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The Supply and Demand of Housing

mixed-resultsAs housing metrics continue to take unexpected turns, it’s become clear by now that the current recovery has functioned unlike any other. In the company's latest Economic & Housing Market Outlook, economists Frank Nothaft and Leonard Kiefer at Freddie Mac took a look at three fundamental areas—mortgage rates, home sales, and household formations—to figure out why.

Dissecting each category, the economists come to the conclusion that the reason why housing has moved in the direction it's taken is due to one of the most basic economic rules: supply and demand.

Starting with mortgage rates, the researchers note that despite climbing compared to last year, rates in the last few months have remained fairly steady, an unexpected reaction to the Federal Reserve's movements to gradually end its monthly asset purchase plan. In fact, as of mid-May, Freddie Mac's Primary Mortgage Market Survey had 30-year average fixed rates at a six-month low.

However, since recent cuts to the Fed's purchases of mortgage-backed securities (MBS) have coincided with a dramatic decline in mortgage originations—and thus MBS issuance—the effect has been minor so far.

"[E]ven though the Fed's purchases of MBS (the monthly 'net addition' plus the replacement of principal pay downs on existing holdings) are down significantly, so are monthly MBS issuances," the researchers said in their latest report. “In fact, the Fed’s acquisitions, as a ratio to new issuance, are slightly higher than a year ago.

"In other words," they went on, "the Fed's 'demand' for new MBS has declined less than has new 'supply', thus keeping the Fed’s share of MBS issuance above year-ago levels."

With refinance demand down so significantly over the past year, originations and issuance are expected to remain low, meaning the Fed's scaledown in purchases won't meaningfully push rates up until asset purchases near zero.

On the topic of the relationship between home sales and prices—namely, prices continuing to rise despite weak sales data—Nothaft and Kiefer argue that nothing out of the ordinary is happening: Though sales are down, demand for housing has stayed strong, as evidenced by the estimated 5.2 months' supply of homes on the market as of March. And with few additional homes trickling into the available stock, the combination of high demand and low supply has lifted prices throughout the recovery.

Also key to the rise in prices is a decline in distressed sales and low-priced stock, bringing the median up.

Finally turning to the actual supply of homes, the two economists observed that though housing starts have risen from their 2009 trough, they have struggled to get back to normal historical levels, in large part because of the lackluster rate of household formations, which have barely crossed the 500,000 mark annually since the Great Recession.

Though birth rates through the late 80's and early 90's are favorable for new household growth at this time, the other main factor affecting household formations—the business cycle—is still weak after the crisis.

"[M]any adults in their 20s have continued to live with relatives (often parents) and have had to wait an extended period to save funds and generate an earnings cash-flow sufficient to set up their own household," the economists wrote. "We understand that we might sound like a broken record here, along with many other economists, but the need to have a job before buying a house is a simple fact of life."

With economic growth expected to accelerate to an annualized rate of 3.0 percent in the coming quarters, payroll gains should improve to a steady 200,000–250,000 per month, contributing to new formations and new starts.

"If we get that, we'll be able to address the underlying 'supply' problem because we know the 'demand' for housing is there," Nothaft and Kiefer concluded.


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