September 20, 2012

For the US economy to undergo a sustained recovery an improvement in the labour market situation also needs to be accompanied by a pick-up in the housing market. The unemployment rate remains above 8%, although more than three million new jobs have been created in the last few years. The rate is thus declining, but it remains high by US standards.

The housing market is sending out more positive signals. The Case-Shiller price index nearly doubled between 2000 and 2006. Despite the subprime bubble having burst house prices are currently still 30% higher than the average for the millennium. However, since incomes have risen by 35% during the same period, the affordability index is now back at its 2000 level – thereby putting the higher house prices into perspective. The correction phase can be regarded as largely completed, and the outlook is improving.

This is confirmed by the latest figures. Housing approvals and starts remain at historically low levels, but they have risen by more than 50% since leaving their troughs and have trended up slightly over the last six months.

Foreclosure rates have fallen by 30% according to data from the National Delinquency Survey. With the stabilising of house prices and interest rates at record lows, foreclosure rates are likely to fall further.

Despite the improved situation: Risks remain

In 2012 so far 25% of house sales have been foreclosure cases. If currently non-performing mortgage loans should be foreclosed, then another sharp increase in the volume of housing stock will loom. However, precautionary measures such as California's “Homeowner Bill of Rights” and interest-rate or payment reduction programmes such as HARP and HAMP aim to avert a renewed downward spiral being triggered by foreclosures. It helps that the very low interest rate level provides scope for renegotiating loans that are at risk of default.

The low interest rate level does, however, also bring risks. Cheap loans provide strong incentives for investments that could lead to renewed exaggerations in house prices and ultimately to a new bubble.

Further risks arise from it being unclear what the future roles of Fannie Mae and Freddie Mac will be. In particular it is unclear whether both are to be run as private, government-sponsored entities or gov-ernment institutions, and attention is being focused on this issue – besides the level of future subsidies.

The risk of recession arising from the “fiscal cliff” could also put paid to the current stabilisation.

As the Fed, however, is intervening with unlimited liquidity injections – it has just been announced that USD 40 bn per month will be spent on purchasing mortgage loans – and if necessary it would even increase its monthly buying, the risks in the property market are likely to be very limited. On the other hand, there are fears that the decline in interest rates accompanying the Fed's intervention will barely be passed on to the end-consumer. The medium-term effect on house prices may then also be small.

Overall, we expect at least a sideways movement and possibly also a rise in housing prices following the pronouncements made by the Fed.