January 20, 2004

Unemployment versus Low Mortgage Rates: The Housing Cage Match

HGX, the Philly listed index of homebuilders, was up 0.25% yesterday, coming within kissing distance of 360. And the National Association of Home Builders came out with a forecast for a “healthy” housing market in 2004. This from today’s WSJ: David Seiders, chief economist for the Washington-based builders group, forecast 1.45 million single-family housing starts this year, a drop of about 3% from last year's 1.5 million but still a historically high number. However, Mr. Seiders said his estimate may well prove conservative because continued weakness in job growth and other factors are putting pressure on mortgage rates to stay low. Housing has boomed in recent years even as other portions of the economy have faltered. The boom was driven in part by low interest rates, which set mortgage rates and helped bring them down to their lowest levels in decades. Mr. Seiders, presenting his forecast at the International Builders' Show in Las Vegas, expects low interest rates to continue. He forecasts that the surprisingly weak December employment data reported earlier this month and the continued low inflation rate will make gains in the short-term rates controlled by the Federal Reserve less likely this year. And so the lines of argument are now drawn out clearly. Historically low-mortgage rates will stay historically low, feeding historically high housing starts historically longer. History in the constant making. The key is mortgage rates. As long as they stay low, new buyers can brought in to the market to buy up the new capacity. Three points here, though, as ride my housing hobbyhorse this grey London morning. First, home buying comes down to affordability of the monthly mortgage payment. And the affordability of the monthly mortgage payment is a function of two things: interest rates, and income. Interest rates are low. They have been low. And they may even stay low for a while. But if the best hopes of the bulls come true and economic activity takes off this year, Fed complicity or not, it would raise rates. Let’s assume, for a moment, that rates stay low. This makes housing “affordable” to borrowers who couldn’t make monthly payments at a higher interest rate. “Affordable,” that is, as long as incomes keep rising. And so the labor market and long-term income growth are ALSO crucial to the sustainability of the housing boom. In the quote above, David Seiders says a weak labor market is an excuse to keep rates low. True. But a weak labor market also eats into the number of potential new buyers who don’t have the jobs or the income to support buying a home. That’s the downside. If you wanted to go really far out in time (and perhaps on a limb), you could say, as I’ve been saying, that incomes are disinflating in America…against a backdrop of a huge structural migration of high-income manufacturing and service jobs OUT of America and TO Asia. If I’m right about this…it won’t be the end of the world for everyone…but it will certainly be bad news for precisely that calibre of buyer homebuilders are counting on to come into the market and purchase a new home for the first time. Even low rates will not compensate for a diminishing pool of buyers with incomes sufficient to afford a new house. For now, though, we’re still in the capacity over-build stage of the boom. Homebuilders are acting as if there’s an infinite demand for their product, and that prices will always rise. This is also a sign that homes are being treated as financial assets…not as the durable goods they actually are (or not so durable with some of the newer homes.) Bottom line….the low-rate environment may be supportive to homebuilders in the first half of 2004…but the income portion of the affordability equation will start to eat into new home sales at some point. Higher mortgage rates or higher unemployment. Take your pick. Neither is good for housing.


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