Fed’s madness — the miserly cut in the discount rate — coming out of the Dec. 11 FOMC meeting. On Dec. 12, the Fed announced creation of a temporary Term Auction Facility (TAF) that could turn out to be a more effective way of adding liquidity to the banking system, and of easing strains in the money market, than a half-point cut in the discount rate would have accomplished. At the same time, the Fed established reciprocal foreign exchange “swap” lines with the European Central Bank and the Swiss National bank in an effort to put downward pressure on interbank dollar rates in offshore markets, particular in the LIBOR market. Interest rates are linked to LIBOR in many floating-rate credit arrangements in the U.S. The TAF actually will advance funds through the Federal Reserve discount window, but at a lower (auction-determined) rate than currently available on discount window loans and without the stigma associated with ordinary borrowing at the window. While the TAF is not designed to increase the overall volume of reserve in the banking system (open market operations will be adjusted), it should make banks more willing to lend into the interbank market, helping to ease strains in the money markets. The first TAF auction was held on Dec. 17, another is scheduled for Dec. 20 and two more will occur in January. If the auctions are deemed successful, the TAF may become a permanent part of the Fed’s monetary policy tool kit. [return to top] Recent housing market indicators show that the dramatic housing downswing that began in the latter part of 2005 still is underway as 2007 draws to a close. On the production side, single-family starts and permits both fell by more than 5% in November, reaching the lowest levels in more than 16 years, and the backlog of unused permits has been whittled down in the process. Recent signals on housing demand still are quite weak, although there are some tentative signs that home sales may be approaching the bottom for this cycle. Sales of both new and existing single-family homes were essentially flat in the September-to-October period, and pending sales of existing homes moved up modestly during that period. NAHB’s surveys of single-family builders provide recent signals on the condition of housing demand. Our proprietary survey of large public and private home building companies shows stabilization of net home sales during the September-to-November period (three-month moving average basis), primarily reflecting improvements in cancellation rates. NAHB’s broad-based Housing Market Index, based on large monthly surveys of single-family builders, was flat during the October-to-December period. The HMI is at a record low of 19 ― down from a peak of 72 at mid-2005 ― but at least builders’ views of the demand side of the market are no longer deteriorating. [return to top] NAHB’s forecast continues to show a bottom for the housing cycle in 2008, followed by a gradual recovery process that will lift home sales and housing production back toward the demographically based trend over a period of several years. Our forecast anticipates a trough for home sales in the first quarter of 2008 and a bottom for housing starts around mid-year. Residential fixed investment begins to post modest positive growth in the second half of 2008 and makes solid contributions to GDP growth by 2009. [return to top] Eye on the Economy will will not be published during the holidays. Publication will resume on Jan. 9. Have a happy and warm holiday season and a Happy New Year. [return to top]
The webcast of the NAHB Fall Construction Forecast Conference held in Washington, D.C. on Oct. 24. is available for purchase through Feb. 5. Those interested can purchase the conference webcast, which includes panels of nationally recognized experts discussing economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys. Purchasers will receive unlimited access to the webcast archive though Feb. 5, as well as electronic copies of the conference handouts and presentation material. Purchasers can watch at their own pace, rewind, fast forward and review important sections. To Purchase the Webcast To purchase the webcast, visit www.nahb.org/cfcwebcast. For more information, contact Kate Carrigan at NAHB, or call her at 800-369-5242 x8244. [return to top]
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. [return to top] For more information or to contact us directly, please visit www.NAHB.org
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