Will US housing steady the economy it wrecked?
While experts expect more glum US housing statistics for 2012, the normal motions of economic cycles indicate there is a recovery on the way, writes Michael Collins.
The United States housing market, with the help of financial wizardry, laughable credit standards and low interest rates, triggered the global financial crisis by bubbling over. The troubled sector might, though, help push along the US economic recovery that has now entered its third year.
There’s scant sign of that rebound yet, though, when you look at the latest data on the US housing market, which is experiencing its worst crash since the 1930s.
Residential investment has dropped to an all-time low of just 2.2 per cent of gross domestic product these days, well below the long-term median of 4.4 per cent.
Housing starts for 2011 are only running at a 592,000 pace, according to Bloomberg calculations. This is well under the record high of 2.1 million starts recorded in 2005, even if the number exceeds last year’s total of 587,000 and 2009’s tally of 554,000 – the lowest annual total since records started in 1959.
Recent declines on stock markets and (linked) concerns that the US and global economies could re-enter a recession have led to a drop in applications for mortgages and building permits. Not even record low mortgages are generating demand for housing as home prices are falling.
Overhanging the housing market is the excess supply from years of foreclosures, as people broken by mortgage payments walked away from their homes that are often worth less than the debt owed on them.
Lender Processing Services estimates there are 2.5 million vacant houses in the US, and this number could jump, given that 4.1 million loans were in the foreclosure process – or at least 90 days delinquent – as of July this year.
CoreLogic (a provider of business analytics) said that at the end of June, 10.9 million – or 22.5 per cent – of US residential properties had bigger mortgages than the properties were worth.
Government attempts to revive the housing market have largely failed so far. Among the disappointing programs is the Home Affordable Refinance Program that was introduced in 2009 to free borrowers from risky loans and to prevent foreclosures. Most of the US$8 billion that the US Treasury allocated to its Hardest-Hit Fund (which was designed to prevent foreclosures) is yet to be spent.
Add on tougher lending standards blunting the benefit of low interest rates and unemployment at 9 per cent and it’s little wonder that house prices are still floundering.
According to the Case-Shiller 20-city index, prices as of August 2011 were almost a third lower (31 per cent) than their July 2006 peak; moreover, the index is only a few percentage points away from its April 2009 low.
Falling home prices and the prospect of foreclosed properties returning to the market give builders little incentive to invest in new housing. Confidence among builders of single-family homes in November stood at 20 on the NAHB/Wells Fargo Housing Market Index.
The neutral level – where pessimists match optimists – is 50.
The cycle at work
Ironically, it’s these grim statistics that could lead to a bounce-back in housing that is big enough to give the US economy a noticeable push.
To understand this may occur, it’s worth reflecting on how recessions slow recoveries (just as robust times set up downturns).
Amid the gloom of tough times, when consumer spending and business investment are low, equipment wears out or becomes obsolete and people run down savings.
Eventually, the build-up in demand for new equipment (whether it be factories, machinery, offices or transport) is so great that businesses are forced to invest in new capital stock.
Low interest rates make this easier to do. More people are employed and they spend the money they earn on postponed purchases. Thus, in many cases, the greater the build-up of demand, the more sustainable the recovery.
The US housing market appears to have created such a backlog of demand which will eventually be unleashed.
Housing starts have been at an unprecedentedly low level for five years – about four million new homes have been built from 2007 to 2011 (using an estimate for this year), versus 9.4 million new homes in the preceding five years.
Since 2007, the stock of housing has aged (especially those abandoned, foreclosed homes) while the US population has grown.
The unleashed demand angle is that household growth has lagged population growth because children are staying with parents longer or more people are sharing in order to save money.
The Economist magazine estimates that, based on figures from the Census Bureau and Bureau of Labor Statistics, there are two million fewer households in the US that population growth since 2007 would suggest should be the case at present.
At some point – and it may be a while off – the demand-supply dynamics of new housing in the US will shift in favour of demand as rundown homes need replacing and household growth catches up to population growth.
Zelman & Associates (a US housing consultancy) expects household growth of 11 per cent this decade, compared with only 8 per cent population growth. This should translate into housing starts of about 1.5 million a year.
Builders will notice a pick-up in demand as 35-year-olds decide they can no longer live with their parents. Construction companies will oblige by investing and hiring again, and the virtuous spiral of recovery will kick in. While the NAHB/Wells Fargo Housing Market Index of building confidence might only be at 20 – that’s its highest level since May 2010.
Zelman is forecasting housing starts to reach 745,000 next year, 940,000 the year after, and 1.12 million in 2014. The forecast for 2014 is almost double the 590,000 Zelman expects for 2011.
One sign of a build-up in demand for housing is that rents are rising in the US. Mortgage rates near record lows are making rental yields on properties positive again as rents are 1.5 times mortgage payments.
Higher rents encourage people to invest in property and push renters to buy their own home – and homes have rarely been more affordable, according to the National Association of Realtor’s index that measures such things.
As gloomy as consumer confidence is overall in the US, according to the University of Michigan Consumer Sentiment Survey, 72 per cent of respondents believe that now is a good time to buy a home as house prices and interest rates are low.
Another hopeful sign is that housing starts jumped a more-than-expected 15 per cent in September to a 658,000 annual rate – the most since April 2010. Builders are competing with foreclosed properties by building smaller homes that are obviously cheaper to sell.
It must be said that housing investment, at just 4 per cent to 5 per cent of the US economy in normal times, is not big enough by itself to rejuvenate the US economy. But its indirect effects can be widespread as new owners need appliances and furniture for their homes.
Any recovery of sorts in home prices will help consumers, overall, regain confidence to spend, even if low house prices reduce this effect to some extent.
Optimism about the US housing market in coming years might seem misplaced as more glum housing statistics are released in 2012. But the normal motions of economic cycles say otherwise.
Michael Collins is the investment commentator at Fidelity Worldwide Investment.
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