The one thing Federal Reserve chairman Ben Bernanke would most like to know is this: How much longer and farther will American house prices fall?
If home prices are near a bottom, then the Fed — and its allies in the White House and Congress — probably have deployed enough forces to prevent a deep, prolonged recession. But if those prices still have a long way to fall, then the Committee to Save the World (Version 2.0) — B ernanke and treasury secretary Henry Paulson, in place of predecessors Alan Greenspan, Robert Rubin and Lawrence Summers — is going to need heavy artillery and air support.
Falling house prices aren’t the US economy’s only challenge, of course; just the biggest one.
It isn’t just that new home construction is — or used to be — an important industry and employer. It’s that houses are American families’ single biggest financial asset. A persistent decline in their value will depress both Americans’ wealth and their spirits.
And it is that — unbeknown to most of us — Wall Street built a fragile house of securities on the premise that US home prices would never fall, except in isolated markets. The premise was wrong. Billions of dollars have been lost as a result.
Wall Street can’t place a value on all its mortgage-linked securities until it can figure out the worth of the houses underlying those securities. And until that happens, the credit crunch is likely to spread and intensify.
So, as Merrill Lynch economist David Rosenberg asked in a commentary this week: “Is the worst over for the housing market?” Replying to his own question with refreshing, perhaps courageous, certainty, he said: “The answer is no.”
Home builders already have cut new home construction to an annual rate of one million units. That’s back to levels last seen in May 1991, and far below what builders — and the Fed — had anticipated would be necessary to restore the balance of supply and demand. Yet, the backlog of unsold houses and condos, measured against the monthly pace of sales, continues to climb. And that’s despite the fact that the median price of a new home — now at $219,200 (Rs87 lakh) — has fallen to where it was three years ago.
Rosenberg predicts housing construction will have to slow to a 700,000 annual pace before the market stabilizes.
Meanwhile, the S&P/Case-Shiller index of house prices in 20 metropolitan markets fell another 2.1% in November for the 16th month in a row. It was down nearly 8% over a year.
Ouch. The looming recession, if it arrives, isn’t likely to be as mild as the recessions of 1990-91 or 2001. In a new Wall Street Journal survey, forecasters give 40% odds it would be worse than the previous two.
Yet, house prices haven’t fallen enough for buyers to jump into the market: The fraction of Americans who say they plan to buy a house in the next six months is lower than at any time since 1994, according to the Conference Board, the research group that conducts monthly consumer confidence surveys. Or maybe potential buyers doubt they can get mortgages, even at today’s more attractive rates.
The US economy will soon be feeling a shot of adrenaline from rate cuts and tax rebates. The Fed clearly has decided to err on the side of doing too much. Bernanke backed a fiscal stimulus plan early on. And the Fed has cut its key interest rate to 3% from 5.25% since September.
Markets now expect the Fed to drop the rate to 2.5% by mid-March. To bring rates as far below inflation as it usually does in recessions, the Fed will have to push the rate down to 2%.
If the Fed succeeds in heading off what might have been a severe recession, it will look like it has done too much. The challenge for Bernanke then will be to boost rates as rapidly as he has just cut them to avoid an outbreak of inflation.
But that is the more pleasant outcome. What if house prices keep falling, and the economy keeps sinking?
Another three or four months like the past one, and Bernanke and Paulson will be thinking seriously about aggressive proposals that — for now — are deemed too radical. Like creating a federally funded outfit to buy mortgages that are in or near default and refinance them at easier terms so the borrowers can keep their homes, as senate banking committee chairman Christopher Dodd is already suggesting. Or helping state and local government agencies buy houses that are in foreclosure and rent them out until the housing market rebounds.
This war isn’t won yet.
David Wessel writes the column, Capital, in ‘The Wall Street Journal’.
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