Eye on the Economy - 08/20/2008 (Plain Text Version)

By David F. Seiders, NAHB Chief Economist

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The Economy Is Moving Through Rough Waters

Economic growth improved in the second quarter but the economy now is traveling through rough waters that could tip the economy into mild recession before the ship steadies next year.

The economy is being whipsawed by wild fluctuations in energy prices, extreme volatility in national and global financial markets, a deepening housing contraction and important shifts in economic policy. The net impacts of these and other factors figure to be negative in the near term, testing the vaunted resilience of the U.S. economy.

NAHB’s baseline (most probable) forecast shows a pronounced deterioration of gross domestic product (GDP) growth during the period ahead ― with negative readings in both the fourth quarter of this year and the first quarter of 2009, followed by a gradual recovery pattern during the balance of 2009 and resumption of trend GDP growth by 2010.

Our forecast also shows erosion of payroll employment through the first half of 2009. We expect the unemployment rate to top out at 6.3% in the third quarter of next year before retreating a good bit late next year and in 2010.

Financial Market Turmoil Boils Up Once Again

The statement issued by the Federal Reserve at the conclusion of the August 5 meeting of the Federal Open Market Committee highlighted “tight credit conditions” and noted that “financial markets remain under considerable stress” — despite the Fed’s stimulative monetary policy stance and maintenance of the Fed’s innovative liquidity-enhancing measures. Our central bank’s perspectives on this front are proving to be right on target.

Like earlier rounds of stress during the past year, the most recent round of financial market turmoil has been provoked largely by developments in the housing finance system, including evidence of deepening problems on the mortgage default/foreclosure front as well as a crisis of confidence in the secondary-market government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac — despite establishment of unprecedented Treasury backstop authority in the Housing and Economic Recovery Act of 2008.

Symptoms of broad-scale credit market stress have once again shown up as widening quality spreads in bond and mortgage markets.

Lower-rated corporations are having to pay very large spreads over comparable-maturity Treasury securities, and even highly-rated corporations have to pay abnormally large spreads over Treasury rates.

In home mortgage markets, the spread between rates on prime conventional conforming mortgages (salable to the GSEs) and 10-year Treasury bond rates has widened quite a bit, partly reflecting higher rates on recent GSE issues of senior debt.

NAHB’s forecast expects the mortgage-Treasury spread to narrow before long, and we’re projecting a reasonably favorable pattern of rates on both fixed-rate and adjustable-rate prime conventional conforming home mortgages. This forecast assumes that Fannie Mae and Freddie Mac will be able to meet market demands for prime conventional home mortgage credit at reasonable rates.

We’re also assuming that the FHA mortgage insurance program will continue to grow. [return to top]

Bank Lending Standards Tighten Systematically

Bond and mortgage rates do not tell the whole story about credit market conditions facing businesses and consumers. The rest of the story is told by shifts in lending standards at depository institutions ― and that story is increasingly serious.

The Federal Reserve’s recent Senior Loan Officer Opinion Survey (SLOOS), conducted in mid-July and released on Aug. 11, documents a progressive tightening of lending standards in all major components of U.S. credit markets.

The July SLOOS also asked banks about expectations for further tightening down the line, and the responses point toward considerably more tightening of lending standards for most types of credit well into 2009 — hardly good news for housing and the economy.

Since early last year, the Fed’s SLOOS has provided separate treatment of prime, subprime and “nontraditional” home mortgages (primarily pay-option and interest-only ARMs as well as Alt-A products).

The July survey showed that 75% of respondent banks had tightened their lending standards on prime mortgages during the previous three months, and the readings for subprime and nontraditional home mortgages both came to 85%.

Of course, this round of tightening comes on top of a series of tightening moves during the past two years, and the cumulative tightening process is alarming to say the least.

Looking forward, large percentages of banks said they expect to tighten lending standards for home mortgages (prime or nonprime) during the second half of this year and during the first half of 2009, adding to the cumulative tightening process.

The July SLOOS also asked banks about lending standards on commercial real estate loans, a category that includes residential construction and land development loans.

Eighty percent of respondents said they had tightened credit standards for approving applications for such loans over the past three months, similar to findings of the Fed’s April survey, and a majority of banks expect to tighten further in the second half of this year and the first half of 2009.

NAHB’s surveys of builders also have been identifying substantial cumulative tightening of lending standards on land acquisition, land development and construction loans in recent quarters, and the Fed’s survey suggests that there’s more to come down the line. [return to top]

Production Cutbacks Are Addressing the Supply-Demand Imbalance in Housing Markets

Single-family starts and permits continued downward in July, falling by 2.9% and 5.2% respectively. Both measures now are down by roughly 65% from their respective peaks during the boom period, and completions of single-family homes are on a similar downtrend.

Single-family starts for-sale (exceeding homes built on owners’ lots) have been falling even faster than total single-family starts. In fact, starts for-sale have been running below new-home sales for the past year, and new-home inventories have been trimmed in the process.

This is part of the essential rebalancing of market demand and supply that will pave the way for a sustainable pickup in housing starts down the line. [return to top]

New-Home Sales Are Approaching a Bottom

While new-home sales have exceeded starts for-sale in recent times, new-home sales volume has continued to trail downward — albeit at a slower pace than last year.

NAHB’s proprietary survey of 30 large builders shows further erosion of gross and net sales in July (seasonally adjusted), and our broad-based single-family Housing Market Index (HMI) was at a record low of 16 in both July and August.

On the bright side, the sales expectations component of the HMI moved upward in August, presumably reflecting expectations of support from the $7,500 first-time home buyer tax credit that was created by the Housing and Economic Recovery Act of 2008.

Furthermore, surveys of consumer sentiment (University of Michigan) show that rising proportions of consumers say home buying conditions have been improving — primarily because of downward price adjustments in many areas.

NAHB’s forecast shows a bottom for new-home sales before the end of this year followed by a 10% gain in 2009 (year-over-year).

This sales pattern, if achieved, will produce substantial improvement on the inventory front and lead to an upturn in housing starts by the second quarter of next year — assuming adequate supplies of credit for residential development and construction. [return to top]

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. [return to top]