During each of the previous three recessions, the American economy was powered back to full strength largely on the back of the housing market. There are many ways in which this recession and recovery are unique, but the lack of a housing comeback may be the most significant. Investment in housing currently accounts for just 2.4% of the country’s GDP, down from a high of 6.3% in 2005 and from an historical average of 4.5%. But since this spring, when many analysts were calling the official bottoming of the housing market, hopes have been high that the sector could throw its weight fully behind a recovery — one that would bring the country back to full employment and output.
Two reports yesterday served to bolster these hopes. The first was from the Commerce Department, which announced that new housing construction rose 2.3% to a seasonally adjusted 750,000 in August. The other, from the National Association of Realtors, showed that existing home sales were up 7.8% to a seasonally adjusted rate of 4.82 million in August, compared with 4.47 million in July and 4.41 million in August of 2011. The NAR report also showed that the median price of an existing home rose 9.5% from last year, the strongest yearly increase in more than six years.
So how good are these numbers? The rise in new housing construction was slightly below analyst’s expectations, but still represents forward momentum. The new home sales numbers are even more encouraging, and are due to a number of different factors. As my colleague Michael Sivy wrote this week, housing prices have declined nationally more than 30% from their peak. These existing home sale numbers seem to reinforce the notion that buyers across American don’t believe that home prices will fall any further. At the same time, as Robert Brusca of Fact and Opinion Economics told The Wall Street Journal , since 2011 represented the worst year for mortgage lending in 16 years, last year is a “low hurdle” to have to overcome.
But one should not downplay the importance of even modestly rising home prices. As Bill McBride of Calculated Risk noted last month, in an environment of rising prices, sellers will be more apt to wait for the right time to put their homes on the market, keeping inventory down which further reinforces price increases. An environment of rising prices will also encourage mortgage lenders to loosen their lending standards, as lenders won’t have to worry about recouping underwater collateral in the event of a default.
But unfortunately, rising prices haven’t yet led to relaxed lending standards. And this seems to be the biggest obstacle to recent efforts by the Federal Reserve to stimulate the economy. The central bank’s latest policy shift – an open ended commitment to buy mortgage-backed securities until the unemployment situation improves – was made partly in the hope that it would reduce real estate financing costs and boost housing prices. One of the main criticisms of the move was that mortgage rates were already at historic lows. The average rate on a thirty-year fixed mortgage was at 3.55% in the week ended September 13, just a few ticks above the all-time low of 3.49% reached this summer. Whether the Fed’s actions have an appreciable effect on the housing market — and on the economy — depends in large part on whether lenders relax their standards and make those low rates available to a wider range of borrowers.
A recent report in the New York Times outlined how the Fed’s efforts are not filtering through to borrowers. Banks issue mortgages, and then package the loans and sell the monthly cash-flow to the bond market as mortgage-backed securities, capturing the difference between the interest rate they charge homeowners and that which they pay investors. Recently, however, the rates banks offer borrowers haven’t fallen as dramatically as the rates that they pay the bond investors. In fact, according to the report, banks are making twice as much as they normally do on each mortgage they issue. The article said that if lenders were maintaining the margins they’ve historically made on home loans, interest rates on a 30-year mortgage would be only 2.8%.
This phenomenon is illustrative of the technical hurdles that the Fed faces in getting low rates to filter through through to the broader economy. Banks appear to be reluctant to lend even with the very low cost of financing. They’re apparently content to keep prices relatively high and the number of loans they make relatively low. Until banks start loosening their standards, and begin competing over borrowers, there won’t be the kind of robust housing recovery that can quickly power us to a full recovery.