The current state of the housing market complete with the United States government assuming control over lending giants Fannie Mae and Freddie Mac has impacted the American economy in many ways and caused serious shake ups particularly in the housing and financial sectors. This housing and mortgage implosion has also created a perfect storm that the homebuilding industry is desperately attempting to weather. With home foreclosures skyrocketing, the homebuilding industry has been left at a virtual standstill with the demand for new houses grinding to a halt as the market has been flooded with new homes that remain vacant.
During the housing boom, homebuilders were buying up land and developing it as fast as they could to keep up with the rapidly rising home prices and demand from those that were looking to profit from the seemingly ever-expanding market. By nature the homebuilding industry can take months to complete a finished unit and when the housing market took a turn for the worse, homebuilders were left with incomplete houses and an excess of land and finished home inventory.
Supply and Demand
According to a United States Census Bureau report released for the second quarter of 2008, around 2.8% of homes in the United States were vacant and for sale in April through June. This is down from the 2.9% seen in the first quarter of 2008 but still amounted to around 2.2 million homes nationwide. For homes built in April of 2000, around 9.8% of these were vacant, more than triple the number of houses constructed earlier than that. With builders capitalizing on the booming market and flooding it with new homes, even in the second quarter of 2008 with a declining market in full effect, the National Association of Realtors still showed an increase in home inventory. With the flooded market, the median home prices fell over 6.1% from the prior year. In addition, an increase in the unemployment rate is also contributing to the slowdown in home purchases (Luhby, T., 2008, July 24).
According to New York University economist Nouriel Roubini, the falling home prices due to a flooded market are not necessarily a good thing. “(Falling home prices) are pushing down the value of homes and putting millions of people underwater. Already today, 8 million houses have negative equity. If home prices fall another 10 percent as expected, we’re going to see 16 million people with negative equity. It’s a big problem (Schoen, J. W., 2008, March 26).” The flooded housing market has led to a decrease in housing prices, driving down the property values of homeowners due to large amounts of foreclosed properties, short sale properties, and bank owned properties. The building of negative equity due to falling home prices puts other home owners at risk of foreclosure. There is also concern that the housing crunch will bleed over and affect commercial and retail markets, especially when put in contention with rising energy and food prices along with an increase in the unemployment rate.
It has been debated whether or not homeownership offers positive or negative societal externalities. According to one theory, homeownership provides a larger financial stake for the owner than renting would, therefore, the owner is more motivated to take better care of their homes and communities making them, in short, a better American. Data gathered from the General Social Survey, a national study carried out annually since 1972, seems to support this. In 1998, Edward Glaeser, a Harvard economics professor, and Denise DiPasquale, now head of the housing research firm City Research analyzed the report and found that more homeowners voted in local elections and knew the name of their school board representative than renters did. They also found that homeowners went to church more frequently and invested more money in the upkeep of their homes than renters. Glaeser also noted a negative impact of homeownership, “Homeowners have spearheaded the movement to limit new housing supply that has artificially inflated housing throughout the U.S. This is the downside to having individuals who have incentives to keep price up (Porter, E., 2005, November 13).”
Negative externalities arise more abundantly when considering the focus on the research and development of technological innovation of the homebuilding industry. Such innovations would produce positive externalities for both the environment and the home owner by reducing energy costs, improving structural resistance to natural disasters, and improved affordability. The fragmentation that the homebuilding industry experiences due to the large number of suppliers that provide all the different components that go into a home has made this innovation difficult. Current innovations in the homebuilding industry have led to market spillovers that create cost benefits to the buyer but not necessarily the builders. Because of these market spillovers and an implied lack of return on investment, homebuilders have been reluctant to invest the time and effort into the research and development of technological innovation and have been more prone to continue with business as usual (Martin, C., PhD., 2006).
There is a large spread in pay rates seen in the homebuilding industry. Much of this is commiserate with experience and classification. Apprentice status usually classifies and unskilled laborer who can perform jobs comprised of relatively simple tasks. This is generally low level clean up or set up work for a job that is to be performed. A journeyman will perform more skilled aspects of their trade and require a higher level of knowledge and attention to detail than an apprentice. Journeymen will often perform the same tasks as an apprentice plus additional tasks and usually will require less supervision or direct instruction. A foreman will oversee a job or worksite and must have intricate job knowledge as well as interpersonal and leadership skills. Small contractors are individuals who work for themselves and can employ a crew of up to 20 workers and large contractors are individuals who work for themselves but employ a crew of 20 workers or more. he wages earned by small contractors and large contractors are not necessarily based on craftsmanship and skill but also on a solid business sense and know-how.
Small residential project construction jobs are usually farmed out to small contractors who hire unregulated, non-unionized labor to complete these jobs. This often gives small contractors an advantage over larger contracting firms because they are able to drastically undercut estimates due to the low wages that these workers are paid. Small contractors generate this advantage due to the lax enforcement of paying low wages to these workers or paying them under the table. The day laborers used by small contractors to complete these jobs tend to be those who recently immigrated to the United States either legally or illegally. These day laborers will often consider jobs in construction more desirable than other options such as dish washing or cleaning jobs despite poor working conditions and dangers of the trade. In addition to being exposed to poor or unsafe working conditions, day laborers also deal with labor law violations such as nonpayment for work completed, payment that is far below the prevailing wage, and overtime violations (Brennan Center for Justice, 2007).
Monetary and Fiscal Policies
During the housing boom of the earlier half of the decade, the Federal Reserve helped bolster the building market by reducing interest rates for 18 straight months. The housing market is impacted by these interest rates as the greater majority of homeowners finance their houses. According to a 2006-2007 economy and housing market forecast, the Federal Reserve would slowly have to start raising interest rates in order to fight rising inflation. These higher interest rates would make housing less affordable and a surplus of homes built during the housing boom would lead to a soft market. These rate increases would be contingent on the stability of current energy prices. The forecast brought out that a combination of volatile energy prices and rising energy prices would lead to a dramatic slowdown in the housing industry (Kalainesan, L., Hoteit, T., 2006, November 10).
With the rapid decline of the housing market, the Federal Reserve cut rates 75 basis points once again on January 22, 2008 in an effort to reduce the impact of the imploding housing market and help provide some monetary stimulus to a slouching economy. Proposed tax credits to home buyers would also help reduce the current sitting inventory that the homebuilding industry has amassed leading to decreasing home prices. The president has also called for a modernization of FHA practices and policies to help regulate future lending practices to avoid the meltdown that has been seen as of late. This was also coupled with a call for an expansion to the FHA mortgage insurance program (National Association of Home Builders, 2008).
Economic Influences and Success
The poor lending practices have affected the economy and the housing market in several ways. Loans that required no documentation or that contained negative interest payments over a period of several years with an adjustable interest rate at the end of the term have put many homeowners on a bad situation with mortgage payments almost doubling when they came to term. The defaults on these loans has led to the collapse of many major banks and has created unstable ground along the banking and financial sectors. With the government recently taking control of mortgage giants Fannie Mae and Freddie Mac has brought some piece of mind to the American consumer, it has yet to be seen whether this will be a stabilizing move or will push large mortgage industry losses onto the taxpayers. Fannie Mae and Freddie Mac currently guarantee almost half of the nation’s $12 trillion dollars of mortgage debt.
Other economic factors are also influencing the homebuilding market indirectly. With the Federal Reserve attempting to maintain a balance by holding keeping interest rates stable in order to stimulate the home buying market and paying close attention to the rise of inflation, they are walking a fine line and contending with rising energy and food prices. While the Federal Reserve has held interest rates steady as of late, banks have still tightened up their lending practices and have held or raised mortgage rates. In addition to this, banks have also clamped down on their lending practices in order to help avoid taking the billions of dollars in losses that they are currently experiencing on future loans. Larger down payments for homes, higher interest rates to the consumer, and a stable increase in energy and food prices have all aided in strapping an already cautious consumer and making them think twice before they purchase a house. With home prices dropping, consumers are being extra cautious before striking out into what has been shown, over the last couple of years, to be a very volatile and potentially dangerous financial situation.
Brennan Center for Justice. (2007). Unregulated Work in the Global City. Retrieved August 22, 2008 from: http://www.brennancenter.org/page/-/d/download_file_49377.pdf
Kalainesan, L., Hoteit, T. (2006, November 10). US Economy 2006 – 2007 Forecast & Housing Market. Retrieved September 4, 2008 from: http://tarek.hoteit.org/research/Hoteit%20&%20Latha%20-%20Fiscal%20Policies_2006.pdf
Luhby, T. (2008, July 24). 2.2 Million Vacant Homes for Sale. Retrieved July 24, 2008 from: http://money.cnn.com/2008/07/24/news/economy/homeownership/index.htm?postversion=2008072419
Martin, C., PhD. (2006). Technology Matters – The Cost of and Returns to Innovating Homes, or Not. Retrieved August 1, 2008 from: http://www.huduser.org/Publications/PDF/AREUEA_Carlos_Presentation.pdf
National Association of Home Builders. (2008). NAHB’s Eye on the Economy. Retrieved September 4, 2008 from: http://www.nbnnews.com/eyeonecon/issues/2008-01-23.html
Porter, E. (2005, November 13). Buy a Home, and Drag Society Down. Retrieved August 1, 2008 from: http://www.smallprop.org/downloads/Home_Ownership_NYT.pdf
Schoen, J. W. (2008, March 26). Too Soon to Look for Housing Market Bottom. Retrieved July 24, 2008 from: http://www.msnbc.msn.com/id/23796366/