April 2, 2008 (Housing Market Monitor)
Non-Residential Construction Continues to Decline
April 2, 2008
By Dean Baker
"Efforts to sustain bubble prices will make housing less affordable for young families."
The Census Bureau reported that private non-residential construction fell for the third consecutive month in February. This sector had been an important source of growth for the economy as the housing sector weakened, but overbuilding has led to excess capacity. Nominal spending on office construction was down 1.7 percent since November, commercial construction was down 2.2 percent, and lodging construction was down 5.3 percent.
Interestingly, manufacturing construction was up 10.6 percent from November. It is up 27.4 percent year over year. This is likely a response to the improving trade picture, which has come about as a result of the decline in the dollar.
There are more reports of banks tightening their rules for issuing mortgages. The Bank of America is now requiring 10 percent down payments for mortgages issued with mortgage insurance and 15 percent in homes with a second mortgage. Many potential homebuyers will find it difficult to meet these conditions.
The continued tightening of credit rules, while appropriate given the current state of the market, will be a source of further downward pressure on house prices, as will be the weakening of the labor market. Economists used to believe that house prices could only fall if the economy was shedding jobs. House prices began to decline last year, when the economy was still adding jobs at a respectable pace. Now that the economy is losing jobs, the price decline is likely to accelerate.
The effort by Congress to prop up the housing market is likely to have, at best, a temporary and limited impact. The proposal put forward by Representative Barney Frank and Senator Chris Dodd proposes a $300 billion bailout fund. This will be of limited use in a $20 trillion market.
If this money were targeted to stabilizing prices in depressed markets, like Cleveland and Detroit, it could prove effective in establishing a price floor. However, if it is allowed to flow into over-valued markets that are in the process of deflating, like Miami, San Diego and Los Angeles, it is likely to have only a minimal impact on the process of price adjustment.
In these markets, house prices are likely to continue to drop, and even the new mortgages that are issued as part of the bailout package are likely to soon exceed the value of houses. The continued price decline will cause many homeowners to default, leaving large losses for taxpayers. Declining house prices will also ensure that most of the homeowners helped under the program in these bubble markets will end up with little or no equity.
This outcome is especially likely since the design of the program will allow lenders to determine which properties qualify for the guarantee. This will create a serious adverse selection problem, since lenders will seek to place their most troubled loans into the pool guaranteed through this program.
The notion of trying to prop up house prices in bubble areas is dubious public policy in any case. Usually, public policy is designed to try to make housing more affordable. In this case, by trying to sustain prices at bubble-inflated prices, the goal is to make housing less affordable.
Mortgage interest rates are down sharply the last two weeks, with the 30-year fixed rate at 5.75 percent according to the most recent data from the Mortgage Bankers Association. In real terms, this rate is under 2.0 percent measured against the CPI, which is probably the lowest real rate in history.
The response to low interest rates has been mixed. There was a big surge in mortgage applications for both refinancing and purchases two weeks ago, but this was completely reversed by a sharp falloff last week. Applications are running close to year ago levels, which suggests a sharp falloff in actual mortgages, since applications are being denied with much greater frequency than a year ago. At this point, there is not reliable data on the refusal rate, but even if it has risen by just 10 percentage points year over year, this would imply a sharp falloff in the number of new mortgages being issued.
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.