Weakness in housing activity and housing prices continues to be a major drag on the overall economy. My colleagues at CERF have long maintained that the homeownership rate (HOR) needs to fall back to its historical norm of 64% before housing can recover. Their view has been that the attempt to increase the HOR by loosening credit standards contributed to creating financial instability. In a classic case of unintended consequences, the attempt to improve the homeownership rate contributed to rising home prices which ended up lowering affordability for first-time buyers.
A rising homeownership rate has been a major goal of public policy for several decades under both Republican and Democratic administrations. The rationale was multi-part. First, it was believed that communities are stronger where homeownership is greater. Second, building equity in a home was viewed as the primary path to improving a family’s financial condition. Finally, lower homeownership among minorities was felt to be an indicator of bias.
Policies directed towards increasing the rate of homeownership included subsidizing first time home buyers, reducing required down payments, and streamlining the application process. Weaker underwriting standards increased the effective demand for housing and helped propel a boom in housing activity and home price appreciation between 1995 and 2006. The overall HOR rose from 65% in 1990 to 69% in 2006 which was applauded on both sides of the political aisle.
However, rising home prices eventually reduced affordability and, along with excess supplies of housing due to overbuilding, led to a peak and then decline in housing prices. The decline in housing prices eventually set in motion forces that generated severe losses to mortgage investors and homeowners alike. The underwriting pendulum shifted from easy to tight and effective demand for houses plummeted. Millions of people have lost their homes and even more have zero or negative equity in their homes. The homeownership rate has now declined from 69% to 66% and appears headed lower.
Another fundamental indicator of housing weakness is the large number of delinquent mortgages and the implied backlog of future foreclosures. Of course, as the foreclosure backlog is worked through, the result will be a decline in the homeownership rate as former home owners become renters. Thus, this issue is not separate from the HOR issue.
A third measure of housing market health is the large number of vacant homes. During the period 2002 through 2005 the housing industry massively overbuilt. The degree of overbuilding can seen by comparing the rate of household formation (about 1.1 million new households per year during this period) with total housing starts, which is the number of new units (including rentals) completed each year.
Total housing starts exceeded two million units per year during the boom. Since the end of the housing boom, total starts have fallen dramatically to around 600,000 per year. If the rate of household formation had remained at 1.1 million per year, then the surplus developed during the boom would have been eliminated by now. However, an important yet obscure statistic maintained by the Census Department, the Vacant Homes For Sale (VHFS), remains at more than one million above its long-term average. What is going on?
I suspect that the rate of household formation dramatically declined following the crisis and subsequent recession. Presumably, this is because more young adults returned to their family homes and multiple families are occupying the same housing unit.
The problem is too much housing stock and too few households. This problem will not be resolved purely by a lower HOR. It will be resolved by rising household formation (even if the new households are renters instead of owners). What we need is more people. One strategy to accelerate the process is to streamline legal immigration and to lift or eliminate quotas on the number of people who can legally come to this country.