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To the 2007 International Monetary Conference, Cape Town, South Africa
June 5, 2007
The Housing Market and Subprime Lending
Over the past four quarters, the U.S. real gross domestic product (GDP) has increased at an average rate of about 2 percent. Growth during the first quarter of this year was held down by some factors—notably, significant declines in inventory accumulation, net exports, and federal defense spending—that seem likely to be at least partially reversed in the near term. Of course, the adjustment in the housing sector is still ongoing, and the slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected. Thus far, however, we have not seen major spillovers from housing onto other sectors of the economy. On average, over coming quarters, we expect the economy to advance at a moderate pace, close to or slightly below the economy's trend rate of expansion.
As expected, we have also seen a gradual ebbing of core inflation, although its level remains somewhat elevated. Despite recent increases in the prices of crude oil and gasoline, energy prices overall are below last year's peak; the rate of increase in shelter costs seems likely to slow, although the timing remains uncertain; and long-run inflation expectations, as derived from both surveys and market-based measures of inflation compensation, have remained contained. However, although core inflation seems likely to moderate gradually over time, the risks to this forecast remain to the upside. In particular, the continuing high rate of resource utilization suggests that the level of final demand may still be high relative to the underlying productive capacity of the economy.
In my brief remarks today I will focus on some recent developments in housing, including the emergence of some serious stresses in subprime mortgage markets. I will also discuss some initiatives taken or planned by the Federal Reserve to respond to the problems in subprime mortgage lending.
Developments in the Housing Market
As you know, the downturn in the housing market has been sharp. From their peaks in mid-2005, sales of existing homes have declined more than 10 percent, and sales of new homes have fallen by 30 percent. A leveling-off of sales late last year hinted at a possible stabilization of housing demand; however, once one smoothes through the monthly volatility of the data, more-recent readings indicate that demand weakened further, on net, over the first four months of this year. House prices decelerated sharply last year, following annual gains averaging 9 percent from 2000 to 2005. Prices have continued to be quite soft so far in 2007, although for the most part outright price declines have been concentrated in markets that showed especially large increases in earlier years.
Homebuilders have responded to weak sales by curtailing construction. Single-family housing starts have declined by a third since early 2006, sufficient to subtract about 1 percentage point from real GDP growth over the past four quarters. Despite the drop in homebuilding, the inventory of unsold new homes has risen to more than seven months of sales, a level well above the average observed over the past decade. Accordingly, and as reflected in the continued downward trend in permits to build single-family homes, residential construction will likely remain subdued for a time, until further progress can be made in working down the backlog of unsold new homes.
Recent developments in the subprime mortgage market add somewhat to the usual uncertainty in forecasting housing demand. Subprime mortgage borrowing nearly tripled during the housing boom years of 2004 and 2005. But decelerating house prices, higher interest rates, and slower economic growth have contributed to an increased rate of delinquency among subprime borrowers. This increase has occurred almost entirely among borrowers with adjustable-rate mortgages; delinquency rates for fixed-rate subprime mortgages have remained generally stable.