May 15, 2014 8:19 pm

Squeezed middle behind US housing slump

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An unexpected slump in the US housing market has exposed the shaky fundamentals of recovery in the world’s largest economy, as a lack of incomes growth for middle-class Americans leaves them struggling to buy a home.

Last week, Janet Yellen, the chairwoman of the US Federal Reserve, warned a risk that had seemed vanquished was once again menacing the economy. “The recent flattening out in housing activity,” she said in testimony to Congress, “could prove more protracted than currently expected.”

Given the depth of the housing slump in the 2008-09 recession, and thus a huge amount of pent-up demand for homes, the recent bout of weakness in the sector is a surprise. It shows how the uneven distribution of incomes growth, with wealthy Americans doing best in the recovery, may be holding the economy back.

The weakness of housing activity so far this year is palpable. Existing home sales were down by 7.5 per cent on a year ago in March; new housing starts were down by 5.9 per cent in the same month. House prices, however – up by 12.9 per cent on a year ago, according to the Case-Shiller index – have kept rising.

There is a list of immediate reasons why housing has slowed. Most important is the rise in mortgage rates since the Fed began to talk about tapering last spring – up from around 3.5 per cent to 4.5 per cent in early 2014, before moderating to around 4.2 per cent today.

“Our research indicates that house sales activity is much more sensitive to rates than it was in the past, because borrowers have fewer products to fall back on,” says Sam Khater, deputy chief economist at Corelogic, a housing data provider. In times past, when 30-year rates rose, borrowers might turn to an adjustable rate, but few lenders are offering them in the wake of the crisis.

Michelle Meyer, a housing economist at Bank of America Merrill Lynch, adds three more short-term factors to the list: a tailing off in distressed sales, which generated a lot of activity; a lack of inventory in the market; and bad weather at the start of 2014.

The recent flattening out in housing activity could prove more protracted than currently expected

- Janet Yellen, Fed chairwoman

Those factors are likely to abate, leading to a stronger recovery later this year, but none of them seem quite sufficient to explain why the housing sector is not more robust, five years into the recovery from such a deep slump.

“I think it’s the scars from this cycle,” says Ms Meyer. “We still have a bit of a credit crunch. A lot of people don’t have enough equity in their home to move. I also think that confidence hasn’t improved enough.”

Mr Khater said he believes “it’s structural”, pointing out that as long ago as the 1990s, there was growth in population and employment, “but during that entire time period we have not had median incomes growth”.

I think it’s the scars from this cycle. A lot of people don’t have enough equity in their home to move

- Michelle Meyer, Bank of America Merrill Lynch

Although the US economy has added several million jobs in the last few years, there has been little incomes growth for the average American, and that may have reduced housing demand. New household formation has been exceptionally low, with many adults in their 20s and 30s continuing to live with their parents.

That helps to explain some of the divergent trends in the housing market. For example, builders are putting up much bigger homes, to cater to wealthy Americans who are doing well, which helps to explain why the number of starts is low.

“If you look at the average size of a new single family home then we're at an all-time high,” says Ms Meyer. The average new home now covers around 2,700 sq ft – even larger than before the housing crash.

The demand for homes is also highest in affluent cities, such as San Francisco, that also have the toughest restrictions on building, leading to rising house prices, but no equivalent rise in activity to boost the overall economy and comfort Ms Yellen.

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