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Housing Affordability Index and Credit Risk, 6 Apr 2012
In this installment, we examine the credit risk implications of the Housing Affordability Index and a new training course series being offered by Prescient Models.
The March 2012 issue of RMA Journal carried our article on consumer risk appetite, and the response has been both supportive and thought-provoking. One reader question was about how the National Association of Realtors' Housing Affordability Index might be used to explain cycles in consumer risk appetite. The suggestion was that HAI might capture in a single index the financial impact to consumers of changes in house prices and changes in interest rates. Essentially, as homes become more affordable, demand from thoughtful consumers, who are presumably better credit risks, should rise. The following chart, created with the assistance of the National Association of Realtors, shows the relationship between credit cycles and an optimal transformation of the HAI.
The correlation to HAI is high, but not as high as to the FRB Senior Loan Officer Opinion Survey of mortgage demand or to house prices and interest rates directly. One possible explanation is that HAI does capture the balance sheet impacts to consumers, but it does not capture the market dynamics. A rapidly falling House Price Index correlates to less demand from good consumers, not more demand as affordability would suggest. This is a common market psychology where investors prefer to wait for a bottom before buying. But as an input to a broader model, the Housing Affordability Index looks very interesting.