2007 August 30 Thursday
Housing Prices Falling As Credit Tightens

Across the United States housing prices are falling.

By one index released this week, home prices are down 3.2 percent from a year ago. Clear-cut gauges of US home prices only go back through the 1970s, but that decline probably exceeds any price drop since the Depression, except for one year during World War II. Economists say the trend could continue well into next year.

Net worth is falling for millions of families as a result. If consumers, feeling less wealthy, cut back on spending, the risk of a national recession would rise.

Why are home prices declining, when by many measures today's economy is much healthier than that of the 1930s? Basically, the good times for housing ran for so long, and prices rose so fast at the boom's peak, that it was unsustainable.

"This time, the problem with housing is not so much that interest rates became especially high.... It was that house prices became especially high," says Nigel Gault, an economist at Global Insight, a forecasting firm in Lexington, Mass. "What was unusual this time is that we had such a long period without any downturn."

Curiously, it looks like the fall in housing prices is now causing higher interest rates rather than the other way around. The drop in prices makes lenders more reluctant to lend which cuts into demand which causes further drops in prices.

Getting approved for a mortgage has gotten much harder.

As mortgage lenders tighten underwriting standards and home prices fall, Bank of America analysts estimated that 40% of home buyers who got a mortgage in 2006 probably wouldn't qualify for a home loan now.

That's a huge cut in mortgage availability.

While mortgage interest rates for lower cost houses (which can be insured by Freddie Mac or Fannie Mae) have stayed near last year's rates the interest rates for larger mortgages have soared.

The average interest rate for 30-year fixed jumbo loans failed to budge this week from a relatively lofty 7.4%. By contrast, the average for smaller "conforming" 30-year fixed mortgages fell 15 basis points to 6.43%, Bankrate.com says, citing housing market weakness.

Jumbo rates have climbed roughly 40 basis points since the end of July. Homeowners refinancing a $600,000 jumbo mortgage now vs. then face paying $162 more a month.

Meanwhile, rates for superjumbo mortgages (typically more than $1 million) have shot up about 200 basis points over the last several weeks to 8%, says Michael Covino, president of Luxmac Covino & Co. in Tarrytown, N.Y., which provides loans for $750,000 to $40 million.

The credit crunch isn't just hitting the mortgage market. Corporations are finding it tougher to get short term credit.

Outstanding commercial paper fell by $62.8 billion, or 3.1%, in the week ended Wednesday to $1.98 trillion, bringing the total decline in the past three weeks to $244 billion, or 11%, the Federal Reserve reported Thursday.

Such a hit has taken place despite commercial paper's seemingly safe-haven status in lending. "It's kind of like a margin account that businesses use for short-term financing," Arnold said.

While it has been a primary source of funding for corporate mergers and acquisitions, it "can be used for almost anything," said Raymond Benton, a Denver-based adviser who purchases individual bond issues for high net-worth clients. Commercial paper is a generic term for most any short-term corporate borrowing, he added. "It's nothing more than a short-term note that can come due in as little as 30 days or less," Benton said.

Reading this kind of news I'm having a hard time believing we can avoid a recession.

Yet the US economy grew speedily in the 2nd quarter.

The U.S. economy bounced back in the second quarter, growing at a 4% annual real growth rate, the Commerce Department reported Thursday.

The credit crunch really took hold in July and August. So analysts are expecting worse news on the economy as the effects of tight credit begin to be felt.

Share |      By Randall Parker at 2007 August 30 10:29 PM  Economics Housing


Comments
John S Bolton said at September 1, 2007 7:59 PM:

The zero-down payment mortgage, and tolerance of fake-ID borrowing, as with illegals getting mortgages,
FAILED to anticipate that house prices could ever go down, or even stay flat for an extended period.
Without the rising prices to hold them in place with a newfound equity position,
these borrowers can be as irresponsible, even fraud-perpetrating, as
should be expected in the regime of flat or declining house prices.


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