Recent Data on Home Prices and New Home Sales: Still Far To Go

Case - Shiller Home Price Index, 10-city composite, January 1987 to April 2012

US new home sales, 1980 to May 2012, annual data

A pair of new reports on housing released yesterday and today have sparked positive reports on conditions in the housing market.  Both indicate that conditions have improved.  But comparisons to the recent past can be misleading as conditions have been so miserable.  It is important to look at the data also in a long-term context.  This blog post updates two which were posted on this site last December (here and here).

Yes, compared to the recent past, conditions have improved.  But viewed over a longer term context, one cannot yet say that the changes are significant.  The recent data might ultimately turn out to have marked a turning point.  But it is too early to say that.  Plus there is far to go before one can say there has been a meaningful recovery from the downturn in US housing that started in early 2006 when the housing bubble burst.

The top graph shows the Case-Shiller 10-City Composite home price index for the period from 1980 to April 2012, where the April figures were released this morning.  The Case-Shiller numbers are three month moving averages (so the “April” numbers represent an average over February, March, and April in their raw data).  The index is calculated by looking at changes over time of individual home prices, comparing the price of the home when it was sold to the price when it was purchased.  There is also a broader 20-City Composite Index, but this index only goes back to 2000.

The Case-Shiller numbers indicate an uptick in prices in recent months.  But the upticks are small, with monthly increases of just 0.7% in April and also in March, no change in February, and negative before.  Compared to a year ago, the index was 2.2% lower.

But all these changes are small compared to the fall of one-third in prices from the peak of the housing bubble in early 2006 to now.  Prices were plummeting in 2007 and 2008, and then finally stabilized within a few months of Obama taking office.  But there has not been a significant change since then.  Nor is it necessarily likely that there will be a significant change anytime soon.  As one can see in the diagram, average home prices were fairly flat for almost a decade, from late 1988 to late 1997.

The New Home Sales figures, released yesterday by the Census Bureau, were somewhat more positive.  Estimated new home sales in May reached 369,000 at an annualized rate.  This was almost 20% higher than the 308,000 figure for May 2011.  The January to May, 2012, average pace of new home sales was 352,800, which was 17% above the 300,400 pace of new home sales over January to May 2011 (with all figures at annual rates).

These increases are more encouraging.  But they are still small compared to the pace of new home sales that reached close to 1.3 million in 2005 at the peak of the housing bubble, as seen in the graph above.  The high rate of new home construction and sales during the bubble was clearly excessive.  As was discussed in the earlier blog post, annual sales of about 900,000 a year in the US right now might be considered roughly what is needed, on average, given the US population and its growth.  Sales at a pace of 369,000 units a year is still far below this.  An increase of 17% over the pace of 300,400 in the January to May 2011 period is good, but sales would need to almost triple (an increase of 200%) to reach 900,000 a year.

Over time, one should expect home building to recover to this roughly 900,000 level.  When this happens, it will serve as a significant spur to the economy.  And it might well start soon.  Taking the 900,000 figure as a rough benchmark, there was excess home construction during the bubble years of the Bush administration from 2002 to 2006.  This is shown as the area in blue in the figure above.  The excess during this period (i.e. the excess over the 900,000 benchmark) totaled 1.1 million housing units between 2002 and 2006.  Construction and sales then plummeted as the bubble burst.  With the continued depressed state of the economy, new home demand has remained low, and the cumulative shortfall from 2007 to now (calculated again relative to a 900,000 home unit per year pace as the “normal” demand) has come to 2.5 million units as of May 2012.  There is therefore now a net shortfall in housing units of 2.5 million minus the 1.1 million previous excess, for a net of 1.4 million units.  And at the current rate of 369,000 units per year (at annualized rates), the net shortfall is growing at a rate of 900,000 – 369,000 = 531,000 units per year, or about 44,000 units per month.

All this is consistent with recent published reports (see this Census Bureau report, or this Washington Post article based on it, from June 20) on how households are “doubling up” in record numbers, particularly with adult children in their 20s continuing to live with their parents.  The Census Bureau estimates that the number of doubled up households increased by 2.0 million between 2007 and 2010, with the number of “additional” adults (over and above the household head and his or her spouse or partner, and excluding students) in such households increasing by 3.8 million over this period.

Many of these additional adults will seek their own homes as soon as they can.  This will happen when the economy improves, and the home purchases will then in turn serve to spur further improvement in the economy.  When this happens, the impact on growth will be significant.  A rough calculation in the previous blog post suggested that new home construction and sales returning to a pace of 900,000 per year would add about 1% of GDP, or 2% of GDP assuming a multiplier of two.  The Congressional Budget Office estimates that GDP is about 5% below potential, so such growth in new housing construction could act to make up a significant share of the gap.

This pent up housing demand could therefore act as a significant spur to the economy once the process starts.  This serves to underscore again how important it is to end the fiscal drag that is holding back the economy, and instead allow fiscal growth such as that which acted as a significant spur to the economy during the Reagan years (as was discussed in this earlier post on this blog).  Once growth starts, the recovery of housing construction and sales to a more normal level will act to reinforce the recovery.

It is, however, premature to claim that the recent housing data provides an indication that this recovery is underway.  While positive, the changes are still too small, when seen in the longer term context, to bear much weight in drawing such a conclusion.

A Comprehensive Mortgage Refinancing Program


The US economy is stuck, with only weak growth.  While the 2008 economic collapse was stopped and then partially reversed through a number of bold government programs (including TARP, the Troubled Asset Relief Program launched under Bush, and the Obama stimulus package), the economy is now growing at too slow a rate to see a significant and sustained reduction in the still high rate of unemployment anytime soon.  The economy is operating far below potential, with a consequent huge loss in what living standards could be.  And the personal human cost of high unemployment is severe in itself.

A primary reason for this continued slow growth is the badly functioning housing market.  Housing prices (see this post) built up in a bubble in the middle of the last decade, reaching a peak in early 2006, and then collapsed.  With the collapse of that bubble, losses built up in US banks and in the US financial system more broadly, leading most spectacularly to the bankruptcy of Lehman Brothers.  The TARP program as well as very aggressive actions by the US Federal Reserve Board succeeded in stabilizing the banks.  But homeowners also lost when the housing price bubble burst, with many now owing more on mortgages than the current value of the mortgaged house itself.

These mortgage holders cannot refinance at the lower interest rates now available on the market, unless they can come up with cash at the time of the refinancing to pay off the balance of the old mortgage in excess of what their new mortgage could be (now normally only 80% of the current home value).  If they do not have such cash, they must struggle to pay the mortgage at the old, higher, interest rates that were obtained when they bought their house during the bubble years (or when they may have refinanced at that time to a higher mortgage amount, or taken out a home equity line of credit on the then higher home value).  Similarly, they cannot sell their house and move to a new location (perhaps in pursuit of a new job opportunity) without bringing cash to the table at the time of closing.

Hence such homeowners remain stuck.  As a consequence, the housing market is not performing as it normally would.  To be blunt, the housing markets, and as a consequence the economy more generally, are constipated.  Economists refer to this as a balance sheet recession, as households (in this case) face financial obligations (their mortgages) in excess of the value of the assets they hold (their homes).  Households hunker down, and try to service their expensive mortgages while trying to save enough to get out of their negative net worth position.  But this can take a long time, and meanwhile the overall economy stagnates.  Japan suffered such a balance sheet recession following the bursting of its asset bubble in 1989 (although for Japan the problem was centered in the corporate sector).  It took more than a decade to recover from this, and to a degree the problem in Japan continues.

One can take a fatalistic approach and say there is not much that can be done.  The Treasury Secretary Timothy Geithner, in an interview with the Wall Street Journal published in its November 21, 2011, edition, appears to take this view.   Asked by the interviewer: “Which happens first?  The economy picks up and housing recovers, or a bottoming and slight recovery in housing helps the economy?”  Geithner responded:  “You can’t engineer a recovery in housing that can lift the broader economy.  It has to be the other way around.”

If true, this would be unfortunate, as the economy will not recover as long as housing is in difficulty.  The purpose of this note is to set out a program which, while ambitious, would be feasible, and which would help unlock those households now facing mortgages that are greater than their homes are worth, and with this unlock the housing markets and the economy more generally.  The scale of the program, as will be detailed below, would be similar in scale to TARP and related programs, which succeeded in stabilizing the banks.  There is a need now to stabilize the households who have similarly suffered from the bursting of the housing bubble, with a similar commitment.

I have labeled the proposal the Comprehensive Mortgage Refinancing Program (CMRP).  The first section below will present the basics of the program, through a simple numerical example.  The section that follows will then elaborate on some of the specifics in how it would work.  I will then present the numbers on how many mortgages would be eligible and the savings these homeowners would enjoy, and aggregate figures on the total costs.  Finally a concluding section will discuss the impact on each of the various entities that would be affected (the households, the lenders, and government), and how each would benefit from the program.  There is a shared interest by each in participating, but leadership by government will be necessary to make it happen.

CMRP in Summary

The program would be built around a government loan (not a grant) to the home owners to allow the mortgage balance to be brought down to 80% of the current estimated home value.  Specifically, all household borrowers with a mortgage balance in excess of 80% of their current home value could participate, if they choose.  It would not be compulsory.  If they do, the house would be appraised, and their existing mortgage balance would be refinanced at a 4% interest rate (approximately the current market rate for 20 or 30 year fixed rate mortgages), for 80% of the home value by the existing mortgage holders and for the remaining amount as a loan on the same terms from the government.  Should the home owner decide to sell his property, perhaps some years hence, the mortgage holders would be repaid (as long as the home is sold for more than the mortgage, which was set at 80% of the value of the home when the program was launched).  The government would be repaid half of any gain above the 80% (half in order to preserve an incentive for the home owner to try to get a good price), while the remaining amount would be treated as a personal loan on the same terms, to be repaid over time.

There are many details still to be covered, but it would be helpful first to present this with a simple numerical example.  Assume that the current value of the home is $200,000, but that the mortgage on it is $250,000.  In common usage, the homeowner is “underwater” by $50,000.  Eighty percent (80%) of the home value is $160,000.  Under CRMP, the mortgage would be refinanced with the existing mortgage holder (or holders, if there is a second lien or a home equity line) providing a new 30 year mortgage at 4% on the $160,000, while the government would provide a loan on the same terms (4%, 30 years) of $90,000.

If the house is then sold for $200,000, the $160,000 mortgage would be paid off, while the government would receive $20,000 (half the difference between the sale price and the $160,000 mortgage), with the remaining $70,000 balance on the government loan to be repaid on the same terms (30 years, 4%) as if it were now a personal loan.  The homeowners could take out the $20,000 and use it as a downpayment on a new home, or could prepay the government if they wish.

Elaboration on the Program

Some of the specifics:

  1. The lender with the first lien on the home (and normally the largest single lender) would cover all the closing costs involved (including the cost of the appraisal by an independent professional firm, chosen by the government) as well as all the administrative costs involved both initially and over time.  No points would be charged on the new mortgage either.  The lenders will benefit greatly by this program, and can absorb such costs.
  2. The program would only be for households where the mortgage is for their principal residence.  The program is not designed to rescue businessmen or others who speculated on a continual rise in home prices during the bubble, nor for the lenders to such speculators.
  3. The program is also not designed for borrowers who cannot cover the debt service on these loans.  It is designed for those households who are servicing their debt, perhaps with difficulty but servicing it nevertheless.  They will gain as the new mortgage terms will be at 4%, versus the higher rates that they currently pay (probably normally in the 6 to 7% range, as these rates were typical during the bubble, or possibly even higher if they took out loans at low initial rates which then stepped up after a few years to higher rates).  There are, unfortunately, also households who cannot afford the homes they moved to even at a 4% rate.  Such cases need to be addressed on an individual basis, where there will be foreclosures as well as major losses to the mortgage holders who made such irresponsible loans.  Other programs exist to help in such cases, but this is not the objective of the proposed CRMP.
  4. The new loans from the government ($90,000 in the example) would be for 30 years at a fixed 4% rate, with the same level payments as for a 30 year fixed rate mortgage.  But one might include an incentive to pre-pay such loans, so that they do not last for decades unless truly needed.  One might include an automatic increase in the rate by say 1% point in year 10, 1% point again in year 15, and so on.  Even with a modest 2% annual inflation in home prices on average from their current level, prices would be 22% higher in 10 years and 35% higher in 15 years.  Homeowners could refinance at that point with a regular commercial mortgage, if beneficial to them, and repay the government obligation.
  5. The seniority of the creditors (i.e. the holders of the first lien, the second lien, any home equity credit lines, etc.) would be kept as they are now.  In the initial refinancing to 80% of the current home value (i.e. to the $160,000 in the example, from the $250,000 initial exposure), each lender will have a proportional reduction in their exposure.  But then if the house is sold for less than $160,000 (or whatever the current mortgage balance would be at some future date, after some period of repayment), there would be losses taken by these mortgage holders, in the order of their seniority as now.  That is, the mortgage holder with a first lien would be paid first, then those with a second lien, and so on.  The holders of these second liens and home equity lines will still benefit a great deal under this program, as the government has in effect already paid them the difference between the initial total mortgage exposure and the 80% home value ($90,000 in the example).  Plus there will not be further losses unless home prices fall by a further 20% from where they are now (as the new mortgages will be 80% of the current value).  But to the extent there are such further major losses, they will bear this.

The Overall Magnitude

An important question to address is what might be the scale of such a program, in terms of the amounts to be refinanced and what the government share of this would be.  The best data from which one can compute this is provided by CoreLogic, a private firm that provides analytical and consulting services on real estate.  They maintain a comprehensive state-by-state data base with estimates of the numbers of mortgages that are underwater, and by how much.  The figures can be worked out from numbers quoted in their most recent press release, available here.

Specifically, CoreLogic estimates that as of the third quarter of 2011, 22 million mortgage borrowers in the US have loans which are greater than 80% of their current home values.  This would define the pool of potential participants under CRMP.  Of the 22 million, CoreLogic estimates that 10.7 million face a mortgage loan greater than 100% of their current home value (i.e. are underwater), with 6.3 million of these having only a first lien on the home, while the remaining 4.4 million have a first lien as well as a second lien (or more).

For the 6.3 million underwater with only a first lien, the average mortgage balance was $222,000, and they were underwater by an average of $52,000, thus implying that their average estimated home value was $170,000.  For the 4.4 million with also a second or other liens, the average mortgage balance was $309,000, and they were underwater by an average of $84,000, implying an average estimated home value of $225,000.  I assumed that the average home value of those 11.3 million with loans between 80 and 100% of their home value, was the same as the weighted average of the homes underwater (equal to about $192,600), and that on average the mortgage balance outstanding on these homes was halfway between the 80 and 100% bounds.

From these numbers, one can calculate that the total mortgage balance outstanding in the US in excess of 100% of the underlying home value, is $699 billion.  In addition, a further $630 billion is outstanding on the mortgage amounts between 80 and 100% of the home values (including all of the 22 million homes with mortgages in excess of 80% of the home values).  Hence the total amount that the government might possibly need to lend, if there is 100% participation by all such eligible mortgage borrowers, would be $1,329 billion.  And the amounts that the lenders would need to provide (for the uniform 80% mortgages) would be $3,390 billion, down from their current exposure of $4,719 billion (where the government share makes up the difference).

These would be the maximum exposures.  However, it is doubtful that 100% of home mortgage borrowers would participate.  The reasons would be various, but would include the requirement that only mortgages on principal personal residences would be eligible.  In addition, CoreLogic noted that in its data, only 69% of the 22 million home mortgage borrowers with outstanding loans greater than 80% of their current home value, have mortgages at interest rates of 5% or more.  It would be these home owners, with high interest rate mortgages, who would gain the most from participation in the proposed program.

While it is impossible to say with any certainty how many mortgage borrowers would choose to participate (a reasonable guess might be somewhere in the 50 to 75% range), for the purposes here, I will assume that 69% do.  Therefore, the outstanding loans to be made by the government to the households would total $917 billion (69% of $1,329 billion), while the new 80% mortgages from the private lenders would total $2,339 billion (69% of $3,390 billion).

A $917 billion program from the government to benefit homeowners and unlock the housing market is of course huge.  But it is similar in scale to the potential exposure the government took on under TARP and related programs to stabilize the banking system.  TARP itself was approved for up to $700 billion, although substantially less was in the end used.  Similar US Federal Reserve Board support to AIG and to JP Morgan for the Bear Stearns purchase totaled $140 billion.  There has also been approved purchases by the US Treasury of equity in Fannie Mae and Freddie Mac of up to $400 billion.   These programs have thus totaled $1,240 billion, plus there were a number of smaller programs.

But it should also be noted that while the potential government losses totaled this $1,240 billion, the actual losses so far have been small.  The US Fed has not lost anything on its programs, including programs that provided massive liquidity support to the banks.  The current estimate of the net cost of TARP to the government is only $19 billion, mostly on programs to support housing where recovery of the funds was never anticipated.  The Government in fact made a significant profit on TARP funds lent to the banks.

Indeed, the main anticipated cost to government of these programs to stabilize the financial system is expected to come from losses in the support provided to Fannie Mae and Freddie Mac.  The Congressional Budget Office expects that these losses will total $389 billion over the next ten years.  To the extent the CRMP proposal being made here is implemented, these losses to Fannie Mae and Freddie Mac would likely be reduced.

One also needs to note that while the government would make loans to the home owners of an estimated $917 billion, these loans would be made at an interest rate of 4% initially (and then possibly bumped up by a percentage point in years 10, 15, and so on, until the loans are paid off).  But the current cost of a 10-year US Treasury bond is less than 2.0%  (indeed only 1.90% as of this writing).  Thus the US Treasury will be earning a positive spread on these loans, where one should note that all administrative expenses under this program would be covered by the primary mortgage lender.  But there will still be defaults, and it is not possible to predict with any certainty how large these will be.

Overall, however, the positive spread the government will earn on the loans that are repaid, plus the savings in terms of reduced losses by Fannie Mae and Freddie Mac, make it possible that the final net cost to government will be small, as it was on TARP.  Plus there will be the broader benefits to the economy from a program to unlock the housing markets, which will in turn lead to more tax revenue to the government.

Finally, the individual home owners will benefit from the lower interest rates on the refinanced mortgages.  While no portion of the loan is being forgiven, they will now pay at a uniform 4% rate rather than the higher rates they are paying currently.  The savings to them will depend on what their current mortgage rates are, and these will vary.  The rates will also be higher on second liens and on home equity lines than on mortgages holding a first lien, and will vary based on whether they have fixed or floating rate loans, step-up payments due, and so on.

But to illustrate, for an average mortgage outstanding of $214,400 (the weighted average in the CoreLogic data cited above), and assuming their current interest rate is 6 1/2% on a 20 year fixed rate loan, the savings would be $6,900 per year in moving to a 30 year fixed rate loan at 4%.  This is a savings of 36%, and would total $152 billion (about 1% of GDP) for all the households.  This in itself would provide a substantial boost to the economy, as much of this will likely be spent.  And for the households that are underwater, and who have second liens and/or home equity lines in addition to a first mortgage, where the average mortgage is $309,000, the savings would be $9,950 per year.

Conclusion:  The Impact on Each Party

It is important to recognize that each of the major groups involved in CRMP would benefit from its implementation:

  1. The home owners who cannot now refinance their mortgage because the mortgage is greater than 80% of the current value of their home, will be able to refinance at 4%, the current market rate.  They will not only realize regular monthly savings compared to what they currently often have to struggle to pay, but they will also be able to sell their house, should they now wish, perhaps to move to a different part of the country to pursue a job opportunity.  This will also help unlock the housing market, with attendant broader benefits to all the home owners in the country.
  2. Mortgage lenders would with CRMP face fewer mortgage defaults and losses from foreclosures.  And losses from foreclosures are normally much more than simply the excess of the mortgage amount over the estimated current home value, as foreclosed homes typically sell at a significant further discount, plus there are substantial legal and other costs in going through the foreclosure process.  Hence they will welcome a government program where the government provides a personal loan to cover the amount of the mortgage in excess of 80% of the current home value.  It is true that such lenders would prefer the home owners to continue to pay at the above market interest rates of perhaps 6 1/2% or so that they are locked into, but they also recognize that many such borrowers will soon choose to walk away from these mortgage commitments.
  3. And while the Federal Government will take on substantial new debt to fund the loans it will make, the net cost in the end is likely to be small.  It will lend the funds at a positive spread, and while there will be costs from defaults, government will also gain from lower losses incurred by Fannie Mae and Freddie Mac.  There will also be higher tax revenues from a better functioning economy, due to a better functioning housing market and as consumer spending rises in a sustainable way.

But while a program such as CRMP makes sense, it is difficult to see in the current political environment that something of this nature will be implemented.   The country’s vision has become too narrow, with no willingness to take bold actions.  As a result, it is much more likely that one will see the slow and unsteady recovery typical of balance sheet recessions where little is done to cure the underlying structural problems.

Home Prices Stagnate, at Levels Similar to Those of 2003

US home prices, Case-Shiller 10-City index, 1987 to 2011

US home prices continue to stagnate, at levels well below the peak reached in 2006 during the housing bubble. They fell sharply in 2007 and 2008 during the last two years of the Bush Administration and then stabilized under Obama, first rising a bit and then falling back a bit, but with no overall trend so far.  Based on the 10-city composite home price index of S&P / Case-Shiller, the prices of single-family homes in September 2011 were 33% below the peak reached in April 2006.

It is useful to view this in the longer term context, as presented in the graph above.  While home prices are fully a third off their peak, they are still higher than they ever were prior to 2003.  The sharp fall in prices is a reflection of the sharp rise in the middle of the decade, as a bubble built up and policy makers decided not to try to do anything to moderate it.  Indeed, many politicians, as well as many existing homeowners, felt quite good about the rapidly rising prices.

Then the bubble burst, and the consequences for the economy have been clear, as the economy collapsed in the sharpest downturn since the Great Depression.  This was then followed by an anemic recovery, with still high unemployment.  Recovery from such “balance sheet recessions” are normally slow, as the entities with the over-extended balance sheets (mortgage holders in the US; the corporate sector in Japan in the 1990s) seek to hunker down and save their way out of their predicament.  Asset prices recover only slowly at best.

If nothing is done, US home prices are likely to continue to stagnate, and may well fall further.  As indicated above, while prices after the bubble burst fell by a third, they are still only at the level seen in 2003.  Yet between 1997 and 2003 they had already doubled.  That home prices have not now fallen further than simply to 2003 levels is therefore even a bit of a surprise.  They could fall more.  And as seen prior to 1997, there can be long periods when prices are basically just flat.

Those households with negative equity in their homes (commonly referred to as “underwater”) face major difficulties, even if they can afford to make continued payments on their homes.  They cannot refinance at the current low rates for mortgages, unless they can come up with extra cash to bring the mortgage down to 80% (generally) of their current lower home value.  And they cannot sell their house to someone else, perhaps to move elsewhere for a new job, without bringing extra cash to the closing to pay off the remaining mortgage balance.  The housing market remains frozen, and with that, the economy remains in the doldrums.

Unless something major is done, this weak housing market will likely keep the economy in the doldrums.  And there is no reason to believe that there will be a jump in housing prices to levels similar to those at the peak of the bubble, with this then curing the problem of the underwater mortgages.   Rather, a comprehensive program, led by government, will be necessary to restructure these mortgages, to unfreeze this market and allow the economy to recover.