Analysis
Amid market fears over contagion from the euro-area and continued housing price declines, there have recently been encouraging signals about the state of the housing market. These positive developments are tenuous, but they signal a more favourable trend.
Positive signals
A marked improvement in US housing market affordability -- for those who have jobs and who have access to credit -- is the most positive signal. However, there are others.
Affordability
According to the Freddie Mac survey, US housing market affordability is now at its best level since the survey began in 1989.
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There are two key factors that explain the improvement in affordability over the past five years:
- Since peaking in September 2006, home prices as measured by the S&P/Case-Shiller index have now fallen approximately 32%.
- Supported by the easier monetary policy stance of the Federal Reserve, primary mortgage interest rates are now at a generational low; 30-year fixed interest mortgage rates are now at or below 4%.
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Rental market boom
A further sign that the housing market is adjusting is that the rental market is now booming. This points towards stabilisation.
With the foreclosure crisis converting many former homeowners into renters, rental supply is as tight now as it was prior to the recession. This is reflected in a decline in the rate of homeownership from a peak of 69.2% in 2004 to approximately 65.9% now. It is also reflected in a rise in rental prices this year by approximately 4%.
Investment in the rental market is booming. Close to one-third of the purchases of existing homes this year have gone to all-cash buyers, the bulk of whom are property investors.
Supply glut challenge
Despite improved housing affordability, the market has yet to find a bottom. The most important factor in delaying the bottoming out of the housing market is the foreclosure crisis. This has produced a steady stream of foreclosed properties -- adding supply to a market already characterised by excess supply. There is every reason to expect that this process will continue to impede any meaningful rebound in home prices for 2-3 years.
In recent Congressional testimony, Laurie Goodman of Amherst Securities observed that the foreclosure crisis creates massive headwinds to any recovery in housing prices.
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Foreclosures are the main impediment to recovery
Of the 55 million mortgage borrowers at present, between 8.3 million and 10.4 million borrowers, or approximately one in five, could potentially default over the next several years. This includes approximately 4.5 million mortgage borrowers who are already non-performing on their loans and around 2.5 million with loan-to-value levels in excess of 120%.
Goodman pointed out that even spreading mortgages likely to default over a six year period, this process would produce additional supply to the market of approximately 1.5 million units a year. This would likely exceed new demand for housing, even excluding the probable figure of 500,000 units of newly constructed housing each year. According to Harvard's Joint Center for Housing, household formation over the next decade is likely to run at a pace of only 1.2 million new households a year.
Other restraining factors
Besides the foreclosure crisis, two additional factors are likely to continuing preventing markedly improved housing affordability from translating into any firming in home prices.
Labour market weakness
Job insecurity has been a major factor inhibiting demand. According to the Labor Department's broad U-6 measure of unemployment ('underemployment'), approximately one-in-six US workers is presently unemployed, discouraged, or involuntarily in part-time employment. The recently downward revised Federal Reserve economic outlook offers little hope that there will be a rapid improvement in the US employment situation in 2012.
Tepid demand
The supply/demand imbalance in the US housing market will likely continue to be exacerbated by the tightening in lending standards on the part of the government sponsored enterprises (GSE) which currently dominate the US mortgage origination market -- principally, Fannie Mae and Freddie Mac. This is readily seen in the higher FICO credit scores (the market leading credit scorer) that the GSEs are demanding, and by the lower loan-to-value-ratios that they are prepared to finance.
Housing price outlook
Over the past year, there has been a renewed modest decline in US home prices. This has occurred despite a marked improvement in housing affordability and it mainly reflects the foreclosure crisis and the continued poor state of the US labour market. It is very likely that these conditions will persist in 2012, which makes any significant 'bounce' off the bottom unlikely.
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Prices could stabilise, but a 'bounce' off the bottom is unlikely
Moreover, the euro-area crisis constitutes a significant downside risk to the US economy and hence to the US housing market. Three possible channels of transmission for potential systemic contagion underline the importance of the euro-area outlook for the US economy:
- Renewed EU economic recession would diminish US export prospects to an important market for US goods.
- A weakening in the euro against the dollar, which would very likely flow from a European banking crisis and from questions about the euro's survival in its present form, would put US exporters at a disadvantage with respect to European companies in third markets.
- In much the same way as the US Lehman crisis of 2008-09 severely impacted the European economy through financial market dislocation, a European banking crisis would materially impact the US economy both through the financial market channel and through a generalised increase in global economic risk aversion.
If the euro-area crisis does not become acute, create systemic contagion, and impair the functioning of US credit markets, the United States looks capable of avoiding renewed recession next year -- thereby keeping the housing market adjustment process on track (see PROSPECTS 2012: US economy - November 8, 2011). If credit contagion does develop, the process will suffer a major setback, even if the United States technically avoids a recession.
