America's Housing Market - As the Fed Sees It

It's always interesting to see how our very best friends that dwell in the rarified air that is the Federal Reserve, deal with the ways that their policies are affecting those of us who live in the real world.  A speech in June by Janet Yellen, the Vice Chair of the Board of Governors of the Federal Reserve System given to the Federal Reserve Bank of Cleveland Policy Summit does just that.  The title of Ms. Yellen's speech is "Housing Market Developments and Their Effects on Low- and Moderate-Income Neighbourhoods", in other words, an examination of the housing markets where most of us live...except those of us that just might happen to be central bankers.

I'm going to select a few salient points from Ms. Yellen's speech.  In particular, I will be selecting the most interesting statistics that might be of interest to my readers.  I am also mindful that many of you are part of these statistics but sometimes quantifying the issues facing America's housing market makes us all realize just how grim things are for many of our peers, friends and neighbours.  As well, much of this data can be found if one is willing to wade through scattered sources but to me, this appeared to be a very compact summary of America's housing market issues.  Think of this as "one stop shopping" for all you need to know about what is happening in the housing market.

Ms. Yellen opens by noting that prices in the housing market have been dropping for the past six years and that only 15 percent of households in America expect that house prices will increase over the next year and, looking further down the timeline, only 50 percent expect that house prices will increase over the next five years. (my bold)  That is a truly frightening statistic because, as we all know, the market often predicts its own trajectory.  For instance, if people (and the media) believe that the market will decline, it quite often does.

Ms. Yellen goes on to state that the fall in house prices and the accompanying stubbornly high rate of unemployment resulted in 4.5 percent of mortgages in the United States currently falling into foreclosure with an additional 3.5 percent falling behind by three or more payments.  In 2010 alone, 2.5 million foreclosures were initiated and that number is expected to be repeated in 2011.  The flood of foreclosures on real estate markets across the United States has depressed prices even further than what might have been anticipated.  Many of these foreclosed homes sit empty for months and fall into disrepair which further depresses prices and has the unfortunate result of creating "collateral damage" to the value of neighbouring homes.

As if foreclosures weren't causing enough market disruption, it is estimated that in the first quarter of 2011, there were nearly 2 million vacant homes scattered across the United States.  While this is down from the 2008 highs, it is still a whopping 60 percent higher than the average vacancy level over the 20 years between 1988 and 2008.  With 2.5 million anticipated foreclosures for 2011, it is unlikely that the rather ample supply of vacant homes is going to disappear any time soon.

Ms Yellen also discussed the issue of tight credit in the housing market.  Commercial banks are starting to open the credit spigots for credit card and consumer loan debt but she notes that the credit score required to access mortgage funds has risen from a median of 740 in 2005 - 2007 to 780 since mid-2010.  To make matters worse (for both banks and the real estate market), demand for mortgages has been very weak, partly a response to a weak economy where potential buyers are uncertain about the stability of both their jobs and the future value of any home that they may buy.  Many Americans have watched their net worth plummet over the past 4 years with one-quarter of all homeowners seeing their net worth drop by more than 50 percent.  As well, with approximately one-quarter of all homeowners "underwater", mortgage holders cannot refinance, cannot easily sell and are more likely to default if they should find themselves unemployed or underemployed.

Now let's take a brief look at the main subject of the speech, the impact of the housing disaster on low- and medium-income neighbourhoods.  According to research by the Fed, house prices in low- and middle-income neighbourhoods rose more during the boom of the 2000's and fell more during the bust of the late part of the same decade than their high-income counterparts.  A study by CoreLogic reveals that from 1998 to 2006, house prices rose an astonishing 11 percent annually in low- and middle-income neighbourhoods compared to 9 percent in their high-income counterparts.  In contrast, during the price bust from 2007 to 2010, house prices in low- and middle-income neighbourhoods dropped at an annual rate of 8 percent compared to 7 percent in high income neighbourhoods.  As well, mortgage application rates differed greatly across social lines.  Between 2003 and 2006, there was a surge in mortgage lending in the lower income neighbourhoods with applications up 60 percent between 2003 and 2006 compared to a rise of only 20 percent in higher income neighbourhoods.  When the market started to collapse, applications contracted by 65 percent in lower income neighbourhoods and by only 50 percent in higher income neighbourhoods.  This had the consequence of leaving twice as many lower income homeowners underwater since they held a greater portion of prime mortgages and, since they had a greater portion of their overall assets tied up in the declining value of their residential real estate, they were far more likely to default on their mortgages.  Statistics show that 13 percent of mortgages that were held by residents of low- and middle-income neighbourhoods were 90 days or more overdue in Q1 2011 compared to only 6 percent in higher income neighbourhoods.

What I find particularly interesting about this speech is that it was given by a member of the Federal Reserve, the body that is in large part responsible for the current mess in the housing market.  With the Fed's easy and cheap money policy over an extended timeframe in the mid-2000s, one would think that they would have picked up on just where all that money was going.  Here is a graph showing what has happened to the Fed Funds Rate over the past 23 years:

Note that the prolonged period of near zero interest rates in the middle of the first decade of the new millenium coincides quite neatly with the massive rise in house prices as shown here:

I guess "Helicopter Ben's" money had to go somewhere!

  

To conclude, here is a direct quote from Ms. Yellen's speech:

"In making a decision about homeownership, prospective buyers need to consider the risks as well as the benefits--in particular, the possibility that house prices can fall and that such declines can have long-lasting effects on their financial well-being. The current decline in national house prices and the preceding run-up were, of course, unusually large even by historical standards. But even during times when house prices were rising nationally, prices fell steeply in certain local markets, such as Texas in the mid-1980s or Massachusetts in the early 1990s. And homeowners are not alone in their difficulty in predicting house prices: The record of industry analysts and economists is also mixed. Although many professionals understood that house values were high at the peak of the recent cycle--probably unsustainably so--there was no consensus about the extent or severity of the coming fall." (my bold)

When Ms. Yellen refers to the mixed record of "economists", I think she really meant to say "central bankers".