President

Finally, the third piece of FHA modernization would eliminate the downpayment requirements. Currently, an FHA mortgagor is required to make a3 percent cash contribution at settlement to be applied to the cost of acquisitionof the property. The Administration’s proposal removes this 3 percentrequirement. Just like risk-based pricing, the change in down paymentrequirements moves away from the “one size fits all” approach and providesthe FHA with the flexibility to insure a variety of mortgage products fordifferent purposes and different borrowers.Macroeconomic ImplicationsThe potential macroeconomic effects of the housing market weakness andthe credit market disruptions may operate through several channels, includingresidential investment, personal consumption, and business investment. Inaddition, the production of some manufactured goods used in constructionhas been weak, and employment in some finance-related sectors has fallenoff. Many economists would agree that the downturn in the housing markethas likely had some effects on consumption and business investment, but themagnitude of the effects are unknown.The effect on residential investment is the easiest to quantify. Betweenthe fourth quarter of 2005 and the fourth quarter of 2007, real residentialinvestment dropped about 29 percent and subtracted an average of nearly0.9 percentage point per quarter at an annual rate from real GDP growth.Single-family housing starts peaked at more than 1.8 million units in January2006 and then fell more than 55 percent, to below 800,000 units, inDecember 2007. Inventories of unsold homes are at elevated levels: the inventory-to-salesratio for existing single-family homes in December 2007—at9.2 months’ supply—was down from the previous few months but still nearhighs last reached in 1991. As prices for new and existing homes adjust toclear excess inventories, housing starts will stop declining and the drag onGDP growth from residential investment will lessen.A second effect of the downturn in housing is the potential effect onpersonal consumption and saving. For many households, their houseis their primary asset and a significant source of wealth. A considerableacademic literature has shown that increases in wealth tend to boostconsumption, though the estimated magnitude of these so-called “wealtheffects” is imprecise and may depend upon the type of asset (such as stockmarket wealth versus housing wealth). In the case of housing wealth, somecalculations suggest that a $100 billion decline in the value of the housingstock would reduce the long-run level of annual consumption by between$4 billion and $8 billion. Importantly, consumption responds only gradually74 | Economic Report of the President