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Booming housing market faces few threats

U.S. home prices continue to hit new record highs, raising concerns that certain markets could already be in a price bubble. Ralph DeFranco, the global chief economist for the mortgage insurer Arch MI, discussed with Scotsman Guide News a range of issues affecting the housing market, and why he’s not concerned about an imminent downturn.

What is your opinion of the relative affordability of the U.S. housing market?

ralphdefrancoIt certainly varies by city, but nationally it is actually surprisingly good relative to pre-crisis levels. Even though it doesn’t feel affordable, and everybody wishes that homes were cheaper, when you are looking to buy a home, compared to historical norms, we are actually roughly 20 percent more affordable than pre-crisis.

Do you see any price bubbles emerging?

I am not concerned as yet. There are some cities that are extremely hot. So, they deserve a close look, including Nashville, Seattle, Portland. But they also have very strong fundamentals. So, I do not believe at this time that there is a reason to be too worried about a bubble. One important thing about bubbles is that it requires a buyer psychology that I have to buy now, otherwise I can’t afford later. That is hard to measure, but we certainly do not have some of the other things that we saw with the last bubble, such as very loose lending criteria. Banks are definitely much different, much tighter and it is more difficult to get a loan now than it was in the last cycle. I am hoping that will protect us from getting carried away in a bubble at the moment.  

Is that why you said in a recent report that a market crash is unlikely. Or are there other reasons?

That is one reason. Another major reason is just because we are underbuilt. Our estimates are that there are about a million and a half too few housing units across the country. The reason for that has been abnormally low construction for the last 10 years. It was understandable back in 2008, ’09 and ’10, because we had become overbuilt back in 2007. But, what has happened  is that it has been too slow to ramp up, and so there is just a fundamental disconnect between supply and demand, and it is not going to resolve itself in the next year or two. It is going to remain a problem. That puts enormous pressure on home prices to continue to rise.

The Realtors have said that the tight supply conditions are bad, but it sounds that it may have an upside in protecting the market from a big crash?

It is certainly bad for them. It is cutting into their business. They can’t sell as many homes as they would like. The demand is there. They could sell more houses if there were more homes on the market. So, it is bad for Realtors. It is bad for buyers. But, it is good if you are in the risk-management business, and you are concerned about home-price declines. It depends on your perspective.

Where do you believe interest rates will be at the end of the year?

We are thinking they will be close to 5 percent for a fixed-rate 30-year mortgage. That is up a half [percentage point] from now. If that happens, it is definitely going to hurt affordability. But, interest rates are notoriously hard to forecast because they depend on future financial-market attitudes.

Do you have any opinion on the tax overhaul? What impact that might have on the housing industry?

It is a net negative because there is less financial subsidy for housing. The interest deduction was a big subsidy helping housing, and it is diminished because more people are not going to itemize their taxes. And so, anybody who doesn’t itemize their taxes gets no benefit from the mortgage-interest deduction. The tax overhaul was structured so that people who were itemizing for last year will not be itemizing for this year. Over time, what that does is that it changes the math between homeownership and renting in favor of renting. Very subtly over the future years, we will have slightly lower homeownership rates and slightly less housing demand. It is not big enough to have any impact on the housing market right now. The housing markets are still strong just because the demand is there, the jobs are there, and people are out there looking for a place to live.

Do you see anything coming out of Washington now that could directly impact the housing market?

In terms of policy, the tariffs have the potential danger of causing slightly higher inflation, which would likely push up interest rates even higher. That is a slight negative. Then there is immigration policy. It hasn’t actually changed dramatically, but there is stronger enforcement. That is hard on the construction industry, because they use a lot of immigrant labor. And so, it is just adding to the existing shortage of construction workers.  

How long do you think the so-called good times for the housing market will continue?

I believe it is going to continue for at least several more years, but it depends on when the next recession comes. We don’t know when that will be. The baseline forecast is that the economy is going to be quite strong for the next couple of years, in which case, the housing market is going to continue to be strong over that time. After that, it is just too hard to say. We would probably expect to have a recession at some point because the economy is probably headed for overheating. There is a danger of inflation getting higher than expected, which could cool the economy. That is more like a few years out. 


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