Forecasting U.S. housing market decline using computable general equilibrium models

Macro-Forecast: Continuing Crisis in Housing

Macro-Forecast of Current Events:

Continuing Crisis in U.S. Housing Market

Macro-Forecast of Current Events: Continuing Crisis in U.S. Housing Market

Recent, startling revelations about unethical foreclosure procedures may delay the resolution of thousands of troubled mortgage loans in the U.S. And are quickly becoming a risk for the housing market, and the U.S. economic recovery overall. The breadth of the problem is uncertain, in terms of the amount of loans involved and the period of time it will take to resolve the issue. Given this macro-economic market uncertainty, it is likely that the outlook for housing prices in the U.S. will continue to decline with a bottom expected in the third quarter of this year.

For this paper, I employ a computable general equilibrium (CGE) model. Like the Dynamic stochastic general equilibrium models (DSGE) models, CGE models are often micro-founded on assumptions about preferences, and constraints. CGE models focus mostly on long-run relationships, making them well suited to studying the long-run impact of economic policies. DSGE models instead emphasize the dynamics of the economy over time (often at a quarterly frequency), making them suited for studying business cycles and the cyclical effects of monetary and fiscal policy. (1) Computable general equilibrium modelling for policy analysis and forecasting, PB Dixon, Handbook of Computational Economics, 1996

CGE models are most useful whenever one wishes to estimate the effect of changes in one part of the economy upon the rest.

CGE models are comparative-static, i.e. they model the reactions of the economy at one point in time.

A CGE model database consists of:

1. Tables of transactions, showing, for example, the mortgage modifications. The database is presented as an input-output table.

2. Elasticities, i.e. parameters that capture behavioural response.

Thus, for this paper I rely on the input-output model to predict the state of the housing economy in the fall of 2011, based on inputs (i.e. today's) housing mortgage modifications and foreclosure trends, and general economic trends which could impact this area. (1)

The scope of foreclosure moratoriums make the risk hard to assess. (2)

The analysis suggests that foreclosure delays could weaken home sales, overall. Thus, house prices may decline more than anticipated during 2011, once the mortgage processing issues are resolved. (2)

The number of loans impacted by recent servicer-imposed moratoriums on foreclosures and the length of these foreclosure freezes is shaping the housing market and the broader economy. Many of the loans thout headed for foreclosure may still ultimately get there. The bank (or in some case state) moratoriums simply delay the predictible impact on home prices. A lot of uncertainty envelopes these dimensions of the problem, but I can estimate the impact based on the available information/data. (2)

Mortgage Foreclosures Suspended

As of last fall, five mortgage loan servicers, including the nation's largest, have completely suspended foreclosure action in 23 states. The largest servicer, Bank of America, even extended its freeze nationwide. Together, the five affected servicers account for 38% of all outstanding mortgages, according a recent report in Inside Mortgage Finance, an industry publication. (2)

Contrasting this information with data on state foreclosure filings from RealtyTrac, I forecast the moratoriums affect approximately 27% of all properties in foreclosure. That also assumes that the servicers' 38% share of outstanding mortgages approximates their share of all defaulted mortgages and multiplies this share by the proportion of foreclosures. Approximately 38% of foreclosure filings and 41% of foreclosure inventory are in states that require judicial review of mortgages, according to RealtyTrac, a trade journal. (2)

Fannie Mae has stopped sales of properties purchased from these suspect servicers. Thus, nationwide foreclosure sales and bank-owned sales may fall by a maximum of 27%.

According to RealtyTrac, foreclosure sales represent 31% of combined U.S. new- and existing-home sales as of September, foreclosure suspensions could depress home sales by 8.4% until they are lifted. That will decrease the foreclosure share of homes sold to 25%. (2)

Once the issues are resolved and foreclosures are completed, distress sales may even cause house prices to dive once more.

Reports in the business press indicate that it will take much longer to work through the huge backlog of distressed homes, delaying the housing market's recovery but also impact the broader U.S. economy. Foreclosure suspensions will likely hold banks back from lending to businesses and households. Banks will not lend more aggressively until they know the true impact of these problem mortgages on their capital positions and profitability.

This analysis is based on current facts and could easily change as the situation evolves.

Consumer and investor confidence has been shaken because of these trends, and this will hold back market demand for homes, and macroeconomic growth in the U.S. In 2011. (2)