The stunning housing down-swing that followed the unsustainable boom of 2003–2005 got an extra push from waves of turmoil in the mortgage finance system during 2007. Fortunately, a good bit of the necessary correction process in housing and mortgage markets is now under our belts. The NAHB’s forecast shows the beginnings of a housing upswing in 2008, assuming some well-timed policy support from Washington.
Housing demand was overstimulated during the boom by serious deterioration of mortgage lending standards, a large influx of investors, and record rates of real (inflation-adjusted) home price appreciation that spurred investment demand. Builders naturally reacted to the surge in demand, pushing production of new single-family and condo units to record highs.
The extended run of rapid house-price appreciation ultimately took a heavy toll on affordability. By late 2005, many areas saw a shift from seller’s market conditions to buyer’s markets characterized by large inventory overhangs and downward pressures on prices. Many investors/speculators quickly detected the shift, and their withdrawal exacerbated the supply-demand imbalance.
The imbalances generated during the boom were corrected to some degree during the 2006–2007 housing downswing. To address flagging demand, many sellers of new and existing homes cut prices and offered a variety of non-price sales incentives. At the same time, median household income grew at a healthy rate (about 5 percent per year). As a result, house price–to-income ratios have fallen in most places and standard measures of affordability (incorporating prime mortgage market conditions) have been on the rise since mid-2006.
On the supply side of housing markets, builders have cut back on production of new housing units, cutting single-family starts by more than 50 percent.
In mortgage markets, unsound practices that helped fuel the boom generally were weeded out during 2007, and we’re not looking for further tightening of mortgage lending conditions in 2008. Quality spreads within the market may narrow to some degree.
On the policy front, we’re assuming that the Federal Reserve will manage monetary policy to keep the economy out of recession, to maintain good growth in employment and household income, and to maintain historically low levels of prime conventional mortgage rates.
We’re also assuming that a modernized FHA mortgage insurance program will grow nicely in 2008, filling a good part of the gap left by shrinkage of the subprime market. With respect to outstanding subprime ARMs facing payment resets, we’re assuming good success from the FHA Secure program as well as from the private sector Hope Now program sponsored by the Bush administration. We also expect constraints on Fannie Mae and Freddie Mac to be eased, giving the government-sponsored enterprises more leeway to help refinance subprime ARMs and support the jumbo mortgage market.
Reductions in home sales and housing starts are virtually inevitable for 2008 on a year-over-year basis. Indeed, the NAHB’s forecast shows a 20 percent decline in total housing starts this year, on the heels of a 25 percent reduction in 2007.
We expect key turning points to occur in 2008. We’re looking for home sales to turn upward in the second quarter, and we expect recoveries in housing starts and construction spending to begin in the second half of 2008. B