Federal Reserve estimates show that the pronounced slowdown in house price inflation during the past year is taking a toll on household balance sheets. In this regard, holding gains on homes slowed sharply as 2006 drew to a close and losses presumably are not far down the line.

At the same time, maintenance of strong growth in mortgage debt has impinged on home owner equity positions, and the Fed’s financial obligations ratios for home owners now are at record highs.
 

The “subprime” mortgage sector has been in turmoil during the past month, and the “Alt-A” market — that financed a lot of investors/speculators during the boom — also is under substantial stress.

Mortgage credit quality deteriorated badly as 2006 drew to a close, particularly in the subprime ARM market, and further increases in delinquency and default rates are inevitable. Lending standards already have tightened up quite a bit in subprime and Alt-A markets, and Federal Reserve surveys suggest that a broad-based firming of mortgage lending standards is underway at commercial banks.

The evolving mess in mortgage markets threatens home sales and housing production through two major channels; reductions in gross and net sales due to tighter mortgage lending standards, and increases in unsold inventories due to a rising tide of mortgage foreclosures.

Furthermore, both factors will put additional downward pressure on house prices, pointing toward further deterioration of household sector balance sheets — with sobering implications for residential remodeling and consumer spending. [return to top]
 

While the March statement continued to highlight inflation risks, it’s clear that the Fed’s confidence in the ongoing economic expansion has eroded and our central bank now apparently views the risks to growth and inflation as essentially balanced.

In this regard, we’re still expecting a quarter-point rate cut at mid-year, assuming that core inflation recedes about as expected by the Fed, and more cuts may be in the cards.

Fed Chairman Ben Bernanke testified today on “The Economic Outlook” before the Joint Economic Committee of the Congress. He noted that “the principal source of the slowdown in economic growth that began last spring has been the substantial correction in the housing market.”

Bernanke also said that “the near-term prospects for the housing market remain uncertain,” that “developments in subprime mortgage markets raise some additional questions about the housing sector,” and that “the correction in the housing market could turn out to be more severe than we currently expect.”

Indeed, he fingered housing as the key downside risk to the Fed’s forecast of moderate economic growth over coming quarters. [return to top]
 

The Federal Housing Administration (FHA) mortgage insurance program, which lost a lot of market share to subprime during the 2003-2006 period, apparently is helping to fill the financing gap created by the abrupt withdrawal of subprime lenders.

Furthermore, Congress may very well “reform” the FHA program to help refinance distressed home owners and bolster the flow of credit to higher-risk buyers — by lowering downpayment requirements, raising loan-size limits and creating a risk-based premium structure that would allow FHA to dip deeper into the credit risk pool. [return to top]
 

NAHB’s forecasts for both home sales and housing production have been trimmed recently, and we now expect new-home sales and single-family housing starts for 2007 to be the lowest since 1997.

We’re still looking for some recovery in 2008, although our current forecast for housing starts is well below our estimate of the sustainable trend level of production. In these terms, the major “correction” process that began in the fall of 2005 will extend at least through 2008. [return to top]
 

Get the answers to these and other questions at the Construction Forecast Conference — Spring 2007 on April 26 in Washington, D.C.

Panels of nationally recognized experts will discuss economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys at the day-long conference.

For more information and to register, click here.

Can't Attend in Person? Webcast of Conference Also Available

The conference is also available via Webcast. For Webcast information, visit www.nahb.org/cfcwebcast. [return to top]
 

The starts forecast includes downloadable Excel tables of total, single-family and multifamily starts by region and state.

To learn more, visit www.housingeconomics.com.

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