March 18, 2009 (Housing Market Monitor)

February Uptick in Housing Starts: Have We Hit Bottom?

By Dean Baker

March 18, 2009

Fannie and Freddie losses on new loans may prompt serious public anger. 

The Census Bureau reported that housing starts in February increased by 22.2 percent from their January level. Virtually all of the gain was explained by a 79.1 percent jump in starts of multi-family units. Starts of single-family units rose by just 1.1 percent nationwide and they fell by 24.1 percent in the West. The rate of starts of single-family units in the West is now down by 85.8 percent from its rate in 2005 at the peak of the bubble.

Starts of multi-family units increased everywhere except the West. The jump in the South was especially striking, with starts of multi-family units up by 118.6 percent from January. However, this jump is against an extremely low rate of starts for the year. Year over year starts of multi-family units in the South are still down by 36.3 percent.

It is likely that most of the movement in starts over the last two months has been the result of weather or just noise. The winter months are always erratic as weather depresses starts hugely across the country. This view is consistent with the fact that the increase in permits in February was just 3.0 percent. Permits had fallen by 2.9 percent in January compared to an 18.9 percent drop in starts. Builders that delayed starting projects in January due to the weather moved ahead with these projects last month.

This view is also consistent with the data from the National Association of Home Builders’ Housing Market Index, which was unchanged in March from its February level. Three of the four regions showed no change, with the East posting a gain of 1 point. This suggests that there has been little change in builders’ intentions over the last three months, just weather induced changes in construction rates.

As noted before, declines in construction are necessary to eliminate the huge excess inventory. However, insofar as the sector continues to contract, it will be a further drag on the economy.

With so much discussion surrounding the unveiling of President Obama’s new housing plan, it is striking that even now, almost everyone continues to act as though the housing bubble is not there. The effectiveness of this or any other plan will of course depend on whether it is used to support homeowners in markets that are still inflated by the bubble or markets in which prices are consistent with their trend levels.

This can quickly be determined by examining price-to-rent ratios. If the ratio of the sale price to annual rent is much above 15 to 1 (there is some regional variation for this ratio), then the market can be assumed to be bubble-inflated. In these cases, house prices will likely fall from their current levels and stay down. The homeowners who are helped in these markets under the plan are likely to pay more in housing costs than they would to rent a comparable unit, and they are likely to face a short sale when they move.

In addition, the government (in the case of Fannie- and Freddie-owned mortgages) will likely face substantial losses on these mortgages, since the default and short sale rate will be much higher than normal, as will the losses on each default. Of course, the situation is made much worse by the fact that the country is in a severe recession with unemployment rising rapidly.

By contrast, in areas in which prices are near or below trend levels, President Obama’s plan is likely to help people stay in their home and can help to stabilize neighborhoods and house prices. It is difficult to understand the refusal to make price-to-rent ratios a consideration in offering assistance to homeowners or offering loans to new homebuyers.
Fannie and Freddie will incur much greater losses going forward because of their refusal to distinguish between bubble and non-bubble markets in their lending. There were huge losses to the taxpayers already baked in when Fannie and Freddie were taken over last August. If these losses rise substantially because of loans made since the government takeover, the public may not be happy about being forced to pay for a larger bailout.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.