Optimists point out that some measures of housing affordability have dramatically improved. According to NAR figures, monthly payments on a typical house with a 30-year mortgage and 20% downpayment were 18.5% of the median family’s income in February, down from almost 26% at the peak””and close to the historical average. But this measure is misleading, not least because credit standards have tightened. A survey of loan officers conducted by the Fed suggested on May 5th that 60% of banks tightened their lending standards for prime mortgages in the first three months of 2007. And, as Michael Feroli of JPMorgan points out, the affordability gauge depends on what measure of home prices you look at. Use the Case-Shiller index, where the affordability of housing worsened sharply during the boom, and mortgage payments are still high in relation to incomes.
A better measure of housing fundamentals is the relationship between house prices and rents. This is a sort of price/earnings ratio for the housing market: the price of a house reflects the discounted value of future ownership, either as rental income or as rent saved by an owner who lives in the house.
A recent analysis by Morris Davis of the University of Wisconsin-Madison, and Andreas Lehnert and Robert Martin of the Fed, shows that the rent/price yield in America ranged between 5% and 5.5% from 1960 to 1995, but fell rapidly thereafter to reach a historic low of 3.5% at the height of the boom. Given the typical pace of rental growth, Mr Feroli reckons house prices (as measured by the Case-Shiller index) need to fall by 10-15% over the next year and a half for the rent/price yield to return to its historical average. Again, that suggests the national housing bust is only halfway through. And, given the scale of excess supply, house prices are likely to overshoot. All told, the pressure on policymakers to help struggling homeowners is bound to increase.