By Jarkko Turunen
A year ago, we were very concerned about lingering weakness in the U.S. housing market, which we saw as a major obstacle to the economic recovery.
But what a difference a year makes! As our latest report on the U.S. economy points out, the housing market recovery has been stronger than expected, and is providing a significant boost to private domestic demand and economic growth.
What has changed in the last 12 months? House prices have rebounded sharply and are currently about 7-12 percent above their level a year ago. Home sales increased by more than 15 percent over the same time period. Thanks to higher house prices and the positive effects of government housing finance programs, fewer homeowners are “underwater” (owe more on their mortgages than their houses are worth) or are behind on their mortgage payments, and fewer houses are entering foreclosure.
What is driving the recovery?
First, highly accommodative monetary policy, including Federal Reserve purchases of mortgage-backed securities, has set the stage for a revival of the housing market. Lower mortgage rates have increased mortgage refinancing, reducing monthly mortgage payments and therefore supporting private consumption, and encouraged home purchases. Lower returns on financial assets, such as long-term bonds, have also made real estate investment more attractive to investors.
Second, mortgage finance policies (such as the Home Affordable Refinance Program(HARP) and the Home Affordable Modification Program (HAMP)) have provided a further boost to refinancing and helped reduce the weight of the shadow inventory on home prices. For example, after an expansion of the program, HARP refinancing activity increased last year. Efforts are underway to enhance these programs, in particular to increase the public’s awareness of them and to streamline the process of loan modifications. Other recent policy initiatives have aimed at strengthening mortgage underwriting standards, thus contributing to a more sustainable recovery.
Is the recovery sustainable?
The housing recovery is likely to continue. However, the speed of the recovery is difficult to predict and recent data has raised concerns about sustainability.
The sharp increase in mortgage rates since May has raised concerns about a bump on the road to recovery, with higher rates potentially reducing demand for housing and dampening house price growth. There is little hard data to evaluate the impact on the housing market thus far—while mortgage refinancing activity has fallen sharply in the past few weeks, other recent housing indicators have remained relatively upbeat. However, mortgage rates remain close to their historical lows, and housing affordability is high, even after the recent increase in rates.
Double-digit house price increases over the last few months have also caused concerns that the housing recovery is moving too fast and is headed toward a new bubble. These concerns seem premature. Despite recent increases, house prices nationally remain well below (about 20 percent by some measures) their pre-crisis level. While the price increases have been broad-based nationally, house prices have generally increased the most in regions where their decline had been the strongest, suggesting that prices are still catching up after the collapse.
Room for additional measures
While the housing market has come a long way over the last few years, it is not yet fully recovered and there is still room for policies to support the recovery.
Highly accommodative monetary policy, and effective communication and careful timing of normalization of monetary policy can provide the right conditions for the recovery looking forward. As the economy recovers, the impact of higher mortgage interest rates on housing market activity and house prices is likely to be mitigated by the positive effects of a better economic outlook on confidence and credit conditions.
Expeditiously completing regulations requiring banks to retain part of mortgage risk on their balance sheet and addressing remaining frictions in the housing market are a priority. While efforts are underway to gradually reduce the footprint of the government-sponsored enterprises (such as Fannie Mae and Freddie Mac)—which currently account for nearly all issuance of mortgage-backed securities—there is scope for additional measures, including an early adoption of a fully articulated medium-term reform strategy for these enterprises.
(Jarkko Turunen is a Senior Economist in the Western Hemisphere Department of the IMF. He was previously in the Strategy, Policy, and Review Department, working on crisis countries and various policy issues, including conditionality, international trade, and jobs and growth. Before joining the Fund, he was a Principal Economist at the European Central Bank.)