Near a Bottom in Housing?

By: Paul Kasriel | Wed, Nov 8, 2006
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On Thursday November 2nd, Reuters News reported that Fed Governor Bies was of the opinion that the bulk of the housing recession was behind us. If Governor Bies is correct, this would go down in post-war history as one of the shallowest housing corrections on record.

Chart 1 shows a history of housing starts from January 1959 through September 2006. I have identified, admittedly somewhat arbitrarily, seven housing cycles prior to the current one. The average peak-to-trough decline of these seven cycles was 47.3%, ranging from minus 63.7% (January 1972 to February 1975) to minus 18.4% (December 1998 to July 2000).

Chart 1

In the current cycle, housing starts peaked at 2.213 million units annualized in February 2005 and reached a low of 1.674 million units annualized in August 2006 for a peak-to-trough decline of 24.4%. If the peak-to-trough decline in the current cycle were to match the seven-cycle average of minus 47.3%, the annualized pace would need to bottom out at 1.166 million units.

How likely is it that this housing correction will be milder than average? To answer this we need to first determine whether the current housing cycle is less extreme than prior cycles. If you look at the dollar-volume of single-family home sales to GDP (Chart 2), you will notice that this is hardly the case. The dollar-volume to GDP ratio reached a record high 16.3% in 2005, almost double the median percentage of the entire series dating back to 1968.

Chart 2

* combined new and existing home sales

So, the current housing cycle isn't less extreme than prior cycles, but is the correction near the bottom? Not according to the supply-demand balance. Chart 3 shows the year-over-year percent change in single-family homes for sale vs. the year-over-year percent change in single-family homes sold. In September of this year, homes sold fell 15.7% year-over-year while homes for sale increased 30.4%. The sold - for sale spread in September was minus 46.1% - the most negative spread ever except for minus 53.2%, which occurred in July.

Chart 3

* Combined new and existing

Add to this the fact that single-family home prices are now plummeting. Charts 4 and 5 bear this out. The median price of a new single-family home fell 9.7% year-over-year in September - the largest percentage decline since December 1970. The median price of an existing single-family home fell 2.5% year-over-year in September - the largest percentage decline in the history of the series, which goes back to January 1968.

Chart 4

Chart 5

If, as indicated by the supply-demand balance, the housing correction isn't near its bottom, then home prices still have further to fall. Falling home prices would imply much slower growth in home equity for households, which, in turn, would imply much less home equity available for withdrawal. As Chart 6 shows, mortgage equity withdrawal by households hit a record high annualized rate of $732 billion (8.1% of disposable personal income) in the third quarter of last year. As of the second quarter of this year, the annualized rate of mortgage equity withdrawal had slipped to $327 billion. Mortgage equity withdrawal, along with record corporate stock buybacks, has enabled households in recent years to spend in excess of their after-tax incomes (see "How Do Households Keep Spending More Than They Earn?"). Chart 6 shows that mortgage equity withdrawal is already slowing, and with the expected further decline in home prices, it is likely that withdrawals will slow even more in the quarters ahead.

Chart 6



Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

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