Financial Commentary

Title: Deepening Financial Turmoil Delays Housing Recovery
Source:   MBA
Date: 10/21/2008

Deepening Financial Turmoil Delays Housing Recovery

Financial Markets More Stressful:

We noted in the previous forecast that the government’s action to place Fannie Mae and Freddie Mac into conservatorship had improved the outlook for the housing and mortgage markets as mortgage rates had the potential to decline as a result.  However, since the forecast was published, the stress in the financial markets has intensified and panic has overtaken the markets.  

Over the past months, policymakers have taken one step after another to stabilize the markets in an effort to help revive the banking sector and fight the global credit crunch.  To shore up capital positions of financial institutions, Congress passed the Emergency Economic Stabilization Act, which gave the Treasury Department authority to acquire distressed assets from banks and other financial institutions in a program called Troubled Asset Relief Program (TARP). 

While the details of the Troubled Asset Relief Program (TARP) remain uncertain, it is now clear that the Treasury will allocate $250 billion of the money authorized for the TARP to directly recapitalize banks, with $125 billion already committed to specific banks.  In addition, the FDIC will provide an explicit government guarantee of new senior unsecured bank debt for three years.  These actions should help unfreeze the short-term credit markets as it reduces the risk of bankruptcy for banks and thus should increase the willingness of banks to lend to one another as well as to businesses and consumers.

Massive liquidity injections by central banks around the world over the past several weeks are slowly working to push down the interest rates on interbank lending.  The Libor rates have slowly declined, which should help reduce financial stress as these rates are used to calculate interest rates on some mortgages and business loans.  Other short-term interest rates such as the rates on commercial papers have declined as well. 

With increased uncertainty on financial markets and the economy and with responses from policymakers to tackle the credit crisis, there is little clarity on how effective these measures will be to shore up the capital position of financial institutions and restore liquidity and confidence to the financial system.   We will closely track market development over the next few weeks to gauge the short-term results of these measures.  For now, we have downgraded our projections of the housing and mortgage markets as a result of the renewed financial turmoil and the deteriorating economy.

Current Conditions:

Mortgage Spreads Widen

The Treasury’s actions on Fannie Mae and Freddie Mac immediately resulted in lower mortgage rates.  The spread between the yields on 10-year Treasury notes and conforming fixed-rate mortgages narrowed to less than 230 basis points in the week following the Treasury’s announcement, from over 260 basis points in the prior week.   However, that spread has recently widened in response to the announcement by the Treasury that it will take equity stakes in banks and the announcement by the FDIC that it will guarantee new bank debt.  Mortgage-backed securities (MBSs) have faced more competition from other government-guaranteed debt.  As a result, the declining demand for MBSs has raised funding costs for mortgages, widening spread on agency MBSs over swap and Treasuries. 

Existing Home Sales Stabilize but New Home Sales Continue to Drop Sharply

Both existing and new home sales declined in August while inventory remained historically high.  Total existing home sales fell modestly compared with new home sales.  Since November 2007, sales have been in a narrow range of 4.8 million to 5.0 million units as foreclosure sales propped up the market.  By contrast, new home sales posted a double-digit drop for the month after showing signs of stabilization over the last several months.

The relatively stronger performance of existing home sales than new home sales largely reflected the rising share of foreclosed homes that were sold through the multiple listing service (MLS).  Many homebuyers have found that foreclosed homes can be substitutes for new homes, especially those that were recently built and are being sold at deep discounts.  The National Association of Realtors estimated that foreclosures account for about one-third of the existing home market, indicating that activity would have been much weaker had it not been for distressed sales. 

The months’ supply measures for both new and existing homes stayed above ten months, which is worrisome given that it has now been over two years of the housing downturn.  For new homes, the Census Bureau does not revise data to account for cancellations of sales contracts, which makes it difficult to gauge true market conditions.  If cancellations are rising, inventory would be temporarily understated.  Major home builders continued to report rising cancellation rates.  For example, KB Home reported that, for the three months ended August 31, the cancellation rate (cancelled units divided by gross orders) rose to 51 percent, up from 27 percent in the previous three months.  With tighter lending standards and reduced credit availability, potential buyers are having trouble selling existing homes and securing financing.

All measures of home prices released over the past month showed accelerating price declines.  The median price for total existing homes posted the largest decline on record at 9.5 percent, compared with a sizable 6.2 percent drop for new homes.  The monthly purchase-only index from the Office of Federal Housing Enterprise Oversight fell 0.6 percent in July from June and 5.3 percent from July 2007.  The large monthly drop was disappointing as the index had shown a slower pace of decline in May and June, offering some hope that home price declines would start to moderate. 

Homebuilding activity continued to fall in September.  This is necessary to reduce excess supply in the housing market given the huge overhang of unsold inventory in many parts of the country and soft housing demand. 

Housing and Mortgage Market Projections:

Leading indicators of home building activity suggested further declines in the near term.  Single-family permitsa leading indicator for single-family housing startsdropped in September for the 17th time over the past 18 months.  Home builders saw no signs of improvement in the housing market.  The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index—a measure of home builders’ confidence—declined in to a record low in October.

Given deteriorating performance of leading indicators of the housing market, we expect continued declines in housing activity.  For housing starts, we downgraded our projections from the previous forecast: starts should hit bottom in the second quarter of 2009 at 800,000 units (originally projected in the fourth quarter of this year at 875,000 units).  For new home sales, we also downgraded our 2008 projection.  Sales should bottom in the second quarter of 2009 at 413,000 units, compared with a bottom of 477,000 units reached in the fourth quarter of 2008 in the September forecast.  Projections for existing home sales for the year were little changed, with sales stabilizing at the current low levels for the rest of year before increasing modestly next year. 

We expect housing activity to remain sluggish in 2009, as the economic downturn continues through the first half of next year.  As economic growth accelerates to trend pace in 2010 and credit conditions return to more normal levels, we expect significant improvement in both housing starts and home sales.  Given the elevated months’ supply, home prices, on average, should decline further through next year before edging up in 2010.

Below are our projections for the rest of this year and next two years:

  • Total existing home sales for 2008 will decline about 13 percent from 2007 to 4.94 million units.  Sales will pick up about three percent in 2009 and about six percent in 2010. 

  • New home sales will decline about 36 percent from 2007 to 499,000 units.  We expect sales to decline another 12 percent in 2009 before rising about 25 percent in 2010.

  • Median home prices for new and existing homes are expected to continue their decline this year, falling about 6-7 percent.  Prices should decline more modestly in 2009 before rising slightly in 2010.

  • Purchase originations should fall this year by another 20 percent to $912 billion from an estimated $1,140 billion in 2007.  Purchase originations should rise about two percent in 2009, as existing home sales recover and home price declines moderate.  For 2010, we expect purchase originations to increase about nine percent as home sales increase strongly and home prices stop declining.


  • Refinance originations will decline about 19 percent from an estimated $1,167 billion in 2007 to $ 949 billion in 2008.  Refi activity will decline another 23 percent in 2009 before increasing about four percent in 2010, as lending standards ease. 


  • Total mortgage production will be down 19 percent from an estimated $2.31 trillion in 2007 to $1.86 trillion this year.  Total originations should see a more moderate decline in 2009 of about ten percent to $1.67 trillion as an increase in purchase originations partially offsets a drop in refi originations.  Projected increases in both purchase and refi activity in 2010 should boost total originations by about seven percent to $1.78 trillion.