The dramatic correction in housing markets is the key factor behind the recent turmoil in financial markets and the recent descent of the U.S. economy into recession. The most damaging aspect of this housing correction is not the falloff in home sales and construction activity but the unprecedented contraction in house prices across much of the country.
The house price correction has exposed the extraordinary deterioration of mortgage lending standards as well as the excesses in mortgage-related securities markets both during and after the 2003–2005 boom in home sales and housing production. This episode also has revealed a strong tendency of today’s homeowners to swim away from underwater mortgage contract obligations, even when they still have the ability to fulfill those obligations.
The vicious cycle of falling house prices and rising foreclosures still is underway. The house price corrections certainly have boosted standard measures of housing affordability and rebalanced standard ratios of house prices to both household income and market rents. But all these measures ignore expectations of future house price movements, and persistently falling home sales (except for sales of foreclosed homes at fire-sale prices) show that price expectations of prospective buyers still are decidedly downbeat.
Builders obviously are struggling mightily in this deteriorating housing market. A series of surveys conducted by the NAHB during the past year show large cumulative price reductions along with unprecedented use of non-price incentives to bolster sales and limit cancellations. But our surveys also show only limited success from such measures, owing largely to the persistent upsurge in foreclosure sales and associated deterioration of house prices and house price expectations.
The deepening problems in housing markets cry out for strong government intervention to save not only the housing sector but also the overall economy and the financial markets. A lot has been done already, but policies in place or in the process of enactment are unlikely to eliminate downward pressures on house prices and break the vicious cycle that’s eating away at mortgage credit quality and the guts of the U.S. and global economies.
The Federal Reserve may bear some blame for the runaway housing boom and the subsequent correction, but our central bank recently has been pulling out the stops to help support the economy and avoid financial market Armageddon. However, the Fed is finding that the stampede to credit quality, triggered by the meltdown of the mortgage market and persistent declines in house prices, is very hard to rein in. Indeed, Fed easing of monetary policy, along with a series of innovative liquidity-enhancing mechanisms, has had only limited success in the interbank loan market and even less success in freeing up credit for households, businesses, and municipal governments.
The Housing and Economic Recovery Act of 2008, signed into law at the end of July, had a number of provisions that held out promise for the deteriorating housing market. But the most promising provision, the temporary $7,500 refundable but repayable tax credit for first-time home buyers, apparently is providing only minimal support to housing demand. And the new Hope for Homeowners provision may turn out to have relatively little effect on foreclosures, considering the immense size of the problem.
The massive $700 billion Troubled Asset Relief Program (TARP), the centerpiece of the Emergency Economic Stabilization Act that was signed into law on Oct. 3, is being used by the Treasury to strengthen bank capital positions as well as to get deteriorating mortgage assets off the balance sheets of financial institutions. While such results certainly are essential to ultimate recovery of financial market conditions, it remains to be seen how well the programs will work in practice.
The strenuous efforts by the Treasury and the Fed are necessary, but they are not sufficient to rebalance demand and supply in housing markets and halt the destructive deterioration of house values. It’s now clear that the administration and Congress need to enact additional measures to stem foreclosures and bolster home buying—as soon as possible.