Housing to Test Economy's Post-Stimulus Strength
By MARK WHITEHOUSE
Even as optimism grows about the strength of the recovery, one big question looms: To what extent is the economy running on government life support?
Over the next several months, the housing market will offer a clue.
Housing has been a major beneficiary of the government's stimulus efforts. Tax credits for homebuyers, the Federal Reserve's unprecedented efforts to hold down mortgage rates, and loan modifications aimed at preventing foreclosures have helped housing show signs of life, albeit not as much as many economists had hoped. Prices have stabilized, while sales and construction are up from their recession lows but still well below long-term averages.
Now, the government is pulling the plug. The tax credits expire on Friday, the Fed has already stopped buying mortgage bonds and the pace of new trial modifications under the Treasury's Home Affordable Modification Program has begun to slow. Whether or not the housing market can stand on its own will provide valuable insight into the broader recovery's ability to keep going when the Obama administration's stimulus package peters out around the end of the year.
"That's the nagging question right now," says Yale University economist Robert Shiller. "How much of the strength in the housing market is just the perception of government support?" he said. "I do have concern about a double dip."
To some extent, a weak housing market can actually be a sign of health. The U.S. economy needs to reduce permanently its dependence on credit-fueled construction, and move more toward selling goods and services to booming emerging markets. At the peak of the housing boom, construction and other housing-related services accounted for about 6.3% of the U.S. economy. Now they account for only 2.5%. The right level is probably somewhere in the middle.
Less dependence on housing and U.S. consumers "will mean a better balance and a healthier recovery," says Joseph Carson, director of global economic research at AllianceBernstein in New York.
Still, if house prices were to head down again in the absence of government support, it could be a problem for the recovery. The recent stabilization of prices, which according to the S&P Case-Shiller Index were down just 0.7% in January from a year earlier, has done a lot to support fragile confidence among consumers and in financial markets.
House prices also underpin the value of the $2.6 trillion in mortgages on banks' balance sheets. If a new decline caused banks to fret about their own finances, that could make it tougher for businesses—particularly the small ones that account for an outsized share of new jobs—to get the credit they need to expand. And without new jobs, the rise in consumer spending would be hard to sustain.
Economists see various reasons to worry home prices could drop again. For one, the rising number of foreclosed homes will weigh on an already weak market—a delayed result of the same mortgage defaults that are, in some cases, allowing consumers to free up more of their income for spending.
As of March, banks and investment trusts had an inventory of about 1.1 million foreclosed homes, up 20% from a year earlier, according to estimates from LPS Applied Analytics. Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That "shadow inventory" was up 30% from a year earlier.
Banks have so far been slow to dump homes on the market: At the current rate of sales, it would take almost nine years to work through both the real and "shadow" inventory. "They're just squeaking them out," says Loren Gonella, owner of Coldwell Banker Gonella Realty in Merced, Calif.
At some point, banks will have to sell all those houses. Meanwhile, foreclosures could accelerate as loan modifications slow and an increasing number of those who received relief go back into default. New government initiatives are also encouraging mortgage servicers and lenders to agree to so-called short sales, in which the borrower sells the house for less than the mortgage debt and the bank forgives the difference.
All that will add to the supply of distressed homes on the market, even as the government programs supporting demand come to an end. Ed McKelvey, an economist at Goldman Sachs in New York, estimates that the combined effect will depress prices about 5%. That's on top of whatever the market would have done on its own—an underlying trend that could as easily be down as up.
"You have a market that's got more supply than demand, and we know what happens to prices in those kinds of markets," says Mr. McKelvey.
A new leg down in house prices could benefit some, such as first-time home buyers who have long been priced out of the market. On average, homes are already more affordable than they've been in decades—though prices still look high by historical standards in many parts of the country, including New York City.
