The housing market is cooling. Yesterday, the
Census Bureau reported that new home construction was down 5% in march. This is the second monthly decline and comes at a time when inventory available for sale is at multi-year highs and affordability is at multi-ear lows. Now the housing question should turn to "what could happen if housing slows."
Here are some statistics on the more speculative side of the mortgage market:
Nearly one in 10 households with a mortgage had zero or negative equity in their homes as of September 2005, according to First American Real Estate Solutions, an arm of title-insurance company First American Corp. The study of 26 million homes in 36 states and the District of Columbia found that one in 20 home borrowers was upside-down by 10% or more.
The situation is even grimmer for recent borrowers. Of those who bought or refinanced homes in 2005, 29% had zero or negative equity, and 15.2% were underwater by 10% or more.
Interest rates on about a quarter of all mortgage loans outstanding, or $2 trillion, are scheduled to reset this year and next, according to Economy.com. Homeowners who opted for extremely low teaser rates in recent years could see their payments eventually double, said Christopher Cagan, First American's director of research and analytics.
Defaults and foreclosures are already on the rise, thanks in part to higher interest rates, cooling real-estate markets and overextended borrowers. Nationally, 117,259 properties entered some stage of foreclosure in February, according to foreclosure-monitoring firm RealtyTrac, a figure that's up 68% from February 2005.
Equity is the difference between a homes market value and the amount left on an outstanding loan. It represents the owner's interest in the property. Thanks to the home equity financial revolution, consumers have been able to take out home equity loans to supplement their income over the last 5 years. This is a primary reason why total mortgage debt outstanding has nearly double since 2000 and currently stands a little above 8 trillion.
The delinquency numbers are increasing from low levels, so we are far from crisis levels. In addition, mortgage resets are typically limited to a specific amount per period. This limits the extreme upside risk of increasing interest rates. However, as interest rates on mortgages move up they are bound to have an effect on consumer spending which represents 70% of US GDP growth.
In addition, consider the breadth of more speculative financings:
Turning to the type of loans used to finance home purchases, interest-only and negative amortization ARMs were almost 42 percent of the market last year, up from 32.6 percent in 2004, according to LoanPerformance's asset- and mortgage-backed database, which does not include Fannie Mae and Freddie Mac securities. As recently at 2001, only 1.9 percent of purchases were financed with so-called exotic mortgages.
The good news is that to date, the delinquency rates for loans on owner-occupied homes and second/investment homes are almost the same, according to LoanPerformance.
That doesn't mean there's nothing to worry about, according to Andy Laperriere, a political economist with International Strategy & Investment in Washington. In an article in the April 10 issue of the Weekly Standard, Laperriere outlined some potential ``Housing Bubble Trouble.''
43 percent of first-time home buyers made no down payment last year, according to a study by First American Corp.
22 percent of the borrowers with initial interest payments of 2.5 percent or less have negative equity in their homes (the market value is less than the size of the loan); 40 percent have less than 10 percent equity.
About one-quarter of the jobs created since the 2001 recession have been in construction, real estate and mortgage finance.
According to a recent IMF report, US credit standards dropped starting in 2003, leading to more speculative lending behavior from financial institutions. Banks have started to tighten their standards, but the genie is already out of the bottle.
The next question is "what will the effect be on banks and financial institutions?"
Every time the subject of banks making risky home loans to bad credit risks -- no money down, no questions asked -- the usual retort is that banks sell the mortgages. They aren't at risk. It doesn't matter if the loan stops performing because they don't own it.
That's not exactly true. According to the Federal Reserve's Flow of Funds report for the fourth quarter of 2005, mortgages accounted for 32 percent of commercial banks' financial assets. Throw in agency- and mortgage-backed securities, and the exposure to outright and securitized mortgage loans is 44 percent.
And everybody has exposure to the more exotic mortgages used over the last few years.
The point of all this is there is risk in the system. There has been no meltdown, or even hints of a meltdown. But, there is risk built into the system, and no one is immune.