Wednesday, September 26, 2007

Home Sales Data

The world of Macroeconomics moves on at a fast pace and there is some interesting data coming out about the housing market. In short, it is getting worse.

The government releases 3 main indicators of home sales: existing home sales (homes already built being sold), new home sales and pending home sales (when the buyer and seller agree and the deal is pending approval.)

Earlier this week we saw the release of existing home sales. You can read the economist James Hamilton's summary here. As you can see, Aug new home sales dropped another 3.8% from Jul. Worse is that there is a 10.7 month inventory, meaning that it will take close to a year to sell all the existing homes on the market. And if that is not bad enough, this data usually includes deals that were in place about a month ago but just closed in Aug. So they don't even include the credit crunch that happened in Aug (just a few weeks before you started). So as you can probably divine, we should expect home prices to start falling.

Luckily for us, also released this week was the Case Schiller Home Price index. Prof. Hamilton explains exactly how this index measures home prices, but as you can see prices are already falling (3.9% lower from one year ago this month). This does not seem like a lot, but when you couple this release with the article I posted last week , I think we can expect further price reductions in homes.

Due up on the plate tomorrow (Thurs) is new home sales for Aug. This is a good release because it will show more of the effect of the Aug credit crunch as well as offer a price estimate of new homes on the market. If the number is weak, look for more pressure on the federal reserve to cut rates.

What are the short run implications of this?

1) Lower home sales mean less construction of homes, this lowers GDP directly in the short run because companies are not starting home building (decline in investment in residential construction).
2) Falling home prices could (and probably will) hurt consumption indirectly because a lot of consumers probably borrowed money against their home to finance spending (mostly on kitchens, living rooms, etc.). This impact is the most debated among economists. Some argue the effect will be huge, some argue the effect will be small.
3) The inability of mortgage borrowers of ARM's to pay off their loans coupled with the markets inability to tell who is going to default and where, means that the market is punishing everyone via higher interest rate spreads. This should hurt consumption and investment.

Medium term implications?

The short run fall in growth is already inducing Fed rates cuts. I would be further rate cuts are in the making and so does the market. If the fed plays this right, they will balance the risks to growth to the risks to inflation. However, if they cut too much then they run the risk of pushing inflation up in the medium term. (Professor Greg Mankiw of Harvard has an interesting post on whether this is being anticipated by the market). If they do not cut enough then the short run effect will be more pronounced, but the market will stabilize.

Long run implications?

As we discussed on Tues, the long run implications are fairly straight forward. Over the long haul the market will adjust. Home prices will fall enough to induce more buyers into the market. Once the inventory of homes is sold, construction of new homes should pick back up and growth will resume (especially as home prices start stabilizing). Growth will return back to normal.

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