Ever since the recovery began in 2009, a weak housing market has held back the U.S. economy. The first rebound in home prices was lackluster and after only a year was followed by another dip. But the recent upturn in home prices looks like the real thing. One clear sign of a turning point: In March, homeownership hit a 17-year low, while the 12-month gain in home prices was the biggest in seven years. Those two extremes suggest that the market has hit bottom. The people who are least well financed have been squeezed out, while demand is growing among people who can afford to pay higher home prices. If that trend continues – and there are good reasons to believe it will – a substantial burden will be lifted from the U.S. economy.
The great surprise since the recession ended has been the weakness of the economic rebound, which has been particularly clear in the housing market. After falling 31% from 2006 to 2009, home prices rose almost 5% over the following year. But that recovery faltered, and during the next 20 months prices fell to a new low. Then the current recovery began, and barring another recession, all the evidence indicates that it will be sustainable:
In the first quarter, home prices were higher (compared with a year earlier) in 133 of 150 metropolitan areas, according to the National Association of Realtors. On a national basis, the median home price gained 11.3%, the biggest yearly gain since 2005.
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The glut of homes for sale has diminished, down almost 17% compared with the previous year. In addition, the number of foreclosures in April (including bank repossessions and scheduled auctions) was 23% lower than a year earlier.
Mortgage applications were up 7% in the most recent week, helped by low mortgage rates. Refinancings, which typically improve homeowners’ finances, have been generally rising in recent months and reached their highest level since December.
And a Fannie Mae survey of consumer expectations for housing found that a majority of those surveyed in April expect prices to rise, compared with only 32% a year earlier. That’s the highest figure since the survey was begun three years ago. “Crossing the 50 percent threshold marks a significant milestone as most Americans believe a housing recovery is truly occurring throughout the country,” the survey concludes.
The housing market has a unique relationship with the economy. Depressed prices hurt certain specific industries, of course, from homebuilders to companies that make building materials and home furnishings. But the huge price drop that occurred during the recession – by far the biggest in the past half century – had much broader effects.
In general, falling house prices make homeowners feel poorer and more cautious about spending. By contrast, during the boom homeowners not only felt more affluent, but also were able to obtain additional spending money by refinancing. They could increase the size of their loans, and their monthly payments might even go down, since mortgage rates were relatively low. After home prices fell during the recession, however, refinancing became more difficult and this source of spending money largely disappeared.
The current rise in home prices and refinancings won’t necessarily lead to an immediate consumer spending boom. Home equity was massively eroded by the recession and has only started to recover. But at least the drag on consumer spending is no longer getting worse.
Further gains in home prices will depend to a great extent on easier lending conditions. “The housing market is improving, but mortgage credit conditions remain quite tight for borrowers with lower credit scores,” says Federal Reserve governor Elizabeth Duke. But she adds, “As the economic and housing market recovery continues, lenders should gain confidence that mortgage loans will perform well, and they should expand their lending accordingly.”
Moreover, the economics of housing will likely lead to a revival of demand. Buying is cheaper than renting in most U.S. cities. Including tax benefits, someone who buys a home today and lives in it for four to seven years will save from 20% to 40% over renting, based on national averages.
Equally important, home ownership offers a valuable inflation hedge. There’s no way of knowing when inflation will become a serious problem again. But considering the enormous amount of money created by the Federal Reserve since Quantitative Easing began in November 2008, it’s likely that consumer prices will start rising significantly faster at some point in the coming decade. In fact, inflation has totaled more than 8% in the five years since the recession, despite the sluggish economy.
At a certain point, these positive trends start to reinforce each other. As the economic recovery continues and unemployment comes down – even if that is happening disappointingly slowly – consumer incomes and average credit scores will rise. And as the number of troubled mortgages and foreclosures diminish, the quality of bank loan portfolios will improve and lenders should be willing to make more credit available.
That would help increase the demand for housing and enable potential buyers to pay higher prices. Moreover, a revived housing sector would add considerable momentum to the economic recovery – and gives this upturn in home prices a much better chance of continuing than the previous one.