by Calculated Risk on 1/08/2007 03:46:00 PM

From Federal Reserve Vice Chairman Donald L. Kohn: The Economic Outlook. Excerpts on housing:

Uncertainty about where we stand in the housing cycle remains considerable. In part, that is because this housing downturn has differed from some of those in the past in important ways. It was not triggered by a restrictive monetary policy and high interest rates; indeed, relatively low intermediate and long-term interest rates are helping to support the stabilization of this sector. But the current contraction in housing did follow an unusually large run-up in sales and construction and, even more so, in prices relative to the returns on other financial and real assets. Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed. And changes in the organization of the construction industry, with activity more concentrated in the hands of large, publicly traded corporations, may also affect the dynamics of prices and activity in response to the inventory overhang.

In my own judgment, housing starts may be not very far from their trough, but the risks around this outlook still are largely to the downside. Although house prices nationally have decelerated noticeably and appear to have fallen in some markets, they are still high relative to rents and interest rates. Building permits decreased substantially again in November, and inventories of unsold homes have only started to edge lower. We also do not know whether the possible stabilization that seems to be taking hold would be immune to a rise in longer-term interest rates should term premiums increase or the federal funds rate fail to follow the downward path currently built into market expectations. Even if starts stabilize at close to current levels, those levels are sufficiently low that overall construction activity would remain a negative for the growth of economic activity in the first half of this year.