Views/Truths About Sub-prime & Economy
A: Nouriel Roubini is a Professor of Economics & International Business at the Stern School of Business at New York University. He is also a blogger and publishes the RGEMonitor, a global economics blog, where he discusses many topics (mostly gloomy yet to me is a realist) including the fundamentals behind why he expects an economic hard landing and a more severe housing downturn. His latest blog entry is particularly interesting and I would like to share it with some of my thoughts here on UrbanDigs.
FIRST OFF - I understand that sub-prime borrowers are only a small portion of all loans outstanding and do not represent the whole. However, it is the side effect of this major problem that worries me. I feel that what we are seeing in the sub-prime world is just the tip of the iceberg and that this disease has already spread to some prime lenders but is yet to show its surface marks. The real issue is any change in lending standards that comes as a result of this problem! If regulations are put in place to protect the consumer and the industry itself, than that means a credit crunch as tighter lending standards will restrict purchasing power and help sustain the housing downturn. That is my worry.
His latest post, "Ten Faulty Consensus Views about Sub-prime and Soft-Landing..and the Ten Ugly Truths about the Coming Economic and Financial Hard Landing" is a great read from a respected economist. Here are a few selected items from the Top Ten List of his stated consensus views, ugly reality, and then my two cents:
Consensus View #1: The Housing recession is bottoming out.
Ugly Reality #1: The housing recession not only is not bottoming out; it is getting worse and it will be the worst housing recession in the last five decades
UrbanDigs $0.02: The housing recession nationally has some serious issues. Things will get worse before it gets better and NYC will lag in this slowdown as it always does. However, I don't expect it to be as catastrophic as the professor states; but then again, he is a professor and I am a lowly real estate agent and blogger. Nuff said.
Consensus View #2: The subprime carnage is only a narrow and niche problem; other mortgages are fine. So there is no risk of contagion to other mortgages.
Ugly Reality #2: The same garbage lending practices used for sub-prime - no/low down-payment, no/low documentation of income and assets, interest rate only, teaser rates, negative amortization, option ARMs - were prevalent among near prime and other (option ARM) prime mortgages. These risky mortgages add up to about 50% of originations in 2005 and 2006
UrbanDigs $0.02: Its very optimistic and narrow minded to think this problem will not infect prime lenders and Alt-A lenders (in between sub-prime & prime: credit score driven loans / lack proof of income). I've been talking for a long time that those who used risky mortgages to rationalize a purchase price above their means will meet with major problems in the years to come. And I expect 2007-2009 to bring these weak players out. How the industry adapts is what I am not sure of yet. I worry about regulations being put in place that might hurt purchasing power.
Consensus View #3: There may be a credit crunch in subprime but not generalized credit crunch in the mortgage market.
Ugly Reality #3: Not only there is a severe credit crunch in subprime (30 plus lenders out of business); there is also the beginning of a generalized credit crunch for the broader set of near prime and other risky prime mortgages. Default and foreclosure rates sharply up in all mortgages, including near prime such as Alt-A. Lenders and regulators are seriously tightening standards for all mortgages. There is now a sharp swing from very loose to very tight lending behavior by every type of mortgage lender.
UrbanDigs $0.02: Sup-prime is definitely adapting to this changing world as tighter lending standards are put in place and weak borrowers are being handed a tough time securing a loan! Many are facing the reality that they cant get a loan. No doubt about it. However, prime lenders have yet to significantly tighten lending standards. Will my fear play out? Probably, but I hope not as that is not good for anybody except those who have been waiting years for a housing downturn that has legs.
Consensus View #10: The recent financial markets turmoil is a temporary blip; the financial party will happily continue.
Ugly Reality #10: Previous market corrections were temporary blips and market opportunities because macro fundamentals were sound. The spring 2006 “inflation scare” turned out to be a “scare” without basis; thus markets recovered after a brief turmoil. Today we do not have a “growth scare”; we have US growth fundamentals that are severely weakening and leading to the risk of a hard landing. In that scenario the market will not have a brief correction; instead all sorts of risky assets – equities, commodities, corporate credit risks, emerging market assets – will have a severe downturn once sucker rallies following expectations of a Fed ease will run out of steam when the reality of a hard landing sinks in.
UrbanDigs $0.02: The stock market is already pricing in for risks. The fallout from restricted consumer spending from the slowing housing market and falling prices cannot be discounted. If people feel less wealthy, they tend to cutback in spending. There are serious issues that are yet to show their full spread. I agree that US growth fundamentals have changed in the past few months and equities have priced in these risks accordingly. It really will depend on the depth of this mortgage meltdown. If it spreads to prime and the problem turns out to be far more widespread than first thought, the future growth expectations of the US Economy will have to be re-assessed to the downside and that means lower stock prices.
It's important to note that recessions DO occur. Housing downturns DO occur. And its extremely important to acknowledge that things happen that are sometimes not forecasted that changes everything! I am very curious to see what happens in the near future and I am doing my best to keep the focus on housing, and specifically NYC housing. But with all these threats in the air, I have to discuss them on the site. I still see tighter lending standards and future job losses from a slowing US economy as the two biggest direct threats to NYC housing. I also think that out of all the markets in this country, Manhattan real estate is one of the safer places to be and that this market generally lags in slowdowns and leads in recoveries.
What do you think? Housing gloom or Housing Boom?
Posted by newbie
Fri Mar 16th, 2007 12:08 PM
Good insight, Noah, and I think your quote sums it all up - "If it spreads to prime and the problem turns out to be far more widespread than first thought, ...."
It's unexpected events that usually drive major shifts because the market (whether stock or real estate) hasn't had a chance to adjust its prices.
Bottom line: we don't know what will happen but a major crash in prices will occur if something unexpected occurs at the 'wrong' time.
Posted by Larry Nusbaum
Fri Mar 16th, 2007 12:20 PM
I have commented about this on my blog. But, keep in mind there is a difference between a sub-prime lender and a sub-prime borrower.
Not all sub-prime borrowers suddenly defaulted this month.
The rules for their lenders did change and most who do sub-prime only blew up.
The question remaining is will these borrowers have any access to credit when they seek it and if not will they be forced into foreclosure casuing more downdraft in the housing market?
Posted by spaceboy
Fri Mar 16th, 2007 01:39 PM
I agree there's some risk here, but my question is as long as jobs stay strong... where will money go? Assuming the stock market will be bad... real estate will be bad... are the majority of people going to flee to bonds? Some probably but if stocks and RE are bad, we have to assume/hope there will be rate cuts and then how long can you keep your money in a high interest account? In some areas of the country, I bet there could be some deep price cuts. However, I think there is a natural sense of greed so as long as there is demand to live in your area, real estate should be fine. Why? I have to think that if a 2BR condo in Manhattan were suddenly HALVED in value, there would be a flock of buyers all over it. I would be. Where's the value line... 50%? 40%? 30%? 20% 10%
Posted by Noah
Fri Mar 16th, 2007 02:36 PM
Spaceboy - I think the value line is 20%, but I also think many homeowners would choose NOT to sell their house if things get real bad. Only those who MUST sell will sell at a loss, so the entire market, inventory wise, will be different.
Also, the fed CANT cut rates too much with inflation issues out there! Thats the big problem. They cant afford to shoot if there is very little ammo. Remember that price stability and inflation are the main problems the fed is suposed to deal with. Not, economic and housing cycles.
Posted by Chris Lengquist
Fri Mar 16th, 2007 03:56 PM
I would only comment on a missing ingrediant. Income. How long will it take for income to catch-up to the current pricing. It really ALL boils down to that. Once income catches up you don't need gimmick loans. Once there is solid income with solid payment history and solid employment there will be a home purchase.
Same thing happened in Washington, DC in the 90's. I bought a TH in Suburban Maryland for $99,900. 5 years later, after the correction, I sold it for $141,000.
Income caught up. Now it's been outpaced again. So, correction. Then income will catch back up...
Posted by drtomaso
Fri Mar 16th, 2007 07:27 PM
If you check out the graph labeled "Median Home Price divided by Per Capita Income" at http://piggington.com/bubble you will see that incomes either have to rise quite a bit (ie: double) or home prices have to fall to return to the long term moving average.*
Which do you think is more likely? Median wages doubling, or home prices halfing?
The reason the recent upward trend in home prices cannot continue is that less than 10% of the population can currently afford the median home price. Unless they have access to some pretty crazy credit.
*- Yes I know this is for Sandiego Cty, but I assert that most east/west coast "urban/suburban" markets look similar to this. NYC should be even worse with a median home price of 1.3M and a median income of 45k.