There are a million things being said about the housing market and about a dozen different interpretations of the data on the market that has been rolling out here at the end of August. On top of it all there are several different programs being discussed by the White House as solutions to the market turmoil. So what is going on? Here is a snapshot:
The End of Summer Situation
August has drawn to a close with weak housing numbers coming in for both July and the second quarter. Inflation adjusted housing prices fell 9.6 percent from the second quarter of 2010 to the end of June 2011. The construction industry is depressed and housing starts fell again 1.5% in July. Pending home sales dropped 1.3 percent, existing home sales fell 3.5 percent, and new home sales dipped down 0.7 percent all from June to July this year.
What is more uncomfortable is that we need housing prices to continue to fall since we are still above the long-term trend for where home prices should be. And that means more households that overpaid for their homes going underwater, and fewer households being able to sell for the price they want. With a shadow inventory of four years supply hanging in the balance and the foreclosure pipeline not operating at full efficiency, there are significant downward pressures on housing prices in the future. Its a rough world out there, and we’re not at the bottom yet.
Ignoring Household Debt Does Not Make it Go Away
Stimulus supporters like to think that if you give people money they will spend it. They don’t, however if they are in debt up to their eyeballs. One of the problems with the housing bubble was that not only did prices get inflated, but homebuyers did it by expanding the debt they used to finance those home purchases (see nearby chart).
Before we are going to see consumer confidence and demand return in force, household debt needs to fall. Call it, rational underconsumption. Unfortunately, the chart above, via CalculatedRisk shows NY Fed data indicating household deleveraging has slowed. There are four ways I see that debt can be lowered:
(1) Programs that incentivize high debt like the mortgage interest deduction could be cut, with the combining effect leading to households paying off a chunk of outstanding balances. In fact, ending the MID could lead to a 30% to 70% reduction in household mortgage debt (see page 3 in this study).
(2) The default and foreclosure crisis could be allowed to accelerate its current course (instead of being stalled by programs like HAMP) forcing banks and investors to eat the losses they deserve on bad mortgages that they financed, eliminating a lot of unpaid balances by just having them written off the books.
(3) Wages could rise dramatically (good luck with that one) and the unemployment rate could fall meaning more money for households to pay down outstanding mortgages and fewer delinquencies.
(4) The Federal Reserve could inflate away the problem, with today’s dollars covering more of yesterdays debt than before, but destabilizing the rest of the economy in the meantime.
Obviously the last option is a terrible idea. And unfortunately wages aren’t going to rise enmass anytime soon with a reduction in the unemployment rate. Actually, the more workers are able to get back into the employment realm the less supply there will be to pay them, so wages may be further reduced. A combination of the first two possibilities in this list would be the best policy approach by the White House and Congress.
It’s the Housing Programs, Stupid
Despite the economy suffering through a fauxcovery the past few years as brought on in part by a failed stimulus, the Obama administration’s housing policies may be its biggest economic policy failure to-date. Nothing has been done about Fannie and Freddie (and they have even been used to bailout the banks in backdoor manners). The HAMP program was an unmitigated failure—even by White House standards. And the mortgage servicing scandal has been dragged through the mud by bickering regulators so severely that it has jammed up the foreclosure pipeline and slowed the deleveraging process. Meanwhile the Fed’s zero interest rate policy has been screwing with housing market prices, keeping us in the housing bubble longer than necessary. How can the solution be more of the same types of programs?
There are two big “ideas” on the table right now to try and solve the housing mess. Both would simply perpetuate the problem:
(1) A refinancing program
The plan would essentially be to let homeowners whose mortgages are owned by Fannie and Freddie get lumped into an universal refinancing deal, setting their interest rate at today’s extreme lows of around 4 percent. No details are available since such an initiative hasn’t been officially announced, but it is unclear how different it would be from the failed HARP (Home Affordable Refinance Program) that was a sister to the failed HAMP over the past few years. Besides this idea already failing, all this would really do is lower mortgage payments for buyers that are already paying their mortgages (even if they are struggling to make the payments) and not reduce foreclosures as is the goal. It is unlikely that delinquent owners, or potentially delinquent owners would be let into such a program. And if refinances could reduce defaults, the banks would be working hard to push through refis as fast as possible. Overall, this program would not strengthen the housing market since it merely lowers interest payments for current homeowners and doesn’t encourage new homebuyers to enter the market.
The program would also cost investors tens of billions of dollars per year. It wouldn’t be as bad as forced modifications, which reduce principal, but unless the investor agrees to this plan it would be a breach of contract to let homeowners that otherwise would not qualify for refinancing, get an automatic refinance just because their mortgage happens to be owned by Fannie and Freddie. And before you go cursing investors for causing the financial crisis, remember that all taxpayers are mortgage-backed securities investors now too because we own Fannie and Freddie and are on the hook for all their losses. Such a refi program would essentially charge the taxpayers billions to give homeonwers, who also happen to be taxpayers, lower mortgage payments.
(2) Selling GSE homes to create a national rental program
This idea, which is being considered by FHFA but not officially proposed, would likely involve the GSEs selling the homes they have repossessed to financial institutions that would be required to rent them out at set prices. The idea would be to reduce supply (since we’re talking 500,000 homes or so) and stablize housing prices. The main problem, as outlined on this blog a few weeks ago, is that we need housing prices to continue to fall. And buying homes from the GSEs does not impact outstanding household debt in any significant way. (There is an entirely separate set of problems with how it would distort the rental market.)
Perhaps that was more of a Lady Gaga-sized nutshell, but there is a lot to cover and this really is just a snapshot of the issue. In summary, we are in a bad place in terms of the housing metrics, and household debt is holding us back. Overall, the government has created more problems in housing, and failed to address the real problems in the system with its programs, a significant reason why the housing market climate is so stormy at the end of August 2011. The only thing our government hasn’t tried is the free market approach (which we’ve previously laid out here).