The U.S. housing market is no longer in intensive care – but don't expect it to start sprinting ahead any time soon.
A dismal labour market still casts a pall over the sector, despite a recent outburst of good news that has fuelled hopes of a full-fledged housing recovery.
To be sure, the Case/Shiller composite index of U.S. home prices has risen for the three months ended in August. Home builders are once again busy and housing starts climbed 35 per cent in year-over-year terms in September.
Also encouraging is the state of the U.S. consumer, who has managed a rapid deleveraging from record levels of indebtedness. Debt service as a percentage of disposable income has fallen from a peak of 14 per cent in 2008 to just over 10 per cent.
But those cheery signs don't necessarily signal a sharp snapback in the housing sector. Look beneath the surface and some glaring problems are evident.
Consider consumers' balance sheets, for instance. The improvement there has not, for the most part, been the result of people paying back loans. Rather, it's the result of many homeowners walking away from their mortgages. Since 2008, Americans have defaulted on almost $90-billion (U.S.) in first lien mortgages. That has left lenders with a much less aggressive attitude toward home loans.
Also missing in action is the collateralized debt obligation (CDO) market. This area, which provided the fuel for the housing bubble, is recovering, but is unlikely to ever approach the scale seen in the pre-crisis years. In 2006, global CDO issuance reached $520.6-billion; so far in 2012, the comparable figure is only $39-billion, according to the Securities Industry and Financial Markets Association.
These factors help to explain the odd disjunction in the U.S. housing market. While the housing affordability index is close to record highs, implying that U.S. homes have rarely been priced more attractively, total mortgage debt continues to decline.
The missing ingredient? Most likely jobs. With U.S. bank balance sheets still under repair and no CDO credit bubble to magnify demand, a sustained increase in housing prices depends on wage growth and employment gains. Neither shows signs of materializing, at least not in the near future.
Growth in U.S. wages has been extremely sluggish in the wake of the financial crisis. Between 2000 and 2006, real wages rose an average of 3.2 per cent a year. Since then, wage growth is averaging 1.1 per cent. Unemployment, at nearly 8 per cent, remains close to postwar highs.
To add to the challenge, interest rates can no longer act as a tailwind for home prices. Since former Federal Reserve chairman Paul Volcker squashed inflation in 1982, steadily declining mortgage rates have helped push real estate values higher.
With rates incapable of a sustained move lower from today's ultra-cheap levels, the credit tailwind is likely over. The U.S. housing boom will only reappear when more employed workers can start bidding on real estate. This rebound is likely to be slower than many investors hope.
Scott Barlow