There are signs that the housing market may finally be hitting bottom, including this week's report that sales of existing homes rose in April from March levels. But there are also signs that the recovery may take a lot longer than usual.
CNBC cited a “refi boom” as perhaps signaling that the worst is over for housing. It seems to me that exchanging debt for debt, even reduced slightly over time, does not do much to put more money into the economy. The only case I could make is that there is again money to borrow, but again, how does that help the economy in general?
— Brian P., Seattle, Wash.
The increased borrowing is a good sign, but it’s not the only one. The biggest benefit to the economy from refinancing is the household spending money that’s freed up from paying higher mortgage-interest payments. Consumers can now use that extra money to save or spend. (In the short run, spending is the better for economic growth.)
Banks are beneficiaries, too, which helps rebuild the financial system and promote more lending. It’s true that a bank holding a mortgage getting refinanced loses out on future interest when the loan is paid off early. But most newly refinanced mortgages carry hefty upfront fees, which go straight to the bottom line of the bank writing the new mortgage. That infusion of cash is helping to fill in the multitrillion-dollar hole in the banking system that needs to be replenished before lending can get back up to speed.
None of this, however, does much for the housing industry. For that you need to see a pickup in new and existing home sales. About the best you can say on that front is that it looks like the pace of sales may have stopped falling. In April, homes were sold at an annual rate of 4.7 million — a bit better than March's level but down from 6.5 million in 2006, according to the National Association of Realtors. The median price of $170,200 was 15 percent below year-ago levels, as nearly half the sales were for "distressed properties" that typically sell at a deep discount.
Home sales add a big boost to the economy beyond the fees earned by real estate agents and mortgage brokers. Home buyers typically also spend money on new appliances, furnishings, repairs and improvements. Buyers of new homes create even more economic activity as the sale price covers wages for all of the contractors and laborers who built the house and as well as materials and supplies.
In April new home construction fell to a record low annual rate of just 458,000 units — down from a rate of more than 1.4 million as recently as 2007.
Even if low mortgage rates spur demand for new homes, builders face a huge overhang of existing homes on the market. In the first quarter, there was nearly 10 months' supply of unsold homes listed. That’s up from an average 6.5 months in 2006 and 4.5 months in 2005. As the housing market shows signs of improving, there may be more listings coming from homeowners who have been hoping to sell but waiting for the market to improve.
In past recessions, the pickup in home sales has been an important foundation for the economic recovery that follows. This time around, the recovery may lag somewhat — largely because home prices are still falling. As of March (latest data available), the S&P Case Shiller home price index was down 32 percent from its peak in June 2006 and still falling.
The loss of trillions of dollars in home equity — the bulk of most Americans' savings before the housing market collapsed — is going to put a damper on consumer spending even after the housing market gets on its feet again. That’s why many forecasters are expecting only a weak recovery later this year and into 2010.
I have read that all this new money that the government will be pumping into the economy will increase the money supply and cause inflation. But I was wondering how much, if at all, that will be countered by the presumed reduction in money supply caused by the large drop in the stock market and real estate market.
— Bob B., Barre, Vt.
That’s exactly what the folks at the Federal Reserve are hoping. So far, there’s evidence that they’re right. Despite the trillions of new money pumped into the economy and banking system — from Fed loans, the Treasury bank bailout and the economic stimulus package — there’s been barely a whiff of inflation. Prices, in fact, have been falling at the fastest pace since the 1950s.
Falling stock and home prices are part of the story. Another is the sharp drop in energy prices after the oil market collapsed last year. A deep global recession has also taken the pressure off prices of raw materials and basic equipment. As demand has dried up, the cost of a ton of steel or a new drilling rig has fallen sharply.
Readers are quick to point out that not all prices are falling. Food costs are up more than 3 percent from a year ago. So are medical costs. And we can confidently report that college tuition payments continue to rise — as they have every year we’ve been paying them.
For now, the inflation risk from all those trillions of new dollars sloshing around the global finance system seems to be fairly low. That risk will rise when the banking system and economy get back on their feet. A return to global economic growth will once again put pressure on prices of energy and raw materials. The huge pile of cash that banks and consumers are now hoarding will again be chasing a limited supply of goods and services. If the Fed hasn’t pulled enough money back out of the system by then, we could be in for another round of inflation — or another asset bubble — or both.
Based on the minutes of recent Fed policy meetings — and comments from Fed Chairman Ben Bernanke — the central bankers are well aware of this risk, even if they don’t see it as an imminent threat. Though he told Congress in February he didn’t see signs of inflation coming back, he did say that “once the economy begins to recover — as usual, the Fed would have to begin to tighten policy. It is very important for us to begin then to unwind our monetary expansion."
The hope is that, with a gradual recovery, the Fed can gradually drain money out of the system and head off a surge in prices. But the timing will be tricky. In some ways, flooding the system with cash to head off the catastrophic collapse of the global banking system was the easy part. Now the Fed has to time its exit just right.
Treasury officials face a similar issue with the hundreds of billions of dollars used to shore up the balance sheets of big banks. While some banks are expected to pay the money back fairly quickly, others may require government funding for some time. Treasury Secretary Tim Geithner assured Congress on May 20 that for the bank bailout to work, it was important to “unwind it as quickly as conditions permit.” That is central to the effectiveness of the strategy.
But, Geithner told lawmakers, “I'm not prepared to talk to that today. It is not quite time yet. We're not quite there yet."
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