Lets recap the potential path for housing and the economy based on news reported in March:
- Economy so-so
- Investors get risk averse
- Subprime defaults increase
- Mortgage underwriting guidelines tighten
- Weak housing market gets weaker as a result
- Housing related jobs decrease
- Economy weakens further, skirts with recession
- A few years of weak housing conditions remain
To expand on each point…
Pronounced weakness in the housing sector is being largely offset by continued strength in the corporate sector, commercial construction activity, and exports…Still, some negative trends have emerged for banks. They include a narrowing of net interest margins, particularly among larger institutions; increasing concentrations of traditionally riskier commercial real estate loans; and emerging signs of credit distress in subprime mortgage portfolios. Ultimately, it is local economic conditions that are the most important determinants of credit quality and earnings strength at the majority of banks and thrifts. In this issue of the FDIC Outlook, our regional analysts identify trends that are expected to affect banking in their areas during the remainder of 2007.
2. Investors get risk averse [Bloomberg]
The concern over subprime lending and rising defaults is increasing the flight to safety. That is, investors are buying treasuries. Price goes up, yield goes down. Lower yields on a ten year have limited effect on most mortgage rates because the term is too short but still, it would probably help maintain a low rate environment.
“The biggest risk we can identify is from the spate of foreclosures in the subprime market increasing the inventory of unsold homes and weighing on home prices,” said Amitabh Arora, head of U.S. interest-rate strategy in New York at Lehman Brothers Inc. “We are much more cognizant of that than we used to be.”
3. Subprime defaults rise [MSNBC]
“Just as the case often was back in college, when you have too much liquidity sloshing around for too long, people tend to do some foolish things,” Wachovia senior economist Mark Vitner wrote in a recent research note. “Apparently that includes loaning money to folks with spotty credit histories to purchase homes not only to live in but also to speculate on.”
4. Mortgage underwriting guidelines tighten [WSJ]
Early February, the Federal Reserve reported a sharp increase in the number of banks tightening mortgage-lending standards. On Tuesday, Freddie Mac — whose main business is repackaging mortgages into mortgage-backed securities — said it was tightening standards on purchases of risky, subprime mortgages. On Friday, banking regulators proposed stricter mortgage guidance.
5. Weak housing market gets weaker as a result [LA Times]
That could hurt the housing market by shrinking the pool of eligible buyers. In addition, many homeowners with high-risk loans whose rates will adjust upward in the next year or two won’t be able to refinance into loans with better terms. That could put some into foreclosure.
6. Housing related jobs decrease [MSNBC]
Housing-related job losses once again put a dent in February job growth, which saw an overall gain of 97,000 — down from a gain of 111,000 in January. Employment in housing-related industries fell by 11,000 in February, bringing to 176,000 the total number of jobs lost in the sector since at sector since April 2006, according to figures compiled by Moodys.com.
7. Economy weakens further, skirts with recession [Bloomberg]
Alan Greenspan, who jolted investors by predicting a one-in-three chance of a recession this year, isn’t as bearish as the bond market, where the risk of a downturn is even money. The probability the U.S. economy will shrink for two quarters has risen to 50 percent, according to a model created when Greenspan ran the Board of Governors of the Federal Reserve System. The formula is based on differences in yields on Treasuries.
8. A few years of weak housing conditions remain [CNN/Money]
Celia Chen, director of housing economics for Moody’s Economy.com, says she thinks it will take until 2009 for prices nationally to reach the peaks hit in 2005. Take inflation into account, she said, and a full recovery could take more than 7 years.
I’d have to agree that its not simply a matter of time before the national housing market returns to 2004/2005 conditions. The housing boom was a period where all the stars were aligned and the universe was in sync. The combination of unusually low mortgage rates prompted by 9/11, loose or perhaps non-existent underwriting guidelines for mortgages, expansion of subprime lending, exotic mortgages, a solid non-inflationary economy, rising productivity, risk oblivious investors who had moved out of the stock market after the 2000-2001 period of volatility, shifting demographics that saw more immigration and a get rich quick mindset created the housing boom.
The news isn’t all bad, however. Modest growth in the housing sector would go a long way in keeping housing more affordable. I think Fannie Mae’s record of 69% home ownership reached last year, which has since slipped, is not going to be passed anytime soon.
On the bright side, March Madness is nearly here and my son’s basketball team won our town’s 3rd grade basketball championship.
Tags: FDIC, Alan Greenspan, Sub-Prime, Lehman
>>>combination of unusually low mortgage rates prompted by 9/11,
BZZZZT. Unusually low mortgage rates were a result of Federal Reserve reduction on the Federal Funds Rate, which began prior to 9/11, but in the same year, and was a response to the tech stock driven market dump. In an effort to keep the economy moving and corporations growing, the drop in interest rates also drove the bond market down, lowering both adjustable and fixed rate mortgage rates to historic lows. Now we have an inverted yield curve, and no clear signs how that will be resolved.
The flight from the stock market goes to bonds, which drops interest rates, though recently less so than usual. If long term rates drop, but short term rates remain steady, the yield curve inverts more. Never a good thing, and historically a very strong precursor to recession.
Believe that 9/11 impacted the rate market and you give the terrorists more power than they deserve. The combination of more ‘efficient’ markets created by innovations in financial securities and the technologies that enabled them and Greenspan’s monetary policy spawned the perfect storm of subprime lending.
We could apply a little bracketology to the lenders cataloged on mortgageimplode.com. Say, 4 brackets of 8, with seeds from 1-8, and see who picks the subprime lenders still lending when the NCAA champ is named.
But that might be more structured analysis than the remaining lenders want to see.
It’s never been busier!
Thanks, Jonathan. This is an excellent “domino” piece.
These type of problems reflect loans mortgages given to people who in normal times would never qualify for one.Also the properties involved are not prime properties. I think we should actually treat this as a different real estate market. If you look at the conventional real estate market across the country there is not really much of a bust.