Housing Market Crisis May Already Have Passed: Kevin
Hassett
By Kevin Hassett
Aug. 27 (Bloomberg) -- Has the U.S. housing market
hit bottom?
The market has been in free fall for some time now,
with the subprime scare roiling bond and equity
markets in a way that has not been seen since the
Asian financial crisis of a decade ago.
Amid all the doom and gloom, it's easy to forget that
all such declines eventually end. There has been a lot
of bad news lately, but the good news is this: The
housing market may be getting close to a turnaround.
Last week, we learned that new home sales rose 2.8
percent in July, and the inventory of unsold homes
fell to 7.5 months. Credit concerns are making
mortgages harder to get, though the numbers indicate
that enough well-qualified buyers have decided to stop
sitting on the sidelines to give the market a boost.
One does need to be cautious about reading too much
into a single month of data. The impact of the
mortgage-lending shenanigans may yet get much worse.
Still, a cold, hard look at the data on the housing
market suggests that its negative impact on the
overall economy may be fading.
Back in the fourth quarter of 2005, household
investment in new homes and repairs peaked at an
annual rate of $711.8 billion in 2006 dollars,
according to Federal Reserve data. By the first
quarter of this year, it had dropped to $549.3 billion
in 2006 dollars.
Housing Economics
That 23 percent decrease is enormous relative to
declines that have occurred in the past, even during
economic slumps. In the recession of 1990-1991,
residential investment dropped about 10 percent.
During the worst housing recession, in 1980, the
decline was only 17 percent. Residential investment
actually increased during the last recession.
Still, a decline doesn't have to stop just because it
is larger than those of the past. To understand
whether the end is near, one needs to grapple with the
economics of housing.
In theory, investment in such a long-lasting asset
plummets when investors decide they have done too much
of it. If society needs 100 million homes but finds
itself with 103 million, new construction drops
precipitously.
The extra 3 million homes aren't destroyed, however.
Instead, homeowners will sit back and let the natural
wear and tear of depreciation work its wonders, until
only 100 million homes are left.
Falling Investment
If the market enters such a state of retrenchment,
then it's apparent in the aggregate data because
investment in housing drops to a level below that
required to offset depreciation.
In a growing economy, with an expanding population,
the retrenchment looks slightly different. In this
case, investment drops to a level consistent with more
sustainable growth in the housing stock. Such an
adjustment has often been witnessed in recessions in
the past.
Outside of recessions, the per capita growth of
housing has been 1.1 percent since 1952, according to
Federal Reserve statistics. During recessions, it
drops not to zero, but to an average level of about
0.8 percent.
So, if you want to know whether investment in real
estate has fallen enough, you need to identify where
it is today relative to normal wear and tear. If
investment is much higher than that required to offset
wear and tear, then one should expect it to drop a
good deal more. If it has already dropped to the
retrenchment point, than it has declined enough and
should stabilize.
Retrenchment?
Here's the good news: The latest Fed data suggest that
investment may have dropped enough to have reached a
reasonable retrenchment point.
Relying on an old government number -- that housing
capital ``decays'' at a rate of about 1.1 percent per
year -- and adjusting for population growth, then the
numbers suggest that the existing stock of residential
real estate is growing at a rate of about 0.3 percent
per year.
That growth is about 1 percentage point below where it
was in 2005, and about half a point below the average
level experienced in postwar U.S. recessions.
It's likely, however, that housing capital decays a
bit faster than that. If so, then the stock of housing
in the U.S. isn't growing at all, and may even be
shrinking. That is exactly the measured response to an
overhang that economics would predict.
Ahead of the Game
Financial markets have suffered tremendously because
of increasing concern that losses from the U.S.
mortgage market will threaten the health of major
financial institutions. Usually, securities markets
move ahead of the game. This time, however, the real
activity has been adjusting for some time.
We may still see a meltdown because of widespread
losses in the subprime market. And housing prices, as
opposed to construction, might well see more declines.
If those two things happen, then the economy may still
end up in a recession, as consumers cut spending once
made possible by taking equity out of their homes, and
stressed lenders increase the cost of capital for
their corporate customers.
But the drag from the housing industry is mostly gone.
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