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Housing Update: Is the End in Sight?
Summary of Remarks by
Doug Duncan
Fannie Mae
February 4, 2010
The health of the housing market is linked to the overall health of the economy. Dr Duncan predicts the growth rate in the first year coming out of this recession will be about half that of the previous post WWII recessions. In the housing arena, policy is paramount. At Fannie Mae, the primary concern is on the factors that can lead to renewed stability in the housing market.
The most important factor in the housing market is private sector employment. It’s also usually the earliest indicator of any problem or recovery in the housing market. In this most recent housing cycle, there was an increase in defaults while private sector jobs were still being created, an unprecedented phenomenon. Duncan thinks the labor market has bottomed out at this point. Temporary hiring has been increasing. Still, as of December 2009, no state has experienced a year-over-year employment gain.
The trigger for the current housing market crisis was subprime lending, but the underlying principle was excessive leverage in households and financial sector firms. (The last time the economy experienced a leverage-induced financial sector disruption, in 1998, the trigger was Long Term Capital Management’s failure.) Consumer spending is still weak and consumers are focused more on paying off debt and increasing saving than spending. During this time of crisis, banks have tightened their lending standards and contracted their private sector lending. Yet consumer debt remains higher than historical norms, even as the demand for credit remains below norms.
In the mortgage arena, refinancing accounted for a big portion of lending activities last year, even as home prices have returned to more affordable levels. Still, refinancing was constrained by tighter lending and a decline in home values and did not reach the record levels seen in 2003. The government share of purchase applications and mortgage originations is increasing, even as mortgage applications overall have been declining.
Last year’s first-time homebuyer tax credit had a temporary impact on homebuilding and home purchases and has since been renewed. The number of new homes purchased over the past few years has dropped dramatically and construction has fallen as well due to the excess supply and vacant property overhang in the market. Duncan estimates there are nearly 800,000 more vacant houses on the market for owner-occupancy than normal. The total excess supply of somewhere between five and seven million units threatens to dampen home prices further. This helps in part to explain why one in four homeowners has negative equity in their home (“underwater”). With mortgage resets, high unemployment, and excess housing supply, delinquencies are likely to increase further.
The outlook for commercial real estate (including multifamily) remains grim. Commercial construction has slowed, vacancy rates have reached record highs, and delinquencies have followed suit.
On the positive side, stock valuations have rebounded, and home equity has stopped falling. The spread between the two- and ten-year Treasury notes has increased while the spread between thirty-year mortgages and ten-year treasuries has declined (mainly due to the Fed entering the market for mortgage backed securities). The steepening of the yield curve typically precedes the recovery of the economy so this is a positive sign.
The housing crisis begs the important policy question, “What is a sustainable homeownership rate?” Clearly the record 69.2% rate was unsustainable, and unfortunately all those excess homes will not evaporate. But how many of these homes will be purchased as investments and put into the rental market? It depends on the price at which investors will break even or turn a profit and the rental rate that implies. Multifamily housing offers some economies of scale to renters (use of infrastructure and energy). While there is relatively little research on the subject, Dr. Duncan speculates the homeownership rate will stabilize near 66%. The housing market should regain equilibrium by 2013.
In order to fix the housing market, the economy will have to grow and thus allow employers to create jobs. Although the economy is improving, and the worst may be behind us, the recovery will be slow and long. As Duncan noted in his last slide, “Consumers are still weak, employment is stabilizing but not growing, and credit markets are repairing but not repaired.” And as far as housing, the market is “stabilizing but nowhere near healthy, and excess inventory and shadow supply are substantial.”
After his prepared remarks, Duncan fielded questions from the audience.
Q: Doesn’t the Fed flow of funds and GDP data suggest long-term weakness in the economy?
A: The data do indicate weakness, especially as banks have and excess of loans extended relative to historical averages meaning they lack capacity to extend credit. The economy can grow, just not robustly.
Q: How do the job losses (perhaps permanent) factor in with the underwater mortgages?
A: The combined factors of weakness (high unemployment, excess housing supply, mismatched tenure) only prolong the time to recovery. We do have a structural adjustment to make in the labor market.
Q: There was a recent article in The New York Times about people walking away from their mortgages and homes.
A: This is a difficult situation involving various factors: Credit damage, unemployment, loss of income, ease of finding other housing, vanished home equity.
Q: What could the government-sponsored enterprises do to stabilize housing markets in the future?
A: Fannie Mae is cooperating with the government to ensure liquidity. Spreads between home loans and other types of debt have come down. Going forward, policymakers will have to determine the principles and infrastructure needed to have a well functioning and efficient financial market.
Q: How long will it take to work off the underwater mortgages?
A: It’s hard to say – there is no precedent.
Q: Can you discuss regional factors in the current housing crisis?
A: The picture is different in different parts of the country. In California, we may be seeing the bottom for lower priced properties. In Florida, we may be several years from the bottom of home prices. In Arizona and Nevada as in Florida, there is excess supply. In the Upper Midwest (like Michigan), the state economies need to be completely restructured.
Douglas G. Duncan is Fannie Mae's vice president and chief economist. Prior to joining Fannie Mae, Duncan served as senior vice president and chief economist of the Mortgage Bankers Association (MBA) since 2000. Prior to joining the MBA in 1992, Duncan worked on Capitol Hill as a LEGIS Fellow and staff member on the Committee on Banking, Finance, and Urban Affairs, and at the U.S Department of Agriculture's Economic Research Service. He has been elected to the Board of Directors for the National Association of Business Economists, is a member of the American Economics Association and the American Real Estate and Urban Economics Association, and is past president of the Housing Statistics Users Group. Inman News has listed him in the “Top 100 Most Influential People in Real Estate”. Duncan received his Ph. D. in Agricultural Economics from Texas A&M University and his B.S. and M.S. in Agricultural Economics from North Dakota State University.
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