Economic Commentary: Two Fronts – Jobs and Confidence

by Lawrence Yun, NAR Chief Economist

Well, we may as well get ready for it. Yes, mortgage rates continue at historic lows, averaging around the 5-percent mark recently. But rates are likely to rise. By December of this year, the average mortgage rate could be close to 6 percent – perhaps as high at 6.5 percent. Why? The reasons for the increase are the macroeconomic forces of a recovering economy and a very high budget deficit. If the U.S. government has trouble borrowing and has to raise interest rates to attract investors to purchase U.S. debt, then the rest of the private sector will also pay higher interest rates.

The good news from that somewhat sobering scenario is that consumer price inflation will remain relatively benign and wage growth tepid, keeping the lid on borrowing rates and preventing them from rising too high. I do not foresee the mortgage rate going above 7 percent, at least for a prolonged period, in the next two years. Those engaged in the jumbo loan market or commercial real estate will note that rates are already that high. But current high rates on jumbo and commercial real estate loans are due to the lack of government guarantees. As the financial market exhibits clear signs of stabilization and as banks continue to build up their capital buffer, it is only a matter of time before lenders start lending to non-government backed sectors. So the underwriting standards for jumbo and commercial real estate mortgages could become less stringent from improvements in the bank capital situation just as interest rates on conventional and FHA mortgages begin to rise.

So, down the road we will have to face into the headwinds of higher mortgage rates on conventional and FHA loans, as well as the expiration of the home buyer tax credit (which ends in April for contract signings). Foreclosures also will remain troubling, as they will surely be just as high this year as last year. Is housing headed for more trouble or for a full recovery? The answer depends on two potentially big support factors: Jobs and Confidence.

Jobs

Potential home buyers (both first-timers and repeat buyers) who hold stable jobs respond to mortgage rate changes. But a new cohort of stable job holders needs to be created in order to sustain housing demand. In March, we saw the first meaningful job additions to the economy in more than three years as a net 162,000 new workers (payrolls) were added to the economy.

March’s job creation figure looks light in the aftermath of 8 million brutal layoffs over the past two years, and it will take some time to make up the difference. From April to the end of 2010, one million jobs could be added to the economy. Another two million could be in the offing next year. It may take four full years to fully recover all the job losses, but at least the darkest part of the job tunnel is behind us. Even the high-paying but hard-hit manufacturing sector appears to have turned the corner with 17,000 job gains. Surprisingly, the construction sector added jobs as well, despite very weak housing starts and a dearth of commercial construction. Infrastructure spending no doubt is helping. Employment in rental-and-leasing also rose – by 1,800. Separately, and to gauge competition, NAR membership in March was 1.063 million, little changed from the 1.068 million one year ago, though down from the peak 1.4 million members in 2007. Past patterns indicate that NAR membership rises from spring well into autumn, before a seasonal dip in winter.

Confidence

A second factor that will be important in supporting the housing market is consumers’ views regarding home purchases. In the past three years, most metro markets experienced successive price declines; rational consumers asked “why buy now when I can buy later for less?” Renters have been staying put for an average 19 months in recent times before making a move versus the typical 14 months (this, according to a Wall Street Journal report). Census data suggests suppressed household formation in the past two years – meaning more people living with roommates or with parents – and so not seeking their own housing.

But with home prices showing signs of stabilization, the change in attitude towards home buying could be at hand. NAR’s median home price data in February indicated only a slight decline from 12 months earlier, while the Case-Shiller price index showed a modest price increase. This price stabilization came about because home buyers responded to the tax credit. There was a surge in home buying late last year as the original tax credit deadline loomed. Pending home sales in February also stirred higher, hinting the beginning of a second surge as the April deadline approaches. This forward momentum will likely – perhaps definitively – signal the “bottoming out” of home prices in few months time. Only then will consumers fully regain their confidence about home purchases. Of course, this home buying confidence is not directly observable, though we know it plays a big factor. A separate consumer confidence index, based on several qualitative questions tallied by The Conference Board, has not shown any notable improvement of late, however. This index stood 70.2 in March, about the same level as the prior nine months, though much improved from late 2008 and early 2009 in the midst of the financial market crisis. (For more information about The Conference Board’s Consumer Confidence Index, see the In Focus column in this issue of Real Estate INSIGHTS.)

Economy

The broader production economy has been doing quite well. GDP expanded robustly by 5.6 percent in the final quarter of 2009 following the 2.2 percent growth in the prior quarter. That’s the good news. The somewhat bad news: the increased production came about with far fewer workers – i.e., fewer workers doing more work. But with GDP growth expected to continue in 2010, albeit not very robustly, the job creation momentum appears intact. Business spending growth has been solid. International trade has picked up volume. The stimulus impact of government spending is also adding to production. But more importantly, the all-mighty consumers are beginning to open up their wallets as they feel more comfortable about their finances.

The baseline outlook is for steady economic growth of near 3 percent this year and in 2011. Note that GDP growth typically tends to be better than 5 percent in the immediate years following a recession, so the growth outlook can be considered subdued. Balance sheet readjustments by both banks and consumers to put aside more for future rainy days will be one key reason holding back growth potential. Nonetheless, the near 3 percent GDP expansion will accompany job growth of about 2 million each year from 2011. Such job growth will boost existing home sales to 5.5 million in 2010 and to 5.7 million in 2011. For comparison, sales were 5.16 million last year and reached 7.1 million at the peak of the housing boom in 2005.

Risks

There are always risks to forecasts. Energy is one: big oil price swings always put a monkey wrench in any economic forecast. For each $10 per barrel rise in oil prices, $80 billion is removed from the economy, though oil-producing countries like Norway benefit immensely. For perspective, oil prices have risen from an average $60 a barrel in 2009 to $85 a barrel in early April 2010.

Another bigger risk – although with a smaller probability – relates to the budget deficit and some possibility of federal spending spiraling out of control. Currently, both foreign and domestic investors justify the high deficit as necessary to boost the economy and to be manageable over time. Keynesian economics backs up that view: go into deficit spending when private demand falters to pull the economy back on track. The recent enactment of truly historic health care legislation will not bust the budget – in fact, it becomes a cost saver over time – at least according to the Congressional Budget Office. But what if the CBO’s projections are way off the mark (which has happened on a few occasions). Then there could be some major headaches ahead. An uncontrollable budget deficit will force interest rates up, perhaps significantly if, for instance, China rushes to the exit. That would push the U.S. economy into another recession. Another recession would mean an even higher budget deficit as there will be fewer people working, thus smaller tax revenues.

Amateur History

Sometimes it is worth a look back into history for some guidance and fun. “Deficits do not matter,” said former Vice President Dick Cheney. Mr. Cheney was addressing the Steady economic growth of near 3 percent this year and next year will accompany job growth of about 2 million each year from 2011 – such job growth will boost existing home sales to 5.5 million in 2010 and to 5.7 million in 2011.experience of the then very high Reagan era deficits that brought robust economic growth and huge job gains. But that was a time when foreigners had just started to finance a U.S. budget deficit in a meaningful way. Today’s deficit is much larger than during the Reagan years and more dependent than ever on foreigners, particularly China, buying U.S. debt.

Let’s look back even further. England truly became an unmatched superpower beginning at the time of Queen Elizabeth I. She was guided by an economist named Gresham, who had no knowledge of Keynesian economics (Keynes would have to wait several centuries) but an abundance of every-day common sense. Gresham had this simple advice: we need to bring the borrowing costs down and strengthen Her Majesty’s currency. To achieve that meant balancing the books. Building a rainy day fund was even better. The Virgin Queen took his words of caution to heart. England invested in a navy (for that rainy day) and Elizabeth did not build a single new palace during her long years of reign. Queen Marie Antoinette, across the channel and in a different era, was known for her frivolous spending habits. In fact, she had a nickname during her reign: Madame Deficit. France was facing ruinous budget problems, and while most of those were unrelated to Marie’s penchant for spending, the image of “out of control” spending added to the revolutionary fervor as the basic needs of the French people were not being met.

I know times have changed from those during Elizabethan England and Revolutionary France. And the U.S. is neither of those nation states. President Obama will no doubt go down in history as one of the most transformative leaders – for better or worse – primarily because of health-care reform. The debate on that health care law continues, sometimes vehemently from both sides. No American President will want to be labeled with Marie Antoinette’s moniker. Only time will tell if President Obama’s health care legislation will go down in history as a monumental success of lowering cost and enlarging coverage or a monumental failure of long queues and resentments and continuously climbing budget deficits. Perhaps one day U.S. policies and programs will allow our nation to build comfortable rainy day reserves while at the same time spend tax revenue on Americans to meet their basic needs. Easier said than done, of course. Which is why if it were to ever happen, that President – whoever he or she may be – will go down in history as one of the greatest ever.

PULL QUOTE: In March, we saw the first meaningful job additions to the economy in more than three years as a net 162,000 new workers (payrolls) were added to the economy.

PULL QUOTE: Steady economic growth of near 3 percent this year and next year will accompany job growth of about 2 million each year from 2011 – such job growth will boost existing-home sales to 5.5 million in 2010 and to 5.7 million in 2011.