06.29.2012
Summer 2012
Housing and the Economic Recovery
Problems in the housing sector have proven to be one of the most stubborn obstacles to a full economic recovery. Is the housing market finally turning a corner, and what policies might help it do so more effectively? On May 11, 2012, the Federal Reserve Bank of Cleveland invited two housing experts to talk with Bank economists and officials about their research. During a break in the presentations, Todd Clark, vice president in charge of the money, financial markets, and monetary policy group, sat down for this interview with these academics.
Clark: Can you talk a bit about where we stand with the housing sector today? Are we any better off now than we were a year ago? Amir, let’s start with you.
Amir Sufi, Professor of Finance at the Booth School of Business, University of Chicago: I think we are better off now than we were a year ago. We’ve seen some recovery in house prices—mainly a leveling off. We’ve also for the first time actually seen, in the last few quarters, a positive contribution from residential investment to GDP, which is a good sign that we’re seeing some building.
But unfortunately, we still have, in my view, a long way to go before we’re at what would be considered healthy or normal levels of building and house prices to be at levels that are sustainable with long-term growth in the housing sector. So I think the news is very cautiously optimistic; we’re not in freefall anymore, but we still have a long way to go.
Chris Mayer, Paul Milstein Professor of Real Estate and Finance and Economics at Columbia Business School, Columbia University: I agree with Amir’s assessment. I think we have hit a bottom; much of it’s because we have a lot of cash buyers—investors—coming into the market who are willing to rent out houses, so roughly 30 percent of houses are going to people who are not going to live in them. But that still has helped put a bottom on house price decline.
But there’s a very uneven recovery. The place that we haven’t seen much improvement has really been on the credit side, which is the ability of new homebuyers to borrow. It would seem credit is, if anything, tighter today than it was a year ago.
Clark: To what extent do you think the problems in the housing sector have been holding back the pace of recovery, and to what extent do we need to address those problems to get a faster pace of recovery in the overall economy?
Sufi: I have a strong view on that. I think that housing ends up being very important for the recovery precisely because households have a lot of debt associated with those houses. Mortgage debt and home equity debt were at historic highs when the housing market collapsed and that continues to be something that’s, in my view, holding back the recovery.
When households have extremely high debt burdens, they have a more difficult time accessing credit. They also may feel poorer just in terms of where they need to be in their net wealth position. And so a very natural reaction, something we found very strongly in our research, is that people pull back on their spending behavior when they find themselves overburdened with debt associated with their home.
So either you have to have a robust recovery in house prices, or you would have to have some kinds of proposals to allow borrowers to access credit more easily. Or, perhaps more dramatically, you do something to help try to write down the debt burdens that households have. And if you were able to do one of those three things, I think you would see a much more powerful recovery. But in the absence of one of those three things—either a house price recovery, helping people refinance into lower rates, or writing down debt burdens— my view is that the recovery is going to be quite weak. We’ll see economic growth, but not the kind of economic growth we would want to generate significant job growth.
Mayer: I’m probably only slightly more optimistic. Just to put some other numbers to it, in a typical recovery we’d be building 2 to 2 ¼ million houses. We’ve been building at about 500,000; that’s probably 2 to 3 percent of GDP. Two to 3 percent of GDP is the difference between anemic growth (which doesn’t create many jobs) and a much more robust recovery.
The optimistic piece of this is that we continue to add 800,000-plus households a year. We have 3 million people who haven’t formed households and at some point are going to start forming households. So I think we are going to see demand grow a little bit—just demographics, not for any other reason—and that is going to lead to some additional construction over time, even with all of the headwinds.
Clark: Are there reasonably feasible policies that you think would help stimulate the pace of recovery in the housing sector over the next couple years?
Mayer: I’ve been a very strong advocate of pursuing a widespread refinancing program starting with loans that are guaranteed by the government through Fannie, Freddie, and the FHA (Federal Housing Administration). Our best estimate is that we could easily accomplish 10 million to 15 million refinancings. We should have done this a long time ago, and that would have significantly helped with the debt burdens. I think that’s the biggest thing.
But the second is, we really have to work through some of the problems that we see in the system—people who are living in houses who haven’t been making payments for two or three years, lenders who are still unsure of what the rules are and often misapplying the rules. We need to get these things fixed finally. I think the state attorneys general settlement will help with this, but we really need a system that borrowers and lenders can rely on so that everyone understands what the rules are going forward. And, unfortunately, I haven’t seen the kind of progress on that that I’d like to see.
Sufi: If you just take a step back and look at the policy responses that the government’s made: It’s been, to be frank, woefully inadequate on the housing side. We’ve seen very aggressive policies in terms of fiscal stimulus and in terms of financial assistance to financial institutions. But in general we have not seen the kind of widespread, successful, “affect-a-large-number-of-borrowers” types of activities.
I also tend to think—something that may be a little more controversial—that we should at least have on the table some kind of program that would assist homeowners in modifying or restructuring their debt. So not only making interest payments lower, but also trying to attack the household debt problem directly through some type of help in restructuring mortgages. We’ve had some of those programs, but they’ve proven very difficult to implement.
Clark: Last question: the long run. We used to think of housing’s importance in the economy as being something like 5 or 6 percent of GDP in terms of residential investment, with that being the long-run norm. Do you think we can ever hope to get—expect to get— back to that?
Mayer: There’s every reason to believe that even markets that have been really severely hammered by this crisis—for example, California— will eventually get back on the growth path. It may take five or 10 years to get there.
But more important in the long run will be productivity in the economy and labor market. If we rely on housing for growth or a recession, we’re in a lot of trouble.
Sufi: I think in the long run things like household formation, productivity growth, and population growth will be the determinants of the housing market. I would add maybe one caveat: The homeownership rate in the United States was at about 63 percent for 30, 35 years, and then it jumped up closer to 70 percent in a period of about 10 years, from 1998 to about 2006.
As an economist, when I look at a statistic that’s stayed level for 35 or so years and then all of a sudden jumps up very quickly, that tends to tell me that probably the long-run equilibrium is closer to what we had before—the 63 percent, 64 percent homeownership rate.