Housing: An abnormally long journey back to normal

- We expect a sluggish U-shaped housing recovery "Housing data have been decidedly weak with home sales tumbling to record lows, housing starts spiraling lower and home prices slipping back. Part of the recent deterioration reflects the volatility induced by the homebuyer tax credit, but even more so, a slower-than-expected jobs recovery. The main factor determining the fate of the housing market will be the macro backdrop. If the economy falls back into recession, which we judge to be a 20% probability, the housing market will follow suit. Otherwise, we expect the volatile bottoming in the housing market to persist for some time, creating a long, painful, U-shaped recovery."
- Another five years until a “normal” housing market "We define a normal housing market to be one in which housing starts are trending at the historical average of 1.5 million homes a year. In our view, we are several years away from this state of normalcy. Housing supply has outpaced housing demand by about 2 million homes over the past few years and is on pace to add another 500,000 excess homes by the end of 2012. For this excess to clear, housing starts must remain at a depressed level, not returning to normal until 2015. This would make it the slowest housing recovery in post-war history."
- What to watch? Labor market and foreclosures "There are two primary interrelated factors that determine when the housing market will normalize: 1) the health of the labor market and 2) the pace of foreclosures. On the demand side, high unemployment and foreclosures will greatly reduce the pace by which new households are formed. Fewer new households will be created as young adults stay with their families longer or live with roommates amid high unemployment and concern about job security. In addition, the loss of homes due to foreclosure leads to doubling up and excess supply."
- Housing will not help, but should only hurt a little "The recession caused serious stress and imbalances in the housing market which will take considerable time to correct. Unlike in prior recoveries, this means that the housing market cannot be looked to for stimulating the recovery, but we do not see much of a drag left from housing construction. The bigger downside risk, in our view, comes from the trajectory of home prices. If foreclosures flood the market faster than we expect, home prices could take another serious leg down, tipping the economy back into recession. The interplay between the economy and the housing market should not be underestimated in our view."

Merrill Lynch Economic Commentary 20100824

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