WASHINGTON—Sound the warning bells. The United States is faced with a greater threat from the current real estate turmoil than it could from any terrorist attack, according to one think-tank.
The National Association for Business Economics (NABE), a Washington, D.C.-based think-tank, in its semiannual NABE Economic Policy Survey press release painted a bleak picture of the U.S. real estate market.
NABE experts say that the culprit is subprime loans—loans to individuals with a tainted or limited borrowing history and that the consequence is a "credit-induced bubble." Several years ago, interest rates were low, and banks opened up their vaults to many otherwise unqualified borrowers in hopes of bigger profits.
"The combined threat of subprime loan defaults and excessive indebtedness has supplanted terrorism and the Middle East as the biggest short-term threat to the U.S. economy," according to NABE.
The above assertion may not be so far fetched. Banks across the United States reported in the most recent Mortgage Bankers Association (MBA) National Delinquency Survey that a large number of their subprime mortgage loans were not being repaid.
Banks in Ohio were hit hardest. They had twice the number of loans in default or homes in foreclosure than banks in any other state. Payment delinquencies are also on the rise in Indiana, Illinois, Kentucky, Tennessee and Pennsylvania.
One of the reasons for foreclosures is due to declining real estate values. Housing prices are on the decline because developers have overbuilt and the supply of housing is far above the demand for new houses. Secondly, in many states, a great number of housing loans are given to investors who bought the house for resale at a later date. These buyers often do not live in the house and make little or no down payment.
Tightening Mortgage Market
Residential real estate sales dipped more than 12 percent in July compared to the prior month and more than 16 percent over July 2006, according to the National Association of Realtors (NAR), a national realtors trade association with more than 1.3 million members.
The most likely reason for the decline is that lenders are curtailing subprime loans and perform a more thorough credit check than in prior years.
"There are continuing issues for subprime borrowers, but there are not serious problems for the majority of buyers who qualify for conventional loans [with a good credit history]," suggested Lawrence Yun, senior economist at NAR.
The turmoil originated in the subprime market have spilled over to other financial sectors and may have detrimental effects on America's overall economy, says Federal Reserve Chairman Ben Bernanke in a recently published speech.
Bernanke suggests that lenders should base their loan decision on the individual's ability to repay and perform rigorous credit checks. Often in approving the loan, when the lender gets title to the house and has the ability to repossess, its review of the financial wherewithal and ability to repay take second place.
Another factor is that most banks sell their loans to others in the form of a security instrument. "The practice of selling mortgages to investors may have contributed to the weakening of underwriting standards," said Bernanke in a speech published in May. The lender has nothing to lose, as the risk of default transfers to the investor.
Credit Crunch
Lenders are quickly abandoning ship. Lehman Brothers Holding, Inc. closed its subprime-lending subsidiary BNC Mortgage LLC last month, laying-off 1,200 employees. Lehman announced that the closure would cost $25 million and would generate a $27 million write-off.
Capital One Financial Corp. stopped selling subprime loans and closed its GreenPoint Mortgage wholesale mortgage subsidiary last month that specifically targeted the subprime market. The shut down cost $860 million and Capital One will close a total of 31 locations across the United States and lay off approximately 1,900 employees.
"For Sale" signs and builders' housing inventories are on the rise. According to ZipRealty, a California-based real estate broker, housing inventories in Los Angeles more than tripled. The Progressive Business Public website shows that during August of 2007, there were approximately 5 million new homes for sale across the nation, up from 4.5 million in June.
Realtors also report that many prospective clients are unable to get loans due to bad credit history or other influencing factors.
Analyzing the Market
However, developers are continuing to build without much strategy or valuable market analysis, suggested Joseph Gyourko, director at University of Pennsylvania's Wharton Business School in an interview with Knowledge@Wharton.
Gyourko believes that the housing market for people with blemished credit histories will not disappear. "The cost of that is going to go up and I think that it is going to go up quite a bit," he says
Lenders will look at the risks associated with lending to a less-than-perfect clientele and price it accordingly—most likely much higher—which will price many individuals out of the market.
The housing-market may not see a turn-around until 2009. "Before the credit-crunch, I thought that sometime in 2008 we would get better [in the housing market]. I'm more worried now," said Gyourko.
Todd Sinai, a professor of real estate at Wharton, states that the ease of getting a loan and the "excesses that were going on in the lending market" are culprits for the financial crisis, not the actual pricing of real estate.
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