Table of Contents
Subject to change
Chapter 1: Executive Summary
Forecast summary
Awash in inventory
Subprime financial shock
Where's the bottom?
Financial threat
Circumspect consumers
Engaged policymakers
Conclusions
Chapter 2: An Historical Assessment
The boom
The bust
Chapter 3: Explaining History
Behind the boom
Behind the bust
Chapter 4: House-Price Primer
Chapter 5: Measuring House-Price Risk
Income-to-price
Price-to-rent
User cost-to-rent
Chapter 6: Leading House Price Indicator
Specification
Estimation
Validation
LHPI's outlook
Chapter 7: Structural Econometric Model
Theory
Historical data
Equilibrium equation
Adjustment equation
Validation
Alternative specifications
Valuation
Chapter 8: Forecast Accuracy
National accuracy
Regional accuracy
U.S. regional forecast consistency
Chapter 9: House-Price Outlook
House-price declines
House-price recovery
Chapter 10:MSAs
Chapter 11: Risks to the Outlook
Baseline assumptions
Negative risks
Positive risks
Chapter 12: Conclusions
Appendices
About Moody's Economy.com
Forecast Summary
The current housing recession is expected to run through early 2009 and will ultimately be severe enough to be characterized as a housing crash. Home sales are exptedted to hit bottom in early 2008, declining by over 40% from their peak, housing starts will reach their nadir in mid-2008, falling by 55%, and house prices are expected to decline by 12% through early 2009. After accounting for the plethora of non-price discounts home sellers are offering to buyers, effective house-price declines peak to trough will total well over 15%.
Awash in Inventory
The housing market’s most fundamental problem is it is awash in unsold inventory. According to the Census Bureau, as of the third quarter of 2007 there was close to 2.1 million vacant unsold homes that were for sale, equal to 2.6% of the stock of owner-occupied homes. Even a well-functioning
housing market has a substantial amount of inventory. But in the quarter-century between the early 1980s and mid-2000s, the vacancy rate was an unwavering near 1.7%. The difference between the current over 2.6% vacancy rate and the 1.7% rate that consistently prevailed prior to the recent boom provides a good estimate of the amount of excess inventory in the market—it currently totals nearly 750,000 homes (see Chart 1-4). This is far and away the highest level of excess inventory in the post-World War II period. 2
Subprime Financial Shock
Subprime financial shock. Inventories of unsold homes will rise substantially further in coming quarters as the ongoing subprime financial shock results in a collapse in home sales and surging mortgage loan defaults and foreclosures. The global financial turmoil ignited this past summer by the rising credit problems on U.S. residential mortgage loans has significantly disrupted the flows of credit into the mortgage market. The issuance of bonds backed by subprime, Alt-A, and jumbo loans has fallen dramatically in recent months. At the peak of activity between 2005 through the first half of 2007, issuance of these bonds totaled close to $1 trillion annualized. During the third quarter—the shock began in late July and August—issuance plummeted to only $300 billion (see Chart 1-5). 5 So far in the fourth quarter, issuance has not measurably revived.
Where's the Bottom
Where’s the bottom? The outlook for the housing market thus appears very daunting. The mountain of housing inventory will only clear sufficiently for the market to find a bottom if homebuilders significantly further curtail construction, and thus new supply, and for home sellers to slash their prices to restore affordability and stimulate housing demand. To gauge just how much lower construction and house prices must decline for this to occur, the Moody’s Economy.com macroeconometric model of the U.S. economy was simulated under a number of different assumptions. Under the baseline (most likely) set of assumptions, the economy avoids recession but experiences slow job growth, the entire Treasury yield curve remains well below 5%, and loan modification efforts soon gain momentum. In this scenario, the housing market finds a bottom by early 2009 with average annual housing starts of approximately one million units over the entire period and a peak-to-trough decline in national house prices of 12% (see Chart 1-12). Housing starts in September were running at a 1.2 million unit pace and house prices are down 5% so far.
Financial Threat
Financial threat. The risks to this disconcerting near-term housing outlook seem skewed decidedly to the downside. Of most concern is that sliding house prices and eroding mortgage quality will reignite another wave of global financial turmoil. The ramifications of this for the economy, and thus housing, would be overwhelming. Behind this worry is the financial system’s substantial exposure to hundreds of billions in mortgage losses that are set to come. While financial institutions have begun to recognize these losses, as is evident from the recent string of billion dollar writedowns, they have fallen well-short of what they ultimately will have to realize.
Circumspect Consumers
Another negative risk to the outlook is posed by the intensifying negative housing wealth effects resulting from the severe and persistent decline in house prices and homeowners’ equity. As consumers turn more cautious in response to their eroding wealth, the economic expansion will surely waver, but if it falters significantly it will ignite a further devolution of the already reeling housing market.
The wealth effect postulates that changes in household wealth measurably impact household spending. If household wealth is rising (falling), then households will spend more (less) out of their current income, and thus save less (more). The idea behind the wealth effect is simply that as households become wealthier they do not need to save as much today to be prepared for their future financial needs. It is no longer as necessary to save for such things as their children’s college education or their own retirement.
Engaged Policymakers
The most significant upside risk to the housing outlook is that policymakers appear fully engaged in stanching the financial turmoil and ensuring that the economy avoids recession. The Federal Reserve has aggressively lowered interest rates in recent weeks and Congress and the administration
are working to aid the hard-pressed mortgage market. More help will be needed, but policymakers appear ready to provide whatever is necessary.
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