In the second year of an ongoing housing recession, measures of housing activity deteriorated sharply. The 25 percent decline in total housing starts in 2007 nearly doubled the drop in 2006. The decrease was more pronounced in single-family starts, which were down 28.6 percent, compared with an 8.3 percent drop for multifamily starts.Since the peak of 2.292 million in January 2006, total housing starts have declined about 56 percent (through December 2007). This has made the current housing recession worse than all the previous housing recessions except the 1973-1975 and the 1980 downturns.
Even with the sizable pullback in homebuilding activity over the past two years, the housing market continues to show considerable imbalance as housing demand pulls back along with the decline in new construction. Demand for homes continues to weaken, hurt by reluctant potential homebuyers in a down housing market with depreciating home prices.
Tighter lending standards are also limiting qualified, potential homebuyers. In the second half of 2006, delinquency and foreclosure rates for subprime loans picked up significantly. As a result, financial institutions began to tighten their lending standards for subprime and nontraditional mortgage loans at the beginning of 2007, according to the Federal Reserve Senior Loan Officer Survey. Since the August 2007 financial crisis, banks also began to apply more stringent standards on prime loans. In the latest January 2008 survey, a net 52.9 percent of banks said they tightened standards on prime mortgages during the final three months of 2007. During the first half of 2007, only a net 15 percent reported more stringent standards for prime loans. Banks continued to tighten standards for other types of loans as well. Overall, loan standards are now the tightest in the 17-year history of the survey. More stringent lending standards have reduced housing demand as more borrowers fail to qualify for loans.
Since the beginning of the financial markets’ turmoil in August 2007, home sales have experienced renewed declines. For all of 2007, sales of new single-family homes fell 26.4 percent—the largest annual decline on record. For existing homes, total sales (including condos) dropped 12.8 percent for the year. Single-family home sales fell 13.0 percent—the largest decline since 1989.
With declining housing construction and dropping home sales, the months’ supply (or the inventory-sales ratio) of homes—both new and existing—have remained elevated at 9.6 months at the end of 2007. For new homes, this is the highest level of month’s supply since October 1981.
For existing homes, sellers, especially those who are still living in their homes, can withdraw or postpone sales, reducing the number of home available for sale. Thus, it is useful to look at the homeowner vacancy rate to gauge existing home inventories. The homeowner vacancy rate is the share of housing units typically occupied by owners that are for-sale and vacant. During the fourth quarter of 2007, the rate rose to 2.8 percent—matching the record level reached in the first quarter of 2007.
The considerable demand-supply imbalance has continued to put downward pressures on home prices. While the median price of new homes sold saw the largest drop on record of 10.9 percent in December, it was up 0.2 percent for all of 2007. The last time the median price of new homes posted an annual decline was in 1991. The reported prices for new homes do not reflect builders’ incentives and offering non-price incentives has become a common practice in the current downturn. For total existing homes, the median price fell 1.4 percent in 2007—the first annual decline in the relatively short history of the series that began in 1999. For single-family detached existing homes, the 1.8 percent decline is the first annual decline since the series’ inception in 1968.
The elevated level of inventories suggests additional declines in home prices are likely. Rising homeowner vacancy rates also put further downward pressure on home prices because sellers of vacant homes (who may be paying another mortgage elsewhere or who may be speculators) are more likely to slash prices in order to make a sale than sellers who still live in their homes. Furthermore, the increased supply coming from foreclosed properties will weigh heavily on home prices, as these properties are generally sold at considerable discounts.
To examine home price trends, it is important to look at measures of home prices that track prices of the same home over time, using a repeat sales transaction methodology. Unlike median or average home prices, they are not biased by the change in the mix of sales. Twomeasures of home prices using this methodology showed significant deterioration in the third quarter of 2007 (the latest data available). The OFHEO HPI showed an increase of 1.8 percent in the third quarter from a year ago, compared with a year-over-year decline of 4.5 percent for the Case-Shiller Home Price Index. The OFHEO HPI tends to overstate home price trends as it is based on data from both purchase and refinance transactions from Fannie Mae and Freddie Mac. Thus the index includes only conventional, conforming loans and thus largely excludes high-priced homes—where prices have weakened considerably over the past year. The OFHEO data also include relatively fewer subprime loans as well as adjustable rate mortgage loans—which have performed relatively worse.
Outlook for the Housing and Mortgage Markets in 2008
There are some positive developments for the economy and the housing market this year. First, the Federal Reserve’s recent aggressive action is reassuring the market that the Fed will act as necessary to help the economy skirt the recession. Second, the passage of the stimulus package should help support housing demand. Unfortunately, it will take a long time for monetary easing and the fiscal stimulus to have an impact on the economy and economic growth will likely slow through the first half of the year. Since there are many unresolved issues surrounding the increase in the loan limits that Fannie Mae and Freddie Mac can buy (e.g., what measure of median to be agreed upon to determine the loan size and whether to include new securitized loans in the TBA market or to set up a separate market) it may take several months to see reduced stress (i.e., narrowing spread between the conforming and jumbo mortgage rates) and increased demand in the jumbo market.
Given projected slowing economic activity in the first half of this year and elevated levels of months’ supply, we have delayed our projection of the trough of housing starts to the fourth quarter of this year from the third quarter. Single-family starts should trend down to 650,000 units in the fourth quarter. We expect that most housing activity will pick up next year except for home prices, which tend to lag home sales. Below are our projections for this year and next:
- Total existing home sales for 2008 will decline by about 15 percent from 2007 to 4.82 million units. Sales will pick up by about four percent in 2009.
- New home sales will decline by about 21 percent in 2008 from 2007 to 610,000 units. We expect sales to increase five percent in 2009.
- Median home prices for new and existing homes are expected to decline this year, with median prices falling about four percent. Prices should remain flat in 2009.
- Residential purchase mortgage originations will decline about 21 percent in 2008 to $914 billion from a projected $1.16 trillion in 2007. Given a recovery in sales in 2009, purchase originations should be up about three percent to 943 billion in 2009.
- The yield on 10-year Treasuries—the benchmark for fixed rate mortgage yields—should remain low during the first half of this year as economic growth is expected to be anemic. However, the spread between the 10-year Treasury yield and conforming mortgage rates has widened and should remain wide for some time. While a large share of mortgage will be in the money for refi, we do not expect a large pickup in refi activity as a result of tighter lending standards and declining home prices in many areas. Thus we project that refinance originations will decline about eleven percent to $1.04 trillion in 2008 from a projected $1.17 trillion in 2007. Refi activity will decline by another 21 percent to $829 billion in 2009 from 2008 as mortgage rates rise in response to Fed tightening expected early next year.
- Total mortgage production will be down 16 percent to $1.96 trillion this year from a projected $2.33 trillion in 2007. Total originations should see another drop of about ten percent in 2009 to $1.77 trillion.