While housing normally leads the economy out of recession, the prospects for this happening anytime soon seem distinctly mixed. Opinions differ. Here a birds-eye view into the most determining factors.
Magnitude of the Crash
House prices are still falling. The latest (Case-Shiller 10 city index) figures are for October, which showed a 1.1% decline versus September, and a 3.0% decline versus October 2010 (3.4% for the 20 city index).
These figures -- although the worst of the fall seems behind us -- do not really indicate any immediate uptick yet (apart, perhaps, from the really top-end segment of the super-rich).
Household Balance Sheets
Nearly a quarter of all mortgage borrowers owing more than the value of their homes or amounting to roughly 11 million underwater mortgages. There is $700 billion in negative equity in the US. This isn't that surprising, considering the quality of mortgages that were sold during the heyday (they're called sub-prime for a reason). According to Martin Feldstein:
Since the housing bubble burst in 2006, the wealth of American homeowners has fallen by some $9 trillion, or nearly 40 percent
These are serious figures by any means. And it's not even the end of the story.
There is little in the way of a job recovery yet. There are still 6.6M jobs less than there were four years ago, with some 23M Americans who would like to work full-time but cannot get a job. The job recovery is way to slow for this to provide an impetus for the housing market
Anyway, people who looking for a housing recovery usually expect that as a sign for the wider economy to recover to normality, as housing usually leads an economic recovery. This time, that doesn't look likely.
Incomes fare little better, with the real income of a typical American household now below the 1997 level, according to Stiglitz.
Mortgage Rates are at record lows, and some people do profit from these and refinance. However, banks have significantly tightened credit policies, and with up to a quarter of people experiencing negative equity, refinancing isn't available for everyone:
Yet as the average 30-year mortgage rate has slipped below 4 percent, the combination of employment insecurity and unusually tight standards for lending are discouraging buyers en mass. Lenders are asking for extensive income verification and tax returns.
This is one area where we feel policy could help.
New Household Formation
It is tempting to argue that since US population growth hasn't really slowed, it's only a matter of time before that spills over into increasing demand for housing. However, in the present economic situation, there are forces at work that suspend that logic, and this might continue for some time.
For instance, new household formation has taken a hit with 1.5 million young people staying home, rather than looking for a place of their own. This isn't terribly surprising, considering that the young disproportionately suffer from unemployment.
What's more, the birth rate is at an 11-year low:
Expenditures associated with one child for a middle-income family are $226,920 over 17 years, with housing the biggest expense, the U.S. Department of Agriculture estimated in June. The number of births fell to an estimated 4 million last year, the fewest since 1999, according to National Center for Health Statistics data.
It's because fewer people are getting married -- just 6.8 per 1000, compared to 8.2 per 1000 inhabitants in 2001. How will this affect demand for housing? More households will likely choose to rent for longer periods of time, and there will be fewer trade-up buyers. However, birth rates usually fall during recessions, and will likely pick up when the economy returns to health.
Since incomes at the top end have recovered from the financial crash faster than the rest of the economy, things look brigher here, and some argue that this signals a bottom is near. According to Philip White, president and CEO of Sotheby's International Realty, a network of luxury real estate companies:
“We think the reason the high-end market is doing well is [that] investors think this is the bottom of the market,” White says.
However, the same article mentions many discounts at the very top, and there is certainly no general frothiness in pricing, even here. Goldman Sachs thinks house prices might have a couple of percentage points further to fall, but will stabilize in the second half of 2012.
The biggest problem with housing is the overhang from the bubble. Foreclosures where up 14% in the third quarter (with respect to the second). It's estimated that some 3.4 million foreclosed homes will be on the books of banks and mortgage companies by the end of this year.
New Home Sales
This is one variable which offers some hope. Basically, new home sales are at multi-decade lows (see the graph below):
According to Warren Hatch from Catalpa Capital Advisors:
With the supply of new homes at such low levels, even a modest pick-up in the pace of sales could have a dramatic impact. When the housing recovery gains real traction, the current supply of new homes could run out within a few months, leading to higher house prices, a boom in residential construction, and an unexpectedly powerful lift to the US economy.
It's good to see there are some optimists out there, and indeed, housing normally leads the economy out of recession. Very helpful is also that it's a labor intensive industry. But so far little of this is visible, and we've provided some elements that guard against over-optimism.
House Prices to Rents
Another somewhat positive sign is that the rental market is tightening. The home price/rent ratio has been on a steep decline, and has now fallen little below historical average:
Actually, the US is doing pretty well internationally with regard to house prices. Here is a table from The Economist that shows that, unlike a host of other countries, house prices are undervalued with regard to rent by some 8% (relative to historical trend).
House Prices to Income
In the same table and graph above it, you can also see that by another measure, house prices to income, the US houses are even more undervalued -- by a substantial 22%.
Considering the very low mortgage rates, the undervaluation is starting to be somewhat remarkable.
This time around there is little evidence that housing will revive the economy. It's more likely to be the other way around. When jobs, income, balance sheets and birth rates return to health, so will housing.
We'll look in a follow up whether some policy interventions could speed things up in the housing market though, the bottleneck in underwater mortgages and foreclosed houses seem a particularly obvious points of leverage.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.