Here's a sobering thought: At the rate that homebuilding has declined over the past three years, starts of single-family homes will fall to zero by November. That's a long way from 1.8 million at the beginning of 2006. The cold reality is that solutions to the problems at the banks, in the credit markets, and in the broader economy depend on a recovery in housing and home prices. Most policy actions to date have been treating the symptoms of the economy's troubles, not the cause. Without supports for housing, home prices will keep falling, mortgage-related bank assets will erode further, the credit markets will stay tight, and the economy will slide deeper into recession.
Most of the market attention on Washington's Financial Stability Plan (FSP) has centered around fragile banks and the lack of details on how the plan will cleanse toxic bank assets. But the FSP's most important component may turn out to be the housing program, which does offer details, with more coming on Mar. 4.
The Homeowner Affordability & Stability Plan (HASP) attempts to do two things: One, boost home demand by lowering mortgage rates and making conventional loans more accessible. And two, stem the tide of foreclosures that continues to dump vacant homes on the market.
It will be a tough battle. Home prices fell 2.5% in December, based on the Standard & Poor's (MHP)/Case-Shiller 20-city housing index, bringing the total drop since July 2006 to 27%. Prices in the fourth quarter dropped 7.2%, twice as fast as in the third quarter, while the credit crunch intensified.
Prices will keep falling until demand firms up and inventories shrink. The National Association of Realtors' index of affordability—based on the ability of a median-income family to qualify for a loan on a median-priced home at the prevailing mortgage rate—spiked to a record high in December. However, that gauge doesn't account for credit availability or fear of job losses by potential buyers.
Sales of existing homes in January, about 45% of which were distressed sales, fell 5.3%. Purchases of foreclosed homes are not keeping up with the supply of those properties coming to market. The inventory of unsold homes in January would require 9.6 months to sell, twice the normal level.
To stop the flood of foreclosed homes flowing into inventories, HASP will provide subsidies to "at risk" homeowners facing default, while offering cash incentives to lenders and mortgage servicers to modify loans. This program could reach 3 million to 4 million homeowners.
HASP will also help "responsible" homeowners to refinance, in an effort to prevent defaults by many with conventional mortgages, those that conform to Fannie Mae (FNM) and Freddie Mac (FRE) guidelines. The program has offered refinancing in cases where, because of falling prices, the ratio of the loan amount to home value exceeds 80%. The new limit will be 105%. About 25% of conventional mortgages, or about 5 million, have ratios between 80% and 105%. This feature should set off a refi boom, acting like a tax cut for those who can take advantage.
The housing plan also aims to open up the secondary market for mortgages by strengthening the capital base of Fannie and Freddie, increasing the size of the agencies' portfolios, and continuing the Federal Reserve's purchases of up to $500 billion in mortgage-backed securities from the agencies. Those efforts already have lowered mortgage rates by about a percentage point, to near 5%.
Federal Reserve Chairman Ben Bernanke was unusually blunt in describing the prospects for a U.S. recovery during his congressional testimony on Feb. 24. "If we don't stabilize the financial system," he said, "we're going to founder for some time." The overall Financial Stability Plan clearly recognizes housing's key role in that stabilization. And until housing activity and prices show signs of bottoming out, even $787 billion in fiscal stimulus won't be enough to promote a sustained recovery.