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Get Four
|  | MAY 27, 2005
By Kathleen Madigan The Long Wait for a Housing SlumpThe Fed hikes rates, yet long-term mortgages don't follow suit. What's going on? Start by asking property speculators and bond tradersAlan Greenspan's "conundrum" has been the housing sector's savior. The housing market continues to make hay of economists' forecasts, which had expected 2005 to be the year that home construction and sales fell. Instead, home sales hit record highs in April. Sales of existing single-family homes and condos jumped 4.5%, to an annual rate of 7.2 million, while new home sales posted their third consecutive monthly increase, to a 1.32 million pace. With no cooling in sight, housing forecasts are being revised. For example, the National Association of Realtors expects new home sales to total 1.04 million this year, up from a 1.02 million projected just 2 months ago. And Fannie Mae now expects existing home sales to fall by just 5.4%, to 6.41 million units this year. Back in March, Fannie was projected a 7.6% decline, to 6.27 million. So why hasn't the big chill happened yet? It all comes down to mortgage rates, which have not risen as expected. "We thought long rates would go up as the Federal Reserve raised [short-term] rates. That didn't happen," says David Lereah, chief economist of the National Association of Realtors. Indeed, a December, 2004, survey by BusinessWeek showed that economists on average expected the 10-year Treasury bond, which determines the rate on a 30-year fixed mortgage, to average a yield of 4.74% in the second quarter, up from 4.26% at the end of 2004. Instead, the 10-year yield fell to 4.06% as of May 24. NO PRECEDENT. The drop in bond yields is unusual given the economic circumstances. Even Fed Chairman Greenspan has admitted the bond market's behavior is a riddle. Although oil prices got as high as $57 a barrel this spring, they didn't make much of a dent on economic growth. On May 26, the Bureau of Economic Analysis revised first-quarter real gross domestic product to an annual growth rate of 3.5%, instead of 3.1% reported earlier. And the latest April numbers on employment, retail sales, durable goods orders, and yes, housing, show the economy began the second quarter with a good head of steam. Economists again see growth of at least 3.5% this quarter. The Fed, meanwhile, has been hiking short-term rates, by a total of 2 percentage points since June, 2004. In the past, such tightening has led to bond yields rising between 1 and 2 percentage points, not the half-point drop experienced in the current rate-hike cycle. The Fed is trying to move its federal funds rate up to a neutral stance -- a level that neither helps nor hinders growth -- in order to head off inflationary pressures in an accelerating economy. LESS AFFORDABLE. Policymakers have already noticed that businesses have been successful in passing along their higher energy costs to customers. This pricing power has pushed up core inflation, which excludes food and energy. Core consumer prices rose 2.2% in the year ended in April, up from a 1.8% pace in April, 2004. Normally, the Fed's tightening and inflation fears would be pushing up bond yields. Instead, traders seem to hold the collective attitude that -- the latest strong data aside -- the economy might be done growing, and so the Fed likely is just about finished raising rates this go-round. Moreover, in an increasingly global financial system, the drop in bond yields may not be saying anything much about the U.S. economic outlook. A glut of global savings is chasing yields, and right now even a paltry 4% payout on U.S. Treasuries beats the 3.5% or less to be gotten from euro bonds. In addition, the central banks of China and other Asian nations are buying dollar-denominated assets to prevent their currencies from appreciating too much against the greenback, thus protecting their export industries and jobs. Despite low bond yields, Fannie Mae's chief economist, David Berson, offers some reasons a slowdown in housing is still a good bet. First, rising prices make affordability an issue for many buyers. Second, the rates of 2003 and 2004 -- the lowest in a generation -- induced some households to buy. That pulled forward sales which otherwise would have taken place in 2005. In turn, says Berson, that should produce lower demand and a cooling in the rapid rise in prices. STOKING THE FIRES. Still, it's hard to talk about housing in 2005 without acknowledging the growing effect of speculators. Lereah says the NAR is trying to get a handle on how many homes are being bought with the expressed goal of "flipping" them for a profit within a short period. The number of speculators is hard to come by, but Lereah feels "there are too many of them now, depending on loose lending" like zero-down loans and interest-only payments. He warns, "They make local markets fragile because they will be the first to walk away quickly" if the market turns sour. The danger is that a fire sale by some speculators would depress prices for all. Fannie Mae's Berson expected speculation would have died down this year as price increases leveled off. Now he admits, "We have less confidence that…home-price gains will moderate." Unless they do, speculation will probably continue to stoke the fires under housing, making local markets more vulnerable to any economic shock. REGULATORY BRAKE? The continued increase in speculation has prompted Greenspan, long-skeptical about a housing bubble, to admit recently that some local housing markets show signs of "froth." And Atlanta Fed president, Jack Guynn, discussed worries about a housing bubble in Florida during a May 25 appearance. Such jaw-boning shows the Fed has become more concerned about the fallout of a possible housing collapse. Already, regulators are trying to crack down on too-easy standards for home-equity loans. At the end of the day, though, a housing slowdown will depend on an attitude change in the bond market. And while market sentiment can turn on a dime, there are no signs right now that traders will pushing rates up soon.  Madigan is the Business Outlook editor for BusinessWeek in New York
BW MALL
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