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A Glimmer of Hope for Housing Balances

 

By Larry DeBoer

Professor of Agricultural Economics, Purdue University

The Great Recession started in the housing market. Housing construction boomed in the first half of the 2000s. Home prices soared. Financing got "creative." Then home prices began to fall in 2007.

Falling home prices depressed home construction. With a glut of homes for sale, builders saw no reason to build more. Construction dropped to record lows. Purchases of building materials and home appliances fell. Construction workers lost their jobs.

Falling home prices disrupted finance. Homeowners found themselves "under water" on their mortgages, owing more than their houses were worth. Default rates increased. Some lenders went under; many others scaled back. Business and consumer lending was reduced.

Falling home prices discouraged consumer spending. Home values are a big part of household wealth. People were less wealthy because their homes were worth less. They cut back on their spending. Businesses reduced production and cut back on hiring. Unemployment increased.

The economy remains depressed, disrupted and discouraged in 2012. Housing is one reason. But maybe, just maybe, there is a glimmer of hope.

Prices are determined by supply and demand, say we economists, so we need an index of housing supply and demand to understand price changes. The monthly supply of homes from the U.S. Census will do. It takes the total houses for sale each month, and divides by the number of houses sold. The result is the number of months it would take to sell all the homes for sale, at the current rate per month.

The number of houses for sale is supply. The number of houses sold -- and bought -- is demand. When the monthly supply of homes is small, we'd expect prices to rise. Homes are selling fast, and buyers are bidding against each other to get one. When the monthly supply of homes is large, we'd expect prices to fall. Homes are languishing on the market, and sellers cut prices to try to make a sale.

Now, let's measure the change in the house price index, adjusted for inflation. We'll use the quarterly price index for new and existing homes from the Federal Housing Finance Agency. During 1998-2006 this price index went way up, 5 percent per year on average, above general inflation. House prices have never increased that fast for so long. Then, from 2007-2011, prices collapsed, falling an average of 5 percent per year.

Next, compare our price index to our index of supply and demand. The magic number seems to be seven months. Since 1980 the monthly supply of homes was less than 7 months in 90 quarters. The house price index went up in 76 of those quarters, 84 percent of the time. When supplies were tight, prices went up most of the time. Since 1980 the monthly supply of homes was more than 7 months in 38 quarters. The house price went down in 34 of those quarters, 89 percent of the time. When buyers were scarce, prices fell most of the time.

During the housing boom of the 2000s, the monthly supply was around four months. Prices shot upward. The monthly supply of homes first topped seven months in January 2007. The price index began falling in the second quarter. By January 2009 the monthly supply topped 12 months -- more than a year. Prices plunged.

With that plunge came a huge drop in home construction. Housing starts averaged more than 2 million a year during 2003-2006. They have averaged only 600,000 since 2009. We almost quit building homes. Very gradually existing houses were sold, and very slowly the monthly supply of homes began to drop. It dipped below seven months in April 2011.

And, sure enough, in the second half of 2011 the home price index stopped falling. As of March 2012, the monthly supply of homes is 5.3 months. Over the past 30 years, supply that tight almost always meant home price increases. We've sold our excess supply of houses, and now it's possible for home prices to rise.

Maybe home prices have hit bottom and are about to turn around. If that happens, perhaps homebuilders will be encouraged, lenders will gain confidence and households will start spending. And if that happens, our recovery could finally get going.