But if the subprime debacle poses no systemic risk (i.e., it will not bring about a collapse or serious contraction of the economic system and credit markets), it does pose a serious economic risk to the growth of the US economy.
Housing accounts for about 23% of the US economy, when taking into account all housing-related purchases of furniture, appliances, and items for new homes, according to the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts. So if the housing market is in recession, which it is, it is no small potatoes. Let’s look at a few recent points of data.
The NAR (National Association of Realtors) says that home sales are off 9%. Real estate analyst John Burns (http://www.realestateconsulting.com/) says that “the housing market has softened much more than is being reported” by the Fed and the NAR. Let’s look at some of his research. He gets it from purchasing the actual closing data for 55% of the country. Using this data, home sales are down 22% for the year through April 2007. The largest nationwide real estate brokerage firm reports sales down 18%.
Mortgage applications for home purchase have fallen 18%, even though many buyers now have to fill out several applications in order to get a mortgage. Taking the states with the worst housing sales/foreclosures crises, Burns found Florida home sales down 34%, not 28% as NAR reported; Arizona sales down 38%, not 28%; and California’s down 37%, not 24% as NAR reports. This strong underreporting of the collapse by NAR, the firm says, only dates from the middle of 2006; it doesn’t claim any intentional misrepresentation by NAR.
As for new-home sales, JBREC reports the Census Bureau is continuing not to subtract cancellations from reported sales, giving sales figures which are much rosier than the grim reality, and these are reported publicly by the Federal Reserve. And cancellations are a big factor, running 40-50% in some markets.
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Homes Prices and Consumer Spending Likely to Deflate
With an even larger backlog of homes, it is likely that existing home prices are going to have to drop at least in line with new homes. A 10% drop in existing home prices will be a shock to many recent home buyers, and mean even more foreclosures as ARM (Adjustable Rate Mortgage) re-set to much higher prices. This will mean that an ever-increasing number of homeowners will not be able to keep their homes. This large overhang of homes coming onto the market from foreclosure is going to last for at least a year, as the foreclosures coming onto the market today are from defaults of last year. As noted above, it takes almost a year from default to actual foreclosure, and defaults are rising.
Fitch data suggests that loans made in 2006 are defaulting in the first 12 months at a rate that is 50% higher than in 2003, and that the actual loan to value of the defaulting subprime market was 89%. A 10% drop means than most of these owners will be “under water” in terms of the value of their homes to their loans.
It certainly means that Mortgage Equity Withdrawals (MEWs) are going to be much harder to obtain. And this will be even more pronounced with much tighter credit standards. And, in a chart readers are familiar with, MEWs are responsible for a good deal of the growth we have seen in the past few years; and the declining MEWs, along with a softer housing market, are now a drag on the economy.
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