March 19, 2008 (Housing Market Monitor)

Housing Market Monitor

Single Family Housing Starts Fall to 25-Year Low

March 19, 2008

By Dean Baker

"Core inflation at the finished goods level is running at a 6.2 percent annual rate." 

The Census Bureau reported that starts of single-family homes fell to an annual rate of 707,000 in February, the slowest rate since September of 1982. This decline in starts of single-family units received little attention because starts on multi-family units jumped for the second consecutive month.

The drop in starts, while evidence of the continuing weakness in the housing market, is also a necessary part of the correction process. The only way to reduce the huge inventory of unsold homes is to curtail construction. Starts of single-family homes are now down by 58 percent from their 2005 level.

While the Fed’s 75 basis point cut in the federal funds rate yesterday was well received by the financial markets, it is not clear that it will have much, if any, positive effect on the housing market. The 10-year treasury rate rose again (it also rose following the prior two rate cuts) after the announcement.

The interest rate on thirty-year fixed-rate mortgages continues to hover near 6.0 percent. While this is low by historic standards, it is higher than it was last fall, before the last three rate cuts. With lenders tightening standards, often requiring 20 percent down payments in markets with rapidly falling prices, many potential homebuyers are now effectively excluded from the market.

Fears of inflation and the falling dollar are undoubtedly factors pushing long-term rates higher. The February CPI came in flat for the both the overall and core inflation rate, but it is likely that this is an anomaly. The PPI for February showed the overall finished goods index rising 0.3 percent and the core index rising by 0.5 percent. Over the last three months, the core finished goods index has risen at a 6.2 percent annual rate, while the core finished consumer goods index has risen at a 7.2 percent annual rate. If the problems in financial markets were not so serious, the February PPI would undoubtedly have made the Fed very concerned.

There is a growing push for some sort of housing bailout program, with former Fed vice-chairman Alan Blinder throwing his support behind a plan similar to ones put forward by the Office of Thrift Supervision, Senator Chris Dodd, and Representative Barney Frank. It is important to understand the goals of any such program before it is adopted.

At this point, the housing market is in the middle of a correction in which prices are falling back from bubble-inflated levels. If the federal government were to intervene in the market by either buying up or guaranteeing large amounts of mortgage debt, it would be handing money to current mortgage holders (banks and other investors) and incurring large losses itself.

Furthermore, even if mortgages are reset to terms that are more beneficial to homeowners, they are still likely to end up losers in spite of the bailout. In many areas, sale price to rent ratios are still close to 20. This means that homeowner costs are likely to be 60-80 percent higher than rental costs for the same unit. With house prices still dropping, there is little chance that homeowners in these markets will accumulate equity. In short, such bailouts could hand tens of billions of taxpayer dollars to banks, with little obvious benefit to homeowners.

It would be simple to construct a Blinder type program in a way that ensured that it did not bailout banks and keep homeowners paying too much for their housing. The purchase or guarantee price of the house can be set at multiple of appraised rent (e.g. 14.5 to 1). This would ensure that the government was not just buying up houses at bubble-inflated prices.

There is no public interest in trying to prevent the bubble from deflating. Each week that the bubble persists simply increases the number of families who buy homes at bubble inflated prices or who fail to recognize how little housing wealth they have in making their consumption decisions.

Proposals for house price supports have less chance of succeeding than a system of farm price supports and could be far more costly to the government and the economy.

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

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