The housing sector has been the poster child for the part of the economy that has lagged during the economic recovery. The housing bubble that existed prior to 2007 was characterized by buyers with no or a low down payment and teaser interest rate mortgages who bet on price appreciation as well as speculative investors hoping to “flip” their purchases amid rapidly rising prices. Low interest rates, falling lending standards, and creative financial engineering of collateralized mortgage instruments helped finance housing purchases. Further, government policy aided and abetted the housing mania. The result was a period in which additions to the housing stock exceeded what population demographics would dictate.
A housing sales collapse led the economy into recession and exacerbated the severity of the general economic downturn. The housing sector has suffered from falling prices, a very low level of housing starts, and a large number of foreclosures. In addition, according to Zillow, about 31 percent of homeowners with a mortgage are currently underwater. Conditions in the sector have affected a number of manufacturing industries because their products are used in construction and/or are purchased in conjunction with houses. After flat-lining for three years, however, there are signs that housing is starting to recover.
The number of annual housing starts averaged 707,000 between September 2011 and July 2012. Although this is less than half of what many consider to be the normal pace of 1.5 million units per year required to accommodate the formation of new households and replacement of homes lost to fires, hurricanes, dilapidation, etc., it is a marked improvement over what occurred between December 2008 and August 2011, when the number of starts averaged just 572,000 (Figure 1). MAPI’s latest (August) forecast projects that housing starts will average 759,000 units in 2012 and 928,000 in 2013.
The Case-Shiller housing price index (based on 20 cities) fell 31 percent between February 2007 and May 2009 (Figure 2). When housing prices are trending down steadily, would-be homebuyers tend to delay purchases in hopes that prices will fall even further. Since February 2012, the Case-Shiller index has edged up, though at a slow rate. If this trend continues, potential homebuyers will have more confidence that purchasing a house is a good investment.
Inventory of Houses for Sale
According to the National Association of Realtors (NAR), the official or “visible” housing inventory stands at approximately 2.5 million units, the lowest level since 2006. In early 2008, the inventory was just over 4 million units. The shadow inventory (houses with seriously delinquent mortgages and homes in the foreclosure process) has steadily declined from more than 4 million units in 2009 to just over 3 million units. The normal shadow inventory from 2000 through 2006 was approximately 900,000 units.
The NAR reported that pending home sales rose in July 2012 to the highest level in more than two years and remain well above year-ago levels. The NAR’s Pending Home Sales index, a forward looking indictor based on contract signings, rose 2.4 percent in July to its highest level since April 2010. The index is 12.4 percent over its level in July 2011. While month-to-month changes can fluctuate, year-over-year changes have been positive for 15 months.
Consumer Balance Sheets
With the end of the housing bubble, consumer finances have been put on a more solid foundation. The personal savings rate out of disposable income rebounded with the onset of the recession, averaging 4.7 percent from 2008 through the second quarter of 2012. This is well above its average of 2.2 percent over the period 2005-2007.
At the same time, the burden of consumer debt as measured by the ratio of total consumer credit outstanding (excluding mortgage debt) as a percent of disposable income is below its pre-recession levels (Figure 3). This ratio has risen in 2012, however. Total household debt is declining, largely because of mortgage write-offs by banks and homeowners paying down their home equity debt and mortgages. In addition, credit card balances are at their lowest level since the second quarter of 2002. The significance of improving consumer balance sheets is that potential homebuyers are in a stronger position to take on additional debt. On top of this, the NAR’s housing affordability index reached a record high in the first quarter of 2012, indicating that higher home prices have been more than offset by lower mortgage interest rates and increased income.
Remaining Barriers to Recovery
The signs of improvement in housing are real and the sector is showing signs of life. Still, a number of barriers to full recovery remain. Lending standards have tightened in recent years, making it more difficult for some to finance purchases of new homes. The continued high level of unemployment has created the “boomerang generation” in which many college graduates move back in with their parents. Added to this is the growing level of student loan debt owed by college graduates who have difficulty finding employment. Together, these factors have reduced the rate at which new households are being formed and thus the demand for housing.
The slow pace of economic recovery and high unemployment is retarding the growth of personal income, a prerequisite for stronger housing demand. The latent or “shadow” inventory of houses created during the bubble implies that any pent-up demand for housing can be accommodated fairly easily. The bottom line is that we expect large percentage gains in housing starts in the coming years but this has to be seen in the context of growth coming from an exceptionally low base.
 Josh Mitchell, “U.S. Households Chip Away at the Debt on Their Homes,” Wall Street Journal, p. A6, August 30, 2012.
 Federal Reserve Bank of New York, Quarterly Report on Household Debt and Credit, August 2012, www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q22012.pdf.