Insight to Stimulus by National Association of Realtor’s Chief Economist

“Stimulating” Debates

by Lawrence Yun, NAR Chief EconomistLawrence Yun

We may see another large dose of stimulus injected into the economy in 2011. As of this writing (mid-December 2010), the White House and the Congress are trying to arrive at a compromise on extending the Bush era tax cuts for all taxpayers. Such a compromise could include adding providing even more cash for working families via a slight reduction in the payroll tax for a year. Some other provisions for stimulating the economy are being discussed as well, but the size of this stimulus measure – at around $900 billion – will be even larger than the first stimulus legislation was passed at the beginning of the Obama Administration when $800 billion was passed.

Of course, all this stimulus talk comes on the heels of the report by the National Commission on Fiscal Responsibility and Reform (i.e., the President’s deficit reduction commission) on the need to sharply reduce the federal budget deficit over the next 10 years. With the unemployment rate rising to 9.8 percent in November – not to mention Wikileaks dominating the news coverage for now – the position seems to be “damn the deficit.”

Our forecast (see page 7) assumed lower stimulus – from an extension of the Bush era tax cuts only for households/taxpayers who had incomes below $250,000. But if the stimulus is larger – i.e., tax cuts extend for a broader range of incomes – then the short-term impact will be positive. GDP growth in 2011 will be closer to 3 percent (rather than the 1.9 percent assumed). Job creation could easily top 2.5 million payrolls rather than our originally projected 1.5 million next year. Of course, there is a downside: because of the larger projected deficit, mortgage rates will surely climb. Indeed, they seem to have already started up the slope. Nonetheless, home sales could still be boosted by 60,000 units on the strength of job gains. That would bring total existing-home sales to 5.2 million next year. Even so, there is no free lunch and there will be a cost in terms of a higher budget deficit and lower economic growth in later years.

Trying to navigate our way to port through all of these various “what will policymakers decide” waters is challenging. Depending on what happens in Washington on the tax/deficit/policy front can change the housing market forecast for next year noticeably higher or lower than is suggested by the baseline figures. One issue that could have a significant impact on the housing market is underwriting standards returning to more normal, reasonable levels. Over the past two years underwriting standards have been a killer – or at least that is what REALTORS® have been consistently relaying to me. No sensible person would advocate for a return to lax and risky underwriting standards of the housing bubble years. But one should always be mindful of not dramatically over-correcting for past mistakes. There is a bankers’ axiom: all bad loans are made in good times. We are still very far removed from good times. So loans that are originated today must surely be good. But how good is ‘good?’ What is the solid evidence that today’s underwriting standards are overly tight?

A review of Fannie Mae and Freddie Mac data on recently originated mortgages clearly validate too-tight a standard. If loans are only made to Bill Gates, Warren Buffet, and other low-risk borrowers, then their default percentage will be nil. But the cost to society at large is that many hard-working, middle-class citizens will be shut out of the capital market. The chart I present in this column reflecting the most recently available data from Fannie Mae and Freddie Mac shows the loan performance by year of origination. Note the superior loan performance of recent vintages after 18 months into the loan period. Quite remarkable! How is it possible to get such superior loan performance in an economic environment of a near 10 percent unemployment rate and home values showing hardly any growth?

The only inference to draw is that loans are going only to the low-risk, most credit-worthy borrowers. FHA loan performance is also showing superior results on recent vintages. With mortgage availability so tight, it is also not surprising that all-cash purchases have jumped this year. In the past four months, 29 percent all existing-home purchases were all-cash purchases.

It is understandable that lenders and government agencies backing those mortgages are tightening up after getting burned in the bubble years. But over-stringency in underwriting standards and superior current loan performance could backfire on the lenders. Lenders are still trying to manage the losses from loans made several years ago. Default rates continue to remain elevated on those older vintage loans, and thereby are introducing a large number of distressed properties into shadow inventory. Distressed sales have accounted for about one-third of all sales this year (or about 1.5 million) and will continue to be at that figure for next year. If the incoming distressed properties are not absorbed with more buyers, then home values will certainly fall further. That, in turn, will lead to more defaults, higher foreclosures and more financial losses for the banking system. The trade-off for the lenders is therefore to minimize losses on past originations or on new originations.

However, even assuming that underwriting standards remain the same and do not “loosen” up, home sales should still experience a moderate gain in 2011. Based on more visible metrics for jobs, income, and interest rates, existing-home sales are still likely to settle at a sustainable level of 5.2 million units. New home sales will depend more on how many homes builders can build — and that depends on the availability of construction loans, which do not have any government backing, and therefore are even more difficult to obtain. Our best guess at the moment is for 400,000 new home sales in 2011, but that is still an increase from 316,000 in 2010. If the lending spigot opens up to a more normal flow – with normal risk-taking – then there will be a nice upside surprise to home sales next year from the baseline forecast figures.

All of Dr. Yun’s presentations, as well as other presentations on real estate and the economy, are available at

Posted on December 15, 2010 at 3:43 pm
Debbie Barger Smith | Category: Uncategorized

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