2. US Economics Analyst
Issue No: 10/22
June 4, 2010
Research Report
Gao Hua Economics Research
at https://portal.ghsl.cn
House Prices Have Not Bottomed Yet
Following their sharp earlier decline, house House Prices Have Stabilized …
prices have stabilized since early 2009 and Index Index
valuations have returned to “normal” levels. 350 350
House Price Indices:
Jan Hatzius But at the same time, temporary boosts from Case-Shiller
jan.hatzius@gs.com government housing policies are fading and FHFA Index
212 902 0394 the housing market remains plagued by 300 Loan Perf ormance 300
excess supply and high—and apparently still
Ed McKelvey rising—mortgage delinquencies.
ed.mckelvey@gs.com 250 250
212 902 3393 To gauge what these opposing forces might
imply for future house prices, we construct a
Alec Phillips model for a panel of 20 metro areas. Our 200 200
alec.phillips@gs.com results show that house price dynamics are
202 637 3746 explained by (1) price momentum, (2)
price/rent valuations, (3) the change in 150 150
Andrew Tilton mortgage delinquencies, (4) the mortgage 00 02 04 06 08 10
andrew.tilton@gs.com
212 357 2619
rate, (5) excess supply and (6) temporary Source: S&P, Fiserv, & MacroMarkets LLC. LoanPerf ormance. FHFA.
factors, including the government housing
Sven Jari Stehn policies. … But Excess Supply Remains Huge
jari.stehn@gs.com and Delinquencies Are Still Rising
Given the excess supply in the housing
212 357 6224 Percent Percent
market and rising delinquencies, our model 3.0 11
David Kelley
suggests that the composite 20-city Case-
10
david.kelley@gs.com Shiller index will fall by 3% over the next
212 902 3053 year and another 1% over the following year. 2.5
9
Our model projects the biggest price declines 8
Maria Acosta-Cruz
maria.acosta-cruz@gs.com
in Las Vegas, Seattle and Portland, due to 7
212 902 6709 high homeowner vacancy rates and/or rising 2.0
6
mortgage delinquencies. Conversely, we
expect modest house price gains in 5
Cleveland, Minneapolis, San Diego and San 1.5
4
Francisco.
Homeowner Vacancy Rate (lef t) 3
The May employment report was a Mortgage Delinquency Rate (right)
1.0 2
disappointment, with nonfarm payrolls 90 92 94 96 98 00 02 04 06 08 10
excluding temporary Census jobs rising just Source: Department of Commerce. Mortgage Banker's Association.
21,000. Even if we average this figure with
the much sturdier gain of 223,000 seen in
April—smoothing may be warranted given
some unusual quirks in the last two
reports—there are as yet few signs of
substantial positive “multiplier” effects in
the labor market. We continue to expect a
slowdown in real GDP growth to 1½% in the
second half of 2010. Important disclosures appear at the back of this document.
3. GS Global ECS US Research US Economics Analyst
I. House Prices Have Not Bottomed Yet
Following their earlier collapse, house prices appear
caught in a cross current. On the one hand, there are Exhibit 1: House Prices Have Stabilized
indications that prices may have bottomed. While Index Index
alternative house price indices differ in details, they 350 350
generally show that house prices have stabilized since House Price Indices:
Case-Shiller
early 2009 (Exhibit 1). Second, measures of valuation
FHFA Index
appear to be back in “normal” territory (Exhibit 2).
300 Loan Perf ormance 300
The Case-Shiller price/rent ratio—which stood nearly
25% above its long-run value in early 2006—is now
broadly in line with its historical average. Housing
affordability—measured as the percent of income 250 250
spent on mortgage principal and interest—has also
improved noticeably during this period.
200 200
Other indicators, however, point to further house price
declines. First, much of the stabilization of house
prices since early 2009 appears due to government
housing policies, including (1) the homebuyer tax 150 150
00 02 04 06 08 10
credit, (2) the Fed’s purchase of mortgage-backed
Source: S&P, Fiserv, & MacroMarkets LLC. LoanPerf ormance. FHFA.
securities and (3) temporary mortgage modifications
through the Obama administration’s Home Affordable
Mortgage Program. We have estimated that these Exhibit 2: Valuations and Affordability Have
housing policies have temporarily boosted house Improved
prices by around 5%.1 Second, the housing market Percent deviation f rom hist. avg
60
Index
25
remains plagued by enormous excess supply (Exhibit
3). Despite recent improvements, both the homeowner 50
vacancy rate and the months’ supply of single-family 40
homes for sale remain well above historical levels.
30 20
Third, the mortgage market remains troubled.
Mortgage delinquencies have continued to rise from 20
their already elevated levels (Exhibit 3). 10
0 15
Given these cross currents, how should we expect
house prices to develop over the next one or two -10
years? Our working assumption has been for a -20
Home Price/Rent Ratio (lef t)*
renewed 5% drop in the national Case-Shiller index NAR Housing Af f ordability (right)
between end-2009 and end-2010, and we already saw -30 10
90 92 94 96 98 00 02 04 06 08 10
a 1.3% decline in the first quarter.2 In this comment
*Home prices is Case Shiller, spliced with FHLMC bef ore 1987. Rent is
we present results from a new house price model owner's equivalent rent, spliced with residential rent bef ore 1983.
suggesting that the remaining decline could stretch out Source: S&P, Fiserv, and MacroMarkets LLC. FHLMC. Dept. of Labor.
over a somewhat longer time period. Specifically, the
model points to declines of 3% over the next year and more data with longer time series are available.3
another 1% over the following year as excess supply However, we believe that the housing market is
and rising mortgage delinquencies take their toll. characterized by sufficient regional variation to
warrant a more disaggregated approach. Exhibit 4, for
Modeling House Prices example, shows very different house price
Our house price model is constructed as follows. First, developments in the three largest US metropolitan
we choose to model house prices at the metro area areas.
level. Most house price models have focused on
forecasting aggregate prices at the national level, as Second, we decide to focus on the Case-Shiller house
price index. Of the three most prominent house price
1
See “Housing Policies and Home Prices: A Big
Boost,” US Economics Analyst 09/42, October 23, 3
See, for example, Vladimir Kluev, 2008, “What goes
2009. up must come down”, IMF WP/08/187, or Joshua
2
See “10 Questions for 2010”, US Economics Analyst Gallin, 2003, “The long-run relationship between
09/52, December 31, 2009. house prices and income”, FRB.
Issue No: 10/22 2 June 4, 2010
4. GS Global ECS US Research US Economics Analyst
Exhibit 3: But Excess Supply is Huge and Exhibit 4: House Price Dynamics Display
Delinquencies Are Still Rising Substantial Regional Variation
Percent Percent Index Index
3.0 11 290 290
Regional Case-Shiller
10
Home Price Index:
Los Angeles
9
2.5 240 Chicago 240
8 New York
7
2.0 190 190
6
5
1.5 140 140
4
Homeowner Vacancy Rate (lef t) 3
Mortgage Delinquency Rate (right)
1.0 2 90 90
90 92 94 96 98 00 02 04 06 08 10 00 01 02 03 04 05 06 07 08 09 10
Source: Department of Commerce. Mortgage Banker's Association. Source: S&P, Fiserv, and MacroMarkets LLC.
indices, the Federal Housing Finance Agency (FHFA) In selecting our specification we aim for a model that
index is least desirable as it covers only transactions describes house prices well both before and after the
involving agency-backed mortgages and our previous collapse of the bubble. When estimated for the full
statistical work has shown that the Case-Shiller index sample until 2010, our model does a decent job at
is the better index at the regional level, containing capturing the turning point in 2006. However, the
more useful information for future house price model is less successful at predicting the 2006 house
appreciation.4 While the Loan Performance house price decline when estimated with data through 2005.
price index (excluding distressed sales) is desirable in
principle, too short a history is available at the metro Key House Price Determinants
level to build a panel model. We identify six house price determinants (Exhibit 5):
We therefore construct a quarterly model of the Case- 1.Persistence. Lagged house price appreciation is
Shiller house price indexes for a panel of the 20 statistically significant with a sizable coefficient,
largest US metropolitan areas for the period spanning confirming the existence of short-term momentum
from 1997Q1 until 2010Q1. Whenever possible we in house prices. All else equal, a 1% price
use data at the metro area level; when insufficient data decrease over four quarters is typically followed
are available we either proxy the metro-area variable by another ½% fall one year later.
with the corresponding state data (for existing home
sales and mortgage delinquencies) or use national data 2.Price/rent valuation. We find a strongly negative
when no state-level data are available (for months’ effect from “overvaluation” on future house
supply of houses for sale and the mortgage rate). prices. All else equal, a 1 percentage point
increase in the price/rent ratio lowers house prices
Our model explains current house price appreciation by 0.2% after four quarters and by a full
by past price changes and a number of lagged percentage point eight quarters later.
explanatory variables.5 Although this approach does
not allow for rich quarter-to-quarter dynamics, it 3.Excess supply. A one-percentage point increase in
permits us to forecast future house prices with current the homeowner vacancy rate lowers house prices
values of the explanatory variables without the need to by 1.8% four quarters later (and 5.4% after eight
project data at the metro-area level. We run separate quarters), while a one-point increase in the
models to project house prices four and eight quarters months’ supply of homes for sale lowers house
ahead. To allow for structural differences in house prices by 1.4% four quarters later. A higher
price dynamics across metro areas, we include fixed volume of existing home sales raises prices, as
effects in our panel. excess supply is reduced.
4
See “Home Prices and Credit Losses: Projections and
Policy Options”, Global Economics Paper 177,
January 31, 2009.
5
This approach follows our previous work, see above.
Issue No: 10/22 3 June 4, 2010
5. GS Global ECS US Research US Economics Analyst
Exhibit 5: House Price Determinants Exhibit 6: House Price Projections
Forecast for: % Change in:
4Q 8Q 4Q 8Q
1. Persistence Atlanta -5 -1
Lagged Dependent Variable 0.5 0.6 Boston -1 0
Chicago -5 -10
2. Valuation
Charlotte -5 -10
Price/Rent Ratio -0.2 -1.0
Cleveland -1 7
3. Excess capacity Dallas -1 1
Homeowner Vacancy Rate -1.8 -5.4 Denver 0 4
Months' House Supply -1.4 -
Detroit -4 0
Existing Home Sales Growth 0.1 0.2
Las Vegas -12 -6
4. Mortgage Market Los Angeles -2 -1
Change in Delinquencies -3.2 -5.0 Miami 0 -3
Mortgage Rate -1.7 -7.2 Minneapolis 1 3
R-Squared 0.85 0.82 New York -4 -9
Number of Observations 1040 956 Portland -4 -12
Note: Dummies for 09Q3-10Q1 not reported. Phoenix -5 -10
All variables sign. at 1%. Area fixed effects included.
Source: Our calculations. San Diego 0 5
San Francisco 2 3
4.Mortgage delinquencies. Rising delinquencies have Seattle -8 -22
a negative effect, lowering house prices by 3.2%
after four quarters and 5% after eight quarters for Tampa -1 2
a one percentage point increase in the delinquency Wash. DC 1 -5
rate.
CS 20 -2.6 -3.5
5.Mortgage rates. Higher borrowing costs also have Source: Our calculations.
significantly negative effects on house prices,
lowering prices by 1.7% after four quarters for home vacancy rates and steeply rising delinquencies
every 100 basis points of nominal mortgage rate are expected to push down prices in all three areas,
increases. some interesting differences emerge. Price declines in
Las Vegas are projected to be front loaded, as negative
6.Temporary factors. To control for the effects of the price momentum and excess supply lead to near-term
housing components of the fiscal stimulus bill, we price declines, before valuation undershoots
include dummy variables for the period from sufficiently to push up prices. For Seattle and
2009Q2 to 2010Q1, which suggest that housing Portland, the model projects back-loaded price
policies—including the homebuyer tax credit— declines as house prices currently look overvalued.
have provided substantial support to house prices
during this period (details not shown). The model projects the largest house price
appreciation in Cleveland, Minneapolis, San Diego
Prices Have Not Bottomed Yet and San Francisco. None of these areas suffers from
sharply rising delinquency rates or high vacancy rates
Given the excess supply in the housing market and
(except Cleveland). In addition, house prices in
rising delinquencies, our model suggests that the
Cleveland appear undervalued and San Diego/San
composite 20-city Case-Shiller index will fall by
Francisco benefit from positive price momentum.
about 3% over the next year and another 1% over the
following year. This projection is weaker than the
Our conclusion: Despite normalization of valuations,
current consensus forecast of a 0.4% drop in the
we expect excess supply, high delinquencies and the
national Case-Shiller index in 2010 followed by a
fading boost from housing policies to push down
1.6% increase in 2011.
house prices somewhat further in 2010 and 2011.
We predict the largest house price declines for Las
Vegas, Seattle and Portland (Exhibit 6). While high
Sven Jari Stehn
Issue No: 10/22 4 June 4, 2010
6. GS Global ECS US Research US Economics Analyst
II. Will the “Multiplier” Overcome the H2 Headwinds?
We expect real GDP growth to slow to just 1½% in May, with both moves due to changes in the labor
(annualized) in the second half of 2010. This forecast force rather than changes in employment. Average
is based on two main considerations. hourly earnings surprised on the downside in April
and on the upside in May. Given these largely
First, with inventories growing at a $34 billion offsetting moves, one might want to look at the
(annualized) pace in the first quarter, the inventory average over two months to get a better read on
cycle is probably close to complete. The pace of underlying labor market developments. Such an
inventory accumulation might accelerate a bit further averaging shows an increase in nonfarm payrolls
from here, but probably not by very much. This (excluding Census workers) of 122,000 per month, a
means that the growth rate of real GDP is likely to flat unemployment rate, and a 0.2% increase in
converge to that of real final demand. average hourly earnings.
Second, real final demand itself has grown at just a But while it would be a mistake to read a renewed
1½% pace since the middle of 2009. Our baseline downturn into the report, what it does show is that
forecast is for little change in this trend in the second there has not yet been much of a “multiplier” effect
half of 2010. This is because we believe that the working through the labor market so far. Employment
“headwinds”—the loss of the federal fiscal stimulus at is growing, but so far it is only growing at a 100,000
a time of ongoing state and local cutbacks, a renewed to 150,000 pace. This is sufficient to keep the
downturn in home sales and residential investment unemployment rate stable and absorb most of the new
following the expiration of the homebuyer tax credit, entrants into the labor force, but it is nowhere near the
and the tightening of financial conditions in the wake 300,000+ pace which would be required to push the
of the European troubles—will weigh on final demand unemployment rate down rapidly, implied by the
growth even as the domestic economy heals from the experience of past cyclical labor market recoveries—
after-effects of the bursting of the housing and credit and ultimately necessary to offset the “headwinds”
bubble. and keep GDP growth from slowing to a below-trend
pace in the second half of the year.
Perhaps the most important way in which our forecast
could prove too pessimistic is via a much stronger To be sure, there are few signs of a material slowdown
“multiplier” effect from the improvement in the labor in output growth just yet. First, while employment
market (which itself resulted from the earlier impulse growth fell short of expectations, the index of private-
to growth from the inventory cycle and the fiscal sector hours worked registered a 0.3% increase in
stimulus in the second half of 2009). If so, final May and is on track for a 4.0% (annualized) increase
demand might accelerate from the sluggish pace seen in the second quarter as a whole. Second, surveys of
in the recovery so far, and this might keep real GDP purchasing managers continue to point to good near-
growth stronger than we are forecasting. This is why term growth, with both the manufacturing and
new information about the performance of the labor nonmanufacturing ISM index holding at or near cycle
market is even more important at this stage of the highs in May. Third, our “tracking” of the monthly
business cycle than normally. data suggests that the risks to our 3% estimate for
second-quarter GDP growth are tilted somewhat to the
In this regard, the May employment report was a upside.
disappointment. Job gains outside the hiring of
temporary Census workers totaled just 21,000, and the But despite all this, we expect slower growth in
household measure of employment dropped 35,000. subsequent quarters as the labor market “multiplier”
These figures contrast quite sharply with the keeps the economy growing but is insufficient to boost
improving trend seen in both the establishment final demand growth sufficiently in the face of the
(payroll) survey and the household survey through the fiscal, housing, and European headwinds.
April report.
Jan Hatzius
How serious is this disappointment? In our view, it
would be premature to conclude that the recovery is
stalling or even giving way to a renewed recession.
All economic data are noisy, and it is striking just how
much the May employment report looks like the
mirror image of the April report. Payroll gains
surprised on the upside in April, and on the downside
in May. The unemployment rate rose in April but fell
Issue No: 09/12 5 March 27, 2009
7. GS Global ECS US Research US Economics Analyst
III. Forecast Highlights
1. The recovery is moderating. Fiscal stimulus funds rate target—even from its near-zero current
(including its multiplier effects) and stabilization in setting—until they see meaningful evidence of
inventories accounted for all of the nearly 4% sustained improvement in labor market conditions (a
annualized growth reported for the second half of substantial trend in payroll growth at a minimum, and
2009. These supports will have dissipated by the preferably clear signs that unemployment is falling).
second half of 2010; meanwhile, the US economy This is especially true if our outlook for further
faces several structural headwinds. Among them: (a) disinflation is right. Until that evidence starts to
weakness in labor income, reflecting the impact of accumulate, we expect the FOMC’s strong
high unemployment on wages and employers’ commitment to low interest rates to remain intact and
reluctance to rehire aggressively, (b) fiscal drag from we do not anticipate a major effort to drain reserves.
the state and local sector, (c) large overhangs of
vacant homes and unused industrial capacity, which 5. Treasury yields are likely to remain low. The
limit the potential for major improvements in private- financial market turmoil in the wake of the European
sector investment, (d) limited credit availability from a crisis has pushed down Treasury yields sharply to just
financial sector that is still on the mend, and (e) a hit above 3%. But even from a more fundamental
of uncertain size from the European crisis. As a perspective, we do not expect much upward pressure
result, we expect growth to slow gradually to an on yields. The increase in Treasury supply is less
annual rate of 1½% in the second half of 2010 before important for bond yields than many investors believe,
reaccelerating in 2011. for two reasons. First, increased saving by households
and businesses creates potential demand for Treasury
2. We expect unemployment to drift sideways in a securities and reduces the competition for lenders’
9½%-10% range through the end of 2011. We think funds. Second, the Treasury’s auction schedule for
the “jobless recovery” pattern of the 1991-92 and coupon securities is now more than adequate to meet
2001-03 recoveries provides a better template for funding needs over the next few years. In fact, the
corporate hiring decisions over the next year or two latest set of refunding questions from the Treasury
than the more robust payroll rebounds of earlier suggests that some reduction in supply may be at
cycles. If our cautious view on the labor market is hand. Hence, we expect Treasury yields to end 2010
correct, then net hiring will not absorb all of the influx at 3¼% and rise only moderately in 2011.
into the labor force that is apt to occur over the next
year and a half, and the unemployment rate will drift
sideways during this period. We should note that these
comments abstract from the effects of federal hiring
for the decennial census, which has now peaked and
will subtract a cumulative 564,000 from payrolls in
coming months.
3. Disinflation continues. Although highly
expansionary fiscal and monetary policies have caused
many market participants to worry intermittently
about inflation, these concerns miss the point that the
policies have been undertaken to combat a large gap
between actual and potential output. Under any
reasonable economic scenario, this gap—estimated at
6.5% of GDP as of year-end 2009 by the
Congressional Budget Office—will require years of
above-trend growth to eliminate. Accordingly, we
expect the core consumer inflation measures—already
below the Federal Open Market Committee’s
(FOMC’s) long-range central tendency ranges—to
trend down further, falling close to 0% by late 2011.
4. We expect no monetary tightening before 2012.
The outlook for Fed policy hinges on what the
recovery—however strong it turns out to be—means
for the labor market and inflation. We think most
members of the FOMC will be reluctant to raise the
Issue No: 10/22 6 June 4, 2010
9. General disclosures
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10. US Calendar
Focus for the Week Ahead
Retail sales probably registered a decent gain in May, driven mainly by motor vehicles. Elsewhere, however, the
report is apt to look weaker (June 11).
Fed Chairman Ben Bernanke will make three appearances, including testimony on the federal budget and the
economy before the House Budget Committee (June 7, 9).
The trade deficit likely widened in April as imports seem to have grown more quickly than exports (June 10).
Economic Releases and Other Events
Time Estimate
Date (EST) Indicator GS Consensus Last Report
Mon Jun 7 8:00 NY Fed’s Potter spks at Connecticut Bank and Trust Conf
15:00 Consumer Credit (Apr) n.a. -$2.0bn +$2.0bn
17:00 SF Fed Pres Yellen spks at SF Fed Asia conference
19:55 Bernanke interviewed by Sam Donaldson, ABC News; DC
Tue Jun 8 8:25 Fed Gov Duke spks at Consumer Bankers Assoc Conf; FL
9:10 Chicago Fed Pres Evans spks at Univ Club of Chicago
19:00 KC Fed Pres Hoenig spks at Fed Agricultural Symposium
Wed Jun 9 10:00 Wholesale Inventories (Apr) n.a. +0.5% +0.4%
10:00 Bernanke testifies before House Budget Committee; DC
12:00 NY Fed’s Sack spks to NY Assoc of Business Economics
14:00 Fed “Beige Book”
16:00 Bernanke spks at Richmond Fed conference; VA
Thu Jun 10 8:30 Trade Balance (Apr) -$42.0bn -$41.0bn -$40.4bn
8:30 Initial Jobless Claims n.a. 448,000 453,000
8:30 Continuing Claims n.a. 4,620,000 4,666,000
14:00 Federal Budget Balance (May) -$130.0bn -$140.0bn -$191.6bn
Fri Jun 11 8:20 Philly Fed Pres Plosser spks on econ outlook; Altoona, PA
8:30 Retail Sales (May) +0.5% +0.2% +0.4%
Ex Autos -0.1% +0.1% +0.4%
9:55 Reuters/U. Mich Consumer Sentiment—Prel (Jun) n.a. 74.6 73.6
10:00 Business Inventories (Apr) n.a +0.5% +0.4%
Minn Fed Pres Kocherlakota spks in Minneapolis on the
12:00
economy
Issue No: 10/22 8 June 4, 2010
