Economics and Mortgage Market Analysis Summary
Market Shows Faint Signs of Progress Views regarding the timing and magnitude of economic recovery at the end of the current and ongoing recession are widely dispersed. There are slim data to support the view that improvements are emerging and hastening the end of the recession; more data suggests that we have a long way to go. The twin keys to economic recovery are the consumer, and the performance of credit markets, including housing finance. The signs of hope come primarily from the short-term credit markets. One-month and three-month interbank interest rates have indeed fallen significantly from their peak levels in the October 2008 time frame. In fact, the one-month rates are nearly back to normal levels. The three-month rates are still elevated, although in both cases it is uncertain what an appropriate level is. We now know that many risk spreads were in fact artificially low prior to the market meltdown, and are expected to stay wider than their narrowest point.
Risk spreads are narrowing in longer-term corporate borrowing, though not nearly to the degree that short-term spreads have. Higher-quality borrowers are seeing risk premia fall back to levels that may be approaching a market normif one takes into account the severity of the recession and the fact that risk premia were too low by historical standards at the end of the expansion. Higher-risk borrowers are still seeing very wide spreads relative to better credit quality borrowers.
Another sign of improvement comes from the commercial paper market. There, some of the nonfinancial corporate borrowing funded by the Federal Reserve in late October and early November matured and high-grade corporations were able to obtain funding in the private sector at terms better than the Fed was offering.
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Consumer spending crashed in the fourth quarterand why wouldn’t it? Consumers took hits to the equity in their homes, the rate of interest earned on their savings, the value of their stock portfolios, and the security of their employment. For example, the unemployment rate rose from 7.2 percent to 7.6 percent in the past month as about 600,000 payroll jobs were eliminated. Furthermore, the portion of the labor market working part-time for economic reasons soared to record levels as production cutbacks followed consumer retrenchment.
Consumers sharply curtailed spending and paid back loans rather than borrowing. Surely, part of the borrowing reduction was a result of tightened credit conditions, but the household savings rate rose to nearly 4 percent at an annual rate at the end of the fourth quarter as consumers sought to repair household balance sheet damage. Over the past 15 years, household debt has risen from 65 percent to 135 percent of after-tax income. During that same period, personal savings fell from about 10 percent to close to zero before the recent beginnings of adjustment.
Policy makers are looking at the key factors that helped bring previous recessions to an end, asking: what factors have traditionally been important in a recovery? A look at the contribution of various sectors to the economy the first year after a recession gives some clues. The average first-year economic expansion is 6.5 percent growth. The largest contributor to the growth is consumer spending, which covers about 58 percent. Businesses typically don’t contribute much through investment in expansion as they wait to see if the recovery is sustained and profitability is restored. They do contribute through inventory building though, as rising consumer demand depletes inventory. Exports tend to be a drag on recovery growth, as the U.S. tends to lead the world out of recession. The third largest contributor is residential investment, or housing, at about 18 percent. In only one instance did it not contribute to growth. That was in the credit crunch in 1980. Thus, it is no surprise that conditions in the housing market are key to an economic turnaround.
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The role of government has been minor, with an average contribution of 7.5 percent to first-year growth. Those instances when it was a major contributor have tended to be when there were significant increases in military spending which translates into near-term expenditures on materials needed rapidly. We expect that the economy will shrink in real terms for the full year of 2009 before beginning a tepid recovery in 2010. A lot rests on the stimulus package; the ultimate effectiveness of the adopted package is a matter of significant debate among economists. It appears to be weighted toward one-time income transfers and longer-term capital spending, the timing of which will matter to growth expectations.
At this point it is hard to envision a significant near-term contribution from housing to a recovery. Supplies of homes are still well above normal as reflected in continuing nearrecord vacancy rates. Foreclosures continue to grow and add to supply at roughly the pace that sales reduce it. Housing starts continue to fall, a harbinger of the eventual rebalancing of supply and demandbut that balance is not likely to occur soon. Starts are now at the lowest point since the recorded data began in 1959.
House prices continue to fall due to both the supply/demand imbalance and very tight credit conditions, and because of recession-related job loss. Interest rates on 30-year fixed-rate mortgages have historically ranged 1.5 to 1.75 percentage points above the 10-year Treasury rate and today stand at roughly 2.25 percentage points. This is in spite of the efforts by policy makers to lower rates through a variety of actions. The decline in rates a month ago brought a surge in 3
refinance applications, but as rates have risen again the application levels have abated. Applications for loans to purchase homes have fallen steadily since mid-2007. The decline in house prices is clearly bringing homes back into the range of affordability for middle-income households. Unfortunately, in the face of job losses, continued house price declines, and tight credit conditions, sales levels are stagnant.
The bulk of the financing available in the market today relies on the government as guarantor or investor. The vast majority of originations are delivered to the GSEs and FHA, as the bank balance-sheet capacity is constrained by capital problems and investors have dramatically cut back their appetite for anything not involving a government role. Originations for home purchase are expected to remain weak this year, falling to the lowest level in about 10 years, as home sales and prices continue to fall. Refinance originations, however, are expected to be high this year as mortgage interest rates are at low enough levels that a large share of currently outstanding mortgage debt has a rate incentive to refinance. As mortgage rates gyrate, this estimate moves around, but it is clear that this year will see a significant amount of refinancing. Of course, there are other factors to consider that would bring the level of refinancing down, but these factors would be somewhat offset by recently announced government actions relating to mortgage refinancing eligibility. __________________________________ Doug Duncan and Molly R. Boesel Economics and Mortgage Market Analysis February 10, 2009 Opinions, analyses, estimates, forecasts and other views of Fannie Mae's Economics and Mortgage Market Analysis (EMMA) group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. Although the EMMA group bases its opinions, analyses, estimates, forecasts and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts and other views published by the EMMA group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.
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Risk spreads are narrowing in longer-term corporate borrowing, though not nearly to the degree that short-term spreads have. Higher-quality borrowers are seeing risk premia fall back to levels that may be approaching a market normif one takes into account the severity of the recession and the fact that risk premia were too low by historical standards at the end of the expansion. Higher-risk borrowers are still seeing very wide spreads relative to better credit quality borrowers.
Another sign of improvement comes from the commercial paper market. There, some of the nonfinancial corporate borrowing funded by the Federal Reserve in late October and early November matured and high-grade corporations were able to obtain funding in the private sector at terms better than the Fed was offering.
1
Consumer spending crashed in the fourth quarterand why wouldn’t it? Consumers took hits to the equity in their homes, the rate of interest earned on their savings, the value of their stock portfolios, and the security of their employment. For example, the unemployment rate rose from 7.2 percent to 7.6 percent in the past month as about 600,000 payroll jobs were eliminated. Furthermore, the portion of the labor market working part-time for economic reasons soared to record levels as production cutbacks followed consumer retrenchment.
Consumers sharply curtailed spending and paid back loans rather than borrowing. Surely, part of the borrowing reduction was a result of tightened credit conditions, but the household savings rate rose to nearly 4 percent at an annual rate at the end of the fourth quarter as consumers sought to repair household balance sheet damage. Over the past 15 years, household debt has risen from 65 percent to 135 percent of after-tax income. During that same period, personal savings fell from about 10 percent to close to zero before the recent beginnings of adjustment.
Policy makers are looking at the key factors that helped bring previous recessions to an end, asking: what factors have traditionally been important in a recovery? A look at the contribution of various sectors to the economy the first year after a recession gives some clues. The average first-year economic expansion is 6.5 percent growth. The largest contributor to the growth is consumer spending, which covers about 58 percent. Businesses typically don’t contribute much through investment in expansion as they wait to see if the recovery is sustained and profitability is restored. They do contribute through inventory building though, as rising consumer demand depletes inventory. Exports tend to be a drag on recovery growth, as the U.S. tends to lead the world out of recession. The third largest contributor is residential investment, or housing, at about 18 percent. In only one instance did it not contribute to growth. That was in the credit crunch in 1980. Thus, it is no surprise that conditions in the housing market are key to an economic turnaround.
2
The role of government has been minor, with an average contribution of 7.5 percent to first-year growth. Those instances when it was a major contributor have tended to be when there were significant increases in military spending which translates into near-term expenditures on materials needed rapidly. We expect that the economy will shrink in real terms for the full year of 2009 before beginning a tepid recovery in 2010. A lot rests on the stimulus package; the ultimate effectiveness of the adopted package is a matter of significant debate among economists. It appears to be weighted toward one-time income transfers and longer-term capital spending, the timing of which will matter to growth expectations.
At this point it is hard to envision a significant near-term contribution from housing to a recovery. Supplies of homes are still well above normal as reflected in continuing nearrecord vacancy rates. Foreclosures continue to grow and add to supply at roughly the pace that sales reduce it. Housing starts continue to fall, a harbinger of the eventual rebalancing of supply and demandbut that balance is not likely to occur soon. Starts are now at the lowest point since the recorded data began in 1959.
House prices continue to fall due to both the supply/demand imbalance and very tight credit conditions, and because of recession-related job loss. Interest rates on 30-year fixed-rate mortgages have historically ranged 1.5 to 1.75 percentage points above the 10-year Treasury rate and today stand at roughly 2.25 percentage points. This is in spite of the efforts by policy makers to lower rates through a variety of actions. The decline in rates a month ago brought a surge in 3
refinance applications, but as rates have risen again the application levels have abated. Applications for loans to purchase homes have fallen steadily since mid-2007. The decline in house prices is clearly bringing homes back into the range of affordability for middle-income households. Unfortunately, in the face of job losses, continued house price declines, and tight credit conditions, sales levels are stagnant.
The bulk of the financing available in the market today relies on the government as guarantor or investor. The vast majority of originations are delivered to the GSEs and FHA, as the bank balance-sheet capacity is constrained by capital problems and investors have dramatically cut back their appetite for anything not involving a government role. Originations for home purchase are expected to remain weak this year, falling to the lowest level in about 10 years, as home sales and prices continue to fall. Refinance originations, however, are expected to be high this year as mortgage interest rates are at low enough levels that a large share of currently outstanding mortgage debt has a rate incentive to refinance. As mortgage rates gyrate, this estimate moves around, but it is clear that this year will see a significant amount of refinancing. Of course, there are other factors to consider that would bring the level of refinancing down, but these factors would be somewhat offset by recently announced government actions relating to mortgage refinancing eligibility. __________________________________ Doug Duncan and Molly R. Boesel Economics and Mortgage Market Analysis February 10, 2009 Opinions, analyses, estimates, forecasts and other views of Fannie Mae's Economics and Mortgage Market Analysis (EMMA) group included in these materials should not be construed as indicating Fannie Mae's business prospects or expected results, are based on a number of assumptions, and are subject to change without notice. Although the EMMA group bases its opinions, analyses, estimates, forecasts and other views on information it considers reliable, it does not guarantee that the information provided in these materials is accurate, current or suitable for any particular purpose. Changes in the assumptions or the information underlying these views could produce materially different results. The analyses, opinions, estimates, forecasts and other views published by the EMMA group represent the views of that group as of the date indicated and do not necessarily represent the views of Fannie Mae or its management.
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