Housing Market Monitor
Fall in Pending Home Sales Quells Hopes of Rebound
September 10, 2008
By Dean Baker
"Interest rates remain extraordinarily low given current rates of inflation."The 3.2 percent drop in pending home sales in July quelled whatever hopes the June increase might have spurred. Given the huge over-supply of housing by every measure (inventories of new homes, inventories of existing homes, and vacancy rates) and an economy that has been consistently shedding jobs for the last eight months, it was unrealistic to expect a turnaround at this point in time. However, the June figure was a positive surprise.
A big factor in the June upturn was a 4.5 percent rise in sales in the West. Sales in the West had been trending upward, even as prices have fallen rapidly. Clearly a large portion of these sales are distress sales of foreclosed properties or short sales. The July figure shows a sharp decline of 10.6 percent, although this is still 6.5 percent higher than the year ago level. Sales in the South had increased by 11.0 percent in June and held that level in July. Year over year, sales are still down by 13.4 percent in the region.
The mortgage applications index showed a modest uptick for both purchase mortgages and refis for the second straight week. The week including Labor Day creates some adjustment problems, but this is encouraging. The index also showed a sharp decline in mortgage interest rates to an average of 6.06 percent on a 30-year fixed rate mortgage from 6.39 percent the prior week.
The takeover of Fannie Mae and Freddie Mac should help to keep mortgage interest rates low, as the uncertainty about their future was leading to an increase in the spreads between treasury yields and mortgage rates. While this takeover was necessary and a positive step for the housing market, there have been some unrealistic hopes created about its potential impact.
By bringing the spread between Fannie and Freddie’s borrowing rate and Treasury borrowing rates to more normal levels (20 basis points), this action should lower the rate on 30-year mortgages by between 20-30 basis points. There were some comments suggesting that the decline would be on the order of 100-150 basis points, which were completely unrealistic.
Mortgage interest rates are already quite low by historic standards, especially considering that the CPI inflation rate has been 5.6 percent over the last year. The spread with Treasury yields is also not unusually large. It is important to remember that the spread with 10-year Treasury bonds will be expected to get larger when interest rates fall (investors don’t expect interest rates will stay low for 30 years). When the yield on 10-year Treasury bonds fell to 3.05 percent in June of 2003, the yield on 30-year mortgages never fell below 5.25 percent, a spread of 2.2 percentage points. And this was long before any significant actors saw any problems with Fannie and Freddie.
The real interest rate on Treasury bonds is strikingly low at this point, with the rate falling at least a percentage point below the inflation rate. This low rate is being sustained by the willingness of foreign central banks to buy dollars in order to keep down the value of their currency. This in effect is subsidizing their exports to the United States.
The main actor, of course, is the Chinese central bank, and recent reports suggest that they may no longer view the gains to their exports to be worth the losses on their dollar holdings. Allowing its currency to rise will also be helpful in its efforts to reduce inflation. While it is unlikely that there will be a rapid flight from the dollar by the Chinese and other central banks, it is certainly possible that they will cut back their purchases. This will put upward pressure on interest rates and downward pressure on the dollar.
In short, it is far more likely that mortgages interest rates will rise in the future than fall further. The takeover of Fannie and Freddie removed an important source of uncertainty and prevented the housing market from deteriorating further. However, it will not be the basis for a turnaround. A turnaround is almost certainly still at least a year in the future.
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.