Quantitative Easing & the Housing Market:

It’s Not About the Money

Altos Research

Scott Sambucci
Vice President, Data Analytics

November 11, 2010

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For questions or comments, contact Scott Sambucci at scott@altosresearch.com or (415) 931 7942 1
While Federal Reserve’s Quantitative Easing Program (QE2) targets the greater economic challenges
facing the United States, expectations are that QE2 will support the housing market by lowering real
interest rates, increasing personal liquidity for mortgage borrowers, and raising asset prices through
inflation.

However, the problems faced by the housing market extend beyond financial and debt relief. The
reasons for the housing market’s ongoing deterioration are not limited just to low prices and high
mortgage debt. Instead, today’s housing market and its participants are exhibiting an evolution in their
structure and behavior that QE2 cannot address. This paper discusses several of these characteristics
that should be considered by policymakers when determining macroeconomic policies that, in part, are
intended to bolster the housing market. Many of these characteristics are interrelated, creating an even
more complex environment.

Falling homeownership rates

As a percentage of population, fewer Americans own a home now than in any time since 1999i, and a
look at the underlying homeownership rates and historical trends reveals troubling signs going forward.

The historical trend of homeownership rates in the United States from 1950 through the 1990s
consistently ranged between 61.9% and 65.9%. At the height of the housing bubble, homeownership
rates nearly reached 70% with this deviation from trend beginning in 1994.

Figure 1: US Homeownership Rates since 1965 (from www.calculatedriskblog.com)

For questions or comments, contact Scott Sambucci at scott@altosresearch.com or (415) 931 7942 2
To examine the effect of declining homeownership rates on the housing market, here’s a simple model
illustrating Housing Demand and Housing Supply:

Figure 2: Housing Demand in 2005 was artificially shifted to the right with an increase in the homeownership (HO) rate. With
the HO rate reverting back to trend following the housing crash, the housing demand curve shifts back to the right.

In this model, “Housing Supply” refers to the active market supply – the supply of homes that are
actively listed and available for purchase by a homebuyer. This does not include the so-called “shadow
inventory” that will enter the market at an unspecified point in time.

Speculation, securitization, and unsound lending practices ultimately led to an increase in the number of
homeowners – nearly 5% above recent historical trends. These market entrants shifted the Housing
Demand curve to the right which resulted in higher prices along the Housing Supply curve.
Subsequently, with homeownership rates now receding to historical trend, the Housing Demand curve is
shifting back to the left which will result in lower housing price levels over the an extended time period.

Housing supply
Considering recent trends in the active Housing Supply leads to an even bleaker outlook. Active market
Housing Supply declined from its peak in 2008, continued lower throughout 2009, and reached a cyclical
trough in early 2010. In recent weeks, the trend is moving lower but is expected reverse course in early
2011 with seasonal effects.

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 Figure 3: Active Market Housing Supply for the Altos 20-City Composite, 90-rolling average

The housing market’s price stability experienced in 2009 and 2010 was not only supported by the
homebuyer tax credit, but buoyed by low Housing Supply brought about by a number of factors,
including loan modification and foreclosure prevention programs (HAMP, HARP) and the capacity
constraints of mortgage lending and servicing institutions on delinquent borrowers. The net effect of
low supply when coupled with demand stimulus was the short-term price stability experienced over the
past two years.

As active Housing Supply bounces from the cyclical trough and persistently increases in the coming
years, the expected shift of the Housing Supply curve to the right along the 2010 Housing Demand Curve
will force prices lower for a significant period – perhaps up to 10 years. QE2 will not be able to influence
the Housing Supply and Housing Demand curves in a meaningful or lasting way.

Figure 4: Effect on Price of Short-term Housing Supply Declines

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Homebuyer tax credit
The 2009-2010 first-time homebuyer tax credit was intended to introduce new buyers into the housing
market – a demand stimulus program intended to resist the movement of the Housing Demand back to
its historical trend previously discussed. Because a portion of these buyers would have likely entered
the market with or without the tax incentive, it is difficult to quantify the success of the tax credit
program in terms of leading truly new homebuyers into the housing market. (The program may have
simply led to a welfare gain for homebuyers that would have purchased a home even without the tax
program, with an equivalent welfare loss for market sellers).

In 2009, the market saw an elevated level of housing sales and price stability throughout the year,
wearing off slowly in the fourth quarter with a normal seasonal slowdown. By comparison, the 2010 tax
credit extension affected the market far less than in 2009, as evidenced by the lower peak values of
homes sold and a faster drop-off following the spring season.

Figure 5: Weekly Listings Exiting the Active Market

This indicates an exhaustion of the short-term pool of homebuyers entering the market, and means that
the market forces leading the downward shift of Housing Demand are overriding the short term effect
of demand stimulus. While QE2 may lead to increased personal wealth and liquidity, it is likely that this
will not translate to any significant levels of new homebuyers streaming into the housing market.

Relating this factor with the inward shifting of Housing Demand offers further justification for a weak
price outlook for the next 5-10 years.

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Generational attitude towards homeownership
While the Silent Generation and the Baby Boomers brought homeownership rates up to the 60-65%
range following World War II, the Gen-Xers and Gen-Yers, in their typical defiance, are working hard to
push homeownership levels below the recent historical trend.

Figure 6: US Homeownership Rates, 1890-1990 (Source: US Census,). Data published in “A Critical Look at Rising
Homeownership Rates in the United States Since 1994” by George S. Masnick, Nancy McArdle and Eric S. Belsky, Joint Center
for Housing Studies, Harvard University, January 1999.

Why the resistance? Research by leading institutions such as the Urban Land Instituteii and the Joint
Center for Housing Studies of Harvard Universityiii shows attitudinal changes about homeownership for
these younger generations.

 Co-habitation - The Facebook generation wants to live and work with friends – keeping those
college years alive as long as possible, which means co-habitation in apartments and rental units
well into their late 20s and 30s.
 Personal debt from student loans and credit cards - The securitization market is filled with these
debt securities because of the preponderance of debt accrued by these two cohorts.
 Distrust of the housing market – The Gen X-ers and Y-ers saw their parents’ retirement funds,
wrapped in home equity and second homes, blown away by the housing crash.
 Birthrates and Marriage Rates – These latter generations are getting married later in life, having
fewer kids, and divorcing less frequently. This means less demand for homes over time.

QE2 is not intended to, nor will it, change generational mindsets developed over the past three decades.

For questions or comments, contact Scott Sambucci at scott@altosresearch.com or (415) 931 7942 6
Paradox of thrift
It’s an age-old axiom - people save when the economy needs them to spend, and spend when the
economy needs them to save. The assumption of QE2 is that personal wealth will be increased by lower
long term interest rates and newfound liquidity – real interest rates will be lower and personal cash flow
will rise. Behavior appears to trump theory since the start of the recent recession.

Figure 7: US Personal Savings Rates

Freddie Mac’s October 27, 2010 press releaseiv provides further evidence:

In the third quarter of 2010, 33 percent of homeowners who refinanced their first-lien home
mortgage lowered their principal balance by paying-in additional money at the closing table.
This is the second highest "cash-in" share since Freddie Mac began keeping records on
refinancing patterns in 1985.

With 25% of homeowners in negative equity situationsv, even those that are current on their mortgages
will be unable to take advantage of refinancing opportunities brought about by QE2.

Corporations are acting similarly – setting up their balance sheets to account for future realized losses
from the past decade’s commercial and residential real estate activity. Even with the opportunity for
increased liquidity and borrowing capacity, companies are cleaning their balance sheets and saving up
for the eventual rainy day.

For questions or comments, contact Scott Sambucci at scott@altosresearch.com or (415) 931 7942 7
So now what?
Even if QE2 is able to provide short-term housing price inflation and eventually lower unemployment,
the evolution of the housing market’s structural characteristics - homeownership rates, generational
shifts, and economic forces - cannot be combatted with any well-intentioned short-term economic or
monetary program. Policymakers should consider these housing market characteristics facing the
economy before embarking on any policy or program. Any expectations that this monetary policy
program will support the housing market should be subdued.

In the meantime, a suggested strategy is to go long on bottled water and call your local contractor to
build that bunker you’ve joked about with your friends. At a minimum, this will spur consumer
expenditures and tackle unemployment levels in the short term. It’s going to be a long road to the
eventual housing recovery.

i
http://www.census.gov/hhes/www/housing/hvs/qtr210/files/q210press.pdf
ii
http://www.uli.org/~/media/Documents/ResearchAndPublications/Fellows/McIlwain/HousinginAmerica.ashx
iii
www.jchs.harvard.edu/publications/markets/son2009/son2009.pdf
iv
http://www.freddiemac.com/news/archives/rates/2010/3qupb10.html
v
http://www.zillow.com/blog/research/2010/11/09/it%E2%80%99s-going-to-be-another-long-hard-winter-in-
housing/

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For questions or comments, contact Scott Sambucci at scott@altosresearch.com or (415) 931 7942 8