Over the past few months, there have been suggestions that the U.S. housing market might finally be bottoming out. Since July, the decline in sales of both new and existing homes has moderated. Moreover, over the past three months, there has been a very modest increase in home prices at the national level as measured by the 20-city S&P/Case-Shiller home price index. However, the high inventory of unsold homes, continuing foreclosures, and double-digit unemployment could mean that housing prices have further to fall.
Reasons for cheer. A number of "green shoots" suggest cause for some optimism:
--Inventory reduction. Whereas housing starts are presently estimated to be running at a 600,000 annual rate, underlying U.S. household formation is presently running at an annual rate of approximately 1.5 million units. Lower residential construction relative to household formation is allowing excessive home inventories to be gradually worked off.
--Cheap mortgages. As a result of the Federal Reserve's highly accommodative monetary policy, and the activity of the government-sponsored home lending enterprises, mortgage rates have declined to more affordable levels. For example, 30-year fixed-rate mortgages have fallen below 5% for the first time in many years.
--Increased affordability. The slide in home values has brought prices more into line with their long-run fundamentals. Since September 2006, U.S. home prices have fallen 27%, bringing prices back to the level prevailing in mid-2003. As a result, the ratios of home prices to rents and of home prices to incomes are now much more in line with historic levels. The index of housing affordability now stands at its most favorable level in the past 20 years.
Reasons for doubt. Despite these "green shoots," there remain a number of factors that suggest that U.S. home prices have not quite hit bottom:
--Inventories historically high. Despite small declines in recent months, the inventory of unsold homes at the national level remains at close to its historic high. A key indication of the degree of excess home inventory is that the number of vacant homes, in which neither an owner nor a renter presently dwells, exceeds its normal level by nearly 1 million units.
--Foreclosure crisis. The United States is presently suffering from a foreclosure crisis that is further adding more homes to a market already characterized by excess inventories. Forward-looking indicators, such as the number of mortgages that are more than 90 days delinquent (i.e., behind payment) suggest that the pace of foreclosures could increase in the months ahead.
--High unemployment. A very weak labor market situation inhibits households from making the long-term financial commitments, such as buying a home. The Labor Department estimates that approximately 16.5% of the labor force is either unemployed or in involuntary part-time employment. At the same time, the huge slack presently affecting the labor market is exerting downward pressure on wage income growth. Most economists--including White House Council of Economic Advisers Chair Christina Romer--do not foresee much improvement in the labor market in 2010.
--Mortgage resets. Next year, approximately $200 billion in "Option ARM" mortgages (adjustable rate mortgages) are due to reset to higher rates. This is likely to add to the foreclosure problem, since these resets will produce a sharp jump in debt service payments.
--Default incentive. Finally, another factor adding to the foreclosure problem is that a growing number of U.S. households now have "negative equity" in their homes (i.e., their mortgage debt exceeds the value of their homes). Since mortgages in most U.S. states are "non-recourse loans" (the lender cannot pursue the borrowers' other assets, beyond the home), negative equity gives homeowners a strong incentive to default on their mortgage loans.
Outlook. The present high level of unsold housing inventories, the poor state of the labor market and the current wave of foreclosures suggest that home prices may have a further 10% to fall (in real terms). This will add to the financial distress facing the banking sector, inhibiting a return to above trend GDP growth in 2010.
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