Aftershocks from the subprime market disaster will deal another body blow to the already reeling U.S. housing market, though the economy should weather this latest storm without a recession, according to an economic forecast released today.
The quarterly Anderson Forecast, produced by the Anderson School of Management at University of California, Los Angeles, reports, “Put bluntly, the credit crunch in the subprime mortgage market will likely trigger a second leg down in the housing market in terms of output and prices.”
Edward Leamer, forecast director and a professor of economics and statistics at UCLA, said the severity of the subprime meltdown was a surprise since the last forecast was produced.
“This thing started in the Midwest, where jobs were weak and prices were weak,” he said, and has since mushroomed to national scale. Foreclosures are on the rise, but the more critical issue for the economy is the ability for consumers to purchase homes.
“There are sad individual stories about people who got into homes they couldn’t afford. I think the real story is not what’s happening to the people who own homes — it’s what happens to prospective buyers who might be buying a home soon. The energy of the market, a lot of it is in the subprime, low-income homes. You need new money in the market in order to fuel the price appreciation. A lot of the new home buyers have been at the lower end — start-up, entry homes. If you pull that out of the market, where’s the fuel that’s going to keep the fire going?”
He added, “The economy overall is going to be impacted by the inability to provide fuel to drive housing forward.”
Foreclosures started from an “extremely low base” in some markets and are now gaining momentum, Leamer said. He noted that foreclosures peaked “shockingly late in the cycle” during the last real estate downturn in California in the 1990s, and he said that trend seems to be recurring. During the last downturn there was a decline in sales volumes and a period of weaker sales that was eventually followed by price reductions and a rising tide of foreclosures.
“Housing alone is not going to cause a recession,” he said, though international investment trends are a potential problem.
David Shulman, a senior economist for the Anderson Forecast, predicted in his forecast report, “A Long Runway for the Soft Landing,” that the Federal Reserve will lower the federal funds rate from 5.25 percent to 4.5 percent by yearend to help reinvigorate the real estate market — “we suspect that once the Fed accepts the notion that inflationary pressure has peaked and that the housing market has started another leg down, policy will be eased. If we are wrong here, it is our guess that the economy will be weaker than what we have forecast because it is the preemptive policy that will soften the impact of the deterioration in the housing and housing credit markets.”
Leamer said there is some difference of opinion among forecasters on the topic. Leamer said he believes that the Federal Reserve “can’t have much impact on the housing sector at this point,” and a lowering of the federal funds rate “is not going to alter the problems in housing — it is not going to reignite the subprime market.”
These problems will need time to heal, he said. “It’s going to take some period of appreciation again in homes. I think that the Fed policy has create a real bind — they seem not to realize that by overbuilding homes and having appreciation that was unsustainable it eliminates the ability to stimulate the economy by the rate cuts,” Leamer said, adding, “It has created kind of an unfortunate environment in which rate cuts are not going to matter much.”
Shulman’s report states that the housing market may take many years to recover, and “will look like the protracted decline that took place in Southern California from 1989-96.”
He also stated, “As we have noted in the past, the great housing boom of the 2000s was fueled by ‘exotic’ finance, and that finance for the marginal borrower, for the most part, is no longer available.” The report states that mortgages were available just a year ago “to practically any borrower who had a pulse,” including those seeking “NINJA” (no income, no assets, no job) loans. California accounted for 38 percent of the $1.2 trillion worth of subprime loans held in securitized pools, and “for all practical purposes, the subprime market is in the process of shutting down.” Existing subprime borrowers facing increasing payments may have difficulty trying to refinance, too, as the credit environment tightens.
Shulman lowered his expectation for 2007 housing starts 10.1 percent in the latest report, from 1.48 million units to 1.33 million units.
Weakness in home prices will likely accelerate, according to his report, with national “peak-to-trough declines” ranging from 5 percent to 10 percent.
“Although we continue to believe that our no-recession, soft-landing thesis for the economy remains intact, we are becoming increasingly nervous about the economic outlook as the period of below-trend growth grinds on,” Shulman states.
A separate report that tracks the California economy predicts “a significant slowing of the California economy in 2007, as the double whammy from construction and mortgage finance creates a drag on the rest of the economy.”
Foreclosure notices have been on the increase in California, with the biggest increases in the San Francisco East Bay area and in the Sacramento, Bakersfield, Ventura and Riverside areas. “This list … may sound familiar from previous California reports: these are the counties where new homes account for a substantial share of total home sales and also the counties which have seen the most weakness in median sales prices,” according to the report by Ryan Ratcliff, an economist for the forecast.
This may be due to “a combination of overextended first-time buyers and builders offering overly aggressive financing in order to close deals,” according to Ratcliff’s report.
Leamer said the higher default rate in areas with a lot of new-home construction activity may be due to weakening prices in those markets and to the construction of entry-level homes favored by first-time buyers. “It’s the starter homes that are in the most trouble,” Leamer said.
Ratcliff’s report states, “Since the subprime market was almost the only thing keeping sales volumes buoyant in the last years of the boom, the drying up of subprime credit suggests that home sales in California will be stagnant for some time to come. It’s too early to tell if this surge of mortgage delinquencies will translate into a surge of foreclosure sales, but our initial assessment is that it is unlikely without substantial job loss.”
Like the national forecast, this California report does not foresee a statewide economic recession.