With the residential housing downturn stubbornly entrenched and credit markets in a wild gyration, the talk has turned to where is the economy heading and what does it all mean. In this story, we bring you some of the expert voices on the topic from the past week.
For starters, Dennis P. Lockhart, president and CEO of the Federal Reserve Bank of Atlanta likens current market conditions to a bout of indigestion (or worse) following a gluttonous period of overindulging. In this case investors were gorging on money given generously without strict underwriting standards. That availability of money more than anything caused the recent historic run up in property values.
"The discomfort (or worse) we sometimes feel after a big meal seems an apt way to describe conditions in the housing sector and the debt capital markets," Lockhart said speaking at the Atlanta Press Club. "I believe we've been experiencing the unpleasant process of the financial world changing its ways after a prolonged period of relatively cheap credit, and in consequence, high leverage. What we've been going through is an intense adjustment in both price and practice, and this process may be continuing.
"So, after the feast comes the dyspeptic sequelae. Fancy phrasing, but a simple notion," he added. "Housing and financial markets have feasted on a period of low rates and easy credit. I'm confident that market conditions eventually will settle down. As we move forward, my voice in Fed deliberations will be aimed at balancing response to immediate problems with concern for the best outcome for the long run."
Fewer Commercial Real Estate Opportunities
"While capital levels and profitability indicators are good now, the continued slowdown in real estate markets in general, and in the subprime loan market in particular, point to potential problems ahead as declines in credit quality are manifested in higher loan loss provisions, and slower home sales result in less demand for construction financing from banks," said Brian Bowling, an officer in the Atlanta Fed's bank supervision division. "Competitive pricing is expected to add additional pressure to profitability margins."
Looking ahead, Bowling said some institutions could see fewer opportunities to make commercial real estate loans. He also said some commercial and retail borrowers could be constrained by higher interest rates and tighter underwriting standards. These real estate-related issues are particularly notable in the Southeast as many banks rely on real estate development and related loan growth, which has slowed along with the housing sector.
It Took 10 Years in Japan
"If you wanted an informative article about real estate that shows just how long it may take, you could compare our current real estate upswing/downswing to the upswing/downswing bubble that Japan real estate had in the late 1980s early 1990s. Compare "mean real estate prices," wrote CoStar Watch List reader William T. Melvin Jr., CEO of Liquid Asset Partners LLC. "Ours almost exactly copies what happened in Japan. They had years of tremendous price increases that outpaced historic growth rates, then a decrease in real estate values that lasted almost 10 years -- and a recession to go along with it. Japan's prices went back down to levels similar to before the years tremendous increases."
"Our slide down may not take as long as 10 years, or it could take longer," Melvin wrote. "Housing prices are not very elastic; they move up and down slowly, as home owners "love" their houses and are willing to hang on longer even if prices go down, many have equity and are not forced to sell, so they try to wait out the downswing, but are eventually forced to sell, due to retirement or other factors."
Sooner Rather than Later
Pending home sales, a forward-looking indicator, shows existing-home sales are likely to decline in coming months as mortgage disruptions work their way through the housing market, according to the National Association of Realtors.
"It's difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren't closing because mortgage commitments have been falling through at the last moment," said Lawrence Yun, NAR senior economist. "These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers."
"If lenders focus on the essentials of creditworthiness and adjusted valuations based on comparable sales, and ignore speculation on what might happen in the future, broader stabilization will come sooner rather than later," Yun said.
Following that announcement, NAR trimmed its sales forecast for the seventh straight month and widened its predicted drop in existing home values.
Existing-home sales should hit a pace of 5.92 million units this year, down from the 6.04 million units it predicted last month. The national median sales price for existing homes should ease by 1.7% to $218,200 this year. Last month the trade group said prices would slip 1.2%.The median new-home price will probably fall 2.2% to $241,100 this year.
A Little Longer
In an interview at the annual Frankfurt International Motor Show, Rick Wagoner CEO of General Motors Corp. said the automaker was watching the downturn in the U.S. housing market closely and blamed the softness there for weakness in vehicle sales.
"It's created an environment where people are a little tense and when they get a little tense they hold onto their dollars and hold their cars a little longer," Wagoner said. "So we saw reasonably weaker sales the last several months."
Wait 'til 2009
Ongoing weakness in the housing market will push the national economy to the brink of recession, but growth in other areas should put the country back on a slow road to recovery by 2009, according to the quarterly Anderson Forecast by the University of California at Los Angeles, which was to be released today.
Economic growth will remain "tepid" around 1% for the remainder of 2008 and return to 3% in 2009, wrote David Shulman, senior economist for the forecast.
"Of course, when the economy slows to a 1% pace, it runs the risk of falling into an actual recession, just as when an airplane's velocity dips down to its 'stall speed' and falls out of the sky," Shulman wrote.
"The small recent minimal declines represent not the end, but rather the beginning of what will be a very painful decline," he wrote.
Shulman expects housing prices to plunge 10% to 15% before they start to recover, sometime in 2009.
A Chain Reaction
House prices may still fall in the future, write Morris A. Davis, assistant professor at he University of Wisconsin-Madison School of Business, François Ortalo-Magné, who holds the Robert E. Wangard Chair in Real Estate at the university, and Peter Rupert, research advisor at the Federal Reserve Bank of Cleveland in a report for the Cleveland bank.
"The price of starter homes will remain flat. New starter homeowners will therefore have little or no capital gains to use to finance the purchase of a more expensive trade-up home. The fact that these homeowners have no capital gains implies that, relative to the previous cohort of expensive-home buyers, they have relatively low down-payments to apply to the purchase of their more expensive trade-up homes."
"Since the equilibrium price of expensive homes is directly linked to the down-payment, low down payments (relative to the previous set of expensive-home buyers) will drive down the price of these homes," they added.
"Second, private mortgage originators have announced substantial changes to their subprime variable-rate mortgage programs, which are likely to result in the sharply curtailed availability of this type of credit," the trio wrote. "Using exactly the same reasoning as before, tightening credit standards will cause the price of starter homes to fall, thus reducing the wealth of the current owners of starter homes, which will itself trigger a chain-reaction decline in the price of trade-up homes."
Prolonged Adjustment
"Financial market turmoil seems likely to intensify the downturn in housing. At the macro level, we would expect some effect on housing demand from the rate increases related to these markets, but the impact from rates alone would likely be modest," said Janet L. Yellen, president and CEO, Federal Reserve Bank of San Francisco at a speech to the National Association for Business Economics. "More important, in my view, are the effects stemming from disruptions to the availability of credit and the tightening of lending standards that are occurring. The illiquidity in many segments of the market for mortgage-backed securities seems likely to limit credit flows and therefore to have at least some negative effect on real residential construction, depending on how long the disruptions persist."
"A key point is that, even when liquidity in the mortgage-backed securities market improves, the risk spreads incorporated in mortgage rates will likely remain higher on a long-term basis than they have been in recent years, and this could prolong the adjustment in the housing sector," Yellen said.
"In the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending as interest rates reset at higher levels and they find themselves with less disposable income," Yellen said.
As a side note, Yellen also said: "Monetary policy should not be used to shield investors from losses. Indeed, investors who misjudged fundamentals or misassessed risks are certain to suffer losses even if policy is successful in keeping the economy on track.
We Don't Know
"We won't know until this unwinds itself what the damage is going to be," William Rhodes, senior vice chairman of Citigroup Inc. told a session of the World Economic Forum in China. "It seems very clear, in the United States it will be an impact on the real economy and that depends on the impact on the consumer. If it affects in any way strongly the consumer, then you've got a problem."
"This world 'Goldilocks' economy is being fueled by open trade and I'm very concerned by about what I see in the markets," Rhodes said.
(EDITOR'S NOTE: So just where is the economy heading and what does it all mean, especially for commercial real estate? Add your voice to this story. E-mail me at Mark Heschmeyer. Read excerpts from pertinent follow up comments at the end of the story as they are added.)