Wednesday 25 February 2009
Housing aid should be focused on nonbubble markets.
The data in the December Case-Shiller 20-City index indicate that the rate of housing price decline is continuing to accelerate. The data show that house prices in the 20 cities fell at a rate of 2.0 percent in the month of December and were falling at a 21.3 percent annual rate in the last quarter of 2008.
It is important to remember that these data reflect sale prices in the three month period from October to December. Since there is typically a 6-8 week period between contracts and closing, these data reflect contracts in a period centered on October. This means that the data is already somewhat dated when it is released. If the recent rate of price decline has persisted, prices are already 8 percent lower on average than the data indicate.
For the fourth consecutive month, prices declined in all twenty cities in the index. While prices continue to decline rapidly in former bubble markets, there were also sharp drops in some markets that had been less affected by the bubble. For example, prices in Minneapolis fell 4.1 percent in December and have fallen at a 31.5 percent annual rate over the last quarter. Prices in Atlanta fell 2.0 percent in December and have fallen at a 21.5 percent rate over the quarter.
However, most of the bubble markets continue to deflate rapidly. Prices in Phoenix, San Francisco, and Miami fell by 4.5 percent, 3.2 percent, and 2.7 percent, respectively, in December. The respective annual rate of price declines in these cities over the last quarter is 35.9 percent, 32.6 percent, 28.2 percent.
The implications of this rate of house price decline are striking. The country is losing approximately $400 billion in housing equity every month and would lose more than $4 trillion in housing equity over the course of a year at these rates of decline. Such rapid rates of price decline also make mortgage lending far more risky. A mortgage issued with a 20 percent down payment will be underwater in less than a year with the current rate of price decline shown in the 20-city index. In the cities with the fastest rate of price decline, a mortgage with a 20 percent down payment could be underwater in less than six months.
The rapid disappearance of home equity also means that fewer buyers will be able to put up any substantial down payment. As plunging home prices destroy home equity, even many long-time homeowners will find themselves in the same situation as first-time homebuyers if they try to buy a new home. With little or no equity in their current home, they will also struggle to find sufficient funds for a down payment.
This background must be kept in mind when assessing the Obama administration's housing proposal. Given the vast oversupply of housing and the sharp downward momentum in the housing market, a $75 billion program is almost certainly too small to have a substantial impact on the rate of price decline in a $20 trillion market. It is also not clear that it will provide substantial assistance to the homeowners who take part in the program.
In the partially deflated bubble markets, homeowners are still likely to be paying more in housing costs even after the payment reductions in the Obama plan than they would pay to rent a comparable unit. Given the continuing decline in house prices and the fact that many are already underwater, most homeowners are likely to still end up with no equity when they leave their home. (The median period of homeownership is just seven years.) Given these circumstances, it is difficult to see this plan as especially positive.
This sort of plan could have been more effective if it focused on the markets where the bubble had already deflated, as measured by the price-to-rent ratio. In these cases, the mortgage subsidies would actually allow homeowners to make monthly payments that are comparable to rents and leave them in a situation where they may end up with equity in their homes. Also, by focusing its money on markets where prices are not over-valued, the government could possibly provide an effective floor.
Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.