Yellen Has Scant Power to Relieve U.S. Housing Slowdown
May 28, 2014
By Rich Miller and Victoria Stilwell of BLOOMBERG
The hesitant housing recovery has surprised and concerned Federal Reserve Chair Janet Yellen and her colleagues at the central bank. It’s not clear how much they can do about it.
While the industry is rebounding from a weather-ravaged first quarter, the pickup will probably fall short of previous projections, according to economists at Goldman Sachs Group Inc. of New York and Macroeconomic Advisers LLC in St. Louis. As a result, they trimmed their forecasts for economic growth in the second half of 2014 to about 3.25 percent from 3.5 percent.
“Housing is a growing worry,” said Macroeconomic Advisers’ senior economist Ben Herzon.
Yellen and many of her colleagues agree. The Fed chair flagged the industry as a risk to the outlook in testimony to Congress on May 7, while Federal Reserve Bank of New York President William C. Dudley said last week he had been surprised by how weak it had been recently. He added that he still expects gross domestic product to “get back on a roughly 3 percent growth trajectory” after stalling in the first quarter.
The trouble from the Fed’s perspective is that many of the forces holding housing back are outside of its control. While the Fed can influence mortgage rates through its conduct of monetary policy, it can’t do much, if anything, to counteract the other causes of faltering demand: lagging household formation, stingy lenders and wary borrowers.
“Mortgage financing is extremely tight,” said Ellen Zentner, senior economist at Morgan Stanley in New York. “And that’s not something the Fed can manipulate.”
The Fed’s ability to affect the supply of housing is even more limited. Builders are complaining about rising costs and an increasing difficulty in hiring skilled workers. They’re also concentrating on developing bigger, higher-priced projects rather than on the starter homes more buyers can afford. And they too are plagued by tight credit.
Dennis McConnell’s company is one of them. Before the housing crisis, Healthy House of Georgia built about 10 homes a year in historic districts in Atlanta. He said he’s put up two in the last six years combined, partly because of difficulties in finding financing.
McConnell said he’s resorting to private lenders to make his deals happen. Private sources can range from friends and family and self-financed projects to “hard-money” lenders — “someone who, when you sign the dotted line, you count your fingers and toes and make sure you have them all back.”
“For those poor saps like myself who build a couple houses a year or have a specialty market like mine, funding just became impossible,” he said.
Statistics released last week suggested that the industry is still struggling. While sales of previously owned homes rose for the first time this year in April, they were still some 7 percent lower than a year earlier, according to data from the National Association of Realtors. New single-family house sales last month were 4.2 percent below the year-earlier level, Commerce Department data showed.
“New home sales bounce back to mediocrity,” was how economists Stephanie Karol and Patrick Newport of Lexington, Massachusetts-based IHS Global Insight characterized the numbers in a May 23 e-mail analysis.
Housing stocks have also taken a hit this year. The Standard and Poor’s Supercomposite Homebuilding Index, which includes companies such as Lennar Corp. and PulteGroup Inc., has declined 1.74 percent this year through yesterday, compared with a 3.4 percent gain in the broader S&P 500 Index.
Drag on Growth
After boosting GDP for 12 straight quarters, residential investment subtracted 0.26 percentage point from growth in the fourth quarter of 2013 and 0.18 point in the first quarter of this year, according to the Commerce Department.
Mortgage-finance company Fannie Mae predicts housing construction will strengthen in the months ahead and lift gross domestic product by 0.2 percentage point this year, said vice president Mark Palim. While that’s only off slightly from last year’s 0.33 point contribution, it’s a third of what Fannie Mae economists were expecting at the start of 2014.
“I think that through the rest of the year, we’ll see an improvement, albeit maybe a little bit slow, but I do think that we’re on the right track,” Larry Nicholson, president and chief executive officer at Westlake Village, California-based homebuilder Ryland Group Inc., said during a May 14 presentation.
Fed policy makers have been repeatedly frustrated by their inability to engineer a full-fledged recovery of housing through their easy-money policies. Then-Chairman Ben S. Bernanke even went so far as to send a central bank study on the housing market to Congress in 2012, outlining steps that lawmakers could take to revive the industry. Senate Republicans promptly rebuked the Fed for overstepping its role by making policy recommendations to Congress.
Mortgage rates have fallen recently as the bond market has rallied, in part on expectations of a continued loose monetary stance by the Fed. The average rate on a 30-year fixed loan was 4.14 percent in the week ended May 22, the lowest level since the end of October, according to McLean, Virginia-based Freddie Mac. However, that’s still up from 3.59 percent a year ago, around the time Bernanke mentioned that the central bank would start tapering its bond-buying program as the economy improved.
The decline isn’t “going to have a terribly big impact” on demand, especially since rates will probably rise again as the economy strengthens, said Mike Fratantoni, chief economist for the Mortgage Bankers Association in Washington.
The MBA’s purchase index, a measure of mortgage loan applications by those seeking to buy a home, stood at 180 in the week ended May 16, below the 197.5 average last year.
“The level of the mortgage rate is not the issue,” said David Crowe, chief economist at the National Association of Home Builders in Washington. “It’s the availability of credit.”
The supply of credit has improved slightly over the past year yet is still well below levels that would be considered normal, according to Fratantoni. The MBA’s mortgage credit availability index was 113.8 in April, up from 108.6 a year earlier but well below the 414.8 level that prevailed at the end of 2004, before the last housing boom.
If credit is key, then the most important policy maker when it comes to housing may not be Yellen, but Melvin Watt, the new director of the Federal Housing Finance Agency, which oversees government-controlled Fannie Mae and Freddie Mac.
In his first speech as head of the agency, Watt announced this month new rules to reduce the risk that banks will have to repurchase bad mortgages from Fannie and Freddie. The changes are designed to allow lenders to relax credit standards.
The steps Watt outlined are only going to help on the margin, said Laurie Goodman, director of the Housing Finance Policy Center at the Urban Institute in Washington. To broaden credit availability, it will be important for the FHFA, Fannie Mae and Freddie Mac to set out a clear timetable for improving the buyback process, she added.
Economists inside and outside the Fed had expected housing to take a hit from the rise in mortgage rates last year and the severe weather over the winter. What’s surprised them is the steepness of the decline and its persistence.
That’s led them to look for other reasons to explain the weakness. At their last meeting on April 29 to 30, Fed policy makers discussed a number of potential causes, according to the minutes of the gathering released last week. They included “higher home prices, construction bottlenecks stemming from a scarcity of labor and harsh winter weather, input-cost pressures or a shortage in the supply of available lots.”
“The housing downturn was very deep and protracted. It takes time to shift resources back into this area,” Dudley told the New York Association for Business Economics on May 20. “In some markets house prices still appear to be below the cost of building a new home. Thus, in those markets it remains uneconomic to undertake new home construction.”
Dudley also cited limited credit availability and reticent buyers as reasons for housing’s weakness. Heavy student debts have encouraged some young Americans to live with their parents rather than forming households of their own. Those debts also have discouraged them from purchasing homes.
What’s significant is that Dudley outlined “structural issues the Fed cannot control” in his speech, Neil Dutta, head of U.S. economics at Renaissance Macro Research LLC in New York, wrote in a May 27 note to clients.
“This supports the notion that the weakness in housing is not enough of a reason to derail the Fed from their baseline policy path,” he said. “Tapering continues.”