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Housing Market Update – Grim News Bolsters Sheila Bair's Plan to Stem the Crisis

Tue, Nov 18 2008, 22:58 GMT
by Northern Trust Economic Research Department

Northern Trust

Housing Market Update – Grim News Bolsters Sheila Bair’s Plan to Stem the Crisis

The grim housing market news continues to support opinions that the mortgage problem is the key to a resolution of the current financial market crisis. The crux of the issue is that falling home prices, foreclosures, and rising inventories need to be replaced by more stable conditions for the economy to turnaround. The National Association of Home Builders reported in the November survey that the Housing Market Index fell to 9.0 from 14.0 in October to establish a new record (see chart 1). The current sales index (8 vs. 14 in October) and the index tracking prospective buyers (7 vs. 11 in October) recorded new lows in November, while the future sales index held steady.

In other housing market news, the National Association of Realtors (NAR) reported that in the third quarter 120 out of 152 metro areas experienced declines in home prices, with 28 metro areas showing gains and the remaining four posting steady prices. According to the NAR 35%-40% of home sales in the third quarter were of foreclosed homes and short sales.

Paulson, Bernanke, and Sheila Bair testifying in the House Committee on Financial Services emphasized the need to focus directly on preventing more foreclosures. Sheila Bair noted that "minimizing foreclosures is essential to the broader effort to stabilize global financial markets and the U.S. economy. There were an estimated 1.5 million U.S. foreclosures last year, and another 1.2 million in the first half alone of 2008. Foreclosure is often a very lengthy, costly and destructive process that puts downward pressure on the price of nearby homes. While some level of home price decline is necessary to restore U.S. housing markets to equilibrium, unnecessary foreclosures perpetuate the cycle of financial distress and risk aversion, thus raising the very real possibility that home prices could overcorrect on the downside.

The continuing trend of unnecessary foreclosures imposes costs not only on borrowers and lenders, but also on entire communities and the economy as a whole. Foreclosures may result in vacant homes that may invite crime and create an appearance of market distress, diminishing the market value of other nearby properties. Foreclosures add inventory and create distressed sale prices which place downward pressure on surrounding home values. In addition, the direct costs of foreclosure include legal fees, brokers' fees, property management fees, and other holding costs that are avoided in workout scenarios. These costs can total between 20 and 40 percent of the market value of the property." She also added the following: "We believe that it is essential to utilize this authority to accelerate the pace of loan modifications in order to halt and reverse the rising tide of foreclosures that is imperiling the economy."

Drawing from the experience with Indy Mac, the essentials of the FDIC plan are: "The government should establish standards for loan modifications and provide for a defined sharing of losses on any default by modified mortgages meeting those standards. By doing so, unaffordable loans could be converted into loans that are sustainable over the long term. This proposal is authorized by the Emergency Economic Stabilization Act of 2008 and may be implemented under the authority provided to the Secretary under that statute." (Link for additional details of testimony: http://www.fdic.gov/news/news/speeches/chairman/spnov1808.html.) In her opinion it would prevent 1.5 million foreclosures in 2009.

Two conclusions can be drawn from the ongoing discussion to tackle the current financial crisis: (1) Banks need additional capital, which is being addressed, and (2) home foreclosures have to be stopped. It is the latter issue that needs the most attention and Sheila Bair’s approach appears to be the appropriate route. Incoming housing market data and economic reports make a strong case for the FDIC plan.

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Published on  Tue, Nov 18 2008, 23:04 GMT