Friday, February 8, 2013

Dr. Mark Palim - Economic and Housing Outlook, by Matt Alexander, CFA

Dr. Palim, an economist with the Economics and Strategic Research group with Fannie Mae, discussed the current state of the housing market on January 16th at the Milwaukee Athletic Club.

“A house is only worth the job you can commute to.”

There have been headline improvements in the labor market. However, job growth by sector has been uneven, driving regional differences in housing market strength. For example, booming growth in oil production is supporting energy producing regions. Manufacturing jobs are beginning to return. Health Care and Education employment have grown steadily through the recession and continue to grow. Against this backdrop, home prices are beginning to recover, even for distressed markets (though not everywhere). Furthermore, valuation metrics are more in line with fundamentals.

But weakness remains. Federal government employment has begun to contract, two years after local and state governments had borne the brunt of public sector layoffs. Broadly speaking, consumer confidence remains near historic lows. Household formation has improved, but the households that have formed tend to be rentals.

Are we becoming a renting society?

Palim cites survey data that reveal some of the attitudes that currently affect household formation. The aspiration to buy is strong, now more so for non-economic reasons than investment motivations. Most people who rent tend to do so mainly for financial reasons; they primarily have trouble with down payments because household financial assets have declined and traditional lender underwriting standards have stiffened. Intergenerational transfers have also declined (bank of grandma). So we may be turning into a renting society, though not necessarily by choice. Even so, overall improvements in housing are reflected in rental and home price expectations; rents are expected to increase 4.4% next year and home prices are expected to rise 2.6%.

The influence of the government is never far off. The Fed holds nearly $1 trillion in mortgages and is, in Palim’s view, the marginal buyer. The FHA has gone from 3% to 30% of the mortgage market and has been very important to first time buyers. Is FHA’s influence similar to subprime prior to the crash? Palim's answer is no – the difference is documentation. No more liar loans or ninjas (no income, no job, no assets) in this mortgage market.

Generally speaking, the mortgage market has become more fragmented. Non-traditional lenders have entered, such as Costco. Morover, the largest banks have seen their market shares decline in favor of smaller lenders. One exception is Wells Fargo, the largest bank in this segment that has seen its share expand*.

What’s the biggest risk to the housing recovery?

Palim names three: adverse international developments, a double dip recession (unemployment) and actions of the Fed. Housing prices will not be as tightly coupled to levels of interest rates as is traditional thought. However, he does note that sudden spikes in interest rates would have an adverse impact on housing prices.

*Author is employee of subsidiary of Wells Fargo & Co. Data and views expressed in this article are those of the presenter.