Meet the Author

O. Emre Ergungor |

Assistant Vice President and Economist

O. Emre Ergungor

Emre Ergungor is an assistant vice president and economist in the Research Department at the Federal Reserve Bank of Cleveland. He is responsible for the household finance section of the Banking Policy and Analysis Group, which conducts research on regulatory policy and banking issues and provides advice on financial policy formulation. He also oversees the Federal Reserve System’s Muni Financial Monitoring Team (FMT), which monitors municipal bond markets, state and local funding, and public pension funds. Dr. Ergungor specializes in research related to financial intermediation, information economics, housing policy, and credit access in low- to moderate-income households.

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03.12.08

Economic Trends

Housing Doldrums

O. Emre Ergungor

The deterioration in the housing market shows no sign of abating. The S&P/Case-Shiller house price index registered a 9 percent year-over-year drop in the final quarter of 2007, the sharpest decline in its 21-year history.  The Office of Federal Housing Enterprise Oversight (OFHEO) price index also moved into negative territory for the first time in its 17-year history.  While both indexes show downward pressure on home prices, the magnitude of the decline differs significantly between the two indexes.  The reason is that OFHEO tracks only homes with mortgages below Fannie Mae and Freddie Mac’s conforming loan limit ($417,000 in 2006 and 2007), while the S&P/Case-Shiller index tracks home sales in all price ranges and is therefore more affected by the pricey housing of the coastal areas. (OFHEO’s limit has been temporarily raised to $729,000 or 125 percent of an area’s median home price, whichever is lower.)

The decline in prices has not translated into higher volumes just yet.  The number of new single-family homes sold has dropped 58 percent since 2005, reaching 588,000 units in January.  The median sales price, now at $216,000, has declined almost 18 percent since March 2007.

In parallel with the weakening of demand and the decline in prices, residential investment has slowed sharply in recent quarters.  Construction permits, which signal building activity going forward, have declined sharply, from 1.8 million units per year in the fall of 2005 to 673,000 units in January 2008.

The sharp decline in new home sales and the high levels of inventory suggest that the weakness in this market is likely to stay with us for some time.  At the current sales pace, it would take about 10 months to move the existing inventory.  This pace represents a significant deterioration from its level early in the decade and is worse than when it bottomed out at the end of the previous housing downturn in 1991.

A concern for economic observers is that a home is the most important asset in the household portfolio, comprising more than 30 percent of total assets.  When the stock market dropped sharply in the 2000–2003 period, the strength in home values cushioned the blow from falling stock prices and allowed households to keep spending.  The slowdown in appreciation over recent months suggests that housing may not be there to pick up the slack in the next downturn.

The deterioration in the housing industry and its impact on the nation’s economic output are visible in construction spending. While nonresidential construction spending (commercial buildings and shopping malls) has increased rapidly in the last two years, its contribution to the economy could not make up for the sharp decline in residential construction activity. As residential construction continues to deteriorate, whether the demand for commercial buildings will remain strong remains to be seen.

As the housing situation continues to deteriorate, mortgage-related losses are taking a big bite out of the profits of mortgage lenders. The earnings of thrifts—FDIC-insured depository institutions that specialize in mortgage lending—dropped sharply in the fourth quarter of 2007, a loss of almost $5 billion from a profit of around $4 billion earlier in the year.

The deterioration in earnings does not appear to be widespread, but the institutions at which the deterioration is concentrated are among the largest in the industry. The chart below shows the total assets of unprofitable thrifts as a fraction of total industry assets in a particular size category. (Year-end data up until the end of 2006 are separated into different categories of asset size and represented by different lines.  Data for 2007 appear in the bars and are divided into four quarters. For example, the green line expresses the assets of unprofitable thrifts with total assets of more than $1 billion as a fraction of the total assets of all large thrifts.) In 1990, almost 50 percent of large-thrift assets were owned by unprofitable large thrifts.  When 2007 began, this ratio was 3.5 percent and it declined to 1.8 percent in the second quarter.  Fast forward two quarters to December 2007, and 60 percent of large-thrift assets are owned by unprofitable large institutions, which exceeds the level during the thrift crisis of the late 1980s.  Note that asset sizes have not been adjusted for inflation.  Therefore, a $1 billion thrift in 1990 was an economically bigger institution than a $1 billion thrift today.

The charts below show the number of unprofitable institutions in each size category.  In the first quarter of 2007 (bars), about 20 percent of thrifts with assets less than $300 million and 10 percent of thrifts with assets greater than $1 billion were unprofitable.  Those numbers jumped to 29 and 27 percent, respectively, at the end of 2007.  These numbers are well below the levels they reached in late 1980s.  What these numbers suggest is that compared to 20 years ago, we have fewer troubled institutions, but those that are troubled are the largest ones.

Bank holding companies and financial holding companies (BHCs and FHCs) seem to have fared better in these difficult times.  BHCs and FHCs are holding companies that own a diverse set of financial institutions, ranging from depository institutions to insurance companies and investment banks.  While the number of unprofitable institutions has increased, the industry as a whole has created enough profit to absorb the losses from the unprofitable institutions.  Overall industry profits were still positive and strong in the last quarter of 2007.