The unsustainable housing boom that peaked around the end of 2005 paved the way for the worst housing bust since the 1930s. Home sales and housing production have been falling rapidly for more than two years. Record-high inventories of unsold homes, a legacy of the finance- and investor-driven boom, have been putting strong downward pressure on house prices. And the price reversal has decimated mortgage credit quality, leading to the disintegration of major parts of the mortgage finance system and provoking serious tightening of credit conditions for builders and developers.
The housing bust obviously has been brutal, and it’s certainly not over. But a lot of necessary market and regulatory adjustments have been made during the bust, paving at least part of the way to a systematic housing recovery.
The essential first step in the recovery process will be stabilization of net home sales (new orders less cancellations), and that will require restoration of housing affordability as well as willingness of prospective buyers to go ahead with home purchases. The stunning price declines of recent times, along with persistent growth of household income and improvements to prime mortgage interest rates, have lifted standard measures of housing afford-ability from the extreme lows of 2006 to levels that prevailed in early 2004. We’re also seeing substantial declines in ratios of house prices to residential rents.
The improvement in affordability measures and the decline in price-to-rent ratios have not yet revived home sales. Surveys of consumer sentiment show little improvement in household assessments of overall home buying conditions despite rising proportions of consumers that view lower house prices as a positive development. On that theme, the NAHB’s surveys of builders have revealed deeper and more frequent price cuts, but the proportion of builders rating price reductions as effective has not risen significantly.
Home sales have been held down to some degree by rising consumer concerns about the weakening job market and surging energy costs, and expectations of further house price declines are holding back many prospective buyers. Furthermore, tightening non-rate mortgage lending standards are filtering out many willing prospects that look viable under standard affordability calculations.
The tightening of conditions in mortgage finance now appears to be mostly behind us, and the system now depends very heavily on fixed-rate loans that can be sold to the secondary market government-sponsored enterprises (Fannie Mae and Freddie Mac) or that can be insured by the FHA. These sources should be able to handle growing demands for credit down the line, particularly if enhancements being debated on Capitol Hill become law.
Improved affordability conditions and a restructured housing finance system are essential to a recovery in home buying, but special measures apparently are needed to overcome the reluctance of qualifying buyers to go ahead. A temporary tax credit for home buyers, now under consideration by Congress, would be an effective way to jump-start a housing market that is poised to move ahead. B