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As the Fed Pulls Back, Can Housing Stand Alone?


Home sales just fell again. With the central bank about to stop buying mortgage securities and the housing tax credit expiring, questions abound over housing's future

For months, investors' favorite parlor game has been betting on the timing—and the impact—of the Federal Reserve's decision to raise its benchmark interest rate from its current near-zero level. But there's a key sector of the economy where a Fed return to normalcy is set to play out much sooner: housing.

Sales of both existing and new homes fell in February for the third and fourth straight months, respectively. Yet at the end of March the central bank will withdraw a big support under the housing market when it ends its $1.4 trillion program to purchase mortgage-backed securities and housing-agency debt. A month later the federal home-buyer tax credit expires. Some housing watchers fret that one-two punch could send the sector back to the mat.

A growing number of economists, however, believe that a pickup in employment this spring, cheap credit, and a glut of affordable homes will allow housing not only to withstand the removal of government help in 2010 but also to contribute to U.S. annual economic growth for the first time since 2006.

Employment is key to this outlook. Morgan Stanley (MS) economist David Greenlaw forecasts as many as 300,000 new U.S. jobs in March, the biggest monthly increase in four years, because of milder weather, government hiring of temporary workers for the U.S. Census, and a growing economy.

Credit conditions also may be improving. A net 13.2% of banks surveyed by the Fed in January reported that they tightened lending standards on prime mortgages in the fourth quarter. That's the smallest percentage in three years.

Meanwhile, falling prices and low mortgage rates have made homes more affordable. The median price of a U.S. home was $165,100 in February, the second-lowest reading since May 2002. And the average rate for a 30-year fixed mortgage was 4.96% in mid-March, not far above December's record-low 4.71%.

The result of that potent mix of less-expensive homes and cheap credit: The average U.S. household had 177.8% of the income needed to purchase a property in January, the highest since last April's 184%, the record.

That's behind some forecasters' optimism. David Crowe, chief economist at the National Association of Home Builders (NAHB), says sales of new homes will likely total 459,000 in 2010, up from 372,000 last year. And Barclays Capital (BCS) economist Dean Maki, who figures overall home sales will rise about 6% this year, says housing will account for 0.25 percentage points of the 3.6% growth he foresees for the U.S. economy.

The first test of that scenario comes later this month when the Fed ends its program to purchase $1.25 trillion of mortgage-backed securities and about $175 billion of housing-agency debt.

Credit Suisse (CS) mortgage strategist Mahesh Swaminathan says private demand for mortgage debt is now strong enough to replace that of the central bank. And Barclays Capital Managing Director Ajay Rajadhyaksha says the spread between the yields on mortgage-backed securities and Treasury notes should widen only slightly this quarter, signaling that the risk premium on mortgage debt won't spike after the Fed withdrawal.

Likewise, the impact of the expiration of the home-buyer credit should be minimal. The original credit for first-time buyers helped boost existing-home sales by 4.9%, to 5.16 million, in 2009, the first rise since 2005. The credit, slated to end last Nov. 30, was expanded to include some trade-up buyers and extended through April. But the extension hasn't helped much: The credit of up to $8,000 will result in only 180,000 extra sales from December to April, says the NAHB's Crowe.

Another challenge in 2010: the supply of properties for sale could rise even further. Foreclosures may increase to 2.2 million this year from 2009's record 1.7 million, predicts Mark Zandi, chief economist at Moody's (MCO) Economy.com. But Thomas Lawler, a former Fannie Mae (FNM) economist, says an improving job market would spur household formation and help absorb the excess supply. While that doesn't portend a robust rebound, it suggests the worst may be over for housing.

Howley is a reporter for Bloomberg News. Miller is a reporter for Bloomberg News.

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