To Shore Up the Recovery, Help Housing by Mark Zandi of MOODY'S ANALYTICS; Special Report
It is hard to be enthusiastic about the economy’s prospects as long as house prices are declining. A house is usually a household’s most important asset; many small-business owners use their homes as collateral for business credit, and local governments rely on property tax revenues tied to housing values.
Most worrisome is the risk that housing will resume the vicious cycle seen at the depths of the last recession, when falling prices pushed more homeowners under water—their loans exceeded their homes’
market values—causing more defaults, more distress sales, and even lower prices. That cycle was broken only by unprecedented monetary and fiscal policy support.
The gloom in the housing and mortgage markets notwithstanding, there are reasons to be optimistic that housing’s long slide will come to an end soon. While a mountain of distressed property remains to be sold, investor demand appears strong. Prices have fallen enough to allow investors to profitably rent out these homes until the market recovers. Rental
vacancy rates have fallen meaningfully over the
past year, suggesting that new construction is
slow enough to let builders work down the still considerable number of excess vacant homes.
Nonetheless, the risks remain uncomfortably high. Policymakers may thus want to consider taking additional steps to support housing temporarily. These might include facilitating more mortgage refinancing, delaying a reduction in conforming loan limits, and supporting more mortgage loan modifications— with principal reductions—more aggressively.
Although none of these steps are particularly
satisfying or likely to be popular, the outcome will be worse if policymakers stand by while a weakening housing market undermines the economic expansion.
Five lean years The housing crash is more than five
years old. Sales of existing homes—a measure
of housing demand—languish near an annual rate of 5 million units, of which about a third are foreclosures and short sales. Sales of new homes are even bleaker, running at a record low rate close to
300,000 units per year.
In a well-functioning housing market, about a million more new and existing homes would change hands per year, and less than a tenth would be distress sales.
1) Housing construction—the marker for housing supply—is even more depressed. Single- and multifamily housing starts are running at close to 550,000 units annualized, and manufactured home placements barely reach 50,000 per year.
This is the weakest pace of residential construction
since World War II. A well-functioning housing market would be producing closer to 1.75 million units annually.
2) A housing market is considered to be functioning well when the broader economy is at full employment and growing at its long-run potential rate over the course of the business and housing cycles.
This housing supply is supported by an average annual 1.25 million household formations, the obsolescence of 300,000 housing units, and the construction of 200,000 vacation homes.
Nationwide house prices are falling again. The Fiserv Case-Shiller national house price index has dropped by a third since peaking in the first quarter of 2006. The fragile stability in prices that prevailed for most of the past two years was broken in recent months as more distressed properties were sold. In
a well-functioning housing market, prices should rise nearly 3% per year.
3) Economic fallout
Although housing is not the drag that it was during the worst part of the recession, it remains a significant weight on growth. This is particularly disappointing since housing is often a major source of growth early in an economic recovery. Falling house prices and the resulting hit to household wealth remain a serious problem. Some $6.5 trillion in homeowners house prices should grow somewhere between the rate of household income (4% per annum) and overall price inflation (2% per annum). Prices are ultimately determined by their replacement cost, which is equal to the sum of the cost of land and the cost of construction. The cost of land is determined by the opportunity cost of that land or GDP per developable acre.
The growth in GDP per acre is equal to the growth in household income (assuming that the profit share of GDP remains constant). Construction costs will grow at the rate of overall inflation (in the long run, as material and labor costs can vary substantially in the short run). Since the proportion of house
prices that are accounted for by land costs varies considerably from place to place (a very high percentage in San Francisco and a low percentage in Des Moines), the growth in house prices will
also vary considerably. For the past quarter-century or so (the recent boom-bust aside), house prices have been growing at a rate closer to household income. As the incentives for homeownership steadily increased (pecuniary and non-pecuniary),households spent as much of their income on housing as possible.
As these incentives have likely peaked and may very well decline, households will devote less of their income to housing, and prices are likely to grow more closely to the inflation rate. The five-year-old housing crash continues to threaten the U.S. economic expansion. Home sales and housing construction remain weak, while house prices are falling again in many parts of the country as foreclosure and short sales are ramping up.
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“Our deepest fear is not that we are inadequate. Our deepest fear is that we are powerful beyond measure. It is our light not our darkness that frightens us. Actually, who are you not to be? You are a child of God. Your playing small doesn’t serve the world. There’s nothing enlightened about shrinking so that other people won’t feel insecure around you. We were born to make manifest the glory of God that is within us.”
It is hard to be enthusiastic about the economy’s prospects as long as house prices are declining. A house is usually a household’s most important asset; many small-business owners use their homes as collateral for business credit, and local governments rely on property tax revenues tied to housing values.
Most worrisome is the risk that housing will resume the vicious cycle seen at the depths of the last recession, when falling prices pushed more homeowners under water—their loans exceeded their homes’
market values—causing more defaults, more distress sales, and even lower prices. That cycle was broken only by unprecedented monetary and fiscal policy support.
The gloom in the housing and mortgage markets notwithstanding, there are reasons to be optimistic that housing’s long slide will come to an end soon. While a mountain of distressed property remains to be sold, investor demand appears strong. Prices have fallen enough to allow investors to profitably rent out these homes until the market recovers. Rental
vacancy rates have fallen meaningfully over the
past year, suggesting that new construction is
slow enough to let builders work down the still considerable number of excess vacant homes.
Nonetheless, the risks remain uncomfortably high. Policymakers may thus want to consider taking additional steps to support housing temporarily. These might include facilitating more mortgage refinancing, delaying a reduction in conforming loan limits, and supporting more mortgage loan modifications— with principal reductions—more aggressively.
Although none of these steps are particularly
satisfying or likely to be popular, the outcome will be worse if policymakers stand by while a weakening housing market undermines the economic expansion.
Five lean years The housing crash is more than five
years old. Sales of existing homes—a measure
of housing demand—languish near an annual rate of 5 million units, of which about a third are foreclosures and short sales. Sales of new homes are even bleaker, running at a record low rate close to
300,000 units per year.
In a well-functioning housing market, about a million more new and existing homes would change hands per year, and less than a tenth would be distress sales.
1) Housing construction—the marker for housing supply—is even more depressed. Single- and multifamily housing starts are running at close to 550,000 units annualized, and manufactured home placements barely reach 50,000 per year.
This is the weakest pace of residential construction
since World War II. A well-functioning housing market would be producing closer to 1.75 million units annually.
2) A housing market is considered to be functioning well when the broader economy is at full employment and growing at its long-run potential rate over the course of the business and housing cycles.
This housing supply is supported by an average annual 1.25 million household formations, the obsolescence of 300,000 housing units, and the construction of 200,000 vacation homes.
Nationwide house prices are falling again. The Fiserv Case-Shiller national house price index has dropped by a third since peaking in the first quarter of 2006. The fragile stability in prices that prevailed for most of the past two years was broken in recent months as more distressed properties were sold. In
a well-functioning housing market, prices should rise nearly 3% per year.
3) Economic fallout
Although housing is not the drag that it was during the worst part of the recession, it remains a significant weight on growth. This is particularly disappointing since housing is often a major source of growth early in an economic recovery. Falling house prices and the resulting hit to household wealth remain a serious problem. Some $6.5 trillion in homeowners house prices should grow somewhere between the rate of household income (4% per annum) and overall price inflation (2% per annum). Prices are ultimately determined by their replacement cost, which is equal to the sum of the cost of land and the cost of construction. The cost of land is determined by the opportunity cost of that land or GDP per developable acre.
The growth in GDP per acre is equal to the growth in household income (assuming that the profit share of GDP remains constant). Construction costs will grow at the rate of overall inflation (in the long run, as material and labor costs can vary substantially in the short run). Since the proportion of house
prices that are accounted for by land costs varies considerably from place to place (a very high percentage in San Francisco and a low percentage in Des Moines), the growth in house prices will
also vary considerably. For the past quarter-century or so (the recent boom-bust aside), house prices have been growing at a rate closer to household income. As the incentives for homeownership steadily increased (pecuniary and non-pecuniary),households spent as much of their income on housing as possible.
As these incentives have likely peaked and may very well decline, households will devote less of their income to housing, and prices are likely to grow more closely to the inflation rate. The five-year-old housing crash continues to threaten the U.S. economic expansion. Home sales and housing construction remain weak, while house prices are falling again in many parts of the country as foreclosure and short sales are ramping up.
“Our deepest fear is not that we are inadequate. Our deepest fear is that we are powerful beyond measure. It is our light not our darkness that frightens us. Actually, who are you not to be? You are a child of God. Your playing small doesn’t serve the world. There’s nothing enlightened about shrinking so that other people won’t feel insecure around you. We were born to make manifest the glory of God that is within us.”
- Nelson Mandela