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Cautiously optimistic: the housing market should benefit from an improving job picture, more confident consumers and a reviving economy in 1993.

The housing market should benefit from an improving job picture, more confident consumers and a reviving economy in 1993. As a result, mortgage lending volume should again hit close to $800 billion, according to MBA's new chief economist - David Lereah.

Like an infant learning to walk-taking a step forward, falling, taking another step, but still making progress - the housing market posted erratic but steady gains during 1992. Traditionally, the housing industry leads an economic recovery, and 1992 was no exception. However, just as housing activity posted only modest gains during the year, so did the economy.

The housing industry had its share of peaks and valleys during the last several years, culminating with price deflation in selected regions and a less than robust overall recovery. The assessments of some housing industry pundits have cast a dark shadow over the market, suggesting that the industry's salad days are long gone and predicting that the industry will struggle to post more than modest gains during the next several years. Others believe the industry's outlook is not so bleak. I fall into this latter group.

Although, the days of achieving two million housing starts per year may not be attainable in 1993 or, for that matter, for the remainder of this decade, the housing industry could be positioned for some steady, solid growth if a variety of factors fall into place.

Factors holding back housing in 1992

The factors that inhibited housing activity in 1992 - an uncertain employment situation, weak personal income gains and falling consumer confidence - should exhibit marked improvement during 1993. It is becoming increasingly clear that the economy is poised to rebound from 1992's lackluster performance, even if the incoming Clinton administration does little to stimulate it.

Confidence in this rebound is further bolstered by knowing that one of Clinton's first priorities is to create jobs. Job gains beget rising incomes, which, in turn, boost consumer confidence. These favorable developments, combined with a continued low interest rate environment, should provide a favorable backdrop for housing activity during 1993.

Last year's silver lining

There is always a silver lining, and 1992 was no exception for the mortgage banking business. Despite sluggish housing activity during the year, mortgage lenders enjoyed a record year in mortgage originations. The industry experienced two refinance booms primarily due to falling interest rates, generating billions of dollars of refinance transactions. Consequently, the industry collectively produced an estimated $825 billion in mortgages loans during the year. About 40 percent of these originations were refinancings.

By reviewing what occurred in 1992, some insight can be gained into how the housing market is positioned for 1993. The MBA economics department's 1993 outlook for housing activity is detailed later in this article after a brief examination of what happened last year in the housing market. I acknowledge upfront that the best one can hope for is to be intelligently wrong or fortunately right.

1992: erratic but steady

Last year was a year of frustration and reflection for the housing industry. Market participants learned that a low interest rate environment is a necessary but not sufficient condition for boosting housing activity. Although, long-term mortgage rates (see Figure 1) fell almost 1.5 percentage points during the year, registering a 19-year low during the third quarter (at about 7.9 percent), housing starts (see Figure 2) and housing sales - both new and existing (see Figure 3) - continued to post historically weak numbers. Virtually all of the gain in starts was in single-family housing, while multifamily housing starts posted historically weak numbers. Total starts averaged about 1.203 million, while new single-family home sales averaged 610,000 and existing sales averaged 3.482 million for the year.

On a national scale, economic activity was uneven and sluggish for most of the year, depriving some families of the financial wherewithal to purchase homes. The economy posted gains of 2.9 percent GDP (gross domestic product) growth in the first quarter and 1.5 percent and 3.4 percent growth in the second and third quarters, respectively. The fourth quarter is projected to post a 2.5 percent growth pace.

Low rates weren't enough

Clearly, the housing markets needed more than just low interest rates. Modest gains in personal incomes, an uncertain job picture (e.g., only 500,000 jobs were added to payrolls for the year) and falling consumer confidence combined to inhibit housing activity. With housing activity floundering, many began to question whether the industry's traditional role of leading the economic recovery would hold true this time around.

Briefly, there are a number of factors worth mentioning that held back economic (and housing) activity last year. * Excessive debt burdens - Both the federal government and consumers continued to shoulder the burdens of the excessive debt buildup of the 1980s. The federal budget deficit approached $290 billion during 1992, severely constraining fiscal policy, while placing upward pressure on long-term interest rates. Consumers chose to pay down their high debt levels during the year rather than spend more, further dragging down economic activity. * Weakened financial institutions - The combination of the S&L crisis, mounting commercial bank problems an regulatory restrictions on lending contributed to the nation's credit crunch. For most of the year the banking industry avoided granting loans to businesses. Instead, they invested heavily in U.S. Treasury securities, indirectly funding the federal budget deficit. * Overbuilding in commercial real estate - Commercial activity has been either down or stagnant for some time in most regions of the country, contributing negatively to overall economic activity. * Problems of state and local governments - A significant number of state and local governments across the nation are experiencing severe financial difficulties, depressing local and state economies. California, unfortunately, is a prime example of the inability of many state governments to fund current projects and programs. California's state budget deficit is well in excess of $10 billion for 1992. * Demographic factors-demographic changes, such as the aging of the baby boom generation, are beginning to have negative consequences on economic and housing activity. The rush of baby boomers to purchase new and existing homes during the 1980s provided substantial support for housing activity e.g., housing starts approached almost 2 million in 1986). Unfortunately, the boomers are now comfortably in their homes and out of their prime, initial, housing purchase phase. Some are moving up to larger homes, but there are no large generational cohorts coming up behind the boomers to stir 1980s-type housing activity. Until the baby boomers' children begin to purchase homes, housing activity is not expected to achieve the robust numbers experienced in the 1980s. * Cold War transition - Although we won the war, the victory was more costly than we had anticipated. During the next five years, the nation will experience a massive transition from military to private business. More than 1 million defense jobs will be lost during this period, and a host of military industries - from planes to weapons - will be severely impaired. Military spending, which currently comprises about 5 percent of GDP, is projected to be about 2.5 percent to 3 percent of GDP by 1997. * Slowing world growth - The United States is clearly entrenched in a globalized marketplace, making our domestic economic fortunes vulnerable to other nations' economic plights. Unfortunately, most of our major trading partners are currently experiencing economic difficulties, dragging down our net exports. Europe is currently undergoing an enormous cross-subsidization of West to East economies (a residual of the Cold War) and has experienced a slowing of economic activity. Japan's economy is finally slowing down and currently is in recession.

A bright spot

The one bright light in the housing and real estate markets for the year was mortgage origination volume, led by refinancing activity. The mortgage banking industry clearly experienced two refi booms during the year (see Figure 5) - January to February and July to October. Consumers were obviously responding to the favorable low interest rate environment.

Current (30-year, fixed-rate) mortgage coupons hovered around the 7.9 percent to 8.3 percent range during most of the year, providing many homeowners holding 9.5 percent to 10.5 percent mortgages with the opportunity to reduce their mortgage payments. While many chose to lower their debt burdens by refinancing to lower coupon, 30-year, fixed-rate mortgages, others chose to shorten the life of the mortgage (i.e., opting for 15- or 20-year terms), while still others refinanced into ARMs and balloon mortgages. Riding the coattails of the refi wave, mortgage origination volume posted a record $825 (estimate) billion during 1992 (see Figure 4).

1993 housing outlook

What kind of housing market will 1993 bring? With cautious optimism, we anticipate a marked improvement over 1992. Housing should be the benefactor of two positive developments during the new year - (1) a relatively healthy economy, projected to grow between 3 percent and 3.4 percent for the year; and (2) a relatively low interest rate environment. Both should provide a favorable backdrop to promote housing activity.

After several years of stumbling along, the economy is poised to exhibit steady, moderate growth during 1993. The structural factors inhibiting growth last year have not gone away and will continue to cast a long shadow upon the 1993 outlook. Those factors include stagnant commercial real estate activity, the costs of the Cold War transition and the slowing of world growth. However, progress has and will continue to be made in other areas. Most importantly, we expect 2.5 million jobs to be added to our nation's payrolls this coming year, compared with only 500,000 job gains last year. This anticipated surge in jobs should have a positive influence on many facets of the economy, but particularly on personal income and consumer confidence. Furthermore, the banking industry's overall financial condition is expected to improve in 1993, suggesting that the lending faucets may soon be loosened. Finally, the anticipated Clinton stimulus programs, slated to be implemented during the early months of his administration, should provide a boost to overall activity as well.

Favorable long-term interest


Perhaps the most encouraging news for the housing markets is the continued expectation that inflation will remain relatively tame throughout the new year. Consumer prices, excluding food and energy, are expected to rise by less than 3 percent for the year. Lower inflationary expectations should provide downward pressure on long-term interest rates. In addition, there is the likelihood (given slow growth) that there could be rate declines abroad - across Europe as well as in Japan, placing upward pressure on the U.S. dollar, which will, in turn, exert downward pressure on U.S. interest rates. Assuming the budget deficit does not escalate during the year, long-term interest rates should come down a notch or two. Rates on fixed-rate mortgages are projected to average about 7.97 percent during 1993. ARM mortgage rates are projected to average roughly 5.16 percent in 1993.

With the backdrop of relatively healthy economic activity and low mortgage rates, most housing measures are expected to post steady gains during 1993. (see Figure 4). Housing starts are expected to average 1.33 million starts during the new year, primarily due to one- to four-family starts. Multifamily construction activity is expected to rise, but the levels will still reflect a struggling market. New home sales are likely to be up 6 percent, and existing home sales are likely to be up by 5 percent on a year-over-year basis.

The housing market, however, is not expected to experience any significant price appreciation for some time. Median prices on new homes are expected to rise by 3.4 percent during the year to $125,700, while median home prices on existing homes are projected to rise 2.9 percent to $106,300.

Finally, the mortgage banking industry is expected to have another robust year in origination volume. With 30-year, fixed mortgage rates expected to average about 8 percent for the year, a relatively high level of refinancing activity is expected. Because mortgage rates are projected to hover around last year's levels, many potential refinancings have already been taken out of the market during 1992's two refi booms. Thus, the MBA economics department is assuming that refinancings win register a lower percentage of total originations for the year. The refi share in 1993 is expected to be closer to 38 percent versus 40 percent in 1992. Refinancings are projected to be about $304 billion by year-end 1993, while purchase originations are projected to be about $496 billion, totaling $800 billion in mortgage originations. ARMs, as a percentage of loans closed, will drop slightly in 1993 to 17 percent from the 23 percent level achieved during the past two years.

The Clinton factor

Because of the uncertainty surrounding the future performance of a Clinton administration, the financial markets have given Clinton a lukewarm reception. There is probably about 25 basis points built in to the long end of the yield curve reflecting this uncertainty. What should we expect in his first 100 days? Expect a modest stimulus package emphasizing job gains, an investment tax credit and a capital gains tax cut, an increase in the top tax rate to 36 percent from 31 percent (for incomes in excess of $200,000) and perhaps a slight tax break for middle-bracket taxpayers. Given the traditional honeymoon period and an eager Democratic-dominated Congress, this package is likely to pass.

Over the longer term, Clinton will push other programs, such as comprehensive health insurance, job training and educational programs and a scaled-down version of his well-publicized $80 billion infrastructure program, emphasizing roads, cities and information networks, to name a few.

With regard to housing, expect the following from a Clinton administration: (1) extension of the mortgage revenue bond program that provides low-income financing to first-time buyers; (2) creation of individual development accounts in which the government may match targeted savings accounts for the purchase of first homes under certain. income conditions; (3)revitalization of FHA, particularly multifamily programs; and (4) increased federal government involvement for housing services as a facilitator, while relying on private business for implementation.

David Lereah is staff vice president and chief economist for the Mortgage Bankers Association of America in Washington, D.C.
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Author:Lereah, David
Publication:Mortgage Banking
Date:Jan 1, 1993
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