Housing Slump May Force Fed to Pare Annual U.S. Growth EstimateThe article does a good job describing the nature of the vicious cycle that the housing market is susceptible to: the end to the run-up in house prices has effects on both supply and demand in the housing market that tend to force prices down further.
Feb. 26 (Bloomberg) -- The U.S. may be saddled with more sluggish growth than the Federal Reserve expects as the economy struggles to shake off a lingering hangover from the housing bubble.
"We're in the midst of a classic boom-bust credit cycle in housing," says Andy Laperriere, managing director at International Strategy & Investment Group in Washington. "And the bust is just beginning."
The worst case: Distress already evident in the riskiest part of the mortgage-lending industry turns into a full-scale credit crunch that cripples the housing market and the economy.
...The financial fallout from the housing slump delivers a one-two punch to the industry and the economy. It increases supply as homeowners with adjustable-rate mortgages can't meet the higher loan payments and are forced out of their houses. Mortgage foreclosures monitored by Irvine, California-based research firm RealtyTrac jumped 19 percent in January.
The credit squeeze also depresses demand as prospective buyers find it more difficult to obtain loans. According to a Fed survey published on Feb. 5, more U.S. banks toughened lending requirements for home loans in the final three months of 2006 than in any quarter since the early 1990s.
...The financial stresses are most evident in the subprime mortgage market for the riskiest borrowers. The segment accounts for 13 percent of the $10 trillion in home loans outstanding, according to Inside Mortgage Finance, a trade publication.
Some 20 percent of the roughly $1.2 trillion in subprime loans made during the past two years will end in foreclosure, with owners losing their homes, says the Center for Responsible Lending in a study. The center, located in Durham, North Carolina, is a nonprofit organization financed by the Ford Foundation and Rockefeller Foundations, among others.
But this piece only hints at the ways in which the housing market downturn can be a drag on the broader economy. The direct effect of lower income and fewer jobs in the construction and home improvement industries is quite clear. And the indirect effect of falling house prices on consumer wealth and spending (including the end of the house-as-ATM) has also been written about extensively. But perhaps the biggest potential impact, however, is the effect that a large number of mortgage defaults might have on credit markets more generally in the US economy.
No one seems quite sure of who is holding the bad mortgages (banks, mortgage companies, and insurance companies who hold such assets all claim to have diversified the risk away pretty effectively), but the fact remains that someone in the US economy must suffer a loss on their balance sheet for every mortgage that ends in default. As those lenders (who may either be direct lenders or, more likely, indirect lenders to US borrowers) absorb balance sheet losses, they will have fewer assets to lend out. That means that the amount of loanable funds in the US economy in general will shrink, affecting not just the housing market, but all credit markets in the US. In particular, it's very possible that the volume of business loans will be forced to fall, which would make it harder for businesses to keep investing and providing an impetus to the economy.
In short: It's important to try to understand the dynamics of why the housing market slowdown may be just beginning. But it may turn out to be much more important to understand the impact that this is going to have on the US's credit markets more generally.