Wednesday, February 15, 2012

Ben, The Fed and America's Housing Market: This Time It Really Is Different

A recent speech by Ben Bernanke sheds some interesting light on the housing situation in the United States.  In this speech entitled "Housing Markets in Transition", Mr. Bernanke goes on at length about what ails the U.S. housing market and how the issue is impacting the so-called economic recovery.  Here are a few salient points from his speech.

Mr. Bernanke opens by noting that, although the economic recovery began more than two years ago (officially in June 2009 according to NBER), it doesn't feel much like a recovery, particularly if you are one of the millions of long-term unemployed or if you happen to own or have lost ownership of a home.  The housing sector is an important driver of the U.S. economy and in a typical recovery, it is housing that drives the economy upward and onward.  Apparently, this time, things really are different.

Here's a quote from Mr. Bernanke:

"The Federal Reserve has a keen interest in the state of housing and has been actively engaged in analyzing the housing and mortgage markets.  Issues related to the housing market and housing finance are important factors in the Federal Reserve's various roles in formulating monetary policy, regulating banks, and protecting consumers of financial services. Traditionally, mortgage interest rates have been a key transmission channel of monetary policy; and banks' mortgage lending policies directly affect their own safety and soundness as well as the access of creditworthy households to mortgage credit."

Perhaps then he should explain why both he and his predecessor, Mr. Greenspan, chose to ignore signs in the housing sector that quite clearly showed that was not well back in 2006?

Mr. Bernanke goes on to note that part of the problem in the housing market is the imbalance between supply and demand, with the supply of available homes far outstripping the demand.  For instance, there are currently about 1.75 million vacant homes listed for sale across the United States, well up from the first half of the decade. Vacancies are particularly high in certain states, particularly of the "sun and sand" variety.  

Here is a graph showing the elevated homeowner vacancy rate (bottom curve on graph):

Homeowner vacancy was as low as 1.8 percent in early 2005; this rose to a peak of 2.9 percent in early 2008 and has dropped to 2.3 percent in the fourth quarter of 2011.  In the fourth quarter, homeowner vacancy rates were as high as 2.5 percent in the mid-west and 2.4 percent in the south down to 2.0 percent in the northeast as shown on this chart:

Here is a graph showing the drop in home ownership rates since the peak of the housing market in 2005 - 2006:

Home ownership peaked at 69.2 percent in 2004 and has fallen to 66 percent in the fourth quarter of 2011.

In combination, these two factors have done this to the median asking price for vacant sales units:

You will note that the median asking price for vacant units has dropped from a peak of just over $200,000 in 2007 to just over $130,000 in the fourth quarter of 2011.  Unfortunately for home-owners, it is this downward trend in the asking price of vacant homes that is putting downward pressure on the valuations of all real estate.

According to Mr. Bernanke, this problem is not going to end anytime soon.  In the past few years, roughly 2 million foreclosures have entered the market and this is likely to continue for the foreseeable future.  Once again, this puts additional downward pressure on the valuations of existing housing and also negates the need for the building of additional housing units.  Single family housing starts since 2009 have dropped to less than 500,000 units on an annual basis, down from more than 1 million prior to the Great Recession as shown on this graph:

In February of 2005, housing starts peaked at 2.207 million units and dropped to a low of 478,000 in April of 2009.  Despite the fact that the economy is nearly three years into recovery, housing starts are still mired at levels not seen in 60 years with starts in December of 2011 reaching a tepid 657,000 on an annual basis.

Nationally, this has been devastating.  Nationwide, house prices have plunged 30 percent in nominal value since the peak and 40 percent in inflation-adjusted terms.  In wealth terms, declines in housing prices have reduced homeowners' equity by more than 50 percent in total across the U.S. since the peak of the housing boom, wiping out more than $7 trillion in household wealth.  More than 12 million or one in five households with a mortgage are now underwater.  This has led to decreased spending; some estimates suggest that households reduce spending by $3 to $5 every year for each $100 in housing value lost.  In total then, reduced consumer spending ranges from $200 to $375 billion annually related solely to the dropping value of residential real estate.  On top of that, we have to add the spending lost by savers who have seen the return on their fixed income investments plummet to near zero.  This has a ripple effect throughout the economy; less spending means lower sales for corporations which results in lowered investments in both mechanical and human capital (i.e. jobs).  Since the housing construction sector is intimately related to housing sales, it has suffered the most.

Mr. Bernanke goes on to question why the recovery in housing has been so slow.  He notes that the outstanding amount of mortgage credit in the United States has contracted by 13 percent in real terms since it peaked in 2007; this is in contrast to other recoveries where mortgage credit began to grow four years after the peak of the previous business cycle.  This time really IS different.

Despite the Fed's best efforts to prod consumers to borrow and banks to lend by implementing a long, long period of a near zero Fed Fund rate and record low mortgage rates, banks have tightened their lending standards, an act that is similar to closing the barn door once the entire herd has escaped.  Lending is restricted for even the most credit-worthy of households.  Fewer than half of lenders are offering mortgages to lenders with a FICO score of 620 and a 10 percent downpayment; this is a far cry from lenders who used the "if you make fog on a mirror when we hold it under your nose" criteria for qualification during the early part of the decade.  These tighter standards have disproportionately impacted first-time homebuyers, even in parts of the U.S. where employment and the economy are solid.  Consumer credit data shows that the share of 29 to 34 year olds that were seeking a first mortgage dropped to 9 percent between mid-2009 to mid-2011 compared to a level of 17 percent between mid-1999 and mid-2011.  Demand for housing by first-time buyers is an important part of incremental increases in housing demand; as well, when first-time buyers abandon the market, they prevent other homeowners who live in so-called "starter homes" from moving up to larger homes since supply of starter homes is greater than the demand for them.

Here is a quote from Mr. Bernanke's speech about the mortgage issue:

"The problem of tight mortgage credit will not be solved easily or quickly. The Federal Reserve, in its supervisory capacity, continues to encourage lenders to find ways to maintain prudent lending standards while serving creditworthy borrowers. But the slow recovery of the housing market and the economy, continued uncertainty surrounding the future of the GSEs and the regulatory environment for mortgage lending, the likely continued absence of a private-label market, and more cautious attitudes by lenders are all barriers to rapid normalization of the flow of mortgage credit." (my bold)

It's too bad that the Fed seemed to ignore its "supervisory" capacity in the lead-up to the housing market collapse, isn't it?  Perhaps if Mr. Bernanke et al had been "supervising" banks and their easy lending standards during the first half of the decade, the whole mess wouldn't have occurred on their watch.

Mr. Bernanke goes on to offer a solution; adding the supply of vacant, real estate owned housing to the nation's rental market, a subject for a future posting.

Mr. Bernanke closes by noting that the overhang of empty and foreclosed homes in combination with unobtainable mortgages has impaired the economic recovery far beyond what would normally be expected in the third year of an economic “recovery”.  He notes that no single solution will be sufficient but that sustained efforts to unlock the factors that are holding back the housing market will pay dividends over the long-term.  Best of luck on that one, Ben.


  1. APJ,

    Excellent combination of graphs:
    So homeownership is down post recession,
    vacancy is up,
    and prices are down.

    Just thinking about Clinton's home ownership goal of increasing it in the long-term; it seems like by the time the US housing market has finally shed it's market distortions; this percentage will be lower than when the policies started!

    In the end; the good intentions of government made society poorer!

    1. Am I wrong to see an implication that programs during the Clinton administration were mostly responsible for the mortgage crisis? That belief is certainly not close to the whole story. But it's a common and convenient GOP talking point, so that makes up for what it lacks in clarity and truthfulness. No wonder I read it so often.

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  3. Part of the problem is also the extremely high property taxes -- back at market peak, while appraisals were high, each city's tax rate was lower than it is now, making the total tax bill manageable for most first time home buyers. Now that market values have fallen, tax rates have gone up so we still see a linear rise in the property taxes of most given units. These taxes are not going to be recouped at time of sale, unlike the high property valuations back at market peak, turning many buyers away from the market at this time.

    In other words, if my monthly payment is the same now as it was in 2005, but a much larger percentage is going to taxes vs towards mortgage, I'm going to keep renting.

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  5. In wealth terms, declines in housing prices have reduced homeowners' equity by more than 50 percent in total across the U.S.

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