The uncertain US housing outlook

What’s at stake: In the US, house prices have started rising again for the first time in several years. U.S. home prices rose for the third straight month in July, raising hopes the market is stabilizing after a three-year plunge. But the recent upturn may only be temporary as the first-time buyer credit of $8,000 which has jump-started housing activity this year and has helped reduce a massive inventory of unsold homes is set to end on November 30.

Calculated Risk says that the housing outlook has probably never been more uncertain and the details are masked by many distortions. On one hand, the supply of distressed homes has been severely restricted by a combination of foreclosure delays and trial modifications. On the other, the demand for homes has been distorted by the first-time homebuyer tax credit, by extraordinary levels of lending using government-insured loans, and the Fed buying MBS which has pushed down mortgage rates. This has led to a buying frenzy in many low end areas, and has pushed up prices. In the short term, existing home sales and prices will probably be strong through at least September, and reported inventories will move lower. But the longer term (2010 or maybe later) remains much more uncertain.

Robert Shiller says that we’re seeing a housing bounce, not a boom. Given the abnormality of the economic environment, the sudden turn in the housing market probably reflects a new home-buyer emphasis on market timing. The sudden turn could signal a new housing boom, but is more likely just a sign of a period of higher short-run price volatility. Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997. So the most likely scenario is that it won’t continue at this high rate of increase, but that it will neither go down a lot, nor up a lot.

William Wheaton argues that fundamentals on the supply side of the housing market imply that US housing prices are about to bottom out. Shiller’s view ignores some critical differences between real estate and other more purely “financial” assets leading to an exclusive focus on demand fundamentals, expectations, and other factors that both create asset price bubbles and their collapse. What is missing from this analysis is the supply side of the market. Real estate is a physical asset and not just a claim on a hypothetical income flow. As housing is a physical asset, its price must eventually equal or exceed the full cost building or rebuilding it. So the real questions in the current crisis are a) when and how much future housing will the US need to construct, and b) are prices today so much higher than the cost of construction that they could still fall significantly and have development remain economically viable?

Nouriel Roubini says that the stress is moving from residential mortgages that are still in deep trouble, to commercial real estate, where they are just starting to recognize that they're going to have massive losses. One of the main risks next year may be from losses on some $2 trillion in outstanding commercial real estate loans. As a result, housing prices may still fall more than 10 percent, killing an incipient recovery, as demand from first-time home buyers fades. James Hamilton also points out that, despite the increase in the S&P/Case-Shiller home price indices, the decline in existing home sales for August, future rise in foreclosures already baked in the cake, inventory of unsold homes, and expected continuing increases in unemployment all raise the possibility that house prices could resume their descent.

Charles Calomiris, Stanley Longhofer and William Miles argue that fears over the macroeconomic consequences of falling home prices dragging down consumption are overrated. Housing values and consumption are indeed correlated, but once one takes into account the fact that housing price changes may be acting as a proxy for future expected income, the measured housing wealth effect, if it exists at all, is much smaller than popularly believed. As changes in housing wealth have little effect on consumption, little gains in macroeconomic growth can be expected from policies targeted specifically at boosting housing prices in order to spur consumption.

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