Saturday, November 22, 2008
The housing market continues to be a big thorn in the economy's side. Housing starts maintain their downward trend, sales have hit an undecided bottomed and vacancy and delinquency rates surge. There's still a lot of overhang to work off, and the big remaining question is for how long?
With global capital losses hitting $1 trillion (and counting) – a good-sized portion of that is tied to mortgages and mortgage-backed assets – the stabilization of the U.S. housing market is of up most importance. So how much overhang still needs to be worked off? Well, according to the Congressional Budget office (CBO), that depends on three things:
- The underlying demographic variables of the housing market: household formation based on population growth and other factors.
- Vacancy utilization rates, or the new vacancies that are utilized (like a second home) relative to those that are unutilized (for arbitrage opportunities, like the American show "Flip This House", which you can watch here).
- Credit availability in response to the current financial crisis and the length/depth of the economic cycle.
The CBO estimates (read paper here) that housing construction will bottom in 2008, 2009, or 2010-2011 depending on the path of economic and financial conditions and the demand for utilized vacancies (e.x. second homes). The optimistic scenario: the economy cycles out as normal, financial conditions improve and some of the surge in vacant units can be explained by a permanently higher demand for vacant homes (above 19990's levels), although for reasons that are currently not known. Therefore there is some excess supply still to work off with added foreclosures going forward contributing to the supply. Housing starts bottom in 2008 and rise back to trend levels by the end of 2009.
The cyclical downturn scenario: the economy cycles out as normal, financial conditions improve and excess vacancy rates fall back to 1990s levels. Therefore, there is still a lot excess and vacant supply of homes to work off with added foreclosures going forward contributing to the supply. Starts bottom in 2009 and return to trend early in 2011.
The pessimistic scenario: household formation remains depressed due to ongoing recessionary and financial stresses and both utilized and unutilized vacancy rates fall back to pre-1990's levels. In this case, there is a very long period to work off the excess supply of homes that includes new foreclosures going forward due to prolonged decline in demand. Starts decline through 2009 and slowly stabilize in 2010 and 2011, but do not return to trend levels until 2012.
It is interesting to think about a positive and permanent shock for utilized vacant homes - I hadn't even considered it before reading this paper. I tend to think that the cyclical downturn scenario is the most plausible, which is slightly more pessimistic than my previous assessment of the housing market in August, but since then, credit and economic conditions have taken a sharp turn downward.