The old rules for a strong housing market appear to have changed in a fundamental manner frustrating traditional analysts who have been predicting a housing recovery.
In the latest Economic and Housing Market Outlook report, Freddie Mac examines three fundamental areas in the housing market that have not behaved as expected which has contributed to the sluggish growth in housing. Banks looking for future earnings growth from mortgage lending are likely to be disappointed as these unexpected negative headwinds adversely affect the housing market for the foreseeable future.
The three areas impacting the housing market examined by Freddie Mac are mortgage rates, home sales, and household formation.
Mortgage Rates and Federal Reserve “Tapering”
Successive rounds of quantitative easing (QE) by the Federal Reserve resulted in the purchase of mortgage-backed securities (MBS) at a rate of over $40 billion per month from late 2012 through the end of 2013. Due to the Fed’s policy of “tapering” or the gradual termination of QE the current level of MBS purchases has declined by over half to $20 billion per month.
Despite the reduction of purchases of mortgages by the Federal Reserve during 2014, mortgage rates have remained low due to dramatically reduced mortgage loan originations. As a result, Freddie Mac notes that the Fed’s purchases of MBS as a percentage of new issues is higher than it was a year ago.
Refinances as a share of the mortgage mortgage market have dropped from 80% of volume last year to only 43% in April 2014. Freddie Mac attributes the huge drop in refinance volume to the 1% increase in mortgage rates since last year and the fact that most people who had higher rates have already refinanced. Freddie Mac forecasts that by the end of 2014 the rate on 30 year fixed rate mortgages will be 4.6%.
Home Prices Increase Even as Home Sales Drop
The amount of home inventory available as a percentage of the total number of households in the U.S. is at the lowest level in 30 years which has contributed to higher home prices even as the number of homes sold declines.
The number of homes for sale has declined due to the fact that there are still 6.5 million homeowners who are underwater on their mortgage and would have to bring cash to closing if they sell their homes. In addition, many millions of Americans have below market rates due to a wide variety of home loan modification schemes implemented by the government since the housing crash. Many of these “modified homeowners” do not want to give up their low rates and many would probably not qualify for a new mortgage if they sold their current home.
The imbalances in the housing market have resulted in home prices increasing by 8% during the first quarter of 2014 even as home sales declined by 6.3%.
Household Formations Have Plunged Resulting in Lower Home Demand
New household formation has plunged since the banking crisis and mortgage meltdown. New households are the largest demand factor in the housing market. The plunge in new household formation derives from both adverse economic and demographic factors.
A declining birth rate and very weak income growth due to a troubled labor market characterized by high unemployment have reduced household formations. Due to low wages and the high cost of housing many Americans are adopting a multi-generational approach to housing. High numbers of young Americans never leave home and many older Americans are moving back home also out of sheer economic necessity.
The fundamental cure for the housing market rests upon a strong economic recovery and wage growth, something we have not seen yet more than half a decade after the housing bust.
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