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Goldman Sachs answers 3 key questions about housing

The outlook isn't that bad

May 6, 2014
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Goldman Sachs (GS) analyst Hui Shan notes that many sectors of the economy are improving.

However, over the last few weeks housing isn't one of them.

An improvement in housing is expected from April and May — the so-called spring buying season — but there are still some weaknesses being caused by higher mortgage rates and tighter lending standards.

"As a downside scenario, we estimate that a failure of housing activity to recover in the remainder of 2014 would shave about 0.5 percentage points from real GDP growth in the second half of 2014," Shan writes in the Goldman Sachs Global Macro Research note from this morning.

"This is significant but would still leave growth near an average of 3% for the remainder of the year," he adds, which would be an improvement over the first quarter near-negative GDP report.

Shan said there are 3 key questions facing housing.

And then, he answered them.

Here is a summary of that Q&A from Hui Shan of Goldman Sachs.

The edits are mine, but most of the words belong to Shan:

1. What happened to housing in the first quarter?

First, the past winter was unusually cold and many regions of the country endured seemingly never-ending snowstorms.

Second, mortgage interest rates are 100 basis points (1%) higher than a year ago.

Third, mortgage-lending standards remain tight.

"The Ability-to-Repay and Qualified Mortgage rules issued by the Consumer Finance Protection Bureau took effect on January 10, 2014. Lastly, changes put in place at the beginning of this year--including the FHA single-family loan limit reduction and the expiration of the Mortgage Debt Relief Act of 2007--may have negatively affected home sales in certain parts of the country," Shan notes.

Bright spots include homebuilders reporting solid results in their Q1 earnings. Also a new increase in pending home sales and rising construction employment are notable improvements, Shan states.

2. Where do we stand at this point?

Here Shan looks closer at the three potential negative-housing drivers mentioned in the first answered question — weather, interest rates and lending standards.

Weather: The negative effect of unusually cold weather on permits is largest in the concurrent month, but there tends to be a positive payback effect two months later.

"In addition, the weather effect is arguably smaller on permits than on other housing activity indicators such as starts and sales," Shan states. "Nevertheless, our finding suggests that normalizing weather should provide a boost to permits issuance in April and housing starts in May."

Interest rates: "As we head into Q2 and Q3, the effect from the May-August interest rate selloff last year should finally be behind us. On lending standards, we have argued that credit availability is the key to the ongoing housing recovery."

Shan also takes issues with reports claiming lending standards are getting looser.

 "Statistics showing much larger declines in credit scores are often distorted by composition effects and do not reflect a true loosening in lending standards," he said echoing a recent Urban Institute report.

"For example, as the share of FHA loans has increased relative to GSE loans, the average credit score has declined because FHA borrowers tend to have lower credit scores than GSE borrowers," Shan states.

3. What would a downside-housing scenario imply for GDP growth?

Well, it doesn't look good, according to Shan, who expects a further drag on GDP from housing. But even in his most pessimistic scenario, the total economic impact is not a recovery killer.

Assuming the negative estimation that housing starts would stay at 0.9 million and existing home sales would remain at 4.6 million by the end of this year, housing would contribute 0.5 percentage points less to real GDP growth in the second half of the year.

"In other words, instead of the 3.5% annualized growth rate we currently forecast, real GDP would grow 3.0% in Q3 and Q4, assuming the broader economy continues to recover despite the significant weakness in the housing market," Shan concludes.

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