New home sales plummet in June 2014
Stymied by high prices amidst weak job and wage growth, new home construction fell dramatically in June.
This wasn’t supposed to happen. Reflating the housing bubble was supposed to lift distressed loanowners above water, stimulate building (and construction employment), and create “escape velocity” in the housing market. Economists had it all figured out, and they advised policymakers to stimulate housing at all costs. Instead, high house prices made housing unaffordable to marginal buyers, and caused sales volumes to plummet. Since builders can’t sell homes, they aren’t building them, and they aren’t hiring construction related trades, so the sought after economic boost isn’t happening. So why did it turn out this way?
The new mortgage regulations changed how real estate markets work. The new mortgage regulations will prevent future housing bubbles (we hope), but we witness the success of these new regulations by an unanticipated change in housing market behavior: high prices are hurting sales volume. The conventional wisdom among housing economists states that rising house prices creates “escape velocity” because potential homebuyers become more motivated to capture appreciation and for fear of being priced out. As a result they compete with one another and drive prices higher. Kool aid is eternal, so the motivation exists, but the key enablers (lenders) of this foolish buyer behavior can’t play their usual games because the new mortgage regulations curtailed affordability products.
Housing escape velocity requires affordability products
When prices get too high and potential buyers can’t afford the houses they want, the first reaction of realtors and mortgage brokers is to suggest the buyer use an affordability product so they can borrow more money with the same payment (rather than substitute down in quality to a different property). This keeps the existing deal alive, makes the realtor and the lender money, and puts the buyer in the home they want. What could be wrong with that? Well, take that approach to every buyer and every deal in the marketplace, and very soon, affordability products proliferate, prices inflate, and the entire market becomes unstable. Over the period of a few years, the lending market becomes saturated with amortizing ARMs, then interest-only ARMs, and finally Option ARMs (Remember 2002-2006?).
Once financing crosses the Ponzi threshold of interest-only loans, the market destabilizes, mortgage defaults accelerate, and a credit crunch becomes imminent; it’s only a matter of time before lenders realize their folly and abruptly stop making bad loans. Once that happens, credit tightens, and lenders retreat to the stability of 30-year fixed-rate mortgages. Rather than repeat this cycle and endure another painful housing bubble, legislators passed the Dodd-Frank law and put in place new qualified mortgage rules and ability to repay rules (See: Will the “Ability to Repay” rules prevent reckless lending?).
Without escape velocity from affordability products, previous economic theories about housing fail — miserably. Since so much economic policy is based on this flawed theory, all the policies designed to stimulate housing fail to justify the costs. We are approaching a frozen market with most of the available inventory suspended in the clouds at prices today’s buyers can barely afford. Further, with a likely rise in mortgage rates forthcoming, the problem will likely get worse, and sales volumes may be weak for several more years.
Economic Growth, Labor Market Face Headwinds
By Eric Morath and Kris Hudson, Updated July 24, 2014 6:47 p.m. ET
Demand for new homes slowed sharply during the first half, a development that threatens to reverberate beyond the housing market and throughout the broader economy.
Sales of new single-family homes fell 4.9% through the first six months of the year compared with the same period of 2013, according to Commerce Department data released Thursday. June sales fell 8.1% from the prior month, and the May number was revised down from the best figure in six years to not even the best figure in six months.
Do you remember the headlines last month touting the strength in housing based on the great new home sales? Turns out it was complete nonsense. When you reflect on it, the news concerning loan originations has been bad all year, and existing home sales are still down, so there was reason to suspect the numbers from the outset.
John Burns, chief executive of a housing-research firm that bears his name, posits that shell shock from the real-estate bust, mounting student-loan debt and last year’s steep increase in new-home prices continues to deter buyers. “I just think there’s a real lack of confidence to buy a home and take on a mortgage right now, which is really hurting the housing market,” he said.
He says that now, but that’s not what he was saying a month ago.
The lack of vigor in the new-home sector could have wide ramifications for the economy heading into the year’s second half, weighing on economic growth and job creation in the well-paying construction sector. Home construction was a major employment and growth engine before the recession—historically accounting for 5% of the U.S. economy, according to the National Association of Home Builders. That figure has fallen to about 3% in recent years.
The side effect policymakers used to justify unlimited housing stimulus was an expected increase in construction employment that hasn’t materialized — and with good reason if they can’t sell the houses they’re building.
“Housing has clearly been a notable area of persistent sluggishness beyond early-year weather disruptions,” said Ted Wieseman, an economist at Morgan Stanley.
The weather… ~ giggles to self ~
It was never the weather; the weather was a convenient excuse, it was plausible enough to buy several months of false hope, but since the weather was never the problem, the real issues of declining affordability and weak job and wage growth finally surfaced.
The main impediments to home construction have shifted in the past year to weakness in demand rather than supply. …
Now, several factors have combined to hamper demand. Rising property values brought more existing homes to the market, creating cheaper competition for new homes.
Competition from existing home sales was never a variable economists considered. Demand was supposed to surge, despite higher prices, and both cloud inventory sales and new home sales were supposed to increase.
Steep price increases in the past two years put new homes out of reach for some buyers. …
And while job growth has picked up, wage gains remain tepid and mortgage-qualification standards too strict for many would-be buyers.
Job growth has been largely part-time and low-paying jobs that don’t provide the income to afford the payments even at low rates.
The absence of momentum in new-home sales heading into the third quarter, along with no improvement in mortgage applications and still-tight lending standards “raise serious questions about the state of the housing market going forward,” said BNP Paribas economist Yelena Shulyatyeva.
Weaker demand for new homes could also curtail construction-employment gains. A slowdown in construction hiring would be a concern because those jobs tend to pay more than positions in retail and food services. In the second quarter, the economy added 94,000 retail jobs and 51,000 construction positions. …
How many retail jobs pay enough to finance a house?
Jobs in residential building have increased 2.6% so far this year, outpacing a 1% gain in overall employment. But with signs that building is slowing, the pace of hiring could be difficult to maintain.
The pace of overall hiring has strengthened this year, with employers adding better than 200,000 jobs for five consecutive months, but the gains have yet to translate into better pay for many Americans. Wage growth has only kept pace with inflation during much of the recovery.
“The labor market may be getting better but wage gains are not and until that happens, families will not be buying new homes at any great pace,” said Joel Naroff, president of consulting firm Naroff Economic Advisors Inc.
That is the simple and inescapable truth. (See: Weak job and wage growth hobbles housing)
Federal Reserve policy makers have expressed frustration about the housing sector’s lackluster recovery. “While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing,” Fed Chairwoman Janet Yellen said earlier this month in testimony before the Senate. …
The fact that Janet Yellen was disappointed by housing tells me that the federal reserve economists don’t understand how the new mortgage rules changed the market.
“The U.S. housing market is being held back,” Mattamy’s Chief Operating Officer Brian Johnston said. Purchasing a new home is “not as desirable as it used to be, given that so many people got burned by buying a new house” when their investment was decimated in the downturn.
Today’s buyers realize housing is not a good investment. They will not see the same appreciation as the prior generation, so the house will be a burdensome expense rather than a lucrative savings vehicle. Without housing kool aid to motivate buying, people rationally recoil at high prices.