[Senate Hearing 109-1085]
[From the U.S. Government Publishing Office]
S. Hrg. 109-1085
THE HOUSING BUBBLE AND ITS IMPLICATIONS FOR THE ECONOMY
=======================================================================
HEARING
before the
SUBCOMMITTEE ON HOUSING AND TRANSPORTATION
and the
SUBCOMMITTEE ON ECONOMIC POLICY
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
ON
THE ISSUES SURROUNDING A HOUSING BUBBLE AND ITS POSSIBLE IMPLICATIONS
FOR THE ECONOMY
__________
WEDNESDAY, SEPTEMBER 13, 2006
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html
----------
U.S. GOVERNMENT PRINTING OFFICE
50-302 PDF WASHINGTON : 2009
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MEL MARTINEZ, Florida
William D. Duhnke, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Peggy R. Kuhn, Senior Financial Economist
Mark A. Calabria, Senior Professional Staff Member
Johnathan Miller, Democratic Professional Staff
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
------
Subcommittee on Housing and Transportation
WAYNE ALLARD, Colorado, Chairman
JACK REED, Rhode Island, Ranking Member
RICK SANTORUM, Pennsylvania DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina ROBERT MENENDEZ, New Jersey
MICHAEL B. ENZI, Wyoming CHRISTOPHER J. DODD, Connecticut
ROBERT F. BENNETT, Utah THOMAS R. CARPER, Delaware
MEL MARTINEZ, Florida CHARLES E. SCHUMER, New York
RICHARD C. SHELBY, Alabama
Tewana Wilkerson, Staff Director
Didem Nisanci, Democratic Staff Director
Kara Stein, Legislative Assistant
------
Subcommittee on Economic Policy
JIM BUNNING, Kentucky, Chairman
CHARLES E. SCHUMER, New York, Ranking Member
RICHARD C. SHELBY, Alabama
William Henderson, Staff Director
Carmencita N. Whonder, Democratic Staff Director
C O N T E N T S
----------
WEDNESDAY, SEPTEMBER 13, 2006
Page
Opening statement of Chairman Allard............................. 1
Opening statement of Chairman Bunning............................ 3
Opening statements, comments, or prepared statements of:
Senator Schumer.............................................. 2
Senator Reed................................................. 4
WITNESSES
Patrick Lawler, Chief Economist, Office of Federal Housing
Enterprise Oversight........................................... 6
Prepared Statement........................................... 30
Richard Brown, Chief Economist, Federal Deposit Insurance
Corporation.................................................... 8
Prepared Statement........................................... 35
Dave Seiders, Chief Economist, National Association of
Homebuilders................................................... 9
Prepared Statement........................................... 47
Tom Stevens, President, National Association of REALTORS........ 11
Prepared Statement........................................... 52
Additional Material Supplied for the Record
Letter from the Housing Policy Council of The Financial Services
Roundtable..................................................... 55
David A. Lereah, Senior Vice President and Chief Economist,
National Association of REALTORS.............................. *
* PowerPoint Presentation on Current and Future Real Estate Trends is
retained in Committee files.
HEARING ON THE HOUSING BUBBLE AND ITS IMPLICATIONS FOR THE ECONOMY
----------
WEDNESDAY, SEPTEMBER 13, 2006
U.S. Senate,
Subcommittee on Housing and Transportation
Subcommittee on Economic Policy
Committee on Banking, Housing, and Urban Affairs
Washington, DC.
The Subcommittees met at 10:02 a.m., in room SD-538,
Dirksen Senate Office Building, Hon. Wayne Allard, and the Hon.
Jim Bunning, Chairmen of the Subcommittees, presiding.
OPENING STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. The Committee will come to order.
Both Senator Bunning and myself like to start on time and
we like to follow the rules of debate, so I would like to have
you watch your time clocks. We have one here and then one on
the table, and then we will proceed.
I am pleased to convene a joint hearing of the Housing and
Transportation Subcommittee and the Economic Policy
Subcommittee. I have always enjoyed opportunities to work with
my friend Senator Bunning.
The possible housing slowdown has significant implications
for both the housing markets and for the economy as a whole, so
this topic is of great interest to both subcommittees. During
recent years the country has seen dramatic escalations in home
values. While this has been very beneficial for homeowners, it
has definitely created challenges for home buyers.
Over the last 5 years, home prices have increased
nationwide by 56 percent. The inflation-adjusted increases are
higher than at any point in 26 years since data has been
tracked. The story is even more startling in selected markets.
For example, home prices here in the District of Columbia have
increased by a whopping 120 percent over the same 5 years.
Part of the price run-up has been fueled by low interest
rates, favorable tax treatment, and changes in the credit
markets. However, there are questions as to whether
fundamentals can fully explain the increases, particularly over
the last several years as interest rates have risen. More
recently we have seen signs that the market is cooling.
Existing home sales are down 11.2 percent. On a year over year
basis in July, new home sales fell 21.6 percent. Last year the
Office of Federal Housing Enterprise Oversight, called OFHEO,
also reported the largest housing price deceleration in three
decades.
We have gone through a period of housing expansion, in part
because of the efforts of Congress to expand home ownership
opportunities. Will there be a significant reduction in the
rate of expansion is a question that would ask, and what are
the implications of this possibility, is a follow-up question.
While housing has received attention, the discussion has
always been as a side issue at other hearings, such as the
semiannual monetary policy hearing. However, these interactions
have only offered a brief glimpse into a very complicated
topic. Today's hearing is intended to offer members an
opportunity to examine this issue in depth.
Specifically, we are interested in learning more about the
current state of the housing market, the degree to which, if
any, the housing bubble might exist, key factors that
contributed to the current status, projections for where the
housing market will be in the short, intermediate, and long-
terms, how these projections will manifest in the economy, as
well as for companies and for individual homeowners and home
buyers.
Today's hearing is designed as a learning opportunity
rather than a policy discussion. Therefore, we have invited
some of the leading housing researchers to testify.
First we will hear from Patrick Lawler, chief economist at
the Office of Federal Housing Enterprise Oversight. Just last
week OFHEO released the updated housing price index, which
showed the largest deceleration in three decades. This recent
housing data, as well as OFHEO's extensive historical data will
be very helpful in today's discussion, as well as projections
for the future.
Next, we will hear testimony from Rich Brown, chief
economist for the Federal Deposit Insurance Corporation. The
FDIC has done extensive analysis of market trends, including a
specific analysis of whether and when booms are followed by a
bust. This information will help us evaluate our current
situation.
Our third witness will be Dave Seiders, chief economist of
the National Association of Homebuilders. As you might imagine,
the Homebuilders collect extensive information on their
industry, which provide important insight into the industry's
future.
Finally, we will turn to Tom Stevens of the National
Association of Realtors. Just as the Homebuilders, the realtors
are in a position to collect and track extensive industry data
through its 1.3 million members.
All four organizations are among the leading housing
researchers and have compiled extensive data. No doubt this
information will be extremely helpful as members try to better
understand housing and its economic implications.
I will now turn to my ranking member, Senator Reed.
Senator Reed. Mr. Chairman, may I yield to Senator Schumer?
Senator Allard. You may.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Well, thank you, Mr. Chairman. I
apologize.
First, I thank you and Senators Bunning and Reed for having
this hearing and I am happy to join in. I apologize. I will
only be here very briefly, and I would ask unanimous consent
that my entire statement be put in the record.
Senator Allard. Without objection, so ordered.
Senator Schumer. I will just make a brief point. I guess,
to paraphrase Shakespeare, is there a bubble or isn't there a
bubble? That is the question. And we all know housing markets
are not growing as vigorously and, in some places, declining a
bit, but will there be a soft landing or will the bubble burst?
That is a very important question for our economy for the next
few years, and to learn what things we can do to decrease the
likelihood of bubbles. And one of the things I am particularly
concerned with is actually relates to our next hearing, which
is on mortgage products and too many people pushing mortgages
that people cannot really afford, the kinds of loss leaders and
other kinds of things that are put in to the various types of
reverse mortgages and other kinds of things around--not reverse
mortgages, but no-interest mortgages, no principle mortgages,
are really troubling.
So, I look forward to reading everybody's testimony. It
particularly affects my area of New York, where we have amazing
growth in housing prices. We bought our coop in 1982, and you
can add a zero to it. That is about the most important thing we
own in New York, in terms of its value.
I look forward to hearing the testimony of everyone. Again,
I apologize for not being able to stay.
Senator Bunning.
OPENING STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Chairman Allard.
I am glad to be co-chairing this series of hearings with
you as we examine current issues in the housing market. Today's
hearing is on the state of the housing market and what it means
to the economy.
Some people, especially in the media, suggest that there
has been a housing bubble and it is about to burst. Others
think we are in the middle of a normal economic cycle and that
the market will take care of itself over time. I hope our
witnesses can shed some light on these views today. Clearly,
the housing market has been hot the last few years. It is also
clear that the market is cooling now, although it is not as
clear how fast or how long-lasting that cooling will be. It is
important to point out that not all parts of the country have
experienced the same price changes. The coasts have seen rapid
home price increases, while, in the middle of the country, home
prices have increased at a slower and more constant rate.
For example, in my State of Kentucky home prices have
increased about 25 percent over the last 5 years, while here in
Washington, D.C., home prices have increased about 120 percent.
So, while the bubble could be about to pop in some parts of the
country, a nationwide collapse in home values, in my opinion,
does not seem likely.
Even though a nationwide housing bust may not happen, a
rapid cooling in overheated markets could have implications for
the entire economy. For example, consumer spending accounts for
over two-thirds of the U.S. economic activity. Therefore, to
the extent that consumer spending has been supported by
increased home values, any stall or decline in home values
appreciation could be very troublesome. A declining market has
already hurt the profits of homebuilders and that could spread
to related industries, as well.
Furthermore, a wave of defaults could hurt the financial
sector and the overall economy. That could happen if lenders
loosen their credit standards in order to write more loans or
if mortgage interest rates continue to climb thanks to the
Federal Reserve interest rate hikes.
At this point, it is hard to tell what the full impact of
interest rates will be because of the large number of non-
traditional mortgages written lately. We will look more closely
at that topic next week. We also have to look at how we got
here. Housing prices began to climb in 1997 and picked up the
pace in 2003. It was not until this year that nationwide
averages have begun to seriously slow. The tech burst in 2000
left people looking for somewhere other than the stock market
to put their investment money, and a lot of that money went
into housing.
The Federal Reserve began cutting interest rates in early
2001, eventually taking the overnight Fed rate to 1 percent in
2003. Former Chairman Greenspan kept rates at this historically
low level for a year before beginning the 2-year string of
increases that just ended last month. That period of extreme
low interest rates makes the beginning of the most rapid
acceleration of the housing boom and caused part of it. I think
it is clear that the Feds actions contributed to the housing
boom and that more recent actions will turn out to be a key
factor in the slowdown.
Many other factors must be examined, as well. Americans'
appetite for bigger and nicer homes has no doubt pushed up the
prices. The growing population and the increased wealth of the
Baby Boom generation has contributed to increased housing
demand. Congress made home ownership more beneficial starting
in 1997 when most homeowners no longer had to pay tax on the
proceeds of the sale of their primary residence.
There is no doubt many other factors that have contributed
to the current state of the housing market. We do not need to
be concerned with factors that contributed to normal market
forces, but if the market has moved because of unsustainable or
artificial forces, we may be in for a rough ride.
I want to thank all of the witnesses for coming today. I
will look forward to hearing from them and to exploring this
important topic.
Senator Allard. Thank you.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Thank you very much, Mr. Chairman, and
Chairman Bunning, for holding this very timely hearing on the
housing bubble and its implications for the economy.
For the past several years, a booming housing market has
been one of the few sources of strength in our economy. That
strength has come not only from homebuilding activity itself,
but also from the household spending supported by rising home
values and increased home equity wealth.
What we are seeing now, however, are clear signs that the
housing boom is cooling off. What we would like to explore in
this hearing is how this process is likely to play out. Will
there be a smooth economic adjustment to a housing market with
a slower pace of home building and house price appreciation or
will the popping of the housing bubble be accompanied by
serious economic disruptions and flat or even falling housing
prices?
A wide range of recent data points to a distinct cooling in
the housing market. Residential investment peaked in the third
quarter of last year and has declined since, directly lowering
economic growth. In the second quarter of this year residential
investment at a 9.8 percent annual rate, the largest quarterly
decline in more than a decade, and directly shaved .6
percentage points off the economy's overall growth rate for the
quarter.
Current indicators of homebuilding also point at the
possibility of further declines. The number of housing units
started in July was 13.3 percent lower than it was a year
earlier. The number of authorizations for new housing
construction was down 20.1 percent, the largest drop since the
recession of 1990. Sales of single family homes in July were
13.2 percent below their level a year earlier.
Moreover, the supply of new single family homes available
for sale rose to equal six-and-a-half months of supply at the
current sales rate, the highest ratio of houses available to
sales in more than a decade. So far we have not seen the
collapse of housing prices, although the rate of increase has
slowed dramatically. After rising 12.9 percent in 2005, the
median price of existing homes published Mr. Stevens group, the
National Association of Realtors, rose a scant .9 percent over
the 12 months ending in July.
Mr. Lawler's office, OFHEO, has a price index that is
constructed differently, but tells a similar story of sharply
decelerating home prices over the past four quarters. A
striking feature of the housing boom and its recent slowing is
its regional character. Prices went up dramatically in some
States in 2001 to 2005, but much less so in others. Now that
prices are coming down, the most pronounced slowing has
occurred in those areas that experienced the greatest
increases, while areas that never had a boom do not seem to be
experiencing a bust either.
What happens to the housing sector and home prices is of
enormous concern to ordinary Americans, for whom their house
is, by far, their most important source of wealth. It is also a
concern for the people in the construction, real estate, and
mortgage lending businesses, whose livelihood depends upon a
very healthy housing sector. And it is a concern for the
overall economy. I hope the economy can make a smooth
transition to a more sustainable pace of housing activity and
house price increases without going through the turmoil that is
often associated with the bursting of an economic bubble.
But I worry that the economy may be headed for a bumpy
landing. As long as the Bush Administration refuses to take any
serious action to address other challenges in the economy,
especially our fiscal and trade imbalances, we cannot count on
strong business investment or an improving trade balance to
offset the loss of housing-based spending.
I look forward to the testimony of our witnesses today to
help us understand this situation as we approach it over the
next several months.
Thank you, Mr. Chairman.
Senator Allard. OK, the Committee plan at this point is
that we will go ahead and start with the testimony from the
experts at the panel and then I will turn the gavel over to
Senator Bunning to be in charge the rest of the meeting.
Mr. Lawler.
STATEMENT OF PATRICK LAWLER, CHIEF ECONOMIST, OFFICE OF FEDERAL
HOUSING ENTERPRISE OVERSIGHT
Mr. Lawler. Thank you very much Chairman Allard, Chairman
Bunning, Ranking Member Reed.
I am pleased to be here, where I enjoyed working as a
Committee staff member some years ago, to testify on housing
market developments and prospects. OFHEO has a strong interest
in housing markets and particularly in house prices because
they have a powerful effect on the credit quality of mortgage
loans owned or guaranteed by Fannie Mae and Freddie Mac, the
enterprises we regulate.
Over the past 5 years we have witnessed an extraordinary
change in the relative price of houses. The general level of
house prices soared 56 percent from the spring of 2001 to this
spring. And the prices of other goods and services rose much
less, so that inflation-adjusted house prices are now 38
percent higher than 5 years ago. That exceeds the inflation-
adjusted increase in house prices from the previous 26 years,
going back to the beginning of our data in 1975.
A number of factors have contributed to these price gains.
Long-term mortgage interest rates fell from about 8 percent in
mid-2000 to less than 6 percent from early 2003 to mid-2005.
Short-term rates declined by more, and borrowers took advantage
as more of them took out adjustable rate loans. Interest only
and negative amortization loans provided even lower monthly
payments. The spread of these products helped stimulate demand
as did the rapid growth of sub-prime lending.
Demographics have also been favorable. Aging Boomers are
reaching their peak earning and investing years, with many
interested in second homes for vacations or future retirement.
Immigration has accelerated household formation. Supply
constraints have made it difficult to meet the increased
demand, lengthening the time necessary for builders to bring
new houses on the market and raising the premiums paid for
prime house locations.
Finally, there is some evidence of speculation, including a
higher share of loans made to investors and anecdotes of
property flipping. Certainly the poor performance of the stock
market early in this decade was in obvious contrast with the
investment performance of houses, and that may have encouraged
some shift in investor focus.
House price increases have been uneven across the nation,
though. While homeowners in Indiana, Ohio, and Michigan have
seen their house values over the past 5 years in constant
dollars roughly stay the same, residents in Florida,
California, and here in the District of Columbia have watched
prices virtually double, even after adjusting for inflation.
Over the past year, the pace of house price inflation over
most of the country has moderated dramatically. The sharpest
decelerations have come in some of the most superheated markets
of a year ago. Nationally, prices rose in the second quarter of
this year by less than the inflation rate of other goods and
services in the economy.
Other market indicators confirm the general chilling of
housing markets across the nation. Particularly noteworthy is
the swelling inventory of unsold houses on the market, which
has risen from less than 3 million houses to about 4.5 million
in, roughly, the last year-and-a-half. The sales rates have
fallen at the same time, so inventories relative to sales are
now the highest since the early 1990s.
Historical patterns of price behavior in housing markets
may provide some guidance about potential future developments.
OFHEO's national house price index has never fallen over a
period of a year or more, but it has come close, and inflation-
adjusted prices have fallen significantly, by 11 percent in the
early 1980s and by 9 percent in the early 1990s.
In the first instance it took nearly 8 years for inflation-
adjusted prices to regain their past peak, and in the second
case almost 10 years. Certainly a similar event is quite
possible now. Cycles in inflation-adjusted home prices have
occurred in a much more pronounced way in some cities, such as
Boston and Los Angeles. The cycles stem from the effects of
local business cycles, the delays in the response of supply to
increased prices, and, to some extent, from speculation.
Over much of the country fundamental factors have pushed up
demand and accounted for at least a large portion of the price
increases of recent years. However, increasing supply, higher
interest rates, and a turn in market psychology may cause
prices in some markets to fall. In the past, significant
nominal price declines have generally been associated with
local or regional economic recession, but the exceptional size
of some of the recent increases could make them vulnerable
without a recession.
In the long run, I expect housing markets to perform well,
especially if immigration continues at recent rates. An
important caveat, though, is that healthy housing markets could
soften seriously from an unexpected disruption in the ability
of Fannie Mae and Freddie Mac to function effectively in
secondary markets.
OFHEO is currently focused on correcting the significant
accounting, internal control, management, and corporate
governance weaknesses identified at both companies through
OFHEO examinations. While both companies have made progress,
much more needs to be done. It is apparent that, in order to
insure the long run safety of these two GSEs, the regulatory
framework must also be strengthened.
OFHEO supports the enactment this year of legislation that
will create a new regulator with adequate funding, bank-like
regulatory and enforcement authorities, and encompassing not
only safety and soundness, but also mission regulation.
Thank you. I will be happy to answer any of your questions.
Senator Bunning. Mr. Brown, go right ahead.
STATEMENT OF RICHARD BROWN, CHIEF ECONOMIST, FEDERAL DEPOSIT
INSURANCE CORPORATION
Mr. Brown. Thank you. Chairman Allard, Chairman Bunning,
and Senator Reed, I appreciate the opportunity to testify on
behalf of the Federal Deposit Insurance Corporation concerning
housing market trends and their implications for the economy.
Like the other panelists testifying today, the FDIC closely
monitors current conditions in U.S. housing markets.
I would like to focus my oral statement on recent FDIC
research into housing boom and bust cycles in U.S. metropolitan
areas over the past 30 years. I believe these results may
provide useful context on the topic of today's hearing.
The FDIC monitors trends in U.S. home prices and mortgage
lending practices as part of its risk analysis process. FDIC-
insured institutions are extremely active in just about every
aspect of housing finance. These activities have helped the
industry to post record earnings for five consecutive years.
Credit losses for the industry remain low by historical
standards, while capital levels remain high. No FDIC-insured
institution has failed in over 2 years. However, our experience
in the late 1980's and early 1990's showed that banks and
thrifts are subject to potentially large credit losses arising
from boom and bust cycles in real estate. This experience was
the motivation for our recent studies of metropolitan area home
price trends.
In this research, FDIC analysts asked three simple
questions. Where have booms occurred? Where have busts
occurred? Does boom necessarily lead to bust?
Using the OFHEO house price index series, our analysts
attributed a housing boom to any metropolitan area that
experienced at least a 30 percent price increase, adjusted for
inflation, during a given 3 year period. A housing bust is
defined as a 15 percent decline in nominal terms over a five
year period.
We use a 15 percent price decline to define a bust because
it would be enough to wipe out the equity of recent homebuyers
who made only a 10 percent down payment and would seriously
impair the equity of those who put 20 percent down. Given that
about two out of five first time homebuyers last year
effectively received 100 percent financing, a 15 percent price
decline could be expected to have significant adverse credit
implications for mortgage lenders and investors.
Applying these standard definitions for booms and busts
over the period from 1978 through 1998, we observe that
movements in home prices tend to be long-term trends that play
out over years. We also see that true housing busts are
relatively rare events, with only 21 such episodes recorded
since 1978.
But of the 54 individual housing booms recorded during this
period, only 9 resulted in a subsequent housing bust, according
to our definitions. Housing booms have typically been followed
by an extended period of stagnation where prices may, in fact,
fall, but usually not by enough to meet the FDIC's definition
of a bust. Where housing busts did occur they were usually
associated with episodes of severe local economic distress,
such as the energy sector problems experienced in Houston in
the mid-1980's.
While these findings are somewhat reassuring from a risk
management perspective, we need to keep in mind that the
periods of stagnation that typically follow booms can be
painful for homeowners, investors, and real estate
professionals. Measures of housing market activity, such as
home sales and construction, tend to suffer larger declines
than home prices themselves.
The fact that current homeowners are very reluctant to sell
at distressed prices during these episodes unless they are
forced to helps to explain why home prices tend to be what
economists call ``sticky downward.'' Our analysis also points
to two important trends that distinguish the current situation
from our historical experience. First is an increase in the
number of boom markets to unprecedented levels, from a then
record high 40 markets in 2003 to 89 individual markets in
2005. Second is the sweeping change that is taking place in the
structure of mortgage loans. Since 2003, we have seen borrowers
migrate toward adjustable rate, interest only, and payment
option structures where monthly payments may start out low, but
can increase substantially if interest rates rise, or as low
introductory interest rates expire. By some estimates, interest
only and payment option loans made up between 40 and 50 percent
of mortgage originations during 2004 and 2005.
In conclusion, FDIC's studies find that housing price booms
do not inevitably lead to housing price busts, and that severe
local economic downturns continue to pose the greatest downside
risk to local home prices. While mortgage credit performance at
FDIC-insured institutions remains excellent at present, we will
continue to monitor these portfolios as this decade's great
housing boom inevitably subsides.
This concludes my testimony, I will be happy to respond to
any questions the Subcommittees might have.
Senator Bunning. Thank you very much.
Mr. Seiders.
STATEMENT OF DAVE SEIDERS, CHIEF ECONOMIST, NATIONAL
ASSOCIATION OF HOMEBUILDERS
Mr. Seiders. Thank you, Chairman Bunning, Chairman Allard,
Senator Reed.
My full statement outlines my view of the basic causes of
the 2004-2005 housing boom and the current housing downswing.
It also estimates the depth and duration of the downswing and
discusses the likely economic impacts of the downswing in
housing market activity, as well as from some secondary housing
effects, like the weakening of the housing wealth effect that
has already been mentioned.
I think the first thing you will recognize is that the
housing boom of 2004-2005 and the current housing downswing
have some really unique features that make these episodes
different from previous housing market swings. Three big
differences that I see are, first, unusually stimulative
financial market conditions before and during the boom. Second,
record breaking increases in inflation-adjusted, or real, house
prices. And third, an outsized presence of investors or
speculators in both the single-family and the condo markets.
To put things in perspective, the current contraction, in
my view, amounts to an inevitable mid-cycle adjustment or
transition from unsustainable levels of home sales, housing
production and house price appreciation, to levels that are
supportable by underlying market fundamentals, that is,
primarily by demographics and household income trends.
With respect to timing, the previous boom involved more
than 2 years of unsustainable housing market activity. And we
are likely to experience a below trend performance of home
sales and housing starts of roughly similar duration. We expect
the downswing to bottom out around the middle of next year
before transitioning to a gradual recovery that will raise
housing market activity back up toward sustainable trend by the
latter part of 2008.
Regarding house prices, national average price appreciation
is likely to be quite limited in the near term as the housing
market weakens. Indeed, some decline is a distinct possibility
in coming quarters. The rate of price appreciation should
remain below long-term trend for some time into the future in
nominal terms. Real house prices, adjusted for general
inflation, are likely to fall to some degree on a national
average basis following the unprecedented surge of recent
years.
In terms of economic impact, the downswing and home sales
and housing production will continue to detract from overall
economic growth through mid-2007. However, much of this
negative impact should be offset by strengthening activity in
other sectors of the U.S. economy, keeping GDP growth
reasonably close to a sustainable trend-like performance. These
sectors include non-residential fixed investment, including
non-residential structures, as well as our trade balance.
There are bound to be some adverse secondary impacts of the
ongoing housing contraction. These effects include, first, less
support to consumer spending from the housing wealth effect.
Second, the impacts of payment shock on homeowners facing
upward adjustments to monthly payments on various exotic or
non-traditional types of adjustable rate mortgages.
At this point, my judgment is that the size and timing of
these two effects are not likely to seriously threaten the
economic expansion in the next few years. My bottom line is
that the evolving housing cycle will definitely exert a serious
drag on the economy through several channels, but that the U.S.
economy should avoid outright recession during the 2006-2008
period.
I should point out that there are significant downside
risks to this outcome, and I have outlined a number of these
risks in my full statement. To mention a few, there is always
the possibility of spikes in interest rates or energy prices. I
have got both of these factors behaving rather quietly in my
baseline forecast. Another major risk is that there could be
wholesale resales of housing units back on to the market by
those investors or speculators that purchased them in the last
couple of years. On the exotic ARM and the payment shock issue,
there clearly are major uncertainties about the dimensions of
that. I am glad to hear you are having another hearing on that
shortly. I will also say that there are major uncertainties
about the actual accurate size of the inventory of the new
homes for sale on the market.
That concludes my oral remarks. I will be happy to take any
questions. Thank you.
Senator Allard. Mr. Stevens, please.
STATEMENT OF TOM STEVENS, PRESIDENT, NATIONAL ASSOCIATION OF
REALTORS
Mr. Stevens. Thank you Chairman Allard, Chairman Bunning,
Senator Reed, and Senator Carper. I appreciate the opportunity
to be here and represent our 1.3 million members of the
National Association of Realtors.
For the past 5 years the housing market has been a
steadfast leader in the U.S. economy. In 2005, mortgage rates
remain near 45 year lows, and the nation's economy generated 2
million new jobs. Existing home sales and new single family
housing starts also set new high marks in 2005. Overall, the
housing sector directly contributed more than $2 trillion to
the national economy in 2005, accounting for 16.2 percent of
economic activity.
After 5 years of outstanding growth and being the driving
force of the U.S. economy, the housing market is undergoing a
period of adjustment. Existing home sales in July have fallen
11.2 percent from a year ago. New home sales are down 22
percent from a year ago. What is especially striking is that
the inventory of unsold homes on the market is at an all time
high at 3.9 million, which is a 40 percent rise from just a
year ago.
Given the falling demand and increased supply, home prices
have seen less than 1 percent appreciation from a year ago,
compared to double digit rate of appreciation in 2005. While
recent market changes raise concerns, it is important to
remember that the housing market varies significantly across
the country. One-third of the country is still seeing rising
home sales. These places include Alaska, Vermont, New Mexico,
and States in the South, with the exception of Florida. The
remaining two-thirds of the Nation are experiencing lower
sales, with some States feeling acute adjustment pains. Sales
are down significantly in Florida, California, Arizona, Nevada,
Virginia, and Maryland.
These regions experienced the greatest rise in home prices
in recent years. Affordability has become a major issue for
homebuyers in these markets, as well. The decline in sales has
resulted in higher housing inventories or tripling and
quadrupling in some cases. These areas are the ones most
vulnerable to outright price declines, particularly if interest
rates continue to increase.
Contrary to many reports, there is not a national housing
bubble. All real estate is local. For example, the housing
market in California is extremely different from the housing
market in Oklahoma. Home priced income ratio, home priced to
rent ration and, more importantly, mortgage debt servicing cost
to income ratio have greatly increased in some housing markets
to unhealthy levels. Markets in Florida, California, Arizona,
Nevada, Virginia, and Maryland have exhibited trends far above
the local historical norm.
Because of these exceptional trends, it would not be
surprising for these markets to experience a price adjustment,
and we are starting to see that in some of the areas. However,
these States have solid job growth. Price declines are likely
to be short lived in a period of solid job growth as new job
holders enter the housing market.
If mortgage rates were to rise measurably to, say, 7.5
percent or 8 percent from the current 6.5 percent for whatever
reasons, then the housing market would certainly come under
more pressure, and many markets would likely undergo price
declines. Rising mortgage rates are the most influential factor
in the housing market coming under more pressure.
Many home buyers in coastal markets have resorted to more
exotic mortgages as the only way to enter the housing market.
For some buyers this has meant financing their home through
interest only, adjustable rate, or option ARMs. These buyers
are at their financial capacity. With raising interest rates,
homebuyers have become exhausted financially, which explains
why sales have tumbled in high priced regions of the nation.
This is where we are in the housing market to date and how
we arrived to this point. The national forecast for the coming
year, based on stabilizing mortgage rates and a modestly
expanding economy through 2007 predicts that existing home
sales will fall 8 percent in 2006, followed by another 2
percent decline in the following year 2007.
New home sales will fall by an even greater amount of 16
percent in 2006, and then 7 percent in 2007. Home price growth
will be minimal or less than 3 percent in 2006 and 2007.
However, some markets will have higher or lower rates of
appreciation as compared to the national forecast. All real
estate is local and based on local economic conditions. Also,
it is important to understand that any significant shift in
mortgage rates and the change in the economy will change the
forecast.
We also expect that spending on residential construction as
part of the economy will drop 3.4 percent in 2006, and 8.5
percent in 2007. In other words, our nation's economy will lose
$21 billion from the GDP this year, and another $49 billion in
2007. This is a sharp contrast to the near $50 billion in added
economic power during the housing market boom of the last 5
years.
The housing market also supports consumer spending for
items such as furniture to cars, travel, education. All of
these spending items have been supported by increases in
housing equity over the past several years. The housing sector
also directly employs real estate agents, mortgage lenders,
construction workers, and is responsible for the expansion of
home improvement retail stores such as Home Depot and Loews.
In the past 5 years, a typical homeowner gained $72,300 in
housing equity, including over $20,000 in the past year. Nearly
all economists would agree that consumer spending has been far
more robust than can be explained by income growth, job gains,
and stock market gains. GDP growth would have been 1.5
percentage points lower had the housing market not provided the
wealth accumulation in recent years.
As the nation's leading advocate for home ownership,
affordable housing, and private property rights, realtors
understand that the housing sector could not maintain the
record-setting pace indefinitely.
We believe that a soft landing is possible and, under the
right circumstances, likely. But a soft landing is dependent
upon policies that support a transition to a more normalized
market and work to mitigate changes in local markets so that
affordable mortgage financing is available to home buyers.
And we stand ready to assist the Congress in any way to
help continue the dream of American homeownership.
And I would, Mr. Chairman, like to support for the record--
our chief economist could not be here, but he has a PowerPoint
presentation----
Senator Bunning. Without Objection.
So ordered.
Mr. Seiders. Thank you.
Senator Allard. Thank you, Chairman Bunning.
Mr. Brown, you talked about some of the differences between
the current growth and value of homes and where we begin to see
that drop down--actually rate of growth decrease in many areas.
You compared that to previous experiences and talked about the
market devaluation increases as a difference, and also you
mentioned mortgage instruments changed considerably as a
difference.
And perhaps Mr. Seiders would also like to comment on this.
But we have also, it seems to me, experienced a pretty good
jump in raw material, right now. The cost of raw materials that
are going into a home--I think the last couple of years, at
least in my State of Colorado it has increased 10 percent, and
you did not mention that. I am wondering what other factors
that you, perhaps, did not mention that you would like to
elaborate on, and I am particularly interested in the raw
materials issue.
Mr. Brown. And that is in terms, Mr. Chairman, of the
difference between today's situation and previous booms?
Senator Allard. Yes. You use the terms boom and bust and
define those----
Senator Bunning. Please bring your mic up just a little bit
so that we can hear better.
Senator Allard [continuing]. And you were talking about
today's housing issues as compared to previous boom and bust
periods.
Mr. Brown. That is right.
Well, Mr. Chairman, the historical cycles that we are
looking at never replay themselves in exactly the same policy
environment or the same economic environment. Clearly, the
commodity price increases that you are speaking of are
important in today's environment. And the structure of mortgage
lending is another important factor. I would emphasize that
with the big changes we have seen as mortgage lending
technologies and instruments have evolved over time, you have a
vastly different institutional environment today than you had
in the booms in the 1970's and the 1980's.
I do think that there are three reasons to believe that our
experience going forward may be similar to what we have seen in
previous booms. First is the consistency of the results that we
have seen over time. Second is the behavioral rationale for the
fact that prices are ``sticky downwards'' or they tend to go
down slowly, with homeowners very reluctant to sell at
disstressed prices. And the third reason is that these episodes
of severe local economic distress, such as Houston in the mid-
1980's, have proven to be relatively rare and especially so
since the rolling regional recession of the 1980's.
Senator Allard. Mr. Seiders.
Mr. Seiders. Yes, Mr. Chairman. That gives the opportunity
to mention a few things.
I consider the virtual explosion of house prices in both
nominal and real terms in 2004 and 2005, even in 2003, to be
primarily a demand-driven phenomenon. Having said that, one of
the factors that exacerbated the upward price movements was,
and still is, pretty serious supply constraints in a lot of the
markets where we have seen the biggest price increases to date,
meaning land use controls, difficulty for the builder to bring
more supply on to meet the surge in demand.
In terms of the costs of production, there is a long-run
relationship between what I will call the replacement cost for
housing and all house values, both new or existing. They sort
of have to gravitate together over the long-term. We have seen
large increases in the prices of the bundle of building
materials that is used in homebuilding. There is a producer
price index, subcomponent for that package of materials that's
running at pretty rapid rates even at this time, for very
different reasons for different parts of the commodities
markets. But again, mainly a demand-driven phenomenon
exacerbated by supply constraints in a bunch of places.
If the cost increases should continue to run this high or
even run higher, over the long-term we may see more upward
pressure on house values than I have in the forecast.
Senator Allard. Now, we have seen some dramatic increases
in home prices and mortgage costs. In fact, thinking back on my
investment, I think my home investment has probably been better
than any stock market investment I have ever made. I was
fortunate enough to be in a home at the time.
How are credit and lending standards influencing these
scenarios where we see increases in both home prices and
mortgage costs outstripping income growth?
Mr. Brown. Well, we certainly saw an intensification in the
home price increases in 2004 and 2005. In 2005, we saw U.S.
prices, on average, rise three times faster than disposable
income. That is a disparity that we have not seen before. Also,
the expansion in the scope of the boom was unprecedented. And
certainly the prevalence of some of the non-traditional
mortgages, the interest only and payment option loans, was
greater in the boom markets than it was in other parts of the
country.
One of the rationales is that people have been using these
instruments to qualify for homes in high-priced markets. It is
a way for them to stretch what they can afford.
Mr. Lawler. Certainly, the availability of mortgage credit
has never been greater. Sub-prime lending, I think is part of
that, as well, taking 20 percent of the market in the last
couple of years, which is a big change from just a few years
ago.
Senator Allard. I did not realize it was 20 percent of the
market. Significant.
Any other panel comments? My time is expiring here.
Mr. Stevens. I would just comment that the housing
affordability, which is key, has shifted and started to turn.
We were just under 70 percent of all Americans owning a home up
until this turn in the housing market started a year, a year-
and-a-half ago.
So, the two things that have affected that are the raise in
rates and the appreciation and home values, the vast
appreciation. So, the affordability index has turned.
Senator Allard. Thank you, Mr. Chairman.
Senator Bunning. Senator Reed.
Senator Reed. Thank you, Mr. Chairman.
Thank you, gentlemen, for your testimony.
Most economic forecasts suggest as you have that there will
be a decline, in terms of economic housing activity over the
next year. Goldman Sachs economists are forecasting a housing
slowdown, which would shave about 75 basis points off the
overall growth in 2007. I think that is consistent with your
comments.
And they have also suggested the OFHEO price index would
likely decline about 3 percent.
So, Mr. Lawler, do you think it would decline by about 3
percent, your price index?
Mr. Lawler. That our index will decrease 3 percent----
Senator Reed. Yes.
Mr. Lawler [continuing]. Over the next year?
We have not made any specific point forecasts. We are more
concerned with what is the worst that can happen. Certainly
something like that could happen. It is a matter of concern for
us. We have never seen anything like that in the past, but we
recognize there are aspects of the run up that we have seen in
the last few years that are unprecedented.
Senator Reed. So it is a possibility that you have not yet
concluded, then?
Mr. Stevens, in that vein, you talked about the regional
characteristics of the housing market, prices appreciating and
depreciating, but could you see a national decrease in housing
prices on the order of 3 percent or less, but a national
housing decrease in prices.
Mr. Stevens. Well, I think, overall, you take all of the
different pockets across the country and you are going to have
an average amount. So, yes, you are probably going to see some
kind of a percentage decrease. I think what is critical to
whether we are talking bubble burst or not is the rate
increases. I think that we are sitting right on a fence where
the Fed has stopped raising rates. I do not think that could
have come any later. We are hoping that it came in time, and it
is our feeling, and our chief economist, David Lereah, who,
unfortunately, could not be here, is that if those rates start
to rise again that will dictate whether we slide off that fence
into a challenging recession, bubble burst-type situation.
Senator Reed. Thank you.
Mr. Seiders, again, thank you for your testimony. You
talked about, in the longer term, beyond 2007, of compensating
economic factors that would make up for this slowing market you
suggested, trade balance and non-residential structures. Would
you care to comment on that?
Mr. Seiders. Yes. This is a puzzle, obviously. This is one
of these mid-cycle rotation processes that I am counting on.
Actually it applies to 2006 and 2007, primarily, and maybe into
2008. We do definitely expect, this year, all of it, and at
least half of next year, for the housing production component
of GDP to be in retreat, stabilizing, hopefully, around the
middle of the year.
I am counting on business spending on capital equipment and
software, as well as non-residential structures to be in
stronger growth phases than they had earlier. I am also
expecting our trade balance to be improving. Now, I realize
that we have recently gotten some troublesome numbers on both
of those fronts. So, it is hard to be exactly sure it is going
on out there. And that is, obviously, one of the downside risks
that I would list to the forecast that I have.
Senator Reed. So, if the compensating factors of the
improved trade balance and business investment do not
materialize, then this housing will pull down GDP even further?
Mr. Seiders. There is no doubt about that. That would be a
much more serious economic picture than I have penciled in or,
I would say, the Blue Chip panel in general.
Senator Reed. Let me ask a question, both to you, Mr.
Seiders, and Mr. Brown, about foreclosures. Data that was
released today has seen an increase in foreclosures,
particularly in the hot markets like Nevada.
How do you factor in foreclosures in terms of your views?
Mr. Seiders. Well, I try to factor in, as I mentioned very
briefly in my statement, the impact of payment shock on
consumers that have these mortgages that are going to come home
to roost. They are coming home to roost now and will later.
There are not only strains on household budgets in store, but
also prospective defaults on loans and so forth.
In my forecast, I had that being a manageable factor. I do
not expect that those default rates are going to move up all
that much, but it is another very gray area. And the thing that
really bothers me about this is, we can tell, roughly, how many
loans were originated with payment-option features, with
negative amortization or interest-only loans or things like
that. What we cannot tell is how various features were layered
on top of each other. You could have a payment-option mortgage
allowing for negative amortization. You could have, on top of
it, a piggyback second written who knows how. It could be a no-
documentation loan--so forth and so on.
So, again, in my forecast, I have got minimal negative
economic impacts from this phenomenon, but it is another area
of substantial uncertainty.
Senator Reed. Thank you, Mr. Chairman.
Will we have a second round?
Senator Bunning. I hope so.
I am going to take my 5 minutes now.
Mr. Lawler and Mr. Brown. Clearly interest rates play an
important role in affordable housing. The lower the interest
rate on mortgage, the more house a buyer can get for their
monthly payment. I think it is clear that rate cuts by the Fed
are what helped drive the housing boom.
What role do you think lower interest rates enabled by the
Fed rate cuts played in heating the housing market and driving
up prices? And, specifically, do you think Fed rate cuts from
2001 to 2003, especially the decision to leave rates at 1
percent for a full year, are the most significant factor in
driving up house or home prices?
Mr. Lawler. I think they are the most significant factor
during that period. Not only did they help lower long-term
interest rates, but they increased the use of adjustable rate
mortgages focusing on extremely low short-term interest rates
and stimulated some of the investor psychology, which added on
top of that. It also encouraged some of the increased use of
other mortgage types, option ARMS, interest only loans, that
really make investment especially easy.
So, I think they were the most important contributor.
Senator Bunning. Mr. Brown.
Mr. Brown. Mr. Chairman, I would certainly agree that
interest rates are a very important component to housing
affordability. It is not just the short-term interest rates,
which were at generational lows during the early part of this
decade, but also long-term interest rates, which also were at
generational lows, and still remain lower than what we have
seen at similar parts of previous business cycles.
This has been attributed in some quarters to heavy
investment by the foreign sector of U.S. Treasury and mortgage
instruments. That has helped keep long-term mortgage rates down
and also has helped to boost housing activity from where it
otherwise would have been.
Senator Bunning. Now, this is the second part of the
question I just asked the regulators, for Mr. Stevens and Mr.
Seiders.
Just as the Fed rate cuts helped drive the housing boom,
the 17 straight rate increases from June 2004 to 2006
contributed to the recent slowdown. However, home prices
continued to climb and even accelerated while the Fed was
increasing interest rates. That suggests that there is a lag
between their action and their impact on the market.
What impact have the Fed rates increases from 2004 to this
year had on the housing market? And do you think that the full
effect of those increases has been felt yet?
Mr. Seiders. Well, first of all, the string of rate
increases until early this year was basically getting back to
or toward monetary neutrality. It had to be done.
During most of that period, the long-term rates still
remained stubbornly low, I think to the Fed's chagrin, at
times, largely because of the international financial market
picture. The Fed is now into the restrictive zone on monetary
policy. There are definitely fairly long lags in the impacts of
monetary policy on the interest-sensitive sectors, including
housing.
That is why we have been strenuously encouraging the Fed,
since before the August 8th meeting, to please stop. We will
see how this evolves going forward. In my forecast, my next
change in Fed policy is rates moving downward, but that is not
until toward the middle of next year.
So, it is very important how the Fed manages monetary
policy as we go forward. They know very well that they have a
lot in the pipeline with a lot of lag to have to worry about.
Senator Bunning. Mr. Stevens.
Mr. Stevens. I echo what Mr. Seiders said and I am in
agreement. It does have a direct effect.
To answer the lag question, I truly do think, based on
history and past economics, that we will see a continued
decline in house values. We certainly have not bottomed out,
yet. There is a lag there in the raising of the rates. That lag
will follow, and prices will continue to decline.
Senator Bunning. Last, do you think if the Fed resumes
their increases, that they are going to go over the top and
send our economy the other way rather than flattening out,
sending it on a cycle down?
Mr. Seiders. If I had to pencil into my forecast Fed
tightening from here forward, I would have to definitely lower
both the housing and the economic outlook.
Mr. Stevens. And I already said the same thing.
Senator Bunning. OK.
Senator Carper.
Senator Carper. Thanks very much. Going back to the reason
there was such a spike in housing prices in, you said, 2003,
2004, 2005, and a moderation today, was part of that driven--
you may have said this and I missed it--was part of that driven
by a flight from equities, as people on the heels of Enron and
other financial disasters we know a lot about in this Committee
drove a lot of people out of equities? And they are looking for
a place to put their money. They put it, in some cases,
improvements in their own homes. In other cases, they put it in
second homes.
Mr. Lawler. I definitely think that that is a contributing
factor. The performance of the stock market earlier in this
decade was weak. And, as Boomers were reaching their prime
earning and investing years, more turned toward housing,
thinking about retirement homes and vacation homes as a way to
combine two things at one time, investment and something to be
used. And that fed on itself as the house increases made
housing look like a really good investment in comparison.
So, I think the psychology was favorable to housing for a
while. And it has continued for quite some time. It is probably
changing now.
Mr. Seiders. If I might add on that, yields on fixed-income
investments were obviously at very rock bottom, both short and
long-term.
Senator Carper. Mr. Stevens.
Mr. Stevens. I echo both comments by the two gentlemen
prior to me. I think there was a flight from the financial
markets.
And then, also, I think wealth accumulation. You had 40
percent of the properties sold in 2005 were investment
properties, second homes and investments, vacation homes. So,
there was a lot of wealth accumulation and people saw the value
and appreciation in real estate and moved to that market.
Senator Carper. What are the implications for second homes,
for vacation homes, going forward for the next year or two or
three?
Mr. Stevens. Well, I think that housing--I will jump in--
that market is still very strong and robust. There is still a
lot of Baby Boomers looking to invest in that property. The
challenge that I think you have today is the coastal areas
where most of them, percentage-wise, want to be near water. You
have got flood insurance challenges. They cannot get insurance.
And, as I stated in my testimony, you cannot get a mortgage
if you do not have insurance. So, they are looking to these
sub-prime-type lending products and that starts another
challenge in the marketplace.
Senator Carper. All right.
Mr. Seiders.
Mr. Seiders. I am worried to some degree about the bona
fide vacation, resort area issue, although it is worth
remembering that the Baby Boom generation, which now is in its
stage where they have a lot of the wealth of the country, are
still going to want those kinds of units.
What I worry most about, on the investment side, is that we
know a lot of the investors were, in fact, speculators. They
had no intention to be using the units even as vacation
properties, or even as rental properties. My builder surveys
are telling me that we are seeing a good number of sales
contracts to those kinds of buyers canceled before closing. And
now we are seeing some resales of units bought by investors for
short-term speculative purposes being resold back on to the
markets.
I think, from a market perspective, that is one of the big
risks that I have in the back of my mind.
Senator Carper. OK. Thank you.
Mr. Lawler. We are seeing in a number of areas in Florida,
for example, huge increases in inventory sales ratios in
vacation areas.
Mr. Brown. I would emphasize that the long-term
demographics appear to be quite positive. Again, with the
maturing of the baby-boom generation and the desire for second
homes, housing is coming to be viewed more as a luxury good,
prompting more investment in such housing.
In addition, many of these boom economies have boomed
before. These are places where people want to be, that are
adding jobs, and that have fairly vibrant economies.
Senator Carper. Thank you all.
My other question, and I would like to start with you, Mr.
Stevens, and then just go to each of the other panelists if we
could. We have grappled with the issue of GSE reform, trying to
make sure our GSEs--Fannie Mae, Freddie Mac, the Home Loan
Banks--have strong regulators. One of the few times in my 5, 6
years on this Committee I have seen us actually break apart
along partisan lines has been on this particular issue. The
House has passed--they have come together overwhelmingly around
a measure over there that I think most folks on our side can
support. We are falling apart in two areas, and Senator Reed
has done a lot of work on the affordable housing fund. My sense
is that we could probably put something together there, but the
bigger issue is the portfolio, restrictions on the portfolio
and composition of the portfolios.
If you could each just briefly share with us some comments,
some guidance, some counsel on how we might bridge our
differences with respect to particularly the portfolio issues
on GSE reform, I would appreciate that.
Mr. Stevens. Well, certainly the Association is in favor of
oversight and--you know, regulatory oversight. I think the
difference in the portfolio, I think it becomes restrictive.
You know, our position has been that we do not think that
should be there. There should be portfolio restriction, but it
should be left up to the regulator. If you are going to put
someone in charge with guidance and restrictive capabilities,
then that should be left up to that regulator. It should not be
an artificially imposed number.
Senator Carper. Good.
Mr. Seiders.
Mr. Seiders. From my economist's point of view, my concern
on the GSE front would be what the reform package could do to
the spread between the home mortgage rate and, say, a
comparable maturity Treasury like the 10-year Treasury yield.
In my forecast, I have got that spread dead-steady about where
it is right now, about 155, 160 basis points.
I just would encourage the Congress to avoid doing anything
that would disrupt the markets to the degree that the mortgage
rate would move up out of alignment from Treasury yields, and
it is possible that rather draconian limits on the GSE's
portfolios, or even requiring some liquidation, could affect
that spread. That is my key concern.
Senator Carper. Good. Thank you, sir.
Mr. Brown.
Mr. Brown. I do not think we have anything to add on that.
Senator Carper. Mr. Lawler, any comment?
Mr. Lawler. Yes. OFHEO strongly supports legislation and
hopes that a compromise will be achieved. We believe that the
portfolios are larger than they need to be and that guidance
from Congress would be very desirable. The Senate language in
the Senate bill appears very restrictive in some areas and may
not--it could be interpreted to restrict the ability of the
enterprises to function in a crisis situation, for example, or
to have all of the appropriate--to be able to invest in all of
the kinds of affordable housing loans that are appropriate for
their mission.
Senator Carper. My thanks to each of you for those
responses. Thank you.
Thank you, Mr. Chairman.
Senator Bunning. Senator Sarbanes.
Senator Sarbanes. Well, thank you very much, Senator
Bunning.
I want to commend Senator Bunning and Senator Allard for
joining the two subcommittees together in order to hold these
hearings. I think it is a very constructive approach, and I
know we will be doing a second hearing next week on some of
these exotic mortgage products. I actually wanted to anticipate
that a little bit.
Mr. Brown, in his testimony--actually, in a footnote to his
testimony--cites data saying that 43 percent of first-time
homebuyers in 2005 obtained 100 percent financing. In other
words, they had no down payment, almost half of all homebuyers.
He cites as his source actually a National Association of
Realtors profile of homebuyers and sellers.
My first question is: Are these homes concentrated in areas
where prices appreciated the most?
Mr. Brown. I do not believe that we have that information,
but I will say that the extent of 100 percent financing really
speaks to the second mortgage situation. Typically, most first
mortgages are still for 80 percent or 90 percent financing. But
whereas a borrower would have had mortgage insurance before,
now they may have a second mortgage that stands in place of the
down payment.
That is a change in mortgage practices that has helped to
bring in new homebuyers. It is something that at the margin has
helped to keep demand going during the latter stages of the
housing boom.
Senator Sarbanes. Well, if this is more concentrated in
areas that are likely to experience house price decreases, what
outcome would we then expect for these homeowners? Are we
facing the potential of sort of a major crisis of defaults and
foreclosures?
Mr. Brown. Well, once again, I do not have specific
information that it is more prevalent in those markets than in
other markets around the country. Certainly incomes tend to be
higher in some of the boom markets with more vibrant economies,
so it is not clear at the outset that that is the case.
However, the research that the FDIC did looking at the
prevalence of large declines in home prices speaks to exactly
the issue that you are bringing up: How likely is it that a
large downward home price decline will wipe out a significant
portion of equity or all of the equity for a substantial
portion of homebuyers? That is a credit event with regard to
lenders and certainly for FDIC-insured institutions, affecting
not only mortgage portfolios but also construction portfolios.
In the problems of the 1980's and early 1990's that the FDIC
experienced, those sorts of busts certainly did have big credit
problems associated with them.
Senator Sarbanes. Does anyone else want to add to that?
Mr. Stevens. The National Association of Realtors, we do
not have those numbers where those first-time buyers
specifically are buying. But, anecdotally, we have found that a
lot of it is concentrated in those resort areas, which you have
a big resort area in Maryland, Ocean City, et cetera. But that
is basically it.
Those products are phenomenal products to get first-time
buyers into homes. The challenge is you have to make sure they
are applied and administered properly. That is where you end up
with your default rates raising and foreclosure rates.
Senator Sarbanes. Right. Mr. Seiders.
Mr. Seiders. Well, just to add, that in what had been the
hottest markets, obviously the price appreciation was very,
very rapid. It obviously depends on when the person got the
loan. There might be a lot of equity already under their belt
and they could absorb, or most of them absorb, at least a
modest decline in house values before they would be thinking of
default.
We also know that there seems to be a fairly strong
correlation between the prevalence of that kind of exotic
financing structure and the prevalence of investor buying. I am
thinking now of the kinds of investors that are not in it for
the long haul but for the short haul, for price appreciation.
If that is the case, I would expect those investors to be
hanging on or getting out without serious damage to themselves
as consumers. So we will see how it winds out. I mentioned
earlier it is one of the downside risks to my forecast as to
how this will all pan out.
Senator Sarbanes. Yes. Of course, I have a concern, you
know, we are not facing a modest decline. I know that OFHEO put
out a release showing that the housing price index shows the
largest deceleration in three decades. It is still going up,
but just in the last quarter, hardly at all, as I understand
it.
I gather that some economists are predicting, actually,
that there is going to be a decline in nominal house values.
So, you know, we may be facing and approaching a crisis
situation, and it underscores, to me at least, what I regard as
the--well, I do not want to use the word ``fragility'' of the
housing finance system, but it is a sensitive structure. It has
worked very well. We have put a lot of people into
homeownership. In many respects it is very complicated.
You all are very much involved in making it work, but there
are two things on the agenda that concern me greatly. One is
this increase in interest rates, which Senator Bunning was
referring to. I have been for some time now urging the Fed to
stop this process, which they have now done, although they had
some dissent on that within the Open Market Committee--at least
one open dissent--actually, the head of my regional Fed Board,
who continues to run around making speeches about this. But the
impact of that can be quite severe.
The other we touched on, as Senator Carper, on the question
of GSEs. Actually, there is no difference within this Committee
about setting up a strong regulator. Both proposals, both from
the majority and the minority, had put significant powers into
the regulator, comparable to what the bank regulators have. We
differed--well, there is not an affordable housing provision
there, and that is a concern, and then the portfolio
restrictions.
We have heard from the low-income tax credit people, the
mortgage revenue bond people, the multifamily housing people,
all of whom try to provide affordable housing, that those
portfolio restrictions would, in effect, put them out of
business. They are fearful that that would be the case. And,
you know, I am happy to give the regulators safety and
soundness authorities over the portfolio, but I am quite
concerned about going beyond that because I think it could
upset this financing mechanism that we have established. So I
think we need to be extremely careful about that.
I wanted to just close--I see my time has expired--by
asking Mr. Seiders for the homebuilders and Mr. Stevens for the
realtors: Do you feel that your voice is heard at the Fed on
some of these complicated issues, that you have a reasonable
opportunity to present your concerns and to have them listened
to? And how does that take place? And what could be done to
strengthen it? And then, more broadly, I would say to all that
the Managing Director for Real Estate Finance at Moody's say,
and I quote him, ``The soft landing is sort of like the white
whale--much rumored, rarely seen.'' And I am sort of interested
in what the members of the panel see in terms of the
possibilities of achieving a soft landing. If you could address
those two very quickly, I would appreciate it.
Thank you, Mr. Chairman.
Mr. Seiders. On the second question first, in terms of the
soft landing possibilities, I think there are some precedents
in history for a housing setback that did not go really deep.
The one that comes immediately to mind is the 1994-1995 period.
The Fed was tightening aggressively during 1994, into early
2005. Housing really did start to lose ground rapidly. In fact,
Chairman Greenspan came and spoke to our board of directors
that January, kind of into the lion's den, but the Fed then
subsequently eased off later in 1995. The whole thing, after a
downshift went ahead fine.
It is a different environment this time in terms of what
has caused this boom-bust and so forth, and my forecast does
have--I guess you would call it a relatively soft landing,
although I've got housing starts down about 11 percent in both
2006 and then again in 2007. So it is a real downslide for
sure. If you want to call that soft, that is in the eye of the
beholder. To me it is a bit alarming.
In terms of our communication with the Federal Reserve, I
think it has been good over the years. We routinely have
meetings with the Fed Chairman or maybe even other members of
the Federal Reserve Board. Sometimes our own officers will take
in the CEO's of the very big building companies. We also take
in CEOs from the big suppliers to our industry that come and
supply the materials and so forth.
We actually have, since some time back with Chairman
Greenspan, done some special surveying of builders that we
share with the Fed, and we share all of our ongoing survey
information with them, even if it is confidential for other
reasons. And Chairman Bernanke seems very, very receptive to
receiving our information and discussing it with us. We had a
meeting with Chairman Bernanke about 10 days ago, I guess,
within the last 2 weeks, and we expect to be able to do that
periodically.
Senator Sarbanes. Do you talk to the members of the Open
Market Committee? They meet as a committee and they vote, you
know. Do you have a chance to make these presentations to the
broader membership?
Mr. Seiders. The last meeting that we had with the Federal
Reserve, there were five Federal Reserve Board Governors
present. That is a fairly good sized piece of the FOMC.
There is some contact with some of the Federal Reserve Bank
presidents who are on the FOMC about what is happening in the
housing sector. That I think could definitely be strengthened.
Senator Sarbanes. Yes.
Mr. Stevens, do you want to add to that?
Mr. Stevens. Very similar. We have pretty much been granted
an open door. We have a meeting with the Fed Chair and the
presidents twice a year.
Senator Sarbanes. The presidents of the regional banks?
Mr. Stevens. Yes. And the Fed Chair has--we send our
reports and our studies to him on a regular basis for their
analysis and use as they see fit. So we feel like there has
been an open-door policy. And we would have liked them to have
listened a little sooner on the increase in the rates. As I
said earlier, we think it is real temperamental right now. You
know, our chief economist's studies show that if they were to
raise rates another half percent, you know, all appreciation
disappears. It stops. If we go another percent, then we are in
about a 2.5 to 3 percent reverse in appreciation. House values
decline.
So we are still sitting there on the fence to see if it was
stopped in time or not. I think by the end of the year will
tell.
Senator Sarbanes. Thank you, Mr. Chairman. Can I just close
with this observation? You know, these members of the Open
Market Committee, they all have a vote, each one of them, and
it seems to me that--I appreciate your suggestion that you
should maybe deal with them directly and not necessarily put
the Chairman of the Fed in the position of having to transmit
it through and be the persuading agent instead of them hearing
very directly from those that are actually in the field and
having the experience as to what the problems are.
Mr. Lawler. I wonder if I could respond briefly to the
Senator's second----
Senator Bunning. Well, he has gone, let us see, about 10
minutes over, so I am going to cut him off. And I just want to
say that Chairman Bernanke has made it very clear that he would
like to diffuse the influence of the Fed Chair and have the
regional bank presidents have more to say about Fed policy.
Now, that is what he said. Let's see what he does.
Senator Sarbanes. Well, if that happens, even more under--
--
Senator Bunning. Even more.
Senator Sarbanes [continuing]. What we were just
discussing.
Senator Bunning. All right. Senator Allard.
Senator Allard. Thank you, Chairman Bunning.
I want to explore a little bit these local markets. You
know, I think a couple of you mentioned the impact of local
markets, and it is difficult to look at it from a national
perspective when you look at housing bust and boom cycles, as
Mr. Brown referred to, because so many times it depends on, if
you have a one-company town, how well that company is doing, or
maybe there are other factors in there that are driving these
local markets.
I think Alan Greenspan in some testimony we had before the
Committee at one time, you know, because of local markets
bubbling up and down, he called it a ``froth'' nationwide. And
his kind of approach was that it had more local significance
sometimes than it does national significance.
The Wall Street Journal in 2005 tried to kind of
nationalize the argument a little bit by saying that 22 of the
metro areas with the fastest-growing price growth had more than
35 percent of the Nation's housing wealth. I guess the thought
that came to my mind--and I would like to hear a comment on
this, and I do not know as I have seen studies of this, but I
suspect that probably family income in urban areas rose much
faster in urban areas than it did in rural areas also.
But I guess the fundamental question here is: Do these
possible local issues actually have some national implications?
I will open that up for discussion from the entire panel.
Mr. Brown. Senator, let me start on that. Yes, certainly,
the scope of the housing boom with 89 markets, including some
very big markets such as San Francisco, Los Angeles,
Washington, D.C., and New York, containing a large proportion
of the value of U.S. real estate, leads to some concerns about
what happens if they slow at nearly the same time and what
effect is that going to have on construction and household
wealth. So I do think that the scope does cause some concerns.
It is unprecedented. It is one of the wild cards in this
situation compared to our previous experience.
Senator Allard. Any other comments on that?
Mr. Seiders. I certainly agree with your premise. We talk
about housing markets being localized largely because you
cannot move inventory around, you know, either in or out. But
people can move in and out, and, you know, very bad economic or
housing market conditions in major metro areas do have their
way of making their way around a bit. And if you do add up the
areas that were clearly overheated, at least in price terms,
you have got a big chunk of the national market.
Mr. Lawler. I think that while it is true that there have
been very different rates of growth in different parts of the
country, the changes in growth rates have been somewhat across
the board. Recently, the deceleration that we have seen has
occurred everywhere. The biggest drops in growth rates have
been in the areas that have been growing the fastest, but areas
with actual decreases that we saw in the second quarter were
areas that had been growing very slowly, prices had been
increasing very slowly before, and where the economies are not
as strong as some other areas.
Senator Allard. OK. Let me pursue the cost of owning homes
compared to renting a home nationwide. How does this compare on
a nationwide basis, particularly in those markets experiencing
the most significant housing price increases? And, also, maybe
comment a little bit on how this compares to historical trends.
Mr. Lawler. Well, we have seen prices greatly outpace rent
growth over the past 5 years, and that has started to change,
especially in the condo areas. The rapid growth of prices for
single-family houses resulted in a lot of switches from rental
units to condos, brought on a lot of new supply, to the point
where those markets have looked suddenly among the very
weakest. But taking those out of the rental markets stimulates
rent a little bit, and these things tend to equalize over time.
Mr. Seiders. The tremendous surge in buying activity drove
the Nation's homeownership rate and the rental vacancy rate to
record highs at the same time in the early part of 2004. And
the cost of owning in terms of monthly payment compared to rent
was climbing dramatically during that period.
One reason it could continue with momentum on the home-
buying side was that, in terms of what people consider the cost
of owning a home to be, it includes expected price
appreciation, and all the price appreciation going on fostered
expectations of further price appreciation. So it felt like a
really good deal, even cost of living-wise in a sense, to be
buying rather than renting.
We have really seen that swing now, and in the multifamily
housing sector, there now is a rather significant downslide in
the condo component. You know, that is going down. There is now
upward pressure on rents and renewed interest in building for
the rental market. Actually, in my forecast I have the
production of rental housing moving up to some degree later
this year and in 2007 as the homeownership side comes down,
including the condo component.
Senator Allard. Interesting.
Thank you, Mr. Chairman.
Senator Bunning. Senator Reed.
Senator Reed. Thank you, Mr. Chairman.
Mr. Brown, following up the line of questioning I concluded
with Mr. Seiders, the suggestion I think that Mr. Seiders had
is that it is hard to sometimes realize what types of mortgage
instrument a borrower has out there. It could be a no-interest
loan. It could be--you know, I do not even understand all the
different products out there.
But, going to the FDIC, do you have a notion of how many
people are having these exotic loans? And are there multiple
exotic loans? And do you feel confident that you understand
actually the situation? I do not say that, you know,
critically, just factually. Do you have a sense you understand
what is going on?
Mr. Brown. Yes, our analysts make use of state-of-the-art
data from companies like Loan Performance and obviously from
the Mortgage Bankers Association and other good sources. Some
of the studies that these groups have put together, for
example, one study by First American Mortgage Solutions, which
is now affiliated with Loan Performance, estimates that about
22 percent of all outstanding U.S. mortgages are adjustable
rate mortgages that were made in 2004 and 2005.
If you couple that with the estimates made using the Loan
Performance database by both Loan Performance and by our
analysts, perhaps 40 to 50 percent of those adjustable rate
loans during 2004 and 2005 were the interest-only and payment
option variety. So you are really talking in the neighborhood
of 10 percent of the U.S. mortgage book. Of that 10 percent,
then, some are taken out by high-net-worth individuals that
have irregular incomes and want to use it for wealth
management. Perhaps other households avail themselves of those
loans as affordability products to try to afford high-priced
homes in some of these boom markets.
This gives us an order of magnitude in terms of the scope
of those markets. Yes, they have really proliferated in recent
years. That is a new thing. And it is uncertain as to how they
will perform as interest rates rise and as the low introductory
rates expire. But I think we have an overall viewpoint as to
the order of magnitude of those loans.
Senator Reed. So your sense is that this potential for
significant foreclosures because of these types of lending
arrangements is not decisive?
Mr. Brown. Well, here is the situation. I think that we
certainly could see some increases in credit problems among
those borrowers who use those affordability products and who,
when the introductory rates expire, will have problems repaying
those loans. I think you are going to see credit distress among
those households. There is no question.
At the same time, we have to recognize that those loans
have been largely securitized in private asset-backed
securities and sold to investors around the world. I think the
consensus of mortgage professionals and economists is that
those risks have been spread around in a fairly efficient
manner. But certainly I think the impact on those individuals
who are caught in that situation, if they really cannot afford
the payments as they go up, will be serious.
Senator Reed. Absolutely.
Mr. Lawler, you might want to comment now. You had a
comment previously for Senator Sarbanes. But you might also
touch upon this issue of the data that you are seeing, does it
give you confidence that you have a reasonable grasp of what
the situation would be with particularly these exotic products?
Mr. Lawler. OK. I wanted to say, with respect to the effect
of legislation on the markets, that it is important to keep in
mind that only about 30 percent of the assets in the
enterprises' retained portfolios help meet their affordable
housing goals. Those are important assets, and I think what is
key in legislation is for Congress to give some direction to
the regulator about what assets really are the most important
for the enterprises to hold and what are of less importance,
what can reasonably be cut back and what might have damaging
consequences for affordable housing if it were cut back, so the
regulator would have some guidance in that area.
On these exotic loans, I think one of the concerns is that
a lot of the loans were made to people who can afford the
higher rates. They were underwritten appropriately and the
borrowers can afford them, in many cases as investors who found
this a very convenient and inexpensive way to maximize the
leverage that they were getting on new properties.
But the risk there is that when rates that they are
actually having to pay go up monthly and start to exceed the
income that is coming in, if they are renting them out, they
may be reluctant to hold onto them and may be more willing to
try and sell them, which could put downward pressure on prices.
Senator Reed. Any other comments? Mr. Stevens, please.
Mr. Stevens. Just in the package that I submitted for the
record, there are some charts in there showing the markets that
carry higher risk due to the adjustable rate mortgages and
things.
Senator Reed. Thank you very much.
Mr. Seiders. Maybe one final comment. One of the things
that I am counting on with a lot of these strange mortgages
coming home to roost in terms of big payment adjustments is the
ability of the homeowner to refinance into something else. And
my understanding is that most of these do not have hefty
prepayment penalties in them. Some of the people in the
mortgage finance industry are looking for a mini-refi boom as a
lot of these mortgages approach their first payment reset. Some
of that is already happening.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Senator Bunning. A couple more. This question is for anyone
who would like to--it is a toss-up. Do you think that price
increases and sales volumes in the last 3 years were driven by
normal market conditions? Or was it something unsustainable?
Was there an unsustainable factor in the housing boom?
Mr. Brown. I would like to start with that. I do believe
that booms historically are situations where prices do get out
ahead of the fundamentals. To that extent, the booms have never
proven to last forever, and by definition, they are
unsustainable.
What really matters, I think, is the aftermath. In two-
thirds of the cases, after we have seen these booms, the prices
fell in at least 1 year of the next 5. We only found, however,
nine cases where they fell as far as 15 percent over the next 5
years. So I think this period of stagnation, which can be
fairly painful for homeowners and homebuilders, is the most
common outcome. And if that is the definition of unsustainable,
yes, I think booms are inherently unsustainable.
Mr. Lawler. I agree that there are some unsustainable
features. One of them clearly were the rates of increase in
prices that were far outstripping growth in incomes. That could
not be maintained indefinitely.
And in the past, at least on an inflation-adjusted basis,
we have seen cycles in many, many cities across the country,
and also even in the national data. As real changes in demand
occur, it is difficult for supply to keep pace, especially in
some areas with more supply restrictions than others, more
congestion, or more restrictions on zoning, for example. And so
that can create cyclical behavior, and we have seen it on an
inflation-adjusted basis for the country as a whole several
times now.
Senator Bunning. This question would be for Mr. Brown and
Mr. Lawler. What, if any, impact has the housing boom had on
consumer spending? In particular, is there reliable evidence
that consumers have tapped wealth from home value increases to
spend on home improvements, durable goods, or other things?
Mr. Lawler. Well, I think definitely we are seeing
substantial volumes of refinancing over the past year--even as
interest rates have increased by a full percentage point--long-
term interest rates over a full percentage points over the last
year, and short-term rates more than that.
The main reason for this refinancing is to take cash out.
We have seen some increases in spending on renovations, but
most of it is going elsewhere, either to pay off debt or to buy
consumption items.
Mr. Brown. Adding cash-out refinancings and the increase in
home equity lines of credit outstanding, totals approximately
$450 billion in 2005. That is around 4 percent of disposable
income. That is a pretty big number in terms of spendable cash.
Now, some of that money is going back into homes. It is not
purely consumption outside the home. And, again, this is in
many cases part of an overall wealth management strategy by
households that may have other assets offsetting their mortgage
debt. The extent to which households decide to do extra
spending based on the fact that they can borrow against their
home, is not necessarily shown by the volume of cash-out
refinancing and home equity lines.
Mr. Seiders. Chairman Bunning, I was going to say on that,
there is little doubt that, the housing wealth effect had a
strong impact supporting consumer spending in the last couple
of years. It really is a factor that has allowed the personal
saving rate to go negative, for as long as it has.
Also, in my view, it is really the housing wealth effect
that matters the most, not how it is, in a sense, accessed. It
does not have to be accessed through mortgage borrowing. You
can spend all of your income. You can use financial assets. You
can use other kinds of borrowing and so forth.
So it is one of these big things in the economy that is
definitely in the process of weakening in terms of support to
the consumer sector.
Senator Bunning. Well, if you all have good memories,
Chairman Greenspan popped the bubble in 2001 and 2002 on the
tech rally, and he always complained about the wealth
component, and he took care of that in about a year and a half.
[Laughter.]
Senator Bunning. So I hope that is not the case for the
housing situation.
We are going to leave the record open for 10 days so anyone
on the Subcommittee can submit a question, if they would like,
to anyone here on the panel.
I want to thank everyone for attending the joint hearing of
the Housing and Transportation Subcommittee and the Economic
Policy Subcommittee, and the hearing is adjourned. Thank you.
[Whereupon, at 11:37 a.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF PATRICK LAWLER
Chief Economist, Office of Federal Housing Enterprise Oversight
September 13, 2006
I am pleased to be here, where I worked as a Committee staff member
some years ago, to testify on housing market developments and
prospects. The Office of Federal Housing Enterprise Oversight, OFHEO,
has a strong interest in housing markets and particularly in house
prices because they have a powerful effect on the credit quality of
mortgage loans owned or guaranteed by Fannie Mae and Freddie Mac, the
Enterprises we regulate.
Over the past five years, we have witnessed an extraordinary change
in the relative price of houses. The general level of house prices
soared 56 percent from the spring of 2001 to the spring of 2006. The
prices of other goods and services rose much less, so that inflation-
adjusted house prices are now 38 percent higher than 5 years ago. That
exceeds the inflation-adjusted increase in the previous 26 years, going
back to the beginning of OFHEO's data.
A number of factors have contributed to these price gains. Long-
term mortgage interest rates fell from about 8 percent in mid-2000 to
generally less than 6 percent in the period from early 2003 to mid-
2005. Short-term rates declined by more, and borrowers took advantage,
as more of them took out adjustable-rate loans. Interest-only and
negative amortization loans provided even lower monthly payments. The
spread of these products helped stimulate demand, as did the rapid
growth of subprime lending. In 2001, less than 10 percent of new
mortgage securities were backed by subprime loans. In each of the past
two years, subprime lending has amounted to more than 20 percent of
that market.
Demographics have also been favorable. Aging boomers are reaching
their peak earning and investing years, with many interested in second
homes for vacations or future retirement, and immigration has
accelerated household formation. Supply constraints have made it
difficult to meet the increased demand. Land use restrictions,
environmental and economic impact studies, natural barriers, and
existing high densities in some areas have lengthened the time
necessary for builders to bring new houses on the market and raised the
premiums paid for prime house locations.
Finally, there is some evidence of speculation, as the share of
loans made to investors has risen and turnover rates have been high,
with anecdotes of property flipping becoming common. Certainly, the
poor performance of the stock market early in this decade made an
obvious contrast with the investment performance of houses, and that
may have encouraged some to shift their investment focus.
House price increases have been uneven across the nation, though.
While homeowners in Indiana, Ohio, and Michigan have seen their house
values over the past 5 years hardly budge in constant dollars,
residents of Florida, California, and here in the District of Columbia
have watched prices virtually double, even after adjusting for
inflation. The coastal areas have generally had more vibrant economies,
more in-migration, and more supply constraints.
Over the past year, the pace of house price inflation over most of
the country has moderated dramatically. The sharpest decelerations have
come in some of the most superheated markets of a year ago, including
Arizona, Nevada, California, and Hawaii in the West and DC, Delaware,
Maryland, and Virginia in this area. Nationally, prices rose roughly
1.2 percent in the second quarter of this year, a rate that only
slightly exceeds the inflation rate for other goods and services in the
economy. For comparison, the appreciation rate in the second quarter of
last year was approximately 3.6 percent.
Housing markets in New England and the Midwest are showing some of
the most significant regional weakness. The relatively anemic New
England market has been cooling for the last two years. While
Massachusetts, New Hampshire, and Maine saw some of the largest gains
in the nation in the late 1990s and early 2000s, rates of price
increase have dropped sharply since. Our latest data suggest that
prices in those states were virtually unchanged in the second quarter
of this year.
Although appreciation rates in the Midwest were only slightly above
baseline inflation levels throughout the latest boom, the rates have
declined somewhat. Price performance in Indiana, Ohio, and Michigan, in
particular, appears weak. Appreciation over the last year was less than
three percent in all three states, and, in the latest quarter, prices
actually declined.
We are seeing continued price strength in select areas of the
country. The areas affected by Hurricane Katrina, for example, have
shown strong increases, presumably a result of the loss of housing
stock. Prices in Louisiana, for example, rose nearly 12.5 percent
between the second quarter of 2005 and the second quarter of 2006.
Price appreciation in the second quarter of this year was more than
double the national rate in that state. Over the past year, gains in
several Katrina-affected cities, including Gulfport-Biloxi and Mobile,
were between 15 and 18 percent, the largest one-year increases we have
ever recorded for these cities.
Select areas in Texas, as well as parts of the Pacific Northwest,
also seem to have fared relatively well. At more than 3.6 percent,
quarterly appreciation rates in Oregon, Idaho, and Washington state
were more than three times the national average. Appreciation in oil-
rich Texas areas like Odessa and Midland also appears to have been
strong.
Other market indicators confirm the general chilling of housing
markets across the nation. Particularly noteworthy is the swelling
inventory of unsold houses on the market, which has risen to 4.5
million from levels generally below 3 million in 2003 and 2004. As
sales rates have fallen at the same time, inventories are now more than
7 times monthly sales, the highest since the early 1990s.
Historical patterns of price behavior in housing markets may
provide some guidance about potential future developments. OFHEO's
national House Price Index has never fallen over a period of a year or
more, but it has come very close, and inflation-adjusted prices have
fallen significantly, by 11 percent in the early 1980s and by 9 percent
in the early 1990s. In the first instance, it took nearly 8 years for
inflation-adjusted prices to regain the past peak and in the second
case, almost 10 years. Certainly, a similar event is quite possible
now.
Cycles in inflation-adjusted home prices have occurred in a much
more pronounced way in some cities, such as Boston and Los Angeles. The
cycles stem from the effects of local business cycles, the delays in
the response of supply to increased prices, and to some extent from
speculation. Over much of the country, fundamental factors have pushed
up demand and accounted for at least a large portion of the price
increases in recent years. However, increasing supply, higher interest
rates, and a turn in investor-market psychology may cause prices in
some markets to fall. In the past, significant nominal price declines
generally have been associated with local or regional economic
recession, but the exceptional size of some of the recent increases
could make them vulnerable without a recession, especially if interest
rates continue to rise.
In the long run, I expect housing markets to perform well,
especially if immigration continues at recent rates. An important
caveat, though, is that healthy housing markets could soften seriously
from an unexpected disruption in the ability of Fannie Mae and Freddie
Mac to function effectively in secondary mortgage markets. OFHEO is
currently focused on correcting the significant accounting, internal
control, management, and corporate governance weaknesses identified at
both companies through OFHEO examinations. While both companies have
made progress, much more needs to be done. It is apparent that in order
to ensure the long-run safety of these two GSEs, the regulatory
framework must also be strengthened. OFHEO supports the enactment this
year of legislation, currently before the full Committee, that will
create a new regulator with adequate funding, bank-like regulatory and
enforcement authorities and encompassing not only safety and soundness,
but also mission regulation.
Research and OFHEO's House Price Index
I now would like to talk briefly about some of OFHEO's research
activities related to measuring home price trends. OFHEO's work has
been focused on our House Price Index (HPI), which we publish
quarterly. We estimate quarterly price changes for single-family houses
at the national level and for census divisions, states, and
metropolitan statistical areas. We use data obtained from Fannie Mae
and Freddie Mac on values of houses in repeat mortgage transactions.
OFHEO is working hard to ensure that our house price index remains
an accurate and reliable indicator for both internal and external use.
Precise measurement of historical price movements is extremely
important in measuring the credit exposure at Fannie Mae and Freddie
Mac, a critical part of OFHEO's regulatory duty. It is also important
because mismeasurement may obscure indications of any accelerations or
reversals in the housing cycle. Such information is valuable not just
to OFHEO, but also to the other disparate entities and individuals that
use our data. Government and private policy analysts, risk modelers at
Wall Street firms, and even individual homeowners interested in
tracking their home values all employ our data. Our historical index
data, as well as related market commentary, are all available on
OFHEO's website.
Accurately measuring house price movements is quite challenging.
One of the fundamental difficulties stems from the fact that houses do
not sell frequently. At best, sporadic measurements of home values are
usually available. Also, homes obviously differ substantially in their
size and quality. This heterogeneity means that the average sales price
of properties reflects not only trends in house prices, but also
changes in the mix of houses transacting.
A final challenge is that home valuation measures are not always
perfect indicators of true home values. For example, much of OFHEO's
home value information is derived from appraisals produced in the home
refinancing process. Such appraisals, for a variety of reasons, may not
always accurately reflect true home values.
OFHEO in fact is actively researching the issue of appraisal bias.
The underlying research question to be addressed is: ``How can
appraisal bias be stripped from the OFHEO index without having to
remove all appraisal data from OFHEO's calculations?'' Although home
price appraisals may systematically differ from purchase price
information, their inclusion can provide valuable information about
price trends, particularly for small cities where the availability of
price data is at a premium. More fundamentally, to the extent that
refinanced homes may have different attributes than other homes, the
inclusion of refinance-related appraisals provides our models with a
potentially broader sampling of appreciation patterns.
Preliminary research suggests that a refined methodology that aims
to remove appraisal bias from the HPI may reflect long-run historical
price patterns that are quite similar to what has been observed in the
usual HPI. Despite the similarity, however, OFHEO may pursue such a
refinement because changes in the mix of refinance and purchase
valuations can affect measured short-term price change patterns.
Another issue of broad research and policy significance is the
effect of home improvements on measured price trends. Some observers
have wondered whether a significant share of the dramatic appreciation
reflected in the OFHEO HPI has been caused by home remodeling activity
as opposed to fundamental price increases. The concern has been
motivated in part by a divergence between appreciation shown in the
OFHEO index and house price growth reflected in a ``constant-quality''
index produced by the Census Bureau.
Although the OFHEO index is generically classified as a constant-
quality index, some recent appreciation may indeed reflect net quality
improvements in the housing stock. Outside research coupled with as-yet
unpublished internal OFHEO work nevertheless suggests that, even under
generous assumptions concerning the impact of remodeling on home
valuations, a relatively modest amount of appreciation is accounted for
by what might be described as ``quality drift.'' In short, the recent
price run-ups are not mere illusions caused by the fact that Americans
are buying bigger and better homes.
While OFHEO does not publish home price forecasts, it maintains a
strong interest in available information concerning future
expectations. One potentially useful development in this area is the
introduction of real estate futures exchanges. Such exchanges, at least
in theory, may one day provide a meaningful summary of the market's
best guess for the future price trends. Unfortunately, trading volumes
on these nascent futures exchanges are relatively low. Thus, although
some futures markets currently point to small home price declines
through the Spring of 2007, the implied price trajectories may not
reliably reflect aggregate expectations concerning future prices.
Conclusion
Although the future direction of home prices is the subject of
great speculation, there is little doubt that several factors may
constrain appreciation rates in the near future. First and most
fundamentally, home prices are at historically high levels and have
already started to stretch past many traditional affordability
boundaries. Home affordability is at very low levels in places like
California and the New England states, for example. Barring very
significant increases in average incomes or interest rate declines,
these price levels will weigh heavily against major price increases in
the near term.
The second constraint on appreciation rates is rising housing
inventories. The number of homes available for sale has increased
substantially over the last year, giving homebuyers much more
bargaining power than they have had in recent periods. Such bargaining
power can lead sellers to reduce prices.
The third and final factor involves market psychology. Although it
has been difficult to accurately quantify the effect of speculative
activity on recent appreciation patterns, anecdotal evidence suggests
that its effect may have been material in select markets in California,
Nevada, Arizona, and other states. To the extent that the recent
slowdown in appreciation rates may sour some potential investors on
real estate investments, home demand may decline somewhat.
Despite the presence of various factors that may act to constrain
price appreciation in the near term, I would like to stress that
housing markets and price appreciation are affected by some very basic
economic and demographic patterns. For example, migration patterns
(both domestic and international) affect the demand for housing and
thus influence price movements. Also, the extent to which retiring baby
boomers opt to increase or decrease their demand for second homes may
also play a role in determining the direction of prices in the future.
Finally, the cost of constructing new homes clearly can play a role in
affecting supply and thus home prices. As is the case in other markets,
the future trajectory of prices will be determined through a netting
out of these factors, in addition to the short-term demand and supply
determinants that have already been discussed. Thank you, and I'd be
happy to answer any questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
House Price Appreciation Slows
ofheo house price index shows largest deceleration in three decades
Washington, D.C.--U.S. home prices continued to rise in the second
quarter of this year but the rate of increase fell sharply. Home prices
were 10.06 percent higher in the second quarter of 2006 than they were
one year earlier. Appreciation for the most recent quarter was 1.17
percent, or an annualized rate of 4.68 percent. The quarterly rate
reflects a sharp decline of more than one percentage point from the
previous quarter and is the lowest rate of appreciation since the
fourth quarter of 1999. The decline in the quarterly rate over the past
year is the sharpest since the beginning of OFHEO's House Price Index
(HPI) in 1975. The figures were released today by OFHEO Director James
B. Lockhart, as part of the HPI, a quarterly report analyzing housing
price appreciation trends.
``These data are a strong indication that the housing market is
cooling in a very significant way,'' said Lockhart. ``Indeed, the
deceleration appears in almost every region of the country.''
Possible causes of the decrease in appreciation rates include
higher interest rates, a drop in speculative activity, and rising
inventories of homes. ``The very high appreciation rates we've seen in
recent years spurred increased construction,'' said OFHEO Chief
Economist Patrick Lawler. ``That coupled with slower sales has led to
higher inventories and these inventories will continue to constrain
future appreciation rates,'' Lawler said.
House prices grew faster over the past year than did prices of non-
housing goods and services reflected in the Consumer Price Index. While
house prices rose 10.06 percent, prices of other goods and services
rose only 4.41 percent. The pace of house price appreciation in the
most recent quarter more closely resembles the non-housing inflation
rate.
Significant findings in the HPI:
1. All states show four-quarter appreciation, but five
Midwestern and New England states had small price decreases in
the second quarter.
2. Price appreciation remains relatively robust in the two
states hardest hit by Hurricane Katrina one year ago--Louisiana
and Mississippi. Four-quarter appreciation rates were well
above the national average in several cities in the area
including: New Orleans-Metairie-Kenner, Gulfport-Biloxi, Baton
Rouge, and Pascagoula. Gulfport-Biloxi and Pascagoula in fact
logged their highest appreciation rates since the beginning of
OFHEO's Index.
3. The South Atlantic Census Division including Florida,
Delaware, the District of Columbia, Virginia and Maryland
experienced its most significant price deceleration since at
least the early 1980s. Its four-quarter appreciation rate fell
from 17.43 percent to 13.74 percent.
4. New England's four-quarter appreciation rate fell from
8.71 percent to 5.68 percent. While appreciation rates in
Massachusetts were consistently amid the 10 highest between
mid-1997 and mid-2003, its four-quarter appreciation rate now
ranks 48th among the states and the District of Columbia.
5. Despite a nine percentage point decline in its four-
quarter appreciation rate, Arizona's housing market still
exhibits the highest appreciation rate among the 50 states.
Prices were up roughly 24 percent compared to the second
quarter of 2005 but grew only 2.94 percent in the most recent
quarter.
6. While the 20 Metropolitan Statistical Areas (MSAs) with
the highest appreciation included nine cities in Florida, the
representation of other states continues to increase. MSAs in
North Carolina, South Carolina, and Washington State have now
entered the list of fastest appreciating markets.
7. Michigan had the greatest numbers of price decreases
among ranked MSAs. Thirteen of Michigan's 16 ranked
metropolitan areas exhibited quarterly price decreases.
One of the more striking elements of the new HPI data is that four-
quarter appreciation rates fell sharply in four of the five states that
had fastest appreciation in last quarter's HPI release. This subject is
discussed in greater detail in the Highlights section of this report on
page 8.
Changes in the mix of data from refinancings and house purchase
transactions can affect HPI results. An index using only purchase price
data indicates somewhat less price appreciation for U.S. houses between
the second quarter of 2005 and the second quarter of 2006. That index
increased 8.27 percent, compared with 10.06 percent for the HPI.
OFHEO's House Price Index is published on a quarterly basis and
tracks average house price changes in repeat sales or refinancings of
the same single-family properties. OFHEO's index is based on analysis
of data obtained from Fannie Mae and Freddie Mac from more than 31
million repeat transactions over the past 31 years. OFHEO analyzes the
combined mortgage records of Fannie Mae and Freddie Mac, which form the
nation's largest database of conventional, conforming mortgage
transactions. The conforming loan limit for mortgages purchased in 2006
is $417,000.
This HPI report contains four tables: 1) A ranking of the 50 States
and Washington, D.C. by House Price Appreciation; 2) Percentage Changes
in House Price Appreciation by Census Division; 3) A ranking of 275
Metropolitan Statistical Areas (MSAs) and Metropolitan Divisions by
House Price Appreciation; and 4) A list of one-year and five-year House
Price Appreciation rates for MSAs not ranked.
OFHEO's HPI report in PDF form is accessible at www.ofheo.gov.
Also, be sure to visit www.ofheo.gov to use the OFHEO House Price
calculator. The next HPI report will be posted December 1, 2006. Please
e-mail [email protected] for a printed copy of the report.
HOUSE PRICE APPRECIATION BY STATE--PERCENT CHANGE IN HOUSE PRICES
[Period ended June 30, 2006]
----------------------------------------------------------------------------------------------------------------
Since
State Rank * 1-Yr. Qtr. 5-Yr. 1980
----------------------------------------------------------------------------------------------------------------
Arizona, (AZ)................................................. 1 24.05 2.94 96.71 323.30
Florida, (FL)................................................. 2 21.28 2.51 112.59 377.53
Idaho, (ID)................................................... 3 20.14 3.78 55.27 229.24
Oregon, (OR).................................................. 4 19.47 3.99 63.79 333.68
Hawaii, (HI).................................................. 5 18.09 0.43 111.21 427.63
Washington, (WA).............................................. 6 17.39 3.67 60.21 363.59
Maryland, (MD)................................................ 7 16.21 2.31 102.68 422.09
District of Columbia, (DC).................................... 8 15.86 1.28 119.97 534.93
New Mexico, (NM).............................................. 9 15.54 4.22 50.30 215.40
Utah, (UT).................................................... 10 15.17 3.75 33.39 229.32
California, (CA).............................................. 11 14.35 1.25 111.93 543.28
Virginia, (VA)................................................ 12 14.24 2.01 83.38 360.29
Wyoming, (WY)................................................. 13 13.97 2.94 55.61 149.60
Alaska, (AK).................................................. 14 12.90 2.82 53.01 169.33
Montana, (MT)................................................. 15 12.66 3.12 55.84 254.28
Louisiana, (LA)............................................... 16 12.48 2.71 37.92 134.09
New Jersey, (NJ).............................................. 17 12.43 1.85 84.98 475.25
Delaware, (DE)................................................ 18 11.78 0.63 70.75 392.00
Nevada, (NV).................................................. 19 11.44 0.26 104.77 312.02
Vermont, (VT)................................................. 20 11.28 2.45 65.97 350.98
Pennsylvania, (PA)............................................ 21 10.69 1.61 55.57 299.17
United States **.............................................. ........ 10.06 1.17 56.49 298.85
New York, (NY)................................................ 22 9.89 0.90 72.76 554.65
Mississippi, (MS)............................................. 23 9.59 2.85 27.62 138.56
North Carolina, (NC).......................................... 24 9.32 1.93 28.41 221.47
South Carolina, (SC).......................................... 25 8.93 1.67 31.48 205.02
Alabama, (AL)................................................. 26 8.91 1.88 30.18 174.32
North Dakota, (ND)............................................ 27 8.88 3.00 39.64 140.99
Connecticut, (CT)............................................. 28 8.46 0.83 62.98 376.96
Tennessee, (TN)............................................... 29 8.10 1.96 28.06 191.09
Arkansas, (AR)................................................ 30 8.01 1.98 32.31 153.66
Illinois, (IL)................................................ 31 7.82 1.12 42.76 270.57
Rhode Island, (RI)............................................ 32 7.43 1.18 94.00 513.89
West Virginia, (WV)........................................... 33 7.40 0.15 34.73 127.04
Oklahoma, (OK)................................................ 34 6.50 1.78 26.75 97.79
Texas, (TX)................................................... 35 6.45 1.93 22.64 111.87
Maine, (ME)................................................... 36 6.25 -0.20 61.74 405.84
Georgia, (GA)................................................. 37 6.14 1.05 28.02 230.46
New Hampshire, (NH)........................................... 38 5.97 0.04 61.03 404.18
South Dakota, (SD)............................................ 39 5.96 2.05 31.18 175.99
Missouri, (MO)................................................ 40 5.77 0.45 33.29 196.36
Wisconsin, (WI)............................................... 41 5.58 0.31 36.00 226.57
Kentucky, (KY)................................................ 42 5.27 1.21 24.94 183.51
Minnesota, (MN)............................................... 43 4.94 0.28 46.61 271.41
Iowa, (IA).................................................... 44 4.30 1.26 23.61 146.78
Colorado, (CO)................................................ 45 4.20 0.96 23.68 263.10
Kansas, (KS).................................................. 46 4.15 1.04 24.10 138.93
Nebraska, (NE)................................................ 47 3.63 0.95 21.57 155.27
Massachusetts, (MA)........................................... 48 3.40 -0.44 56.98 631.67
Indiana, (IN)................................................. 49 2.76 -0.04 17.00 154.65
Ohio, (OH).................................................... 50 2.14 -0.05 18.40 172.34
Michigan, (MI)................................................ 51 1.01 -0.72 18.95 222.11
----------------------------------------------------------------------------------------------------------------
* Note: Ranking based on one-year appreciation.
** Note: United States figures based on weighted Census Division average.
______
PREPARED STATEMENT OF RICHARD BROWN
Chief Economist, Federal Deposit Insurance Corporation
September 13, 2006
Chairman Allard, Chairman Bunning, Senator Reed and Senator
Schumer, I appreciate the opportunity to testify on behalf of the
Federal Deposit Insurance Corporation concerning housing markets and
their implications for the economy. Like the other panelists testifying
today, the FDIC closely monitors the current conditions in U.S. housing
markets.
Rather than restating the housing data available for economic
analysis, my testimony will summarize some recent analysis performed by
FDIC staff economists on historical boom and bust cycles in the U.S.
housing markets. This analysis of almost 30 years of boom and bust
cycles should complement the presentations of my fellow panelists and
provide the Subcommittees with perspective on the credit risks of these
cycles to banks and thrift institutions.
My testimony will address four main topics: 1) the condition of the
banking industry and its role in housing finance; 2) the historical
performance of real estate loan portfolios at banks and thrifts; 3) the
FDIC's recent analysis of housing boom and bust cycles; and 4) the
implications for the future path of U.S. home prices.
Banking Industry Condition and Role in Housing Finance
At the outset of my testimony, I would like to emphasize that FDIC-
insured banks and thrift institutions continue to exhibit strong
earnings, low credit losses and historically high levels of capital.
The industry as a whole has posted five consecutive annual earnings
records and two consecutive quarterly earnings records. As of June 30,
noncurrent loans measured just 0.70 percent of total loans, the lowest
such ratio in the 22 years these data have been collected.\1\ At that
same date, the industry's Tier 1 Risk Based Capital Ratio was 10.72%,
near a historic high for this ratio. In addition, no FDIC-insured
institution has failed in over two years--the longest such period in
the FDIC's history.
---------------------------------------------------------------------------
\1\ Noncurrent loans are defined as loans 90 days or more past due
or in nonaccrual status.
---------------------------------------------------------------------------
FDIC-insured institutions are extremely active in virtually every
aspect of housing finance. These institutions act as lenders for home
construction and the permanent financing of both single family and
multifamily homes, as loan servicers and as issuers and investors in
mortgage-backed securities. These lines of business have been very
important in recent years to the ability of depository institutions to
generate both loan growth and fee income, and have helped support the
recent high levels of earnings.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Table 1 (attached) shows that housing-related assets held by FDIC-
insured institutions generally grew faster than commercial and
industrial loans in the early stages of this economic expansion. In the
most recent reporting period, year-over-year growth in holdings of
single-family mortgages slowed slightly to 10.5 percent, but holdings
of construction and development loans (which include both residential
and nonresidential properties) are currently growing at an annual rate
of over 30 percent.
Historical Performance of Real Estate Loan Portfolios at Banks and
Thrifts
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Across the historical period for which loan performance data are
available, mortgage lending has generally proven to be a relatively low
risk line of business accompanied by comparatively low returns. Charts
1 and 2 show that both the average return on assets and the average
loan chargeoff rate for institutions specializing in mortgage lending
have generally remained below the average for all FDIC-insured
institutions over the past 15 years. This performance is not surprising
because mortgage loans have traditionally been collateralized, subject
to industry-standard underwriting practices and tradable in a fairly
deep and liquid secondary market.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
In contrast, the credit performance of construction and development
(C&D) loans has tended to be more variable over the long-term.
Specifically, Charts 3 and 4 show that C&D loans performed poorly on
average during the banking and thrift crises of the late 1980s and
early 1990s. During that period, speculative construction loans, both
for residential and nonresidential properties, played a significant
role in the failure of institutions insured by the FDIC and the
FSLIC.\2\ By contrast, the average overall performance of home mortgage
loans remained comparatively strong during the early 1990s and has
remained so up to the present time.
---------------------------------------------------------------------------
\2\ See FDIC, History of the Eighties-Lessons for the Future,
Chapter 3: ``Commercial Real Estate and the Banking Crises of the 1980s
and early 1990s,'' 1997.
---------------------------------------------------------------------------
It also is important to note that recent ratios of both problem
loans and net chargeoffs have been very low by historical standards in
every loan category related to housing finance. This performance can be
attributed in large part to the low interest rates of recent years, as
well as the large home price increases that have been seen in many
parts of the nation.
Notwithstanding the lower losses generally associated with mortgage
loans over time, mortgage credit distress has been observed
historically in certain metropolitan areas where severe local economic
distress was accompanied by steep declines in home prices. A prime
example was Houston, Texas between 1984 and 1987. As documented in the
FDIC's history of the period, the shifting fortunes of the oil
industry--from boom in the early 1980s to bust after 1985--was the
primary force behind both a real estate bust in the latter half of that
decade and the failure of hundreds of federally-insured depository
institutions in the region. This boom-bust cycle represented the most
serious of the regional banking crises experienced around the nation
during that era.
Recent FDIC Analysis of Housing Boom and Bust Cycles
Given its historical experience, the FDIC has in recent years
continuously monitored trends in U.S. home prices and mortgage lending
practices as part of its risk analysis activities. FDIC analysts issued
two companion studies in our FYI series in February and May 2005 that
examined housing boom and bust cycles. These studies, which are
summarized in my testimony and available on the FDIC's website\3\,
concluded that housing booms do not necessarily lead to housing busts.
Instead, the analysis found that housing busts were usually associated
with episodes of local economic distress.
---------------------------------------------------------------------------
\3\ C. Angell and N. Williams, ``U.S. Home Prices: Does Bust Always
Follow Boom?,'' FDIC, FYI, February 10, 2005, http://www.fdic.gov/bank/
analytical/fyi/2005/021005fyi.html, and Angell and Williams, ``FYI
Revisited--U.S. Home Prices: Does Bust Always Follow Boom?,'' FDIC,
FYI, May 2, 2005, http://www.fdic.gov/bank/analytical/fyi/2005/
050205fyi.html.
---------------------------------------------------------------------------
Analytical Approach
The FDIC studies make use of the OFHEO House Price Index (HPI)
series, which tracks average house prices for many U.S. metropolitan
areas as far back as 1977. Based on ``matched sale'' observations of
sale prices, and appraisals on refinancings, for the same properties
over time, these data are thought to be a reliable indicator of home
price trends that is relatively unaffected by changes in the
composition of the housing stock.
Measuring annual changes in HPI for all metropolitan areas for
which it is available, the FDIC analysts asked three simple questions:
Where have housing booms been located?
Where have housing busts been located?
Does boom necessarily lead to bust in U.S. housing
markets?
In order to answer these questions, the analysts first had to
develop definitions of boom and bust in terms of observed price
changes.
The definition of a housing boom used in the studies includes any
metropolitan area that experienced at least a 30 percent increase in
its HPI--adjusted for inflation--during a given three-year period. This
definition serves not only to identify cities that have experienced
large cumulative upward price changes in a relatively short period, but
the inflation adjustment also helps to create a standard yardstick that
can be used to compare price changes during periods of relatively high
inflation (the late 1970s) with periods of relatively low inflation
(since the early 1990s).
The analysts also created a standard definition for a metropolitan-
area housing bust, namely any metropolitan area that experienced at
least a 15 percent decline in HPI, in nominal terms, during a given
five-year period. Nominal, as opposed to inflation-adjusted, price
changes were used in the definition of a bust because it is nominal
price declines that can potentially erode the equity of homeowners and
reduce the incentive to repay the loan as well as the proceeds that can
be obtained from the underlying collateral in the event of foreclosure.
A nominal price decline of 15 percent was chosen because this
represents a serious erosion of value. Such a decline would eliminate
any equity of homebuyers who made only a 10 percent down payment and
would seriously impair the equity of those who made a 20 percent down
payment. Given the increase in high loan-to-value mortgage lending
during the recent housing boom, a decline of this magnitude could cause
concern.\4\
---------------------------------------------------------------------------
\4\ In 2005, 43 percent of first-time buyers obtained 100 percent
financing. Source: ``2005 National Association of Realtors Profile of
Home Buyers and Sellers,'' NAR, January 2006.
---------------------------------------------------------------------------
Finally, a five-year period was chosen in the definition of bust
because of the observation that price declines tend to be long, drawn-
out affairs rather than brief, precipitous declines. What this means is
that home prices tend to be--in economist jargon--``sticky downward,''
with consequences described below.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Historical Results
Applying these standard definitions for booms and busts over the
period from 1978 through 1998, FDIC analysts generated the list of
cities that appears in Table 2. Based on these results, a few
straightforward observations may be made.
1. Housing booms and housing busts, as well as other price
trends that do not quite meet the FDIC's definitions, tend to
be long-term trends that play out over years.
2. Despite the fact that the definition of a bust is somewhat
less stringent than that of a boom, busts are observed to be
relatively rare events. Prior to 2000, only 21 busts were
observed compared with 54 housing booms.
3. Of the 21 metropolitan-area housing busts, only nine (43
percent) were preceded within five years by a housing boom.
4. Conversely, of the 54 observed metropolitan-area housing
booms, only nine (17 percent) led to a housing bust within five
years.
5. Housing booms do not last forever. Most commonly, they are
followed by an extended period of ``stagnation'' where prices
may fall, but usually not by enough to meet the FDIC's
definition of a bust.
Based on these results, FDIC analysts could not conclude that boom
necessarily leads to bust. Instead, they found that housing busts were
usually associated with episodes of local economic distress, such as
the energy-sector problems that beset Houston in the mid-1980s.
Other metropolitan areas where housing busts were at least in part
attributable to problems in the energy sector included Anchorage, AK;
Casper, WY; Grand Junction, CO; Lafayette, LA; Oklahoma City, OK; and
five metropolitan areas in Texas. The study also attributed early 1990s
housing busts in parts of New England and Southern California to a
combination of defense industry cutbacks, a slowdown in commercial real
estate construction, and the effects of the 1990-91 recession. Finally,
the busts recorded in Peoria, IL from 1984 through 1988 and Honolulu,
HI from 1996 through 2001 were largely attributed to the effects of
distress in the U.S. farm sector and the Japanese economy,
respectively, and were both interpreted in the study as arising from
outside the local housing sector itself.
The finding that housing booms do not necessarily lead to busts is
somewhat reassuring from a risk management perspective. The periods of
price stagnation that typically follow booms have not necessarily been
associated with high mortgage credit losses to the degree that have
sometimes been seen in bust markets. Rather housing stagnation tends to
be characterized by steep declines in common measures of housing market
activity, including new home sales, existing home sales, and housing
starts. Home price stagnation can also be marked by declines in home
prices that do not meet the FDIC's criteria for a bust.
The FDIC's analysis shows that average home prices fell in at least
one year of the five years following a housing boom in 35 of the 54
booms that were identified. In 28 cases, the cumulative five-year
change in home prices following the boom was negative, although only
nine of these cases met the ``15 percent'' criteria for a bust.
These periods of stagnation can be painful for homeowners, real
estate investors, and others who make their living in real estate. In
places like metropolitan New York, where prices fell by nine percent
between 1988 and 1991, or Washington, D.C., where home prices remained
essentially unchanged on average between 1990 and 1995, many can still
recall the difficulties and disappointments they experienced trying to
sell properties during the early 1990s. While often difficult in an
individual situation, the credit implications of such periods of
stagnation are much less severe, at least for mortgage loans, than
situations where home prices decline sharply.
Current Boom Markets
Somewhat less reassuring, however, are the results derived by
applying the studies' framework to the U.S. housing boom that developed
during the first half of this decade and that now appears to be near an
end.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chart 5 tracks the number of boom markets from 1978 through 2005.
It shows that the number of boom markets has grown rapidly all through
this decade--accelerating after 2002 as the number of markets exceeded
its previous 1988 peak and nearly tripling to 89 metropolitan areas. A
listing of all recent boom markets and 3-year cumulative percent
changes in average real home prices in these markets is provided in
Table 3.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
As in previous housing booms, recent boom markets have continued to
be concentrated in the Northeast, the Middle Atlantic States,
California, the Northwest, and areas of the Mountain West States. The
state of Florida, which had never experienced a boom market according
to the FDIC's criteria between 1977 and 2002, was home to 21 boom
markets as of 2005.
Factors shared by many boom markets--particularly those that had
recurrent booms across time--include a combination of vibrant economies
that are generating jobs and drawing in new residents, or a scarcity of
available land on which to build new homes to meet demand, or both. By
contrast, metropolitan areas in the middle of the country that depend
more heavily on agriculture and manufacturing, and where land is
readily available, have generally had much lower rates of home price
appreciation in this decade.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
However, the intensification of the home price boom sinc 2002 has
been unprecedented in scale as well as in scope. Chart 6 tracks annual
changes at the national level in both the OFHEO home price index and
disposable personal incomes, both measured in nominal terms. It shows
that while disposable incomes have grown slightly faster than average
home prices during most years, home prices began to grow faster than
incomes beginning in 2001 much the same as they had during previous
boom periods in 1978-79 and 1986-87. What stands out in Chart 6 is the
acceleration of average U.S. home price growth to double-digit rates in
2004 adn 2005. Average U.S. home prices grew more than three times
faster than disposable incomes in 2005.
However, the intensification of the home price boom since 2002 has
been unprecedented in scale as well as in scope. Chart 6 tracks annual
changes at the national level in both the OFHEO home price index and
disposable personal incomes, both measured in nominal terms. It shows
that while disposable incomes have grown slightly faster than average
home prices during most years, home prices began to grow faster than
incomes beginning in 2001 much the same as they had during previous
boom periods in 1978-79 and 1986-87. What stands out in Chart 6 is the
acceleration of average U.S. home price growth to double-digit rates in
2004 and 2005. Average U.S. home prices grew more than three times
faster than disposable incomes in 2005.
Recent Changes in Mortgage Markets
In seeking to explain the recent acceleration in home price growth,
the FDIC analysts in their May 2005 FYI study pointed to important
changes in the mortgage lending business in 2004 and 2005 that may be
related to the acceleration of home price growth. Certainly, low short-
term and long-term interest rates are factors that have helped to
support home price growth in recent years. However, in 2004, just as
short-term interest rates were beginning to rise, borrowers began to
migrate toward adjustable-rate mortgages (ARMs) that are commonly
indexed to short-term interest rates.
According to the Federal Housing Finance Board, over 30 percent of
all conventional mortgages closed in 2004 and 2005 were ARMs. The ARM
share moderated to 25 percent by the second quarter of 2006. The
percentage of ARMs among subprime mortgages is higher. Within subprime
mortgage backed securities, the share of ARMs was far higher, close to
80 percent.\5\ The prevalence of subprime loans among all mortgage
originations doubled from 9 percent in 2003 to 19 percent in 2004.\6\
---------------------------------------------------------------------------
\5\ See ``ARMs Power the Subprime MBS Market in Early 2006,''
Inside B&C Lending, July 21, 2006. Subprime mortgages are higher-
interest mortgages that involve elevated credit risk. For more on
subprime mortgages, see C. Angell, ``Breaking New Ground in U.S.
Mortgage Lending,'' FDIC Outlook, Summer 2006. http://www.fdic.gov/
bank/analytical/regional/ro20062q/na/2006_summer04.html.
\6\ See ``Mortgage Originations by Product,'' Inside Mortgage
Finance, February 25, 2005.
---------------------------------------------------------------------------
One possible explanation for the shift toward ARMs and subprime
loans is that prime borrowers with a preference for fixed-rate
mortgages refinanced in record numbers as long-term interest rates fell
to the lowest rates in a generation in 2003. This refinancing boom may
have tended to skew the composition of mortgage loans in 2004 and 2005
more toward subprime and ARM borrowers. Another explanation might be
that new homebuyers were increasingly using the lower monthly payments
associated with ARMs to cope with rapidly rising home prices.
Adjustable-rate mortgage borrowers also increasingly turned to
interest-only and payment option loan structures in 2004 and 2005.\7\
These mortgages are specifically designed to minimize initial mortgage
payments by eliminating or relaxing the requirement to repay principal
during the early years of the loan. Although it is difficult to measure
the use of these mortgage structures across all mortgage originations,
they appear to have made up as much as 40 to 50 percent of all loans
securitized by private issuers of mortgage-backed securities during
2004 and 2005.
---------------------------------------------------------------------------
\7\ In an interest-only (IO) mortgage, the borrower is required to
pay only the interest due on the loan for the first few years, during
which time the rate may be fixed or fluctuate. After the IO period, the
rate may be fixed or fluctuate based on the prescribed index; payments
consist of both principal and interest. In a payment option ARM, the
borrower may choose from a number of payment options that may include
options that allow for negative amortization--an increase in the
principal balance of the loan. For more on these loan types, see C.
Angell, ``Breaking New Ground in U.S. Mortgage Lending,'' FDIC Outlook,
Summer 2006. http://www.fdic.gov/bank/analytical/regional/ro20062q/na/
2006_summer04.html.
---------------------------------------------------------------------------
Finally, there is evidence that a significant proportion of
mortgage loans were made to real estate investors in 2004 and 2005. The
National Association of Realtors found that 28 percent of all homes
purchased in 2005 were for investment rather than occupancy by the
buyers, up from 25 percent in 2004.\8\ This high share signals an
increase in speculative purchases of residential properties,
particularly condominiums. While speculative buying is a fairly common
feature of housing booms, this activity deserves particular mention
when home price increases have been so large and when use of
nontraditional mortgages has increased as much as in the past two
years.
---------------------------------------------------------------------------
\8\ ``Second Home Sales Hit Another Record in 2005; Market Share
Rises,'' NAR, April 5, 2006, http://www.realtor.org/
PublicAffairsWeb.nsf/Pages/SecondHomeSales05?OpenDocument. Loan data
compiled by LoanPerformance Corporation from its loan-service companies
found that 9.5 percent of home-purchase mortgages in 2005 were for
investors, up from 8.6 percent in 2004. The discrepancy between the two
reports may lie in differences in data collection and reporting.
LoanPerformance does not capture data on homes purchased without a
loan, and some investors may not identify themselves as such to lenders
in order to avoid higher rates typically charged to investors.
``Investment Homes To Get Less Focus, Realtors Predict,'' The Wall
Street Journal, April 6, 2006.
---------------------------------------------------------------------------
Implications for the Future Path of U.S. Home Prices
After undergoing a boom of historic proportions in recent years, a
variety of recent indicators show that housing market activity is
waning in most areas of the nation. Sales of new homes in July 2006
were 22 percent lower than a year ago, while sales of existing homes
were down 11 percent. Home price increases in most markets appear to be
tapering off to single-digit rates, while small price declines have
been seen in a number of markets located in the upper Midwest states.
The FDIC's analysis of metropolitan-area boom and bust cycles over
a period of almost 30 years indicates that the metropolitan-area
housing booms that have recently occurred in record numbers cannot last
indefinitely. In their aftermath, there will almost certainly be one of
two possible outcomes: (1) a period of stagnation with weak home prices
and even weaker measures of housing market activity; or (2) a price
bust, or a sharp decline in home prices with severe adverse
consequences for homeowners, lenders and the real estate sector as a
whole.
The historical experience clearly implies that a widespread price
bust remains an unlikely outcome for two reasons. One is that
historically price busts are typically associated with severe local
economic distress that arises from outside the housing sector itself.
While recent macroeconomic performance has benefited a great deal from
expansion in the housing sector, the prospects appear good that the
solid growth in jobs and incomes that has occurred in recent quarters
will continue to be supported by other sectors of the economy,
including business investment, exports and nonresidential construction.
The second reason a home price bust remains an unlikely outcome is
the anticipated response on the part of homeowners to weakness in their
local real estate market. As was mentioned earlier in my testimony,
home prices tend to be ``sticky downward'' in large part because
homeowners are usually extremely reluctant to sell their homes at a
loss unless forced to do so by the relocation or loss of their jobs.
Under a wide range of adverse economic scenarios, homeowners have
proven to go to extraordinary lengths to avoid selling their homes at a
loss. Most commonly, they will simply choose to remain in them, or to
rent them so as to cover at least part of their debt service costs.
While the reluctance to sell has the effect of limiting the extent of
the decline in home prices, the resulting period of stagnation can last
for years.
The exception to this rule has been episodes of severe local
economic distress that produce large job losses, declines in personal
incomes, and, in many cases, out-migration to other areas where job
prospects are brighter. While such circumstances remain possible in
areas dominated by troubled industry sectors, they will remain the
exception rather than the rule.
What is yet to be determined is the effect that recent changes in
the mortgage lending business may have on the ability of homeowners to
meet their monthly obligations under adverse housing market conditions.
While adjustable-rate mortgages are not new in the marketplace, many of
the newly popular interest-only and payment option structures may lead
to a significant increase in monthly payments due to higher short-term
interest rates or simply the expiration of low introductory interest
rates. It remains uncertain how much the ``payment shock'' associated
with these structures may contribute to selling pressure in local
housing markets on the part of distressed homeowners or lenders looking
to sell foreclosed properties.
It is important to note that the overall prevalence of
nontraditional mortgage structures remains fairly limited. While total
ARMs originated in 2004 and 2005 are estimated to represent
approximately 22 percent of all U.S. mortgage loans, it is likely that
just under half that amount is comprised of interest-only and payment
option structures.\9\ Borrowers who took on nontraditional loans as a
means to afford a more expensive home may be particularly vulnerable to
adverse housing market conditions. However, other borrowers who have
used these structures to help manage their wealth or compensate for
irregular income streams will be less severely affected.
---------------------------------------------------------------------------
\9\ ``Mortgage Payment Resets: The Rumor and the Reality,'' C.
Cagan, First American Real Estate Solutions, February 8, 2006.
---------------------------------------------------------------------------
Conclusion
In conclusion, FDIC studies indicate that housing price booms
historically have not necessarily been followed by housing price busts.
Instead, they found that housing busts were usually associated with
episodes of local economic distress, such as the energy-sector problems
that beset Houston in the mid-1980s. Housing booms are more frequently
followed by periods of housing stagnation that tend to be characterized
by steep declines in common measures of housing market activity,
including new home sales, existing home sales, and housing starts. Home
price stagnation can also be marked by declines in home prices that do
not meet the FDIC's criteria for a bust.
Although housing price booms have not necessarily been followed by
housing price busts, there are two factors in today's markets that are
different from the historical experience. The number of boom markets is
substantially higher currently than the historical experience. In
addition, the use of ARMs and non-traditional mortgage products is
unprecedented and could have an impact on future market performance.
This concludes my testimony. I will be happy to respond to any
questions the Subcommittees might have.
______
PREPARED STATEMENT OF DAVID SEIDERS
Chief Economist, National Association of Homebuilders
September 13, 2006
THE HOUSING DOWNSWING: CAUSES, DIMENSIONS AND ECONOMIC CONSEQUENCES
Chairman Allard, Chairman Bunning, Ranking Member Reed, and Ranking
Member Schumer, my name is David Seiders and I am the Chief Economist
for the National Association of Home Builders (NAHB). I am pleased to
appear before you today to share NAHB's views on the outlook for
housing and the economy. NAHB represents 235,000 member firms involved
in home building, remodeling, multifamily construction, property
management, housing finance, building product manufacturing and other
aspects of residential and light commercial construction.
Summary and Conclusions
The U.S. housing market exhibited ``boom'' conditions during most
of the 2004-2005 period but home sales and housing production now are
coming down. Indeed, housing has already swung from a powerful engine
of economic growth to a significant drag on the economic expansion, and
there are serious questions about the impacts of housing on the economy
going forward.
This statement outlines the basic causes of the current housing
downswing, estimates the depth and duration of the downswing, and
discusses the likely economic consequences of the falloff in housing
market activity as well as the likely impacts of several secondary
effects of the evolving housing cycle. The basic conclusions are as
follows:
Both the housing boom of 2004-2005 and the current
housing contraction have unique features that make them
substantially different from previous housing market swings.
The big differences relate primarily to unusually stimulative
financial market conditions during the boom, record-breaking
increases in inflation-adjusted house prices, and an outsized
presence of investors/speculators in single-family and condo
markets.
The current contraction amounts to an inevitable
mid-cycle adjustment, or transition, from unsustainable levels
of home sales, housing production and house price appreciation
to levels that are supportable by underlying market
fundamentals.
The previous boom involved more than two years of
unsustainable housing market activity, and we're likely to
experience a below-trend performance of home sales and housing
starts of roughly similar duration. The downswing in home sales
and housing production should bottom out around the middle of
next year before transitioning to a gradual recovery that will
raise housing market activity back up toward sustainable trend
by the latter part of 2008.
National average house price appreciation is likely
to be quite limited in the near term. Indeed, some decline is a
distinct possibility, and the rate of price appreciation should
remain below trend for some time. ``True'' house price
appreciation, accounting for upward bias in key price measures
as well as price support from non-price sales incentives
provided by sellers, presumably will be even weaker.
The downswing in home sales and housing production
will continue to detract from overall economic growth through
mid-2007. However, much of this negative impact should be
offset by strengthening activity in other sectors of the U.S.
economy, keeping GDP growth reasonably close to a sustainable
trend-like performance.
There are bound to be some adverse secondary
effects of the recent housing boom and the subsequent downswing
on the ongoing economic expansion. These effects include
negative impacts on consumer spending from a fading wealth
effect as house prices adjust as well as from the impacts of
``payment shock'' on homeowners facing upward adjustments to
monthly payments on ``exotic'' types of adjustable-rate
mortgages (ARMs) originated since 2003. However, the size and
timing of these effects are not likely to seriously threaten
the economic expansion.
The housing and economic outlook characterized
above rests on a number of key conditions, and downside risks
to the outlook are considerable. These risks include the
possibility of spikes in interest rates or energy prices as
well as large resales of homes back onto the markets by
investor/speculators. There also are considerable uncertainties
about the true dimensions of the risk facing homeowners with
``exotic'' ARMs, and there are major uncertainties regarding
the size of the inventory overhang in the market for new homes.
Causes of the Housing Downswing
The roots of the current housing downswing were cultivated before
and during the housing boom of 2004-2005. The housing boom actually was
touched off by the extraordinary monetary stimulus enacted by the
Federal Reserve to fight off the threat of price deflation in the U.S.
economy. The Fed dropped the federal funds rate to 1 percent at mid-
2003 (a negative ``real'' rate), held it there through mid-2004 and
then embarked on a gradual path back toward monetary ``neutrality''--a
journey that didn't reach its goal until the early part of this year.
Furthermore, the extraordinary degree of monetary stimulus in the U.S.,
together with low long-term rates abroad, kept long-term interest rates
in the U.S. at historic lows during most of the 2003-2005 period. This
extremely favorable financing environment fueled buying activity in the
interest-sensitive housing sector, pulling some demand forward in the
process.
The surge in housing demand quickly put substantial upward pressure
on house prices, aided and abetted in many parts of the country by
land-use constraints that limited the amount of supply that builders
could bring onto the markets in short order. Surging prices bolstered
expectations of future price appreciation, driving down the user cost
of capital and bolstering the investment aspects of homeownership. The
extremely favorable tax treatment of capital gains on housing (enacted
in 1997) certainly contributed to these developments.
The extraordinarily low interest rate structure and the rise in
house price expectations attracted many households out of rental
apartments and into first-time homeownership, driving both the
homeownership rate and the rental vacancy rate to record highs by early
2004. Furthermore, waves of investors/speculators bought into the
single-family and condo markets to share in the unprecedented real
capital gains being generated--at a time when our stock market was in
questionable condition, yields on interest-bearing investments were at
rock bottom and it was difficult to find attractive investment
alternatives in foreign markets.
The mortgage lending community also contributed to the housing
boom, marketing a wide range of ``exotic'' ARMs (to coin a Greenspan
term) that were designed to help get prospective buyers (including
subprime credit risks) into homeownership and to accommodate investors/
speculators with short-term investment objectives. These lending
practices naturally fueled demand further, adding to the already
considerable upward pressures on prices of single-family homes and
condo units. Both federal regulators of depository institutions and
financial rating agencies raised flags about overly aggressive mortgage
lending practices, particularly payment-option ARMs that permit
negative amortization, but these flags apparently had little influence
on lending practices in either the regulated or unregulated markets.
The ongoing accumulation of large house price increases began to
weigh on housing affordability measures by the early part of 2004,
despite the stubbornly low interest rate structure. However,
proliferation of the ``exotic'' ARMs kept a lot of prospective
homeowners in the game, particularly in relatively high-priced markets.
Meanwhile, the investors/speculators continued to plough ahead, still
drawn by the lure of future price appreciation.
Home sales and house price appreciation kept rising to higher and
higher records throughout 2004 and into 2005, and the affordability
measures kept falling. Affordability was subject to additional downward
pressure after mid-2005 as the whole interest rate structure finally
shifted upward, and the aggregate demand for homes finally started to
give way in the third quarter of last year.
The combination of fading demand on the part of prospective
homeowners and a supply train that still was moving ahead quickly
changed a raging ``sellers' market'' into a market where inventories
were climbing and buyers could shop and bargain. Symptoms of the switch
naturally caught the attention of savvy investors who cut back on
buying, started cancelling sales contacts before closing and even
started reselling vacant units they had closed on earlier.
In retrospect, it was the finance- and price-driven acceleration of
buying for homeownership and for investment that drove housing market
activity into unsustainable territory during the boom. We're now
experiencing a ``payback'' in demand for homeownership, following the
surge that pulled demand forward into the boom years, and net purchases
by investors/speculators are coming down considerably as price
expectations are being marked down.
Dimensions of the Housing Downswing
The 2004-2005 housing boom took home sales and housing production
well above levels supportable by demographics and other fundamental
demand factors. The cumulative excess of housing starts apparently
amounted to at least 400 thousand units, and the excess supply now
resides in builder inventories or in the hands of investors who may
cancel contracts or sell vacant units at any time. In this regard, it's
worth noting that the single-family rental vacancy rate soared to
record highs during the boom, came down to some degree during the first
half of this year, and presumably is heading lower for some time.
It's clear that the housing downswing still has some distance to
go, if only to work off excess supply in markets for both new and
existing homes (including the condo market). Builders are cutting back
on new permit authorizations as well as on starts of new units, and
they are trimming prices and offering sizeable non-price sales
incentives to limit cancellations and bolster sales. Furthermore,
various economic and financial market fundamentals figure to be
supportive of housing demand for the foreseeable future, helping to
facilitate the inventory correction. These fundamentals include the
following:
Payroll employment growth is proceeding at a decent
and sustainable pace.
Household income growth is strengthening as the
economic expansion proceeds.
The interest rate structure is favorable, mortgage
credit is readily available and monetary policy has stabilized
following a long run of upward rate adjustments.
Energy prices have receded from record highs
earlier this year.
As long as the economy remains in good shape, interest rates remain
close to current levels, energy prices remain below recent highs and
sellers of new and existing homes adjust prices or offer incentives to
fit current market realities, the rest of the housing market correction
should be of limited depth and duration. It's likely that the bulk of
the downswing in home sales and housing production will occur this
year, with market activity stabilizing around mid-2007 and moving back
up toward trend by late 2008. NAHB's forecast has a cumulative
shortfall of housing starts (below our estimate of sustainable trend)
of roughly 400 thousand units from the middle of this year through the
end of 2008, in line with the estimated excess supply generated during
the boom period.
House Price Adjustments
House price appreciation was very rapid during the housing boom,
and ``real'' house price appreciation soared to record rates. The
national appreciation rate has slowed considerably since then, in both
nominal and real terms, as sales volume has fallen and inventories of
both new and existing homes have climbed. Absolute price declines
actually were recorded for some markets in the second quarter of this
year, although most of these markets were located in the beleaguered
economies of the Great Lakes region rather than in previously
overheated areas.
The size of the current inventory overhang and the marked slowdown
in price appreciation that's already occurred point toward a
generalized flatness in nominal house prices in the near term, and some
price erosion certainly could occur in coming quarters. In any case, an
extended period of below-trend national house price appreciation lies
ahead, and ``real'' house prices should come down to some degree. These
adjustments certainly will give a boost to affordability for
prospective homeowners as time passes.
It's worth noting that all available measures of house price
appreciation have technical deficiencies--even the purchase-only
version of OFHEO's quarterly repeat-sales House Price Index. This
measure is not reflective of the entire market, it contains some upward
bias because it does not account for improvements to homes over time,
and there's no way to adjust price appreciation downward to account for
non-price sales incentives provided by sellers. Despite these
limitations, it's the best available gauge of house price change in the
U.S. as well as in regions, states and metro areas.
Economic Consequences of the Housing Downswing
The U.S. economy can continue to grow at close to a trend pace even
as the downswing in home sales and housing production runs its course.
For one thing, the housing correction is a relatively isolated sectoral
event, primarily reflecting recoil from earlier excesses within the
sector. Unlike previous downswings, housing affordability has been
squeezed primarily by price increases and the normally close
correlation between housing activity and other interest-sensitive
components of aggregate demand is not strong this time.
It's also true that the housing downswing is occurring at the same
time that other sectors of the economy are in mid-cycle expansion
phases. This apparently is true of spending on capital equipment and
software, nonresidential structures and exports. This type of sectoral
rotation actually could give new life to the economic expansion (now
nearly 5 years old), and the net outcome could very well be trend-like
GDP growth with manageable core inflation and reasonably stable
interest rates. That's an environment where housing would be able to
deliver healthy trend-like performances of its own, riding on strong
demographic trends and other fundamental demand factors.
Household Wealth and Consumer Spending
The ongoing deceleration of house prices, and possible national
house price declines, will take some strength out of consumer spending.
After all, the rapid runup in house values and household wealth clearly
fueled consumption expenditures during the housing boom, allowing the
personal saving rate to go negative for an extended period of time.
Furthermore, much of this spending was financed via borrowing against
accumulated housing equity (cash-out refinancings and home equity
loans) at a time when interest rates were lower than now.
It's true that the housing wealth effect on consumer spending will
be weakening to some degree as house prices slow and possibly even
decline, but the erosion of support to consumer spending should be
gradual over time and occur primarily after the downswing in home sales
and housing production has run its course and residential fixed
investment has completed its contraction (mid-2007). Households
typically react to changes in wealth with long lags (one to three
years), and the influence of the recent dramatic wealth buildup on
consumer spending should carry through for some time.
With respect to the influence of increases in the cost of accessing
housing wealth via mortgage borrowing, a wealth of research shows that
it's the wealth (or net worth) effect that really matters, not the
amount of housing equity that's ``withdrawn'' via mortgage borrowing.
Wealth-driven consumer expenditures can be financed by spending more
out of current income (for those with positive savings), by running
down financial assets or by using non-mortgage debt (e.g., personal
loans).
Mortgage Payment Shock
The proliferation of ``exotic'' ARMs during the housing boom
(payment-option, interest-only, etc.) has raised the specter of
widespread ``payment shock'' for homeowners when such loans hit their
first rate resets and/or when the loans begin to require repayment of
principal. These adjustments, when they occur, will put heavier demands
on household budgets, with downside implications for consumer spending,
and some homeowners will be forced into delinquency and even loan
default. Subprime mortgage borrowers presumably are the most at risk.
There's no doubt that the surge of ``exotic'' ARMs, and the
associated relaxation of lending standards at both regulated and
unregulated financial institutions, helped fuel the housing boom and
will be creating problems for some homeowners. However, most
outstanding mortgage debt is either fixed-rate or standard types of
ARMs, and household income growth since loan origination should enable
the majority of homeowners facing ARM payment adjustments to handle the
higher monthly payments. Price appreciation since origination also will
provide a financial buffer for many of those facing unanticipated
increases in monthly payments.
Homeowners facing large payment adjustments on exotic ARMs also can
refinance into other types of ARMs or into fixed-rate mortgages at
historically low rates, and most of the ``exotic'' ARMs apparently do
not carry substantial prepayment penalties.
It's also worth remembering that there was a strong correlation,
across metro areas, between the frequency of ``exotic'' ARMs and
investor shares of home mortgage originations. Many investors
apparently used these types of loans to minimize short-term financing
costs, and many presumably will be paid off or refinanced before upward
payment adjustments occur.
Everything considered, payment shock associated with ``exotic''
ARMs written during the boom will most likely be a negative for
consumer spending in the next few years but should not threaten the
projected economic expansion.
Downside Risks
The housing and economic outlook described above rests on a number
of key conditions, and downside risks to the outlook are considerable.
Housing forecasts always are subject to the risk of unanticipated
interest rate spikes, and reluctance by foreign investors to continue
to finance our huge current account deficit could put serious upward
pressure on the U.S. interest rate structure. Furthermore, recent
experience in energy markets suggests that a major surge in energy
prices can't be ruled out.
There also are major uncertainties about the prospective behavior
of the unprecedented numbers of investors/speculators that bought
single-family homes and condo units during the boom. NAHB's surveys of
builders show large numbers of cancellations of sales contracts before
closing as well as less-frequent reports of resales of units closed on
earlier. Our forecasts assume that any reflow of units back onto the
markets is of manageable proportions and that wholesale dumping does
not materialize.
The prospective impact of payment resets on ``exotic'' ARMs,
particularly payment-option ARMs with negative amortization, also is
difficult to predict. It's possible to estimate the volume of
potentially troublesome loans outstanding as well as the approximate
timing of the first payment resets. However, there are a lot of
uncertainties about the quality of loan underwriting during the boom
housing years, including the degree of ``layering'' of permissive
lending practices, and it's hard to predict the ultimate outcome on
loan quality and consumer spending.
Another uncertainty relates to the true size of the inventory of
new homes for sale. The Commerce Department's estimates exclude homes
left with builders when sales contracts are cancelled, and
cancellations have been rising sharply since this time last year.
NAHB's forecast attempts to account for this factor, but the true size
of the inventory overhang remains a grey area at best.
Mr. Chairman, that concludes my remarks. Again, thank you for the
opportunity to appear before this joint subcommittee today. I look
forward to answering any questions you or the members of the joint
subcommittee have for me.
______
PREPARED STATEMENT OF TOM STEVENS
President, National Association of Realtors'
September 13, 2006
Chairmen Allard, Bunning and Ranking Members Schumer and Reed, and
Members of the Subcommittees, my name is Tom Stevens, and I am the
former President of Coldwell Banker Stevens (now known as Coldwell
Banker Residential Brokerage Mid-Atlantic)--a full-service realty firm
specializing in residential sales and brokerage. Since 2004, I have
served as senior vice president for NRT Inc., the largest residential
real estate brokerage company in the nation.
As the 2006 President of the National Association of
REALTORS', I am here to testify on behalf of our nearly 1.3
million REALTOR' members. We thank you for the opportunity
to present our views of the current real estate market as well as
prospects for the future. NAR represents a wide variety of housing
industry professionals committed to the development and preservation of
the nation's housing stock and making it available to the widest range
of potential homebuyers. The Association has a long tradition of
supporting innovative and effective housing programs and we continue to
work diligently with the Congress to fashion housing policies that
ensure housing programs meet their mission responsibly and efficiently.
For the past five years, the housing market has been a steadfast
leader in the U.S. economy. In 2005, mortgage rates remained near 45-
year lows while the nation's economy generated 2 million net new jobs.
Existing-home sales rose 4.4 percent in 2005, resulting in five
successive record years. Both new-home sales and new single-family
housing starts also set new high marks in 2005. Overall, the housing
sector directly contributed more than $2 trillion to the national
economy in 2005, accounting for 16.2 percent of economic activity. In
addition, commercial real estate contributed an additional $330 billion
to the nation's economy.
After five years of outstanding growth and being the driving force
of the U.S. economy, the housing market is undergoing a period of
adjustment. I have experienced this first hand as my prior home has
been on the market, in Northern Virginia, for over a year. Existing
home sales in July fell 11.2 percent from a year ago. New home sales
are down 22 percent from a year ago. The inventory of unsold homes on
the market is at an all-time high of 3.9 million, which is a 40 percent
rise from a year ago. Given the falling demand and increased supply,
home prices have seen less than 1 percent appreciation from a year ago
compared to the double-digit rate of appreciation in 2005.
While recent developments raise concerns, it is important to
remember that the housing market varies significantly across the
country. One-third of the country (by population) is still seeing
rising home sales. They include Alaska, Vermont, New Mexico and many
states in the South (excluding Florida). The remaining two-thirds of
the country is experiencing lower sales with some states feeling acute
adjustment pains. Sales are down significantly in Florida, California,
Arizona, Nevada, Virginia, and Maryland. These regions experienced the
greatest rise in home prices in recent years and affordability has
become a major issue. The sharp decline in sales have resulted in a
much higher housing inventory (tripling and quadrupling in some cases)
and these areas are vulnerable to outright price declines, particularly
if interest rates were to rise further.
The industrial Midwest region did not participate in the nationwide
housing market boom of the past five years due to weaker job market
conditions. Job gains have been minimal in Ohio and Indiana during the
recent nationwide economic expansion. Job losses have been continuing
in Michigan--for five straight years.
Contrary to many reports, there is not a ``national housing
bubble.'' All real estate is local. For example, the housing market in
California is extremely different from Oklahoma. Home price-to-income
ratio, home price-to-rent ratio, and more importantly, mortgage debt
servicing cost-to-income ratio have greatly increased in some markets
to worrisome levels. Markets in Florida, California, Arizona, Nevada,
Virginia, and Maryland exhibit trends far above the local historical
norm, thus it would not be surprising for these markets to experience a
price adjustment. However, these states have solid job growth--Because
of solid job growth, price declines are likely to be short-lived as new
job holders provide demand and support for the housing market.
If the mortgage rates were to rise measurably--to say 7.5 percent
or 8 percent from the current 6.5 percent--for whatever reasons (be it
Chinese dumping dollars on the market, higher inflationary
expectations, or monetary tightening by the Federal Reserve) then the
housing market would certainly come under more pressure and many
markets would likely undergo price declines.
The most influential factor is the rising mortgage rates. Many
homebuyers in coastal markets have resorted to more exotic mortgages.
Due to very high home prices, interest-only, adjustable rate, and/or
option-ARMS became the only way to enter the housing market for some
homebuyers. In essence, the homebuyers in the coastal markets are at
their financial capacity. With rising mortgage rates, homebuyers are
becoming exhausted financially, which explains why sales have tumbled
in high priced regions of the country. In the industrial Midwest, as I
said earlier, the housing market is more job market dependent and less
mortgage rate dependent.
Another factor is the insufficient presence of Government Sponsored
Enterprises (GSEs) and the Federal Housing Administration (FHA) in the
high priced regions. The increases in GSE/FHA loan limits have not kept
pace in places like California, Florida, and parts of New York among
others. For example, loan limits rose 7.8 percent in 2005 while home
prices rose 19 percent in Los Angeles, 25 percent in the D.C., and 30
percent in Miami. Consider, for a moment, that FHA's share of loans in
Los Angeles went down from nearly 20 percent in 2000 to essentially
zero today.
As you know, FHA loans often serve neglected demographic segments
of the housing market--first time, lower income, minority, and
immigrant homebuyers. NAR applauds the Bush Administration's FHA reform
proposal currently being considered in Congress. A modernized FHA will
be a valuable tool to people seeking to buy a home in softer housing
and mortgage markets. As we have seen in the past, in soft local and
regional markets, FHA has filled significant gaps in the private sector
lending market, becoming the predominant tool to achieve homeownership
and helping to carry regions out of an economic downturn. In the mid
1980s, in Colorado, Oklahoma, Louisiana, and Texas, the FHA loan
program stepped in, while private mortgage providers left those in
distressed economic areas, and took over a substantial role in
providing available mortgage credit to those in affected states. An FHA
with the tools to complete the task will be important to thousands of
Americans hoping to buy a home, but in particular, in those markets
that really need the help.
Florida has also been hit by another unique factor--the lack of
affordable property insurance. The unprecedented number of strong
hurricanes hitting the Florida shores in 2004 and 2005 has resulted in
a dysfunctional insurance market where premiums have either increased--
literally through the roof--or are simply not available. We have heard
many stories from our membership in Florida about how potential
homebuyers backed away at the last moment either due to the insurance
sticker shock or due to outright unavailability of insurance.
The national forecast for the coming year, based on stabilizing
mortgage rates and a modestly expanding economy through 2007, predicts
that existing home sales will fall 8 percent in 2006 followed by
another 2 percent decline in 2007. New home sales will fall by an even
greater amount of 16 percent in 2006 and then 7 percent in 2007. Home
price growth will be minimal (less than 3 percent) in both of these
years, again, it is important to remember that all real estate is
local. Therefore, some local markets will not comport with the national
forecast. Any significant shift in mortgage rates and the state of the
economy will also alter the outlook.
Based on the housing market forecast mentioned above, the
residential construction spending portion of the economy will contract
3.4 percent in 2006 and 8.5 percent in 2007. In other words, $21
billion will be subtracted from GDP in 2006 and another $49 billion
slashed in 2007. That would be a sharp contrast to the near $50 billion
in additions during the housing market boom.
The more important contribution of the housing sector has not been
in the direct employment of real estate agents, mortgage lenders,
construction workers, or expansion of Home Depot and Lowe's to name a
few. Consumer spending of all things (from furniture and autos to
travel and education) has been greatly supported by the increase in
housing equity accumulation. A typical homeowner in the U.S. gained
$72,300 in housing equity in the past five years, including over
$20,000 just last year. Nearly all economists will say that consumer
spending has been far more robust than can be explained by income
growth, job gains, and stock market gains. GDP growth would have been
1.5 percent points lower had the housing market not provided the wealth
accumulation in recent years.
NAR understands that the housing sector could not maintain a record
setting pace indefinitely. A soft landing is certainly possible and
under the right circumstances likely, but that soft landing is
critically dependent upon policies that support a transition to a more
normalized market and mitigate changes in local markets in the
availability of mortgage financing and other essential elements to
homeownership.
In conclusion, the National Association of REALTORS'
commends the Subcommittees for holding this important hearing and for
its leadership in fashioning housing and economic policies that
stimulate the U.S. economy. The NAR stands ready to work with Congress
to continue to open the door to the American Dream--Homeownership. This
concludes my testimony and I look forward to answering any questions
you may have.
______
ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD
Housing Policy Council,
The Financial Services Roundtable,
Washington, DC, September 12, 2006.
Senator Wayne Allard,
Chairman, Subcommittee on Housing and Transportation
Senator Jim Bunning,
Chairman, Subcommittee on Economic Policy, US Senate Committee on
Banking, Dirksen Senate Office Building, Washington, DC.
Dear Chairman Allard and Chairman Bunning: Thank you for holding a
joint Subcommittee hearing on the current state of the U.S. housing
market. This is a timely subject and the Housing Policy Council (HPC)
welcomes the opportunity to share its views on this issue and an
important step that Congress can take to provide increased support and
protection for our Nation's housing finance system.
The Financial Services Roundtable's Housing Policy Council's
members are twenty-two of the nation's leading mortgage finance
providers. We estimate that Housing Policy Council member companies
originate over sixty-four percent of mortgages for American consumers.
The Financial Services Roundtable is the national trade association of
one hundred of the nation's leading diversified financial services
companies.
As your subcommittees considers data on the current state of the
nation's housing market, we urge you to keep in mind that Congress can
take a very strong step to insure the safety and soundness of the
housing finance system by passing legislation to strengthen the
regulatory oversight of the housing GSEs. The GSEs--Fannie Mae, Freddie
Mac and the Federal Home Loan Bank System are integral parts of the
secondary mortgage market. Their safety and soundness is essential to
effectively managing changes in the housing market. The current
regulatory system, particularly the statutory authority of the Office
of Federal Housing Enterprise Oversight (OFHEO) is currently inadequate
to effectively regulate Fannie Mae and Freddie Mac in the increasingly
complex housing finance system.
As you will hear from a variety of sources, the U.S. housing market
in recent years has experienced some of the strongest growth in our
history. That unprecedented growth is now slowing significantly as
indicated by a variety of indicators:
Housing starts are down from the January 2006 peak
and are the lowest since November 2004
New and Existing Home Sales have declined over the
past year
Mortgage applications to purchase homes are down
over 23% from the 2005 peak.
It is anticipated that this weakening of the housing market will
continue for the near future. While the strength of the housing market
in recent years has been a tremendous boon to individual Americans and
the overall economy, the current weakening of the housing market
reemphasizes the need to put safeguards in place now to deal with
possible housing market developments.
Improving the ability of the federal regulator to oversee the
housing-GSEs is one step that Congress is very close to accomplishing,
and we urge that the final steps be taken to enact this needed reform
legislation.
Failure to pass GSE regulatory reform legislation this year would
limit OFHEO's ability to deal with potential safety and soundness
matters at the GSEs, which could become serious, if the weakening of
the housing market is worse than most currently expect.
OFHEO currently lacks some of the fundamental safety and soundness
regulatory authority that other financial services regulators have long
possessed. For example, unlike the federal banking agencies, OHFEO
lacks the authority to adjust capital for the GSEs to address safety
and soundness problems. OFHEO must rely upon its cease and desist
powers to force adjustments in capital. Those cease and desist powers
also are more limited than the powers Congress has granted to the
federal banking agencies. Congress has given the federal banking
agencies the authority to bring cease and desist actions against any
officer, employee or consultant of a bank for a violation of any law or
regulation. OFHEO, on the other hand, cannot issue a cease and desist
order to an employee or a consultant of a GSE, and may only issue such
an order when certain laws and regulations are violated. Furthermore,
because OFHEO is subject to the Congressional appropriations process,
the agency has often lacked the resources necessary to properly review
the activities of the GSEs. No federal banking agency is subject to the
Congressional appropriations process.
We believe that remaining issues regarding the appropriate
authority for the regulator can be addressed. For example, on the issue
of regulating the size of retained mortgage portfolios of the GSEs, the
new regulator clearly needs the ability to adjust the portfolios of the
GSEs to reflect the needs of the housing market and potential systemic
economic risks.
Improving the regulatory oversight of the housing-GSEs would
strengthen the foundation for our housing finance system. Congress is
very close to achieving this goal and should complete it this year.
Creating a strong, independent regulator with authority comparable to
other federal financial services regulators is long-overdue and much
needed for the future of our housing finance system.
Thank you for considering our views.
With best wishes,
John H. Dalton,
President, Housing Policy Council.