Mortgage Rate Rise Pushes US Housing, Economy to "Blood Bath"
 Kathleen M. Howley - Bloomberg
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| | A sign points to a home for sale in a new subdivision in Vancouver, Washington, April 25, 2006. Countrywide Financial Corp., the largest U.S. mortgage lender, on Tuesday said it made 15 percent more home loans in May as the pace of refinancings increased, though the foreclosure rate doubled. (Richard Clement/Reuters) |
The worst is yet to come for the U.S. housing market.
The jump in 30-year mortgage rates by more than a half a percentage point to 6.74 percent in the past five weeks is putting a crimp on borrowers with the best credit just as a crackdown in subprime lending standards limits the pool of qualified buyers. The national median home price is poised for its first annual decline since the Great Depression, and the supply of unsold homes is at a record 4.2 million, according to the National Association of Realtors.
"It's a blood bath," said Mark Kiesel, executive vice president of Newport Beach, California-based Pacific Investment Management Co., the manager of $668 billion in bond funds. "We're talking about a two- to three-year downturn that will take a whole host of characters with it, from job creation to consumer confidence. Eventually it will take the stock market and corporate profit."
Confidence among U.S. homebuilders fell in June to the lowest since February 1991, according to the National Association of Home Builders/Wells Fargo index released this week. Housing starts declined in May for the first time in four months, the Commerce Department reported yesterday. New-home sales will decline 33 percent from 2005's peak to the end of this year, according to the Realtors' group, exceeding the 25 percent three-year drop in 1991 that helped spark a recession.
"Economic Recession"
"It's not just a housing recession anymore, it looks more and more like an economic recession," said Nouriel Roubini, a Clinton administration Treasury Department director and economic adviser who now runs Roubini Global Economics in New York.
Goldman Sachs Group Inc., the world's biggest securities firm, and Bear Stearns Cos., the largest underwriter of mortgage-backed securities in 2006, said last week that rising foreclosures reduced their earnings. Bear Stearns said profit fell 10 percent, and Goldman reported a 1 percent gain, the smallest in three quarters. Both firms are based in New York.
The investment banks, insurance companies, pension funds and asset-management firms that hold some of the U.S.'s $6 trillion of mortgage-backed securities have yet to suffer the full effect of subprime loans gone bad, said David Viniar, Goldman's chief financial officer. Subprime mortgages, given to people with bad or limited credit histories, account for about $800 billion of the market.
"I continue to believe that we haven't seen the bottom in the subprime market," Viniar said on a June 14 conference call with reporters. "There will be more pain felt by people as that works through the system."
He didn't return calls this week seeking additional comments.
Homebuilder Stocks
Homebuilding stocks are down 20 percent this year after falling 20 percent in 2006, according to the Standard & Poor's Supercomposite Homebuilding Index of 16 companies. Before last year, the index had gained sixfold in five years.
"There isn't a recovery about to happen," said Ara Hovnanian, chief executive officer of Hovnanian Enterprises Inc., the Red Bank, New Jersey-based homebuilder. The company's stock tumbled 42 percent this year through yesterday.
The share of people taking out all types of adjustable-rate home loans averaged 29 percent during the past three years, compared with the 17 percent average of the prior three years, according to data compiled by Mclean, Virginia-based Freddie Mac.
Higher fixed mortgage rates and stricter lending standards mean some of those borrowers won't be able to refinance into fixed-rate loans. Many of them have seen their home's value drop even as their interest rates adjust higher.
"Millions of People"
"When all these people see their mortgage payment and it's up 40 or 50 percent, they're going to say, `We can't stay in this house,"' Pimco's Kiesel said. "And there are millions of people in this situation."
The average U.S. rate for a 30-year fixed mortgage was 6.74 percent last week, up from 6.15 percent at the beginning of May, according to Freddie Mac, the second-largest source of money for home loans. That adds $116 a month to the payment for a $300,000 loan and about $42,000 over the life of the mortgage.
The recent increase in mortgage rates is the biggest spike since 2004. The change means buyers can afford 8 percent less house than they could five weeks ago, Kiesel said.
"Prices are going lower," he said.
The housing sector will push the U.S. economy into recession unless the Federal Reserve cuts its benchmark rate at the first surge in unemployment, said Kiesel, who expects the Fed to reduce rates.
Home Equity Loans
In addition to their primary mortgages, homeowners had $913.7 billion of debt in home equity loans in 2005, more than double the $445.1 billion in 2001, according to a paper by former Federal Reserve Chairman Alan Greenspan and James Kennedy on equity extraction issued by the Fed three months ago.
About a third of that money, extracted as home values surged 53 percent from 2000 to 2005, was used to buy cars and other consumer goods, according to the paper. The interest rate on those loans doubled to 8.25 percent in 2006 from 4 percent in 2003.
If the Federal Reserve lowers the rate it charges for overnight lending to banks, that would cut the prime rate that moves in tandem with it and reduce the interest on many types of adjustable home loans, including home equity mortgages.
Federal Reserve policy makers probably will keep the overnight bank lending rate unchanged at a six-year high of 5.25 percent when they next meet on June 27, according to a Bloomberg survey of 72 economists.
Boom and Bust
Homebuyers who got an adjustable-rate mortgage, a so-called ARM, in 2004 have seen their rate climb by about 40 percent. That's enough to add $288 to the monthly payment for a $300,000 mortgage. The average adjustable rate last week was 5.75 percent, an 11-month high, according to Freddie Mac.
Roubini predicts the decline in U.S. home sales will last at least another 12 months, reducing the median house price by 5 percent this year and next. That would take home prices back to 2004, when the national median was $195,200.
The primary cause of the 1990 to 1991 recession was a real estate boom and bust similar to the past seven years, Roubini said. A real estate "bubble" in the mid-1980s led to speculative buying and lower credit standards that resulted in widespread foreclosures, he said. The defaults triggered a credit crunch that turned into an economic recession in the spring of 1990, said Roubini, who is an economics professor at New York University's Stern School of Business.
He put the chance of a recession this year at "50-50," above former Fed chief Greenspan's 33 percent estimate. A recession is a decline in gross domestic product for two consecutive quarters.
"Significant Drag"
Greenspan warned of "froth" in the real estate market in 2005, before leaving the central bank in January 2006. Three months ago Greenspan said there was a "one-third probability" of an economic recession this year, in large part due to the unsteady housing market. He reiterated that view last month at a conference hosted by Merrill Lynch & Co. in Singapore
"There is no doubt there is a slowdown going on in the U.S.," Greenspan said at the conference. "We are clearly having troubles in the capital investment area, as well as potentially in the consumption area and obviously housing being a significant drag."
A Fed survey of senior loan officers issued in April said that 45 percent of lenders had restricted "nontraditional" lending, such as interest-only mortgages, and 15 percent had tightened standards for the most creditworthy, or prime, borrowers. More than half had raised standards for subprime borrowers, according to the survey.
Subprime mortgages have rates that are at least 2 or 3 percentage points above the safest so-called prime loans. Such loans made up about a fifth of all new mortgages last year, according to the Mortgage Bankers Association in Washington.
Housing Chain
Making it harder for those people to buy houses is going to create trouble all the way up the housing chain as people who own starter homes find it more difficult to sell their real estate and buy bigger properties, said Neal Soss, chief economist at Credit Suisse Holdings USA Inc. in New York.
"The subprime market has changed character dramatically, and that takes a number of entry-level buyers out of the picture," said Soss, who was an adviser to former Fed Chairman Paul Volcker.
Home sales won't increase in any sustained way until 2008, though the stumble probably won't cause a recession because the housing market hasn't reduced consumer spending, he said.
Retail Sales Endure
"Here we are a year and a half into the housing slowdown and retail sales are off the chart," Soss said. The economy expanded at a 1.9 percent pace in the first quarter, compared with a year earlier, the smallest gain since the 1.8 percent rate in the second quarter of 2003, "but it hasn't collapsed, and I don't think it will," he said.
Bank of America Corp. Chief Executive Officer Kenneth Lewis yesterday said the U.S. housing slump is almost over. "The drag stops in the next few months," said Lewis, whose bank relies on the U.S. market for almost 90 percent of its revenue. "We do not see a recession. Because that drag stops, you'll see the economy begin to pick up in the third and fourth quarters."
The median U.S. price for a previously owned home fell 1.4 percent in the first quarter from a year earlier, the third consecutive decline, according to the National Association of Realtors. Before the third quarter of 2006 prices hadn't dropped since 1993. The quarterly median may dip another 2.4 percent in the current period, the Chicago-based industry trade group said in its June forecast.
Measured annually, the national median hasn't dropped since the Great Depression in the 1930s, according to Lawrence Yun, an economist with the trade group.
Increase in Foreclosures
The share of mortgages entering foreclosure rose to 0.58 percent in the first quarter, the highest on record, from 0.54 percent in the final three months of 2006, the Mortgage Bankers Association said in a report last week. Subprime loans going into default rose to a five-year high of 2.43 percent, up from 2 percent, and late payments from borrowers with poor credit histories rose to almost 13.8 percent, the highest since 2002.
Prime loans entering foreclosure increased to 0.25 percent, the highest in a survey that goes back to 1972. That's a sign that even the most creditworthy borrowers are being squeezed, Roubini said.
"We have a lot of people, even prime borrowers, who are at the edge because they either bought with no equity, they have an ARM that's seen a rate spike, or they used their house like an ATM and turned their equity into cash," Roubini said. "Many of those people are under water today, and if they have to sell, it's going to drag down values in their neighborhood."
Adjustable Rates
Some owners are selling their homes at "fire sale" prices to avoid foreclosure after seeing their adjustable mortgage rates spike, said Lawrence White, an economics professor at the Stern School of Business.
"Prices will continue to soften for as long as we have distressed sellers," White said. Some regions of the U.S. could see price declines of 10 percent in the next six to 12 months, he said. The slump probably won't cause a recession, he said.
"It's not going to be the 1929 stock-market disaster, with people jumping out of buildings, but there is going to be widely dispersed pain for the next few quarters," he said.
The biggest problem is volatile home prices, said Gary Shilling, head of A. Gary Shilling & Co., an economic forecasting company in Springfield, New Jersey. Shilling put the chance of a recession this year at 75 percent.
"A lot of people went out on a limb to pay the record high prices for homes, and they're in trouble now," he said.
"Exploding ARMs"
Borrowers who got loans with so-called teaser rates are in the biggest bind, according to Shilling. Prices surged a record 12 percent in 2005, spurring buyers to "stretch" to qualify for bigger loans by using interest-only ARMs or so-called option ARMs with low introductory payments.
Some have payments based on interest rates as low as 1 percent. At the end of an introductory period, the rate can more than quadruple, leading them to be called "exploding ARMs," he said. Some loans allow borrowers to choose how much they want to pay, with the balance added to the loan's principle, making it possible to owe more than the home's purchase price.
"Homeowners with adjustable-rate mortgages are getting squeezed on all sides," said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. Real estate taxes have surged along with home prices, and many U.S. homeowners saw their property insurance double after Hurricane Katrina ravaged Louisiana and Mississippi, she said.
Swonk said the housing slide will last into next year. Still, she doesn't expect the economy to slow because of it.
"The economy could easily beat expectations in the second half of this year," she said. "The housing correction remains the primary threat to that happening."
To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net. |
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