What Assumptions Did the Stress Tests Make About Housing Prices?
Dear Ali;
I'm trying to figure out whether housing prices have bottomed. I heard on the radio that the government assumed that they would fall further in the "stress tests." What were these assumptions based on, and what do you think of them?
A: As reported by NPR's Yuki Noguchi, stress test scenario No. 1 is that the economy comes back next year with 2.1 percent growth, while unemployment peaks at 8.8 percent next year. Housing prices in this scenario would drop 14 percent this year and 4 percent next year.
Stress test scenario No. 2 is that the economy grows next year, but only marginally, by 0.5 percent. In that case, unemployment hits 10.3 percent next year. Housing prices in this scenario would drop 22 percent this year and 7 percent next year.
These scenarios were drawn up using consensus forecasting. The first scenario represents a consensus of what forecasters were thinking in February. The other one (which the government calls "more adverse") is not a Mary-run-for-the-hills, but simply a tweaking of the first scenario by taking housing prices down about 10 percent. (If you've wondered, this is what economists do all day.)
So the first scenario seems plausible, even though it feels like it's sort of ignoring the whole idea of the stimulus package. Remember, the point of those billions of dollars is to get lending moving again, and even though more job losses should drag real estate prices down, more available mortgage money should be acting to move them up.
I certainly have a really hard time with the second scenario. While the Fed doesn't have a lot of room to play with interest rates, surely, in a case where housing prices dropped by a fifth, there would be some attempt from the government to help real estate out on that end.
Even the Fed admits, in its 21-page report on the assumptions (which I read so you don't have to), there's only a one-in-ten percent chance of the "more adverse" scenario happening.
Which brings us to CramerWatch: The Mighty Jim says that housing prices are going to bottom on June 30. That's just 51 days away.