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Housing Market Still On A Decline
Wednesday, July 23, 2008
The housing market continues to get hit by bad news on an almost daily basis. The most important issue for the near term will be the structure of the bailout of Fannie Mae and Freddie Mac. While there is no doubt that Congress will honor the debts of the GSEs, the key question for the housing market will be the extent to which these institutions are able to continue to extend capital to the mortgage market.
The financial markets clearly have some concerns about the effectiveness of Fannie and Freddie following the bailout. The Mortgage Bankers Association (MBA) reported that the interest rate on a 30-year fixed rate mortgage rose to 6.59 last week from 6.22 percent the prior week. This is an extraordinary one-week jump and it came before a sharp rise in Treasury rates on Monday.
The MBA data also showed sharp declines in mortgage applications for both refinancing and home purchases. The home purchase index stood at just 335.6 last week. By comparison, it was often over 500 in the peak years of 2005 and 2006.
The falloff in purchase mortgages is even larger than indicated by the index number for two reasons. First, there has been a huge reduction in subprime loans, which were disproportionately made by institutions that are not members of the MBA. Second, many more applications are being rejected now than at the peak of the bubble. This means that the same number of applications will correspond to fewer mortgages actually being issued.
Private banks will continue to face large losses certainly through the rest of this year and most likely through 2009 as well. As a result, their lending will be constrained, making Fannie and Freddie more important than ever in the mortgage market.
The inflation data from last week gave grounds for concern that mortgage rates will rise still higher in future months. The overall PPI rose by 1.8 percent in June driven by another jump in food and energy prices. It has risen at a 14.1 percent annual rate over the last quarter. Even the core PPI indexes are now showing higher rates of inflation. The core finished consumer goods index rose by 0.3 percent. Over the last quarter, the core finished consumer goods index has risen at a 4.3 percent annual rate, up from a 3.4 percent rate over the last year.
The overall CPI jumped by 1.1 percent, while the core index rose 0.3 percent. The overall CPI has risen at a 7.9 percent annual rate over the last quarter, while the core CPI rose at a 2.5 percent annual rate.
These rates of inflation are likely to put more upward pressure on long-term Treasury rates. This will add to any increase in mortgage rates that results from a higher risk premium due to the collapse of Fannie and Freddie.
The housing starts data for June show that construction continues to plunge almost two years after the peak. A tax-induced surge in the construction of multi-family units in New York led to 9.1 percent increase in starts overall, but starts of single-family units fell by another 5.3 percent. Single-family starts now stand 62.3 percent below their 2005 level. The falloff in starts over this period is sharpest in the West, which has seen a decline of 70.3. Single-family starts in the West are lower than at any point since the Census Department began keeping the data in 1984. As noted before, the extraordinary decline in starts is good news since it will quicken the rate at which the oversupply of housing is absorbed, allowing the market to stabilize sooner.
All the data from the last week suggest that the housing market is continuing to weaken. There is a prospect of further difficulties resulting from the problems at Fannie and Freddie and elsewhere in the financial sector. At this point, it seems highly probable that the full bubble driven run-up in prices will be reversed; the real question is whether the market overshoots on the downside.
By Dean Baker