By David A. Lereah
RISMEDIA, Jan. 8, 2009-As we begin the New Year, we look back before we look forward. Not since the Great Depression has America experienced such economic and financial deterioration.The U.S. financial system collapsed in 2008 with the flow of credit virtually frozen throughout the financial markets.
Two of the nation’s most respected investment banks- Lehman Brothers and Bear Stearns failed and the nation’s largest mortgage lender- Countrywide- went belly up. The two mortgage funding giants, Fannie Mae and Freddie Mac, were taken over by the federal government and are now under conservatorship.
Goldman Sachs and Morgan Stanley sought safer harbor by becoming bank holding companies. The government bailed out our nation’s largest insurer, AIG, and then handed a bailout package to two of our largest automakers, General Motors and Chrysler.
Government rescue efforts were massive during 2008. The Treasury and Federal Reserve combined to spend trillions of dollars bolstering the credit markets and a struggling economy in an attempt to keep businesses and financial institutions afloat. The Federal Reserve also cut the federal funds rate 10 times in 15 months and the rate now hovers in the unthinkable 0 to 0.25 percent range.
The Treasury convinced Congress to approve a $700 billion rescue package called the Troubled Asset Relief Program, TARP, originally designed to purchase problem assets from financial institutions with the funds. But Treasury Secretary Paulson used some of the money to inject capital into the financial institutions instead. The TARP program has yet to be implemented.
There were a host of housing stimulus and foreclosure mitigation programs tried or proposed throughout the year. FHA Secure, Hope Now and Hope for Homeowners were some and none of them seemed to be effective.
Senator Barrack Obama was elected the nation’s 44th President based partly on his message of change and an inspirational message of hope. The President-elect inherits a nation facing challenges of historic proportions not faced since Franklin D. Roosevelt was inaugurated in the depths of the Great Depression in 1933.
According to official data, the U.S. economy was in recession throughout 2008. The economy lost an alarming 1.9 million jobs last year (not including December). Most industries and geographic regions of the nation experienced economic contraction. Consumer and business confidence plunged throughout the year resulting in weak consumer spending on both durable and nondurable goods and services and weak business investment spending as well. The dramatic drop in aggregate demand also exerted downward pressure on both consumer and producer prices on goods and services. Deflation is now a serious concern as we enter the New Year. Falling oil prices contributed to deflationary pressures. At its peak, oil topped $147 a barrel in 2008, only to plummet to about $40 a barrel by the end of the year.
The stock market experienced its worst performance in 2008 since the 1930s (during the Great Depression). As of this writing, the Dow Jones Industrial Average was down 34.7 percent for the year, while the S&P 500 and Nasdaq were down 39 percent and 41.5 percent, respectively. Similarly, home values in 2008 also experienced their worst performance since the Great Depression. According to the Case-Shiller 20 city index, home prices fell by 18 percent in 2008 (October 2008 compared with October 2007). It is now estimated the over 12 million homeowners have negative equity in their homes.
Falling home prices have reduced homeowner wealth by over $3 trillion. In addition, the falling stock market has reduced household wealth by almost $ 7 trillion. Over 1 million homes have been lost to foreclosure since the housing crises hit in August of 2007.
Simply stated, households lost a great deal of wealth last year, shattering their confidence as they enter the New Year.
The real estate business experienced a sharp recession in 2008. Residential construction (housing starts) plunged by over 45 percent during the year as builders suffered their worst year since World War II. With the economy in recession, home values falling, and foreclosures mounting, demand for new homes fell off dramatically. Existing home sales were off about 12 percent last year, but over 30 percent of those sales were foreclosure properties. Even with foreclosure sales, existing home sales are currently hovering at cyclical lows.
Mortgage originations fell 25 percent in 2008 compared to a year earlier. We estimate that mortgage originations will total about $1.5 trillion in 2008, compared to $2.3 trillion in 2007. Of course, there were significant changes in the composition of originations by year end. FHA/VA market share rose to about 30 percent from as little as 3 percent earlier in the year, while sub-prime and Alt A loan shares fell to almost nothing. Similarly, fixed-rate loan shares surged at the expense of variable-rate shares.
Looking ahead, 2009 promises to be a year filled with caution and hope. The economy is mired in a deep recession and the financial markets remain broken but that could change later this year. President Obama and Congress have promised to put together a significant stimulus package approaching $1 trillion to re-start the economy. We expect that package to be in place during the first quarter.
In addition, the Federal Reserve and Treasury have promised to provide the necessary liquidity in the financial markets so that consumers and businesses can have adequate access to borrowed funds. We expect interest rates to remain at relatively low levels throughout the year.
Most economists are projecting fourth quarter GDP to fall about 4.5 percent on an annualized basis, which would be the largest decline since the first quarter of 1982 when real GDP fell 6.4 percent annualized. It is likely that GDP will fall in the first quarter, the second quarter and maybe in the third quarter as well.
If the stars are aligned (and that is hoping for a lot), an economic recovery is expected in the latter part of the second half of the year. There are some positives: household debt is improving and households are saving more; the Obama stimulus packages promises to eventually energize economy; households are likely to receive tax breaks early this year; consumer and business borrowing costs are expected to remain relatively low; and inflationary pressures are at bay.
However, the recovery is likely to be limited and weak for a number of reasons. First, consumers have lost a great deal of wealth during this recession due to large home price and stock market declines and thus will find it difficult to return to more normal spending patterns. Second, it is likely to be a long process for banks to recapitalize and rid their toxic assets from their balance sheets. Third, after experiencing a severe credit crisis, it is likely that credit will remain tight long after the recession is over. And finally, the government has spent trillions of dollars in attempts to rescue the financial system and the economy over the past several quarters. There will likely be a huge hangover cost to this excessive spending.
If the economy experiences a slow recovery in the second half of this year, so will real estate. So even when home sales eventually bottom out, do not expect an energetic rebound in sales activity. Similarly, when excess inventories return to more normal levels and home prices begin to stabilize, do not expect home price appreciation to return to the historical norms of 3 to 5 percent any time soon. However, even modest price appreciation and home sales growth would present a favorable picture for the housing marketplace. We note that the National Association of Realtor’s affordability index is at its highest level (most affordable) since the early 1970s. And if mortgage rates can drop further via additional government action, we could experience a meaningful uptick in sales activity. We will take what we can get.
David A. Lereah, president of Reecon Advisors, is a recognized expert in real estate economics and financial services. Dr. Lereah was Senior Vice President and Chief Economist of the National Association of Realtors and Chief Economist for the Mortgage Bankers Association of America. This commentary first appeared in the Reecon Advisory Report, an independent source of news, insight and intelligence on the real estate economics that are shaping real estate markets. For more information, go to www.reeconadvisoryreport.com.