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Is the robust U.S. housing market about to cool? Probably not in 2003, says Kent W. Colton, Senior Scholar, Harvard Joint Center for Housing Studies, and President of K. Colton, LLC. He recently published a working paper on the history of the housing finance system in the United States. His new book, Housing in the Twenty-first Century: Achieving Common Ground, is scheduled to be published by Harvard Press in June.
Cullen: Do you see any end in sight to the current refinancing boom among consumers given the steady decline in interest rates?
Colton: In 2002 the housing industry achieved record levels in loan production, reaching $2.77 trillion in mortgage volume. According to Federal Reserve Chairman Alan Greenspan, close to 10 million regular home mortgages were refinanced, and the outsized dollar volume of these refinances (net of cash-outs) was $1.75 trillion. (Greenspan used the term regular mortgages to exclude both home equity and construction loans.) As long as interest rates stay low in 2003, refinances will continue at record rates, and the predictions for loan production in 2003 vary from a high of $3.2 trillion by Fannie Mae to most estimates which predict a continuation of the level of activity in 2002 from $2.5 trillion to $3 trillion in mortgage volume.
Obviously, at some point the current refinancing boom will slow down, and the driver will be interest rates. If the economy picks up in the second half of 2003, which most economists predict, assuming a generally positive conclusion to the war, then refinances will slow. Still, housing finance production and refinances will be solid in 2003, and housing will continue to be a solid part of the economy. As housing activity slows down somewhat, housing will still be a mainstay in the economy, but other sectors will also need to pick up.
Q: Do you think it's probable that property prices will go down or stabilize in the next year or two, or will low interest rates or other factors prevent this?
A: To begin, it is important to recognize that housing has played a unique role in the last recession. Often in past years, a drop in housing (housing starts and sales) has led the economy into a recession, and then a rise in housing has been key in leading the economy out of the recession. During this downturn, due to low interest rates as well as strong demographic demand for housing, housing has been one of the mainstays of the economy throughout the recession. Housing starts have been at record levels for single-family housing, and home prices have risen in the range of 5 to 7 percent over the last three years. Without strong housing starts, housing sales, record refinances—with people using much of this money to purchase goods and services—the economy would have suffered a far worse downturn.
| Some people have talked about a bursting of a "housing bubble," and that kind of talk just doesn't make sense. |
| — Kent W. Colton |
It is only natural to expect that there will be a gradual slowdown in the housing area. You can't maintain record levels forever, but the activity for 2003 will be solid. For example, if housing starts drop 10 percent in 2003, they would still be at a very strong pace by historical standards—in the range of 1.45 million to 1.5 million, compared to 1.61 million. It is also likely that the rise in property prices will slow somewhat, with national average home prices rising in the 3 to 4 percent range.
However, I want to be clear. Some people have talked about a bursting of a "housing bubble," and that kind of talk just doesn't make sense. First, the housing market is not a bubble, per se, and it is not like the stock market. Most people buy a house to live in it, not to speculate. Of course, values will rise and occasionally drop, and regional markets will vary significantly, but movements are generally at the margin, not punctuated by big drops and rises like we've seen in the stock market over the last few years. Second, the long-term shifts in the housing market will be driven by demographics, and the demographic demand is strong for at least the next decade. In fact, as I document in my forthcoming book (Housing in the Twenty-First Century), the demographic demand for housing is greater in the decade of 2000-2010 than it was for 1990-2000.
Q: What impact do you feel employment figures will have on domestic real estate?
A: Employment is a very significant factor in the housing market and for domestic real estate. Single-family housing has held up well because of low interest rates, but multifamily rental housing has been hit harder—both because of rising unemployment and because renters have taken advantage of low interest rates to go from rental housing to homeownership. At least one-third of the turnovers in rental housing are for renters becoming homeowners. Vacancies are high for rental housing, above 10 percent, and commercial real estate has been hit even harder by the recession and rising unemployment. So far this has generally been a "jobless recovery." For rental housing and commercial real estate to pick up, the economy will need to grow at a faster pace and job growth will be key to recovery in these two areas.
Q: In your report on the background of the U.S. Housing Finance system, you include an informative piece on the reform that took place in the housing finance system in the early 1980s due to the unplanned-for pressures of high interest rates. In view of the extended slowdown in our current economy, do you see that further revision of the U.S. Housing Finance system is warranted?
A: I think we will need to continue to fine-tune the system, but at this point the changes that were made in the first part of the l980s to provide for a "broader-based, more resilient system" of housing finance that I refer to in the paper are working amazingly well. As I noted, 2002 was a record level in terms of housing production, and that would not have been possible without a vibrant system of housing finance in general and a strong secondary market in particular. Also, it is not an accident that housing has been the mainstay of the economy over the last several years. A strong housing finance system upheld by a strong secondary market has been one of the lynchpins of that success. When other segments of the economy faltered, and other financial markets paused, the strong access for housing to the capital markets through Fannie Mae, Freddie Mac, and Ginnie Mae has meant that money has been there for the homebuyer.
Also, we are the only country in the world with a 30-year fixed-rate mortgage without prepayment penalties. As the workpaper notes, the 30-year fixed-rate mortgage is part of our housing finance system because of the secondary mortgage market.
Q: What is your view of the future of mortgage-backed securities and the key role Fannie Mae and Freddie Mac play in this sector?
| For rental housing and commercial real estate to pick up, the economy will need to grow at a faster pace and job growth will be key to recovery in these two areas. |
| — Kent W. Colton |
A: I think Fannie Mae and Freddie Mac are essential in the housing finance system. The analogy I sometimes use is that the housing finance system is the circulatory system for housing delivery, and Fannie Mae and Freddie Mac are a key part to that circulatory system. They have also been essential in providing innovation in the mortgage market. Low down-payment mortgages, automated underwriting systems that have streamlined the housing finance process and allowed borrowers to qualify for a mortgage in minutes (even seconds), access to the capital markets, and lower interest rates to the home owner due to the secondary market have all been essential in the growth of homeownership and the role that housing has played in the economy over the last few years.
Of course, we still have significant challenges as we look to the future. Homeownership is at an all-time high but there is a large gap in the homeownership rate between white households and minorities—20 to 25 percent. Continued innovation and a strong role from Fannie Mae and Freddie Mac, along with a growing partnership between all aspects of the public and private sectors, will be key if this gap is to be addressed.
Q: In the press there have been some claims that Government Sponsored Enterprises (GSEs) for housing finance, such as Fannie Mae and Freddie Mac, are overextended. Are these concerns warranted?
A: The GSE's for housing finance—Fannie Mae, Freddie Mac, and the Federal Home Loan Banks—should have strong regulation to assure that they are not overextended. What many in the press fail to realize is that such regulation is already in place. Fannie Mae and Freddie Mac are subject to both safety and soundness regulation by the Office of Federal Enterprise Oversight (OFHEO) and program regulation by the Department of Housing and Urban Development (HUD). Both Freddie Mac and Fannie Mae have to meet both core capital and stress test requirements that have recently been put into place, and both organizations are monitored carefully. Further, both have agreed to a variety of disclosure requirements in order to assure both their regulators and the public that they are operating safely and soundly. Both institutions are also limited in their activity, and whereas banks and other financial institutions deal with a wide variety of credit risks, such as commercial loans, credit card risk, etc., Freddie Mac and Fannie Mae are confined to the mortgage business.
With this in mind I am comfortable in saying that concerns about Fannie Mae and Freddie Mac being overextended are not warranted.
Q: What effect could global markets have on the markets of mortgage-backed securities?
A: The housing finance system is already very much a player in the world of global capital markets. One of the key innovations in the first part of the 1980s described in the working paper was to provide access for the U.S. home buyer and borrower to the broader capital markets, first in the United States, and then in the world global markets. This innovation has worked extremely well. However, should we be concerned that a major impasse in global markets will impact the U.S. mortgage market? In part the answer is yes—we should always keep our eyes open for problems. However, experience has shown that in this case Freddie Mac and Fannie Mae play a major role in insulating mortgage markets from global capital market problems. If you will remember, in 1999 there was a major catastrophe in the world financial markets. This hit housing finance for a day, but then Fannie Mae and Freddie Mac stepped in and began to purchase whatever loans were for sale. The U.S. housing finance market picked up and continued to work extremely well, despite problems overseas.
To some extent, then, it appears that the U.S. housing finance system has the best of both worlds. When global markets are strong, we can take advantage of this strength by selling mortgage-backed securities and mortgage papers overseas. When obstacles arise in global markets, then we are provided with a system that generally insulates us from those problems.
