The Hindu Business Line : US housing sector

US housing prices have been moving up over the past two years despite the bursting of the stock market bubble and the slowdown. They have not seen a similar pace of growth since 1979.

FEDERAL Reserve left the interest rates unchanged in its January meeting with bias towards easing. Some of the data releases in the run up to the meeting gave a modicum of comfort to the policy setters, but the overall risks remain strong.

Mr Alan Greenspan did the glass is half empty to its half-full somersault in January. Indeed, it is the role of the central banker to sound positive and keep a focused eye on the macro-economic risks. It's important to keep in mind that during the last one and half years the significant negative wealth effect of the plunge in the equity markets had been cushioned by the rally in the housing sector.

There are now signs that real estate is becoming almost hot. In case this bubble is burst there would be negative wealth effect, which could trip the chances of revival. In this article we examine the housing sector and the risks that it presents.

US housing prices have been moving up over the past two years despite the bursting of the stock market bubble and the slowdown. One of a good measure of the American housing prices is the index compiled by the Office of the Federal Housing Enterprise Oversight. This index has risen by 8.4 per cent in Q3 2001 over a similar period last year. This increase is just a little lower than the peak of 9.5 per cent growth seen in Q1 2001.

American housing prices have not seen a similar pace of growth since 1979. The price increases are not as widely dispersed like that witnessed during the bubble seen in late 1980s. It is the top of the end properties in the town that have reached vulnerable levels.

Though the median property prices are also not far away from such levels. Some of the States that could be close to the bubble would include those clustered in the pacific and north central regions.

During the last two years the GDP growth numbers and house prices have gone in different directions. In normal conditions one would expect that the correlation between these two would be pretty high. Over the past 3 decades the correlation between these has been in the region of 60-75 percent. Such a correlation exists as underlying forces like interest rates affect both these.

In recent times the correlation has collapsed thereby breaking the link. Why has housing managed to shrug off slowdown? The absence of inflation and shifting of assets from equities to real estate may be the key reason. Inflation has remained low even during the run up to the slowdown.

This helped in keeping the mortgage rates low and allowed Federal Reserve to ease monetary policy aggressively.

The current slowdown has been an unplanned one. It has not been caused by the central bank raising interest rates to contain inflation.

Easing of interest rates have helped households in getting their housing loans refinanced at lower rates and also getting some part of this gain as a cash out payment.

Fall in the equity market and the slowdown has helped push the housing prices. As household balance sheet deteriorated due to the falling equity prices, households have moved assets out into cash. This has led to increase in the deposits with the banking system.

Due to the slowdown banks have become more risk averse and prefer mortgages to commercial loans.

This increases the supply of mortgages and together with the rising demand has kept the house prices higher.

In earlier slowdowns since 1960s the housing sector had caused contraction on average by around 0.8 per cent of the GDP. The reversal of the sector contributed to overall economic recovery. This time around housing sector has already contributed 0.2 per cent to the gross domestic product. This means that housing may not be able to contribute significantly to the upswing.

A look at the valuations of property suggest that the ratio of real estate wealth to personal income currently is at its highest since 1980.

It is close to the high seen during 1989, which was the peak of the property bubble. One important point to note is that the commercial property is less worrying than the residential real estate.

Any increase in mortgage rates would affect the disposable income of the household and also affect the valuations. Valuations take into account the present value on the rental income.

Hence the discount rate or the mortgage rates could easily affect the fair values. This would make any significant increase in rates difficult.

Any increase in rates would affect the housing sector and may put economic recovery into doubt. This may set up a disappointing growth outlook for 2003.

Alternately in case economy remains sluggish and send mortgage rates lower, it would further push up the housing prices.

In any case, the increase in rates would eventually risk affecting the health of the housing sector.

Health of housing sector would remain an important factor controlling monetary policy in America.

What helped in keeping the economy from a worse fate may become a risk to recovery.

(The author is Senior Manager, Corporate Treasury Sales, Southern India with HSBC. The views expressed here are his own and not of his employer.)

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