As Monday’s Lex notes regarding the US stock bounce has a sting in the tail
Don’t look now but amid the negative news on everything from the shambles in Europe, America’s debt wranglings or worries over China, the good old US of A seems to be stringing together a nice run of positive data…
… Anything less than a massive rebound in bank shares, therefore, should be read as a warning sign. And there is indeed reason for caution. Why? Because the one series of data that has not improved of late is also one of the most important: house prices.
However, the bottom is in sight, according to Goldman Sachs. It reckons prices will decline another 2.5 per cent before stabilizing in the second half of 2012.
This is based on a new house price model that bank has constructed, which uses a much larger sample (147 metro areas) and a two-stage error correction approach.
We will spare you the details of that and get to the meat of the report by Jan Hatzius and his team.
Following the bursting of the housing bubble, house prices appear caught in a cross-current. On the one hand, there are indications that prices may finally be turning. First, homes no longer appear “expensive.” For example, a simple price/rent ratio—which stood more than 50% above its long-run value in early 2006—is now slightly below its historical average (Exhibit 1). Second, housing affordability—measured as the percent of income spent on mortgage principal and interest—is now at its best level in decades.
Other indicators, however, point to further house price declines. First, the housing market remains plagued by enormous excess supply (Exhibit 2). Despite recent improvements, the homeowner vacancy rate remains well above its historical level, and will take a number of years to return to normal. Second, the mortgage market remains troubled, as foreclosure inventory and delinquency rates have stayed elevated.
Given those powerful cross currents, why does Goldman expect house prices to bottom in the middle of next year?
Using our model to decompose house price changes during the last 15 years provides an intuitive account of the build-up and burst of the bubble (Exhibit 8). Our analysis suggests that fundamentals—such as income and population—were the main driver of the (modest) house price gains of the mid-1990s. Thereafter, house prices accelerated sharply due to (1) massive easing in lending standards through increased subprime loan origination and (2) increasing (and selfreinforcing) house price momentum. But as house prices continued rising, they became increasingly overvalued. This disequilibrium became so large in 2006 that prices started to turn.
The decline accelerated sharply in 2007 and 2008 as subprime lending dried up, vacancy rates increased and negative momentum gathered steam. The homebuyer tax credit then made an important contribution in mitigating this downward spiral in 2009 and 2010. Since its expiry, home prices have moved down again mainly due to the elevated vacancy rate.
Our model projects that the national Case-Shiller index will decline by another 2½% from mid-2011 through mid-2012, before stabilizing in the year thereafter. (Our forecast for the 20-city Case-Shiller index is a 3½% decline from mid-2011 through mid- 2012, before stabilizing in the year thereafter.) Excess supply and negative momentum are the main drivers of the projected decline over the next four quarters. Thereafter, negative momentum weakens and house prices are projected to stabilize. This forecast is only a bit weaker than the latest consensus forecast.
So Goldman’s fancy new model with its enhanced sample size etc backs up the consensus view on house prices.
We’re not sure if that’s reassuring or not.
Anyway, here’s how the forecast breaks down:
Miami, Cleveland and Detroit, which is 50 per cent below its equilibrium price level, show gains, while Portland, New York and Atlanta all show losses.
And in case you are wondering, yes Hatzius & Co do expect the Federal Reserve to return to balance sheet expansion before this bottom in house prices.
We expect that the Fed will ultimately announce a return to balance sheet expansion sometime in the first half of 2012, likely including purchases of mortgagebacked securities (MBS). We also expect Fed officials to begin publishing their forecasts for the federal funds rate in the quarterly Summary of Economic Projections (SEP). Like the current forward guidance in the post-meeting statement, this would emphasize that rates are likely to stay low, but would be more clearly conditional on outcomes for economic activity and inflation.
(Hang on a minute. Haven’t we read that somewhere else this morning? – Ed).