Mortgage credit to impact housing next year
Expect more frustrated sellers as lenders tighten standards

Friday, November 10, 2020

By Lou Barnes
Inman News

Well. The elections are over, and the outcome had no detectable impact on the financial markets. Far more important than the switch in congressional control is President Bush's transfer of national security policy from Neo-Con hands to Daddy's bailout team -- grounds for optimism for the world ahead. However, we're not interested in the world, we're interested in money; not the House but housing, and the bond market much prefers pessimism to optimism.

There were no noteworthy economic data released this week, but the bond market and mortgages improved by a chart-pattern whisker. News of healthy payrolls blew up the bond market last week, threatening a return to the 4.83 percent September high for the 10-year T-note and mortgages to 6.5 percent ... but it didn't happen. The 10-year this morning is 4.58 percent, back where it was before the payroll news, mortgages poised for another run at the 6.00 percent barrier.

To break through to the fives we need some bad news, and the center of that hopeful expectation among bond ghouls is still a collapse of the housing bubble.

I continue to disbelieve the existence of a housing bubble in the financial market sense, a market due for a 20 percent-30 percent price decline. The post-boom housing experience will be ugly in some markets, but not enough to knock the economy into recession. A recession from some other cause (a consumer or employment collapse, a Fed forced to overtighten into inflation) would certainly make housing worse, but not the other way around.

With one exception: a mortgage-credit spiral.

Housing markets are the slowest-roller of all. The last buyers in the party get burned by a routine and minor retreat in price in the year after the peak, but then prices just go flat, sometimes for decades. The bubble zones appear to be entering that flat phase now. The effect on GDP is thus far minor, mostly caused by the decline in mortgage equity withdrawal, sawing about 1 percent off of GDP -- a reduction in stimulus, not a braking force.

The one, narrow path to spiral risk will begin with the exposure of people who bought but shouldn't have. The press is wildly magnifying the risk from ordinary ARMs, option ARMs with negative amortization, and interest-only loans. The real risk is in a short and stark list: those who put little or nothing down and/or with aggressive subprime financing, and were short of post-closing resources -- savings, job stability and discipline. The killer is the combination; Colorado for the moment leads the nation in foreclosures, and that's the profile.

The next step on the path will be the reduction in future buyers. During the late boom, the national percentage of home ownership grew from 66 percent to 69 percent, some of it pushed by well-intended "affordability" loan programs, blind to the need for post-closing resources. I expect that gain to roll back, painfully for many of those buyers, and for today's sellers.

The moment the spiral could turn ugly: when the mortgage-risk players on Wall Street discover that the home-price boom has camouflaged the true extent of risk. If your house rises 20 percent in value, you have to really work hard to lose it. During the boom, the mortgage default rate fell to the lowest levels ever measured, and based on that credit-quality illusion, mortgage underwriting standards in the last five years have been the easiest ever seen. If you want a mortgage, you get one. Sign here.

When the illusion falls away, underwriting will tighten. When underwriting tightens, fewer buyers will be able to buy. Owners in difficulty today can accomplish defensive refinances on terms that by next summer may not be available, and that will drive the default rate up more. Just when the housing market most needs credit, credit will be withdrawn, and a deteriorating sales-to-inventory ratio will put more pressure on prices.

This process will take time, I suspect well into 2007 before we begin to know how exposed the mortgage-risk players really are. Mortgage underwriting in current form is unsustainable, but may not deteriorate into a spiral.

If trouble develops, you won't learn first in the housing stories. The first news will come from the Street in garbled stories about trouble in the "credit derivative" market, and then perhaps from neighborhood word that someone's buyer actually got turned down for a loan.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at [email protected].

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Copyright 2006 Inman News


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