Housing trends continue to inform economic and credit analyses in the U.S. and around the globe. Economists and analysts continually assess the prospects for imbalances in property markets in Canada, China, Brazil, France, and other emerging markets. At the same time, Spain and Ireland continue to feel the weight of housing busts following pre-crisis booms. For Canada, however, the risk of a housing market bubble and correction is diminishing as housing activity indicators continue to show that this market is slowing.
Similarly, a recent International Monetary Fund (IMF) commentary suggested that house prices are well-above their historical averages and are a significant risk to economies for some countries, including Australia, Belgium, Canada, Norway, Sweden, Hong Kong, and Israel. The IMF’s global house price index was up 3.1% year over year based on first-quarter 2014 or fourth-quarter 2013 data. U.S. house prices are not in bubble territory, still 13.4% less than their long-run average relative to incomes, but 2.6% higher relative to rents. Japan has the cheapest housing market, with prices about 41% below the long-run average relative to incomes.
Meanwhile, it’s clear that the housing and credit markets are highly correlated, over time and across regions. Rising home prices are consistent with growth in mortgage originations and increased lending in residential construction. This correlation undoubtedly runs in both directions, with easy mortgage availability and low interest rates driving up housing demand, and mortgage lenders then accommodating this demand, especially as the collateral value of houses increases. Based on this, rising interest rates or falling home prices would reduce lending and building activities and possibly cause financial distress, as it did in 2007-2008.
Home-price behavior is a key consideration for Standard & Poor’s in evaluating credit conditions across a range of sectors including homebuilders, construction materials producers and suppliers, REITs, public housing finance entities, financial institutions, and residential mortgage securitizations. During our quarterly credit conditions committees, we often discuss global housing and trends that would point to any imbalances in the global housing markets. In our cross-sector scenario analysis, housing remains a key systemic variable that would potentially affect the economy and various sectors simultaneously.
Academic studies have shown linkages between home prices and financial and economic conditions. These include the effect of economic fundamentals on home prices, as well as the relationship between the effects of changes in the housing market and the subsequent condition of an economy. There is substantial evidence that housing is among the most important sectors to look at to understand economic cycles, with residential investment (as a component of GDP) usually indicating early signs of a recession. Historically, substantial problems in the U.S. housing market have preceded the past several recessions.