By guest contributor Peter Fugiel, Ph.D.
Although the housing industry has taken the speculation out of its practices, the gigantic U.S. housing market is not recovering fast enough to help with a more robust economic recovery. All three segments of the home ownership sector: high-end, middle-income sellers, and first-time buyers need to be properly functioning. While Congress is prepared to preserve housing’s most expensive subsidy for high-end owners, it has yet to figure out what ails the middle-income and first-time buyer segments of this bellwether industry.
Sales Volume – Not Price – the Story of the Recovering Housing Market
While most market commentators were fixated on last year’s home price declines and negative benchmark price activity, the national home market turned in a steady and improving sales record. When it comes to U.S. home sales, it is 2000 all over again. That was the last time home sales were around the 5 million mark. Not so surprisingly, 2000 was also just about when U.S. home prices left their historically steady price trend line, and began to reflect speculative price behavior. Now that the speculation is out of the market, sellers sell because they need to, not because they have a capital gain. The ’churning’ mentality that made 2005 a 7 million sales year is gone.
The healthy 2010 home sales volume of over 5 million units belies all the doom and gloom about the end of the home ownership market as we know it. There were a record number of cash sale buyers, and widespread sales improvement in each region. It does not appear the expired federal tax credit ’borrowed’ buyers from the future market. If anything, it is unusually tight credit standards imposed on buyers that have kept many first-time buyers from entering the market. In addition, sellers with unfavorable lender appraisals are prevented from paying the transactions costs associated with a sale. Unless prices are stabilized, transaction costs stand in the way of a fully recovering market. And while the high-end market is holding firm, middle-income markets suffer from needless price declines, and the affordable market is really missing its normal inflow of young buyers.
Undercapitalization of Home Ownership Continues to Depress Prices, Even in Good Local Markets
The loss of federal agency and bank lending capacity all over the country continues to depress home prices. In the case of the federal agencies, the only federal game in town is HUD’s FHA program, which used to be the loan program of last resort. In 2011, bank conventional loan programs are all but non-existent. Realistically, when banks don’t have robust lending programs, the drop in home prices only adds to the potential losses banks will have on shadow inventory and home improvement loans. Federal attempts to refinance troubled and at-risk loans will work only when home prices in middle-income markets stabilize. Refinancing will be effective only when owner values begin to stabilize. Most market analysts agree: U.S. home prices have adjusted to their pre-bubble levels. So what now?
The Five-Year Recovery in the Housing Market
Currently, only a fraction of foreclosure filings are resulting in actual foreclosures in many markets. The depressed price levels are discouraging lenders from disposing of any more distressed assets in many markets. The approximately 40% of all local markets that are really depressed are simultaneously suffering both from very low prices and no buyers. Even in the stronger local markets, where foreclosures are a manageable presence in the market, sellers can’t handle the transaction costs if their price is too low. And as long as existing homeowners see nothing but price declines, they will be tempted to go late on expensive loans that appear to be under water permanently.
Federal Policy Leadership is Lacking
Recent attempts to protect the mortgage interest deduction indicate there is the political will to protect the U.S. housing markets. Federal support for high-end housing is strong. This is true even when it is generally agreed that the mortgage interest deduction pushes up home prices. Despite policy misgivings, many owners claim the deduction.
However, the vast middle-income housing market is less affected by the value of the mortgage interest deduction. It is more reliant on the existence of positive owner equity. Using targeted tax credit programs to cover transaction costs, in an undeniably undercapitalized market, can be a cost-effective way to keep the distressed loan inventory from growing any larger. Adding to the number of loans in arrears at this juncture is counter-productive. Incremental policies that reduce the long-term cost of bank and federal agency recapitalization are worth considering once again. Targeting specific market niches is well worth the effort.
The starter, first-time buyer market just suffers from policy leader (and lender) over-reaction to housing industry excesses. It is one thing to make sure ’no doc’ loans are never used again. It is quite something else when the FHA, “loan of last resort” program, raises its credit requirements above historical standards. It is also a problem when most of the lending institutions use even tougher credit standards because, basically, they can’t afford to make home loans.
Of course the starter market misses a fuller federal presence in the housing market. It might be better to have a local market-oriented federal program that pays attention to what the guarantee amount should be in any one market. Adopting national standards for all local markets is not a prudent capital measure. There are sensible improvements that the capital markets can and should make to the federal approach to home lending. But not to want to try something new that works is to subscribe to the new policy paradigm of the decade: ’too big to fix.’ That does not sound all that original.
About the Author
Peter Fugiel is a housing and public finance consultant in Chicago. He holds a Ph.D. in government from Northern Illinois University. Peter’s latest research specialty focuses on sub-market, (community-based) real estate research, called Metrometrics. It combines community real estate market analysis with municipal bond credit research. Peter was a long time municipal bond housing analyst, who helped pioneer the supplement to federal HUD programs with the self-financed state housing agencies.