JPMorgan Chase Bank NA, New York Economic Research

Robert Mellman Global Data Watch

July 31, 2009

Economic Research note New home sales and single-family housing starts

The US housing market is %ch saar, 3m/3m, both scales

50 New home sales Starts 100

finally in a recovery phase
25 50
• Home sales look set to increase from extreme lows, re-
versing declines during the worst of the financial crisis 0 0
• Single-family starts should rebound 50% over the
next year, as sales rise and inventory correction eases -25 -50

• The evidence on house prices is more ambiguous, and -50 -100

they probably have further to fall 2006 2007 2008 2009

Housing Affordability Index

In the three years ending 1Q09, the one constant in eco-
100=qualify for mortgage; NAR measure
nomic performance has been the sustained collapse of the
housing market. Over these three years, new home sales 180
Housing more
plunged 70%, single-family housing starts plummeted affordable
79%, and the Case-Shiller house price index dropped 32%. 150
The worst of the financial crisis and severe recession took
housing activity to extraordinary lows by 1Q09, even rela- 120
tive to the standards of prior deep downturns.
90
As the sense of panic has receded and financial markets
60
have begun to heal over the past few months, home sales 81 86 91 96 01 06
have started to bounce from extremely low levels. Contin-
ued improvement in the economy and financial markets New home sales, single-family housing starts per 1000 households
should bring further gains in home sales in the year ahead. Ratio Ratio
Single-family housing starts are leveraged to sales and Home sales
12 25
likely to increase 50% over the next year, a much larger
increase than for sales, as builders boost activity to reflect 10 20
both improved demand and a more gradual reduction in
8 15
inventories of unsold new homes. A year from now, even
after these gains, housing activity will still be at severely 6 10
depressed levels. But the shift in housing, from subtracting Starts
1% from annualized real GDP growth to adding 0.5% or 4 5
more to growth, will boost the economy’s overall growth 2 0
prospects. The latest data also hint at a possible stabiliza- 63 68 73 78 83 88 93 98 03 08
tion of house prices. But with inventories of unsold homes
still high and foreclosure-related sales set to increase in about as negative in the second quarter as in the first. The
2H09, house prices probably have further to fall. economy continued to contract in the second quarter, and
the unemployment rate continued to rise. Mortgage rates
were about the same in the second quarter as in the first.
A bounce off of extreme lows And house price expectations did not turn appreciably
After three years of relentless declines in home sales and more optimistic in the spring.
starts, just about every measure of single-family housing ac-
tivity improved in 2Q09. Reports on new home sales, exist- The recent housing dynamic is best explained as a bounce
ing home sales, and single-family starts each showed con- from extreme low levels that reflected panic avoidance of
secutive increases in the three months through June, and in- big-ticket purchases during the worst of the financial crisis
creases in the Homebuilders survey continued into July. and economic downturn. Housing affordability improved
enormously between 3Q08 and 1Q09 as both mortgage
The recent upturn in housing activity came as a surprise, rates and house prices tumbled. Despite this help, both new
since many key influences on the housing market were and existing home sales continued to ratchet lower.

11
JPMorgan Chase Bank NA, New York Economic Research
Robert Mellman The US housing market is finally
in a recovery phase
July 31, 2009

From the point of view of a home buyer, 4Q08 and 1Q09 New single-family home sales and starts for sale
was a time of surging unemployment, and collapsing Mn, saar
household equity market and housing wealth. Consumer New single-family home sales
1.5
confidence plummeted to multi-decade lows. This was no
time to buy a house. And for buyers that were attracted by
vastly improved housing affordability, financing became 1.0
even harder to obtain. Mortgage lenders were realizing
large losses on residential mortgage portfolios and disin-
clined to add exposure to the mortgage market. 0.5
Single-family housing starts built for sale
(the share built for sale is estimated in 2Q)
By 2Q09, the sense of panic had eased somewhat. The
0.0
economy was moving toward stabilization, and both equity 2004 2005 2006 2007 2008 2009
prices and confidence readings improved noticeably. More-
over, President Obama had signed legislation providing tax
incentives for first-time home buyers and the Fed was pro- New home inventories and single-family starts
viding large-scale financing for the housing market through Mn units, both scales
MBS purchases, adding greatly to the already considerable 200 Inventories 600
support for the market from the FHA. 500
100
400
Home sales and housing starts did bounce from their lows
last quarter, but not enough to recover ground lost since 0 300
last September. After three months of good gains, June lev- 200
els of both sales and starts were still roughly 20% below -100 Starts less sales
100
their 3Q08 levels. In assessing recent gains in housing ac-
tivity, two points are key: -200 0
85 90 95 00 05

Housing activity is still at extremely depressed levels.

Despite recent gains, levels of new single-family home
sales and housing starts are still extremely depressed, even
by standards of prior deep recessions. The 2Q09 level of
single-family starts per household (to scale for demo-
graphic growth) was 45% below its previous modern-era
lows in early 1982, a time of deep recession and long-term
mortgage rates just under 18%.
A partial recovery in housing activity will have a notice-
able positive impact on economic growth. Real residen-
tial investment has declined an average 21.1% saar over the
three years through 1Q09 and subtracted an average 1.0%
from annualized real GDP growth. As housing stabilizes
this quarter and starts to increase next quarter, the swing
from deep decline to increase will boost overall economic
growth significantly.
Starts are leveraged to higher home sales
The economic forecast looks for gradual improvement in
the economy and healing in the financial markets over the
next year. If this forecast plays out, the sense of panic that
gripped potential home buyers during the depths of the re-
cession should abate, pointing to further gains in new home
sales from what are still very low levels.
Home sales: Housing affordability has improved greatly
since last fall, but other influences on new home sales are
still negative. The unemployment rate is very high and ris-
ing. Consumer confidence readings are very low. Even
with the recent rise in equity prices, households have seen
massive wealth destruction over the past year. And lending
standards are, by all accounts, still tight. Against this back-
ground, further near-term increases in home sales are likely
to be limited. Even so, by 2Q10 new home sales should
manage to get back to levels reached in 3Q08, reversing the
declines since the financial crisis erupted in full force. This
forecast would leave new home sales in 2Q10 more than
50% below their 1998-2007 average, but it implies that the
16% increase in sales over the past three months will be
followed by another, more gradual, 20% rise by 2Q10.
Single-family housing starts: Single-family housing starts
being built for sale have been brought well below sales, a
condition that allows the industry to bring excess invento-
ries of unsold homes more in line with sales. Consequently,
inventories of unsold new homes have been falling rapidly
and the number of homes for sale has finally come back
down to previous norms. Continuation of these trends
would bring inventories from extreme highs a few years
ago to extreme lows within a few quarters.

12
JPMorgan Chase Bank NA, New York Economic Research
Robert Mellman Global Data Watch
July 31, 2009

Indeed, with the forecast now calling for steady increases Housing market forecast
in new home sales over the next year, single-family starts Mn units, saar
would have to grow appreciably more rapidly than sales to 3Q08 1Q09 2Q09 4Q09 2Q10 2Q10
keep the inventory/sales ratio from falling to rock-bottom %oya
levels. The forecast table opposite shows that single-family New home sales 0.460 0.338 0.356 0.420 0.460 29.2
starts would have to increase nearly twice as rapidly as new
home sales over the next year (54% vs. 29% in the year Single-family starts 0.598 0.358 0.423 0.550 0.650 53.7
ended 2Q10) just to keep the months’ supply of unsold Single-family permits 0.551 0.361 0.406 0.528 0.637
homes from falling appreciably below the long-term norm for sale 0.343 0.222 0.248 0.333 0.427
of about six months. The forecasted rise in starts reflects Inventories of unsold homes 0.409 0.327 0.292 0.242 0.219 -25.0
both the increase in final demand (home sales) and a mod-
Months' supply 10.7 11.6 9.9 6.9 5.7
eration in the pace of inventory reduction. The forecast for
an increase in housing supply well in excess of final sales Note: Official Census statistics calculate changes in inventories of unsold new homes as the
increase in permits to build a house for sale (additions to inventories) less new home sales
is very similar to the forecasted surge in motor vehicle pro- (subtractions from inventories). Since both permits and sales are expressed at annual rates,
duction this quarter, well in excess of the rise in auto sales. the change in inventories each quarter is calculated as the difference between permits for
sale and sales divided by four.

Even with a better than 50% gain, single-family starts

would be at extremely low levels and, after adjusting for
demographic growth, starts would remain well below the Single-family residential construction as share of GDP
weakest quarterly pace in the early 1980s. Moreover, the Percent
positive contribution to real GDP growth from a 50% in- 4.0
crease in starts would be relatively modest. With new 1960-2009
3.5
single-family construction down to only 0.8% of GDP, a average
3.0
50% increase in activity would only add about 0.5% to an-
nualized real GDP growth. Increased broker sales commis- 2.5
sions and renovations could also lift the contribution to 2.0
growth from real residential investment. 1.5
1.0
Limited upside risk. An environment of falling unemploy- 0.5
ment and stable house prices, as forecast for next year, 60 65 70 75 80 85 90 95 00 05
could lift sales closer to previous norms than forecast. But
price measures weigh prices of a sample of homes that are
the shift in circumstances is probably not enough to bring a
sold, and the mix of home sales may differ substantially
sales boom. The unemployment rate is expected to remain
from the mix of homes in the US. For example, the Case-
well above 9% well into 2011, meaning that most house-
Shiller price measure overrepresents homes in large urban
holds will continue to be insecure and hesitant to take on
areas. The FHFA measure is limited to home purchases fi-
large new financial commitments. And though the inven-
nanced with conforming mortgages. Median new and exist-
tory of new homes may well return to more normal levels
ing home prices reflect a shifting mix of homes sold by size
in relation to sales by the middle of next year, the inventory
and geographic region.
of unsold existing homes, including large numbers of late-
model homes going through foreclosure, should keep a lid
Having said this, the recent change in trend in virtually all
on house prices and limit the rise in new construction.
price measures since the beginning of the year is striking.
Both the FHFA purchase-only measure of house prices and
Prices stabilizing, but more forced sales in 2H the Loan Performance measure (as seasonally adjusted by
The apparent end to the sustained downturn in home sales J.P.Morgan) have stabilized over the past three months.
and single-family construction activity provides a signifi- Interpretation of the Case-Shiller house price index, the
cant boost to chances for sustained economic recovery. So, most widely followed of the three, is more complicated.
too, does the possible end to the decline in house prices.
Price stabilization would be a huge relief to both house- The interpretation of the Case-Shiller measure that is most
holds and the US financial system. There are some recent positive for home prices looks at the monthly changes in
signs that house prices might be stabilizing. But identifying seasonally adjusted prices. These have moderated from an
a bottom in house prices is not straightforward. All house average 2.1% decline over the first three months of the year

13
JPMorgan Chase Bank NA, New York Economic Research
Robert Mellman The US housing market is finally
in a recovery phase
July 31, 2009

to a 0.84% decline in April and a dip of only 0.16% in House price measures based on repeat sales
May. Since these reported monthly figures are actually 3- %ch saar, over 3 months
month averages (to smooth volatility), there is a good
20
chance that the observation for May alone (not the 3-month
average) would show a monthly increase in house prices. 10 FHFA purchase only

The more negative interpretation notes the similarity be- 0

tween trends in 2008 and 2009 and ascribes this to recent -10
seasonality in the seasonally adjusted data. Pricing and Loan Perfromance
sales have historically been stronger in the spring and then -20
Case-Shiller 20 city
weakening in the fall and winter; the seasonal adjustment
-30
factors take this normal pattern into account. But over the 2005 2006 2007 2008 2009
past few years foreclosures and other forced sales have ac-
counted for a greatly increased share of the market. Since Case-Shiller 20-city house price measure
foreclosures are not nearly as seasonal as home sales, %ch m/m, samr
forced sales are a higher share of the index in the fall and 2
winter (tending to exaggerate normal seasonal price de-
clines) and a smaller share of sales in the spring and sum- 1
mer (tending to exaggerate normal price increases). Many 0
observers think that the monthly Case-Shiller measures will
turn softer again in the fall. There is probably some truth to -1
both arguments. Declines in the Case-Shiller index prob-
-2
ably are moderating, but the latest monthly reading over-
states the extent. -3
2005 2006 2007 2008 2009

Importantly, a sizable pent-up supply of homes was frozen Unsold inventory of existing homes in California by price range
during the 5-month moratorium on foreclosures that was Months' supply; Source: California Assn. of Realtors
honored by many banks and servicers. The number of
May-08 May-09
forced sales entering the market is expected to increase
Over $1,000,000 10.5 15.2
substantially during the second half of this year, a source of
$750K-1,000K 8.9 6.8
significant further downward pressure on house prices.
$500-$750K 8.2 4.5
$300-$500K 8.8 3.4
House prices remain hard to read Under $300K 16.1 3.1
Differences among the various house price measures means
that it is not clear just how national house prices are per-
forming. This is also the case when looking at how the House price change by price of home in California
%ch saar, as of Mayy 2009, Case-Shillerpprice measures
various components of the housing market are changing.
For example, there is some evidence that prices at the low Over year ago Over 3 months
end of the housing market have begun to stabilize while Los Angeles - high price -13.4 -11.1
price declines are increasingly concentrated at the high end - low price -30.4 -27.6
of the market, where limited pricing for jumbo mortgages San Diego - high price -15.8 -13.1
are impeding sales. The California Association of Realtors, - low price -33.3 -26.8
for example, shows high and rapidly rising inventories
San Francisco - high price -15.8 -13.1
(measured as months’ supply) for high-priced homes and
low and rapidly falling inventories of lower-priced homes. - low price -23.5 -18.6

Yet this result is at odds with Case-Shiller data showing part of the market as defined by Case-Shiller is too inclu-
steeper price declines for low-priced homes than for high- sive, and that prices at the very high end are performing
priced homes, including for cities in California. The expla- worse that indicated. This example warns against making
nation for this discrepancy seems to be that the high-tier casual generalizations about house price performance.

14