Who can forget the childhood experience of setting up a column of dominos, tipping the first one, and watching as the sequence flattens everything? Today, we can watch the same idea in massive video versions that stretch almost endlessly and last longer than attention spans. In a more painful market version of this phenomenon, the housing market saw falling house prices knock housing production to 27 percent of the peak, which pushed the U.S. economy into a slump exceeded only by the Great Depression.
Now we await a reversal of that domino effect so that, to continue the analogy, the first domino to fall, house prices, pulls up housing production, and in turn home building pulls the economy upright. The tail end of the cycle remains nearly prone as the U.S. economy is limping along at an expected subpar 2.2 percent growth rate for 2012. The middle section of the cascade, single-family housing starts, has shown an improved growth rate that should provide a 23 percent increase in 2012. And, house price declines, a significant and early thrust to this sequence, began a reversal in scattered markets about a year ago, and that trend has begun to show up in the national house price indexes.
Evidence of a price turnaround is spreading. At first, the movement was not evident because only a few markets experienced house price increases. The Federal Housing Finance Agency (FHFA) tracks prices in 384 metropolitan areas. The share of metros experiencing a year-over-year increase rose steadily from 10 percent in the third quarter 2011 to 46 percent in the second quarter 2012. At the same time, the amount of the annual increase grew from 1.2 percent to 1.6 percent. As larger metro areas joined the list, their greater weight has helped the FHFA index increase 0.6 percent and 3.1 percent the last two quarters.
In December 2011, only one of the 20 S&P/Case-Shiller large metropolitan area indexes experienced an annual increase. By May 2012, half the metros had increases, and 13 metros sustained annual increases in July. The NAHB/First American Improving Markets Index includes positive local house price movements as one of three measures of improvement, and that index rose from 12 in September 2011 to 99 in one year.
The size and breadth of home price increases provides greater assurance that the trend will continue. More importantly, the underlying forces that appear to have caused prices to begin their positive moves are continuing. Economics 101 teaches that prices reflect the intersection of supply and demand. House prices collapsed at various rates and times because the excess of supply over demand varied across markets and at different times. Supply was up because of vacancies due to un- or under-employment and mortgage distress and both reinforced each other in a downward spiral. Demand diminished because of fewer household formations, strongly influenced by fewer jobs. All of these forces have been reversing.
While unemployment rates remain high by historic standards, the national level is down 1.7 points from its peak, and there are 4 million more people employed than at the trough. Annual net change in the number of households went from near zero to one million this year. The share of homeowners in mortgage distress has fallen almost 2.5 points from 9.7 percent in late 2009 to 7.3 percent in mid-2012. The level remains elevated, and foreclosures will continue as the number of delinquent mortgages is slowly reduced. While elevated in most states, the concentration of mortgage distress is greatest in a relatively small number of states but diminishing for more recent distress. At near the end of the mortgage distress pipeline, half of all foreclosures are in five states, but at the beginning of the pipeline, half of the mortgages more than one month late are in 23 states.
As long as major external forces remain at bay, the uprighting sequence will bring us back, eventually.