Drivers of sustained homeownership rate growth and economic impact in the United States

¶ … Family Home Ownership

This report uses both primary and secondary source material to investigate and present various aspects of single family home ownership in the United States. Single family home ownership can be considered one element of many that comprise the United States Gross Domestic Product. The Gross Domestic Product is a tool used to track statistics and affects on domestic economic trends, governmental policy and fiscal changes.

The effects of single family home ownership on America in an economic sense has dramatically changed in recent economic boom periods which occurred during the years of 1996 through 2000 and then economic downturn periods between the years of 2000 and 2004. These thirty-six quarters in our nation's history have provided us with a combination of highly prosperous times coupled with extremely disastrous recessionary times. These two extremes have kept the entire spectrum of the real estate industry in constant flux.

Our new world outlook has put our nation at a disadvantage. By world standards, constant crisis's pertaining to the economic, military, political, and social order have added new fears to how we live. The report attempts to provide a picture of the overall economy through specific insights into the housing market. The paper utilizes both economical and statistical figures and attempts to provide an assessment of their meanings and how they pertain to the Gross Domestic Product and the United States economy. The report hyper focuses on the single family home ownership aspects of the housing industry and views those details as they pertain to the Gross Domestic Product and the aggregate demand formula.

Other insights such as the prime interest rate and how changes in total mortgage interest rates affect single-family homeownership. The report touches upon monetary and fiscal policy changes, major external events aboard and contributions to our economy. However, the main objective of the report was to demonstrate how various housing industry aspects affect the Gross Domestic Product while also creating unique and measurable trends and cycles in housing industry variables such as interest rates, mortgage origination volumes, and more.

Introduction

The main objective of this report is to provide information on the various housing industry aspects and their affect on the Gross Domestic Product. This report examines single family home ownership and tries to explain the forces behind the sustained rise in the rate of homeownership in the United States and the overall impact on the nation's economy. The existing macroeconomic signs seem to indicate that we as a nation are at a turning point for the United States' economy as was demonstrated by the final quarter of the twentieth century.

The extreme changes of that period gave a ray of hope that the world was in for a new economic upswing. but, events such as the ending of a long bull market, a redirecting of the nation's fiscal policies and the terroristic attacks on September 11, 2001, put an end to the vote of confidence and quickly reversed our nation to a point where concerns and doubt pushed us into bleak situation.

This report tries to examine the single family housing industry as it pertains to the United States Gross Domestic Product to see what can be learned from economic fundamentals to help influence future choices. The report also attempts to analyze specific housing industry statistics to attempt to forecast the shape of the economy over the course of the next few years as well as attempting to predict some of the consequences the real estate industry may face.

Through primary and secondary sources, aspects of single family home ownership in the United States will be used to understand the history and affects of home ownership on the economy and the United States Gross Domestic Product. Single family home ownership is also used in this research paper to track some of the associated statistics and affects on domestic economic trends, governmental policy and fiscal changes.

The period of review is based on the economic boom period between 1996 and 2000 and the downturn between 2000 and 2004. Through both economical and statistical data, the report hones in on the single family home ownership aspects of the housing industry and aggregate demand. The report also provides insights into prime and mortgage interest rates and their affect on homeownership as well as monetary and fiscal policy changes, major external events aboard and contributions to our economy.

The Industry

Recently, the housing industry has been moving along at an unprecedented rate even though the United States economy has been sputtering. The housing industry success rates have been attributed to various factors. Some more influential factors are:

Historically low mortgage interest rates

Strong demand coupled with low inventories of unsold existing homes

New construction

Long-term investment philosophy

While some slippage of housing market activity was anticipated during the fourth quarter of 2001 and the first quarter of 2002, along with weakness in general economic activity, housing is nevertheless well-positioned to lead the economy forward in 2002." (NAHB) as both long-term mortgage interest rates and the prime interest rate remain at all time lows, American home buyers look to take advantage of their increased purchasing power.

Limitations

As the National Association of Home Builders point out, interest rates of thirty year long-term mortgages lows on average and adjustable rate mortgages were even lower at around five percent. These very low interest rates permit new and existing families to not only buy first time homes, they are moving right into more expensive homes that historically could only be purchased by second and third time around buyers who had accumulated equity as collateral.

This phenomenon has stimulated the United States economy through two different types of sales. In other words, the direct sales transaction is only one way to boost the economy. The housing boom also has indirect economic advantages as a result of related purchases and expenditures that are needed for a family to settle into the new nest. Furniture, appliances, utilities, and even sprinkler systems and lawn services are all positively affected by single family home sales. "The recent, dramatic rise in home values also should provide a boost to other sectors of the nation's economy as consumers put their equity to work." (Sicks, "Home Builders Group Sees Mild Recession")

Although the National Association of Home Builders wants everyone to see through rose colored glasses a picture that the group paints, there are also some less obvious down sides to existing housing industry trends. Low interest rates have adverse affects on individuals who bought their homes at earlier times at high levels of interest and therefore in a position to sell at these lower interest rates. "But anyone who bought a home during that period of inflated prices probably has found that selling at much of a profit hasn't been easy since 1990. Many sellers cannot even cover the cost of settlement without going to their savings accounts." (Sicks, "Area Home Sales Good, Not Great")

Other trade off is an apparent 'economy of scales' affects. "Moreover, for at least the past 20 years, the ever-increasing amounts of capital used to finance the sale and resale of existing houses at ever-higher prices has come at the direct expense of investment needed to maintain America's industries, infrastructure, and general standard of living. As a result, not only are today's younger Americans paying unprecedented prices for housing but they are earning less real wages than they would have otherwise. In 1973, the average 30-year-old male needed to pay only 21% of his income for the mortgage on a medium-priced house. By 1984, that had jumped to 44%." (Longman)

Today, that percentage continues to increase. As a result, the number of mortgage defaults and foreclosures among lower-income buyers is steadily rising. Sub-prime loans and an ever increasing amount of borrowers who have less than five percent equity can not keep up with the cost of living coupled with mortgages at or near fifty percent of their income. "

History

So how did we get here? We have to look back to the pre and post World War II era for answers to some of the questions affecting us today. "The Depression made clear in the minds of policymakers in the United States the need both to stimulate the economy and to create a new economic order geared towards stability. Turning a 'nation of renters' into a 'nation of owners' was seen as a way of extending the possession of stable assets to the majority of the population. In the United States, Franklin D. Roosevelt introduced a federal initiative to stimulate the private housing market." (Friedman) in 1934, in an effort to restart the depression savaged United States economy, Congress passed a main function of President Roosevelt's housing legislation called the National Housing Act. The Act established the Federal Housing Administration. The National Housing Act made an attempt to eliminate short-term mortgages so as to eliminate the opportunity for lenders foreclosing at the end of periods as short as two or three years.

These short-term mortgage policies during the Great Depression were a major contributor to the collapse of many real estate values. The National Housing Act indirectly promoted the idea of lenders offering much longer-term mortgages with the currently accepted concept of monthly payments with the dual interest and principal payment scale. Amortized real estate mortgages opened the door for an average person to purchase and own a single family home.

As a result of the National Housing Act, the United States government inadvertently committed itself along with private lenders to insure long-term mortgages that could be held for as long as twenty or more years at an interest rate that was affordable. Although the process at first was bogged down by paperwork and bureaucracy it eventually caught on.

Part of the reason the process took hold was because in addition to guaranteeing the loans, the National Housing Act through the formation of the Federal Housing Administration also investigated properties and neighborhoods which added an extra measure of security and guaranteed real-estate properties on government backed notes. "If for any reason a homeowner fell behind on a mortgage guaranteed by the FHA, the agency would take over the debt, thereby insulating the mortgage holder from almost all risk. In effect, the government had made it much safer for an investor to put his money into FHA mortgages written by any small, local bank or savings and loan than to own stock in even the largest, most secure corporations." (Longman)

Since opportunities pertaining to a reliable financing process was in place, the post World War II veterans were then in a position to purchase single family homes. However, because of the combination of a weak economy during the depression and the man power shortage due to the World War II, construction output was low and therefore there was an inadequate supply of homes and demand surged proportionately. The result of these new demands coupled with the inadequate supply needed and thus created an immediate surge in the single family home construction markets.

Housing Construction, Federal Republic of Germany, 1950-1988

Year Number of Newly Constructed Per 1,000

Dwelling Units Inhabitants

1950-

1988

Van Vliet)

The fact that personal savings from war-based salaries were high and the government had also recently instituted the new Veterans Administration loan guarantee program combined with the already successful FHA loan protection process paid off and Americans bought single family homes at unprecedented rates. The surge to suburbia was on. "The number of houses built rose from 114,000 in 1944 to 937,000 in 1946 and a peak of 1,692,000 in 1950. Overall, a yearly average of 1.4 million houses were built between 1945 and 1965. These new homes were, by the standards of the past, both relatively easy to afford and generally of high quality." (Longman)

For maybe the first time in American history, there was a trade off because of the housing boom as almost over night the nation began to incur long-term debt at the same time as their personal savings became depleted. "Between 1945 and 1965 mortgage debt for houses increased from $18.6 billion to $212.9 billion. As a percentage of the nation's gross national product, this was an increase from 9 to more than 30%." (Longman)

Current Situation

Post World War II economics has been built on the fact that since around 1965, our nation's volume of mortgage debt has continued to climb and is currently well over a trillion dollars. "From more than 20% of GDP in the 1960s and 1970s, gross saving in the United States has fallen to roughly 15% of GDP in the 1990s. " (Browne and Hellerstein)

As more homes sold the United States household debt was raised proportionately. To put things into perspective, residential real estate as a percent of disposable personal income is at a post-WWII high and household debt as a percent of household net worth is neat twenty percent. "The picture is somewhat less clear when one looks at the cost of borrowing. Nominal interest rates today are low compared to rates through most of the 1970s and 1980s, but to the firm contemplating a long-term investment, the relevant concept is the rate of interest adjusted for expected inflation. A high nominal rate will not be an impediment to investment if inflation is expected to be high, since the income stream generated by the asset will grow over time with inflation." (Browne and Hellerstein)

United States Daily Economic Commentary)

As a result, households have no option other than to borrow more against their already heavily burdened disposable personal income. Although we are seeing the lowest interest rates on household borrowing in the history of the nation, households are still faced with unbearable financial obligations due to mortgage principal and interest, taxes, insurance, and of course payments for the Hummers. "A home ownership opportunity divide that now seems quite small threatens to grow into a huge gap. At least one major sector already has grown smaller. More younger people -- 35 years of age and under -- face serious affordability problems. Among such households, the rate of ownership dropped from 45% in 1979 to 37.3% in 1987 and has recovered to only 39.7% in 1999. Home ownership rates for African-American households, meanwhile, are 27 points below white non-Hispanics, and Hispanic home ownership rates are 28 points lower than white non-Hispanics." (Peterson)

United States Daily Economic Commentary)

In addtion, there are basically two different markets when one considers the single family home. There is new construction homes which create jobs and new economic opportunities through material, construction and labor and there are also existing home resale which adds much less value to the nation in an economic sense as compared to new construction. For example, realtors distinguish between the two distinctions, new and resale, as if they were completely different markets.

Based on news releases by the National Association of Realtors, existing single family homes sales have been rising and new monthly records were being produced with signs of continued success and strong gains. "Existing-home sales increased 3.0% in January to a seasonally adjusted annual rate of 6.09 million units from an upwardly revised level of 5.91 million in December. Last month's sales activity was 2.2% above the previous record high of 5.96 million units in January 2002." (Existing home sales hit new record in January)

But there is an economy of scale here. In other words, when we invest in one thing that capital can not be invested somewhere else.

Future Growth

Low interest rates will continue to help new and resale home sales well into the future as well as assist existing home owners to lower their mortgage payments through the refinancing process. "In contrast, there is little doubt that the U.S. housing market today is being driven by the fundamentals, particularly if one includes the stock market as a fundamental. Employment has been rising at a healthy rate in most metropolitan areas, pushing the unemployment: rate below 3% in many. Personal income growth has been extraordinary, and the gains in stock market wealth have already been discussed." (Case)

The refinancing process also adds value in the sense that an existing home owner's equity is instantly increased. "In turn, this process pours money directly into the economy since it frees up consumers' resources for discretionary spending." (NAHB)

As the National Association of Builders show, demographic forces will continue to contribute to increased demand for new homes in the future. Our population has been growing due to factors such as increased birth rates and higher percentages of legal immigration and migration.

NAHB)

Even with the inherent concerns about the baby boomer generation nearing retirement age, the nation's growth expectations over the next one to two decades continues to look promising in the terms of demand on new construction of single family homes. "Although the U.S. is by any standard the best housed nation in the world, it still faces a critical shortage of affordable housing. Almost 14 million households have "critical housing needs," meaning that they spend more than half of their income on housing or live in seriously substandard conditions. One in every seven renter households (5.3 million Americans) is included in this group, and they receive no government assistance." (NAHB)

Gross Domestic Product

The Gross Domestic Product is a governmentally standardized tool that measures our nation's income by evaluating the values of goods and services produced within the nation. When evaluated in detail, Gross Domestic Product should never be calculated with depreciation and is should signify only income generated from national resources within the United States even when income is earned in a foreign currency. The foreign currency can only be counted toward the Gross Domestic Product if it was earned within the country. and, the Gross Domestic Product should on take into consideration the final goods and services within the country.

To compute the Gross Domestic Product, one needs to perform three basic components:

personal consumption expenditure gross private domestic investments government purchases

The component, personal consumption expenditure, is the expenditures made by individuals for durable and non-durable goods. The second component, private investment, entails investments made by business as well as non-profit organizations in both non-residential and residential buildings, supplies and equipment. The third component represents government purchases.

Although home sales are a major factor in respect to the economy, some feel that home sales do not affect the Gross Domestic Product because it is based on older data. "The Gross Domestic Product is an important measure of the strength of the economy; it covers relatively old data in the eyes of many investors. Many other reports already available on July activity, such as Friday's home sales report, suggest a slowing in the economy in the third quarter." (GDP Up; Home Sales Down)

The Gross Domestic Product can either increase or decrease in regard to the before mentioned three components. An increase for the Gross Domestic Product can often be attributed to an increase in American's disposable income which promotes an increase in the public's spending habits. When there is an increase in spending the result can increase the level of prices and therefore lead to inflation. To curb inflation, the Federal Reserve Bank has an obligation to reduce all inflationary pressures on the economy.

The Central Bank uses the flow of money by either increasing or decreasing the interest rates on either deposits, loans or both. For example, if inflation is rising, the Fed might increase interest rates which in turn would make borrowing more expensive for banks and therefore would cause them to raise their expected interest rates when they loan money. As capital becomes more expensive, corporate and business profits decrease which in turn slows down growth.

A slow or lower Gross Domestic Product, on the other hand, could indicate that the economy would be in need of a boost because of recessionary tendencies. Thus, the Federal; Reserve would be required to increase capital flow in the economy by decreasing the lending rates. Historically there has not been an ideal growth rate for the Gross Domestic Product. Consistent and sustainable growth in the long-term is the goal in an economic mindset and could be the closest thing to ideal. In general, the economy should avoid drastic jumps in either direction so consistency counts.

The housing industry is a very good indicator of the direction and consistency of the Gross Domestic Product. "One of the few long-term measurements of construction output is the contribution of the construction industry to the Gross Domestic Product." (Finkel) the housing market is a very consistent indicator of the rise or fall of the Gross Domestic Product because the housing industry is driven by the availability of capital for consumers.

As demonstrated, when consumers have money they buy new homes and the associated products needed for those new homes.

GDP up; home sales down)

The rise in consumer spending however leads to inflationary periods and the economy must be slowed which in turn reduces the amount o capital consumers can spend on the housing industry. And the cycle continues as the construction companies can not build new homes if demand is low and vise versa. An example can be seen from 1999. "Meanwhile, the National Association of Realtors reported existing home sales hit an annual rate of 4.79 million in the month, down 9.8% from both the June figure and the July 1999 level. It attributed the decline to higher mortgage rates." (GDP up; home sales down) the rates were raised because of inflationary fears.

Components of Aggregate Demand

In macro-economics, economic indicators measure market activity for the entire economy or at other times major segments of an economy. The gross domestic product for example is our nation's most important economic indicator. Generally, it represents a very broad measure of the overall economic activity of the nation while also signaling the direction of overall aggregate economic activity. The Gross Domestic Product can be calculated through the use of the components of aggregate demand:

I + G + (X - M), where C = consumption; I = investment; G = Government; and (X-M) represents World Trade, with "X" standing for exports and "M" for imports.

Through the use of this formula, one can see that an increase in any of the components of aggregate demand has a type of multiplier effect on the overall economy such as an increase in spending through consumption. The key factor of this formula is that each of the various sectors spends and the resources are then spent, re-spent and then re-spent again in a never ending cycle.

In other words, when the government increases spending for new language brochures with a multiplier of 4 in the economy, the money creates new jobs for printers distributors and paper sellers and thus the brochure spending actually increases national income more than the aggregate governmental spending. But there are other indirect benefits of the spending as well. The direct beneficiaries like printers now have the disposable income to buy a new car, eat at a fancy restaurant, buy new clothes and so on. As the cycle progresses, the owners of those establishments will also receive the benefits of income and follow suit by buying clothes, cars and new single family homes.

Thus, of the various methods for calculating the Gross Domestic Product, the expenditure approach is one of the most accepted and probably the most common. The approach takes the sums of total expenditures in the various sectors of the economy which are household consumption, business firm Investment, Government purchases, and Next Exports which is eXports - iMports. A simple example can show the effects from the aggregate demand figures and also puts some perspective of each figure to the overall big picture:

GDP

By plugging in hypothetical figures, one can see how easy it is to calculate and the overall effect each factor would have on the end result. By adding across, in this hypothetical example, the Gross Domestic Product would equal 7350 billion dollars or just less more than seven trillion dollars. The key point to this figure is each sale has a multiplier effect of price times quantity and the dollars are recycled.

To put single family homes into perspective, consider the effect that the housing industry has on the Gross Domestic Product. "Housing also is vital to local and state economies, creating jobs and generating taxes and wages that positively influence the quality of life. The construction of 1,000 single-family homes generates: 2,448 jobs in construction and construction-related industries, approximately $79.4 million in wages, and more than $42.5 million in federal, state and local tax revenues and fees. Construction of 1,000 multifamily homes generates: 1,030 jobs in construction and related industries, approximately $33.5 million in wages, and more than $17.8 million in federal, state and local tax revenues and fees." (NAHB)

Consumption

We are a nation of consumers and that fact is a key to understanding how single family homes pertain to the Gross Domestic Product. Our nation has been facing major economic downturns of the periods between 1996 through 2004. Many companies have been able to produce profits through job cuts, corporate migration overseas, mergers and restructurings. "Media giant AOL Time Warner lost $99 billion in 2002. With results like these, corporate investment is not going to revive any time soon." (United States Daily Economic Commentary)

There is an obvious economic crisis coming out of the airline industry as the major carriers like American Airlines, Delta, United and Continental continue to operate in the red. Each of these carriers faces the daunting task of increased fuel costs, terrorism and an overall weak world economy.

The vacation travel industry has also been hit hard as the effects of the terrorist attacks on September 11, 2001, continue to put fears in the hearts of vacationers. "In addition, the U.S. gross domestic product contracted for the first time in eight years in the third quarter of 2001. According to the U.S. Department of Commerce, gross domestic product contracted by 0.4% during this period. Economic forecasters have attributed this contraction in part to the sharp impact of the attacks on consumer spending, airline and vacation travel, factory production and business investment." (Dhooge)

The war in Iraq and many other oil-based problems have pushed oil prices to record highs thus effecting manufacturing, construction, delivery and every other aspect of American life. "At the same time, the possibility of war with Iraq has further clouded the economic situation. And the European economy, which a couple of years ago was expected to be the growth leader for the world over this time, continues to fade." (Gonzalez) Who wants to buy a car if they can't afford the gas to drive it?

Through all of this turmoil, our United States consumer confidence has somehow kept the world economy afloat and single family home sales have remained steady. Can we as consumers continue to do so? "Sales of building materials and garden equipment fell 7.5%, the biggest drop on record. Purchases of clothing and accessories slid 3.6% while sales at furniture stores dropped 1.6%." (United States Daily Economic Commentary)

Investment

Although the first thing that comes to mind is the stock market when one thinks of investments, the overall market value of single family homes owned in the United States is approximately twelve trillion dollars.

NAHB)

Single family home ownership as an investment increased over 50% in recent years. Homeownership is steady and at times more lucrative than our infamous stock market. An investment in a home can provide a solid return on investment as the price of a single family home appreciates. "Furthermore, housing equity (market value less mortgage debt) increased by the same proportion over this time frame and was approaching $7 trillion by the end of 2001 despite equation." (NAHB)

New construction in the single family home industry represents a major portion of the nation's buying power into investments. Single family homes have a unique importance to our national economy because of the previously y explained cycle of spending and re-spending capital.

The United States economy is highly dependent on the housing market. "The production of housing and the value of housing services produced by the housing stock account for about 14% of the nation's Gross Domestic Product, and housing market activity drives other closely-related components of the economy as well." (NAHB)

NAHB)

Government

Other than the agriculture sector, there is no sector of the economy that gets as much governmental attention through the manipulation of prices and legal statues than the real estate sector. Since the introduction of President Roosevelt's housing legislation in 1934 and the introduction of the Veterans Benefits program. The governmental intervention has been affecting the single family home sales. "They are essential and they should continue to be, in the face of the present onslaught on most housing subsidies as fiscally irresponsible, risky, distorting, regressive, humiliating, or failing to achieve their designated goals. In our definition of enabling housing policies -- that is, setting boundaries and providing support, while relinquishing control -- subsidies are, in essence, one of the fundamental supports needed to make the housing sector work efficiently and equitably and to overcome market and policy failures." (Angel)

Since the Great Depression until today, the federal government has continually help secure mortgage credits and tax benefits that were specifically geared to keep single family owned housing affordable to as many Americans as possible. From a local perspective, communities regulate land use so as to ensure suburbia remains safe and pleasant. "Infrastructure provision is a fundamental form of support for housing the poor. The poor benefit most if they have access to citywide services, even without any subsidies, because they usually pay more if they are not part of the system. Extending infrastructure networks to poor communities is thus a highly enabling housing policy. It reduces utility costs for the poor; it also reduces discrimination against the poor in the provision of services. In addition it improves overall public health, and it generates new housing investment." (Angel)

There is no doubt that this intervention has put single family home ownership as an option for Americans. The trade off however is that the infrastructure can not afford to repair decaying bridges or refurbish abandoned factories. In other words, the economies of scale for keeping Americans in a position to buy single family homes has ultimately led to declining real wages and lost opportunities in elsewhere.

World Trade, with "X" standing for exports and "M" for imports.

The United States is and will continue to be at a distinct disadvantage regarding international trade. "The competition for most misunderstood economic statistic is hard-fought, but there is a clear winner: the trade deficit. No other number is interpreted so differently by professional economists and the general public. Common reactions to the U.S. trade deficit range from belligerence to dejectedness: It is thought that America's trade deficit exists either because of the skullduggery and unfair trade practices of countries that shut out U.S. products, or because American companies are failing to compete against their global competitors." (Taylor)