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New Construction Housing Starts Trend Down

Posted Wednesday, August 20, 2008

Housing starts fell 11.0 percent in July, wiping out any hope that the market had begun to turn. The June data, driven by a jump in apartment construction in New York, showed an 8.6 percent increase (revised up to 10.4 percent in the July release), leading some analysts to see signs of a bottom.

Starts in July fell to their lowest level in this cycle, with starts of single-family units continuing their long downward trend. Single-family starts were 39.2 percent below year ago levels and down 62.6 percent from the 2005 average. While the West saw a modest gain in single-family starts in July, the region has been hardest hit in the downturn, with starts of single-family homes down by 67.4 percent from 2005 levels.

It is unlikely that there will be a turnaround in starts before inventories start to fall and prices stabilize. Starts will be a lagging indicator of a turnaround, not a leading indicator.

The mortgage applications index continues to trend downward, suggesting that demand is still weakening. This is likely reflecting both the weakening of the labor market and higher interest rates, in addition to the downward dynamics of the housing market itself.

The Mortgage Bankers Association reported that the average interest rate on 30-year mortgages edged down slightly from 6.57 percent the previous week to 6.47 percent last week. By historic standards, this is a low rate (especially with an inflation rate close to 5.0 percent), but it is an unusually large spread measured against a 3.9 percent 10-year Treasury rate. This reflects the ongoing turmoil in the mortgage market.

New York Times columnist Floyd Norris reported on a remarkable memo in his blog yesterday. The memo was prepared by outside consultants at Wachovia, one of the country's largest banks, who were trying to determine how the bank managed to plunge to the edge of insolvency.

The memo indicated that the bank's chief financial officer and chief risk officer did not realize that offering interest option ARM mortgages (you pay want you want each month, but face a higher interest rate), would attract less creditworthy borrowers. They also didn't realize that allowing homeowners to refinance down to new zero-equity levels made them high default risks.

In the same vein, the Washington Post yesterday discussed the difficulties of Fannie Mae. It reported that it was still buying up subprime mortgage backed securities at the beginning of 2007, after the market had already begun to collapse. The article reported that Fannie had performed stress tests in which they saw no serious problems with these securities even if house prices fell by 5 percent for two consecutive years. Of course house prices have fallen by close to 20 percent over the last two years and by more than 30 percent in many of the markets with high concentrations of subprime mortgages.

It is incredible that Fannie could invest hundreds of billions of dollars based on such an inadequate assessment of risk. There were economists who had noted the unprecedented 70 percent real increase in house prices over the prior decade. Competent management would at least have considered the possibility that much or all of this run-up would be reversed.

It was only due to extremely bad policy and regulatory decisions at all levels of government, first and foremost at the Fed, that the housing bubble was allowed to grow to the enormous proportions. However, it was the private sector that actually drove the bubble. The top executives in major financial institutions took extraordinary risks. These risks may have increased short-term profit, but they eventually led to enormous losses, which is endangering the survival of many of the country's largest financial institutions.

These recent accounts about behavior at Wachovia and Fannie Mae suggest that the top executives at these institutions had no idea what they were doing. This is astonishing because these are huge institutions. It would be expected that the top management, who are very highly paid, would have some level of competence in their work.
By Dean Baker