Economic Outlook: Interview with Doug Duncan

2014 Banking Outlook Conference: Challenge, Opportunity, Risk

Donna Fay: Welcome to the 2014 Banking Outlook Conference at the Federal Reserve Bank of Atlanta. My name is Donna Fay, and with me today is Doug Duncan, senior vice president and chief economist with Fannie Mae. Welcome Doug; we're so glad to have you here.

Doug Duncan: Thanks.

Fay: Doug, what are your thoughts and outlook for the housing market over the next 12 to 18 months? Have we turned the corner, and are we in the midst of a recovery?

Duncan: Yes, we have turned the corner and we are in the midst of a recovery. But we also caution people that it's not a straight-line progression. It will have some fits and starts because we are going to see other economic factors changing around it. And then to get back to what would be considered normal in the construction space based on demographic factors, income growth, and employment, we don't see that happening until about 2016; perhaps the latter half of 2016, but we're on the right trend line.

Fay: Excellent. There's been some speculation, and I know I've read it in some of the financial journals, that we're entering into a second housing bubble. What are your thoughts on that?

Duncan: Well, I suppose it's a possibility, but we don't believe it's a practical reality. The house price increases that we've seen, and they were pretty substantial in 2013, we think we'll see about half that in 2014, are born largely of supply side issues. On the supply side, you have several factors working against lower house price appreciation. For one thing, the level of new construction is still way below normal levels. Our view is, demographically, that should be about 1.7 million units of apartments, manufactured housing, and single-family homes. In 2013 we made only about 930,000, so we're still way below what would be a normal level of supply in that space.

On the existing-home side of the market, you have several things going on. One is you saw a large influx of institutional investors who took out significant supplies in some markets at very low price points, limiting the available properties for owner-occupant purchase. You also have still some 5 or 6 million households who owe more on their house than it's worth. There are several restrictions on the supply side of the equation that mean that if demand increases, you're going to see price appreciation as a result of that until the supply side catches up.

Fay: So when buyers enter into the market, what will happen with that?

Duncan: We do believe prices are still going to rise above the long-term average in this year, just not as fast as they did in 2013, because we do think builders will ramp up this year.

Fay: Shifting gears a little bit, in terms of new regulations that are coming around in the mortgage lending market. Are you seeing any impact from those new regulations on mortgage lending?

Duncan: Well, there is always an impact from regulation; otherwise, we probably wouldn't do it. So the answer is yes. We at Fannie Mae actually started incorporating those new rules in the middle of last year to get ahead of the curve and kind of signal out to the market what they knew was coming and start to adapt practices.

We've done some research that suggests maybe on the 2012 book of business, had those rules been in place then, maybe 5 percent of the loans would not have met the characteristics of the Qualified Mortgage Rule. But even there, there's ways that households could adjust the way they took the mortgage credit. They could bring more equity to the table, they could buy a smaller house or take a smaller mortgage, they could adjust the terms to make the loan meet the qualification, so it's not clear if even that entire 5 percent would have been affected by that new rule.

But at least in the very near term, people are still adjusting to exactly what that rule means. We believe that will have some modest impact on tightening.

Fay: So maybe more to come on that?

Duncan: More to come, but as the economy continues to grow and we think it will grow at a little less than 3 percent in real terms this year, the prospects for healthy lending improve. One of the things that we have seen is, we have a set of rules associated with what we will guarantee and then lenders, sometimes based on their risk preferences, will put an additional set of rules over that, which we call "overlays." We've seen some reduction in those overlays. In part, it's a competitive thing. As the interest rates have risen, the refinancing activity has dropped off, so firms with capacity then maybe have eased some lending conditions to keep their workforce going on the home purchase side of the equation. So we've seen some reductions in the risk buffers in that area.

Fay: Thank you so much for sharing your insight with us. You've given us a lot to think about.

Duncan: My pleasure. Glad to be here.