Housing Bubble vs. Housing Market Slowdown

The central issue addressed by the April 2006 Economic Outlook issued by Freddie Mac on Monday is the conflict created between the strength of the economy and the increasing lack of housing affordability.

Freddie's Office of the Chief Economist cites the strong employment numbers for the first quarter of 2006, a total of 590,000 jobs created during those three months; an unemployment rate of 4.7 percent, the lowest in over four years; and average hourly earnings which are up 21 cents since the end of 2005. But the report is quick to temper this rosy employment picture, stating that many of the new jobs are in states where the housing market has made purchasing a single-family home a tough stretch for average families.

The report points to two regions of the country, the West and the Midwest to illustrate what it calls an inverse relationship between job growth and housing affordability. The West Coast has seen the greatest job creation, adding 610,000 jobs from February 2005 to February 2006. However, a median income family could purchase only 81 percent of a median priced home in that region. The Midwest showed the poorest rate of job creation, adding only 224,000 jobs (the two regions are fairly equal in population) during the same period but, in the Midwest a median family could qualify to purchase 164 percent of a median house. And this discrepancy is growing; the difference between the fastest house growth region and the slowest was at 12 percent last year compared to four percentage points a decade ago. Therefore, families are increasingly hard pressed to find a good job and a house they can afford without a very, very long commute.

The report goes on to tie this lack of affordability to the growth in the popularity of adjustable rates mortgages and especially to nontraditional ARM products such as negative amortization and interest only loans. Use of these types of loans is often the only way families can qualify for a mortgage in these high cost communities. According to data from LoanPerformance quoted in the report, interest only and negative am loans including the so-called option mortgages represented 31 percent of all ARMs in 2005 as compared to 11 percent two years earlier. The Outlook draws no conclusions about the ramifications of this increasing reliance on what are generally regarded as risky ways to finance a home.

Freddie is projecting that long term interest rates will rise only slightly, ending 2006 at 6.5 percent, a figure close to what they have been projecting for many months, and interest only and option payment hybrid ARMS will continue to drive the use of ARMS beyond what would be expected given the narrowing difference in interest rates between long term loans and ARMs. It projects that, while the inverted or flat yield curve (which creates that decreasing difference) will remain for at least the rest of 2006, low introductory or "teaser" rates that artificially depress ARM rates in order to keep that product marketable. The estimate for a 1-year Treasury Indexed ARM rate is 5.5 percent average for this year and 5.7 percent in 2007. Freddie expects that the ARM share of mortgages will continue to average around 27 percent for the remainder of the year, close to the current share and that single family loan originations overall will moderate by 13 percent to an estimated 2.45 trillion dollars this year. Most of this decline will be accounted by the volume of refinances which is forecast to fall from a 44 percent market share in 2005 to 36 percent this year.

Housing starts have remained so strong that the Outlook has revised its March forecast for the first quarter of 2006 from 2.04 million starts on a seasonally adjusted basis to 2.21 million units. Estimates for the remainder of the year are much lower, dropping from an annualized 1.98 million in Quarter Two to 1.86 million in Quarter Four. This would put the year-long estimated total at 1.99 million units, 4 percent lower than 2005.

Total home sales have slipped during the first two months to 7.07 million seasonally adjusted units so the Outlook now forecasts 7.46 million units for the year, a decrease of 7 percent from the record sales recorded in 2005.

On everyone's favorite topic, home price appreciation, Freddie is no doomsayer. While prices are no longer expected to be increasing by double digits, the report is anticipating a healthy increase of 8.7 percent although with the caveat that the stronger piece of this growth will happen, or may have already happened, in the early part of the year. Peering even further into the future, the report projects continued appreciation of 7.0 percent in 2007 and 6.3 percent in 2008.