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Economic Update
Northern Trust
By Carl Tannenbaum and Asha Bangalore
November 22, 2012

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  • A look beneath the surface reveals a housing sector still struggling with post-crisis transition.
  • The Federal Reserve is intent on promoting a broader recovery in this area.

As American merchants and consumers brace for Black Friday (which, in some corners, is set to begin on Thursday!), the economic news has been focused on sales of a bigger-ticket item.  With just five weeks left in 2012, housing has undoubtedly been among the bright spots for the US economy this year.  But a close examination reveals an industry still facing significant challenges, which remain a focus for Federal Reserve Chairman Ben Bernanke.

On the bright side, residential investment has made a positive contribution to economic growth in recent quarters after an extended malaise, and employment in the construction sector has improved.  We learned this week that sales of existing homes moved up 2.1% in October to an annual rate of 4.79 million units, matching levels last seen sustainably in 2007 (there were brief bursts in 2009 and 2010 created by temporary first-time home buyer programs).

Economic Update Chart 1 11-21-2012

New housing starts are fully 40% higher than they were a year ago, inventories of unsold homes are below their historical averages, and the CoreLogic home price gauge has risen for nine consecutive months.  These tallies clearly show that housing has bottomed out.

At the same time, there remain worrisome signs.  The National Association of Realtors report on October existing home sales indicates that foreclosures and short sales accounted for 24% of transactions.  To be sure, the share of distressed properties in total existing home sales has trended down from a high of 49% in March 2009 but this remains a problematic feature of the housing market. 

Further, an estimated 20% of outstanding home mortgages are larger than the value of the underlying homes.  Programs to resolve these situations are still moving very slowly through banks, Federal agencies, and the courts.

Economic Update Sidebar 1 11-21-2012The home ownership rate has fallen to 65.5% in the third quarter from a peak of 69.4% in the second quarter of 2004, despite the historically low mortgage rate environment.  This decline reflects three basic factors.  First, the loss of income and employment has put a housing purchase out of reach for many.  Roughly 8 million jobs were lost during the Great Recession and the recovery in employment has been sub-par.  Second, home mortgage underwriting standards remain tight.  The Fed’s Senior Loan Officer Opinion Survey shows that a majority of lenders have yet to change the tough stance they adopted in 2007.  Third, a decline in home prices has held back equity gains that are recycled to purchase homes.

Economic Update Chart 2 11-21-2012

As a result, an increasing fraction of families are renting.  And the composition of construction has been skewed toward multifamily dwellings.  More than one-third of October ’s housing starts were apartment buildings, as opposed to single-family homes; this is double the share seen at the peak of the housing boom seven years ago.

While there is certainly no shame in renting, finding proper balance in the housing market remains an elusive goal.  Ben Bernanke devoted an entire speech to this topic last week.  Noting that “(P)olicymakers must take into account how their decisions affect the least advantaged, not just the economy as a whole,” the Fed Chairman noted that “Strengthening and broadening the housing recovery remains a challenge.”

Through its work in community affairs, the Federal Reserve has always had a special interest in housing, and has been front and center in forwarding proposals to heal the lingering ills afflicting lenders and homeowners.  To many, this is a productive congruence of compassion and the Fed’s desire to improve economic growth.  To others, this seems a stretch of the Fed’s mandate.

While it may not be explicitly mentioned in our central bank’s objectives, housing is a central industry which has broad carry-over to others.  As any home owner knows, the commitment to economic stimulus does not end on closing date; it is rather just beginning.  Weekend trips to the home improvement center and periodic remodeling create a strong multiplier to residential investment.

Further, other agencies tasked with supporting housing have been critically impaired.  Freddie Mac and Fannie Mae are still awaiting formal word on what their mission should be, and the Federal Housing Administration (FHA) announced recently that its liabilities significantly exceed its assets.  FHA’s efforts to provide credit to home buyers with modest down payments and credit scores are almost certain to be curtailed.

Whenever he chooses to depart, the response to the 2008 financial crisis will certainly be the highlight of Chairman Bernanke’s tenure.  But his willingness to view the possibilities of Fed policy more broadly is also notable, and worthy of reflection.

In his remarks over the years, the Chairman has defined the Fed’s mission broadly—going beyond economic aggregates to look at underlying distributions.  From his words and deeds, it is clear that Bernanke views the Federal Reserve’s purchase of mortgage-backed securities as productive for both monetary and social policy.

(c) Northern Trust


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