Friday, December 5, 2008
I saw an article on another weblog about the record-high National Association Realtor’s Housing Affordability Index (HAI). The author of the post could not believe that this news had not made headlines because that is “good news for the real estate market, since it will help in the recovery process.”
I disagree. The 2008 HAI only reflects precipitously falling home prices, and we already knew that. But bank lending standards are extremely tight, and obtaining a mortgage is increasingly difficult. Bank lending standards are not included in the index's composition, so no matter how low the price falls, potential homebuyers may not be able to get a loan.
The chart lists the HAI composite index spanning January 1976 to October 2008. There is an obvious correlation between mortgage rates and the affordability index. In 1981 mortgage rates surged amid record inflation (see this post for an interest rate chart), and housing affordability (HAI) hit a cyclical low. During the Volcker disinflation era – 1981 to 1983 - mortgage rates fell, and housing affordability surged.
October 2008 HAI hit a peak since 1994 but not because interest rates are falling. Affordability is high because the median home price fell to $181,800 - a 12% decline since May 2008 (just five months ago) - while mortgage rates rose 0.13% to 6.23%. This cannot describe affordability in the current housing market because increasingly tight bank lending standards are left out of the HAI (you can see the components of the index here), and most households cannot afford a home without a mortgage loan.
Even if potential homebuyers wanted to purchase a home at rock-bottom pricing, it is becoming increasingly difficult to obtain funding. According to the Federal Reserve Bank’s Senior Loan Officer Survey, “Large majorities of domestic respondents reported having tightened their lending standards on prime, nontraditional, and subprime residential mortgages over the previous three months.”
Real estate loan growth in 2008 is down significantly. Annual loan growth started to decelerate in February 2007 and continued to decelerate on into September 2008. October loan growth surged, but that is simply a technicality. According to the Fed, loans from nonbanking institutions (probably WaMu) were assumed by banking institutions, and the shift in assets explains the surge in real estate lending (commercial and real estate). Without this technicality, monthly real estate lending would have declined.
The housing market is crippled. The Fed and the Treasury are trying to create incentives to kickstart demand and supply in the mortgage market. Until incentives or lending standards change, the housing market is set to fall further.