Housing Slump Brings Wider Concerns

cu360
February 27, 2007

With drops in the volume of home sales and falling home prices, the question for anyone connected to real estate is: How far and how fast? The expert consensus, according to The Christian Science Monitor, is that the slump could last into the summer of 2007. And the speed may depend on how many people hit the panic button or take their homes off the market.

Cautionary reports just keep on coming—new home construction fell sharply in August, meaning it's down about 20% compared with last year. There are seven months of unsold homes waiting for buyers—a record number. That's causing some economists to use the ‘R' word when they talk about the housing market—and warn about what that might mean for the economy as a whole.

"Housing is in a recession, there are no two ways about it," says Paul Kasriel, chief economist at Northern Trust Company in Chicago. "Typically when we get declines in housing of this magnitude, with a lag, the economy goes into recession. There have been exceptions, but not many."

The housing slump isn't welcome news in Washington as the Federal Reserve ponders interest-rate policy. Partly because of the problems in the housing sector, economists expect the Fed to leave rates unchanged in upcoming months.

"Housing is a big worry for the Fed," says Scott Brown, chief economist at Raymond James & Associates in St. Petersburg, Fla. "At the start of the year they expected an orderly decline, but this summer the market started to fall apart."

How Long, How Deep?

The National Association of Realtors (NAR) takes a largely upbeat view. "This is the price correction we've been expecting. With sales stabilizing, we should go back to positive price growth early next year," NAR economist David Lereah said in a statement accompanying September 2006 reports.

But some economists are forecasting a tougher climate, thanks to an extraordinarily large run-up in prices in the past couple of years and homebuyers' increasing reliance on exotic types of mortgage loans. Merrill Lynch predicts a 5% home-price drop in 2007, while Goldman Sachs forecasts a 3% decline nationwide.

"The housing market is weak and getting weaker," says Mark Zandi, chief economist for Moody's Economy.com. "It appears the downturn has a ways to go."

The future direction of home prices could have a significant impact on the direction of the economy and on the finances of millions of families. Pessimists say a speculative ‘bubble' has built up and now needs to deflate, possibly over several years.

"Additional price declines should not be surprising," says Asha Bangalore, an economist at Northern Trust Company in Chicago. "We have a recession in the housing market, and it usually takes two to three years to stabilize."

Despite the slump in the housing market, many economists continue to predict the economy as a whole will weather the slump.

"It doesn't appear the bottom will fall out by any means," says Peter Morici, a professor at the University of Maryland School of Business. "I think lower oil prices—they're now down $15 a barrel—have taken any further slowdown off the table."

"Even though prices have fallen, people still have a lot of wealth and equity built up," says Bob Brusca of FAO Economics. "We would need to see a lot more decline before it materially affects consumer finances."

One new uncertainty in this cycle is today's greater reliance on adjustable-rate mortgages. With interest rates on those loans shifting upward, a key question is how many owners will have to unload homes they bought when values were rising and interest rates were low. "The probability of a more disorderly correction is raised by this element," says Bangalore.

Home Equity Lending

Given the slowdown in home sales, real estate advisors are now suggesting that homeowners concentrate on improving value to boost sales appeal. But in today's market, improvement options may boil down to what the homeowner can afford and how to pay for everything from materials to contractor services.

This brings the home equity loan back into favor for many homeowners. Even as homeowners sit on the real estate sidelines, most home values continue to build. And as that value piles up, more money is available through home equity channels for home improvements or other ways the homeowner chooses to spend those funds.

"Even as rates have risen, we still see home equity as the financing option of choice for lots of homeowners," says Peggy Lawlor, senior vice president for Bank of America. "It's got the most flexibility and the homeowner knows even as they sit back, their home continues to climb in value over the long term."

Lawlor says Bank of America does not track how homeowners spend home equity lines of credit, but "as we talk to homeowners, home improvement is the primary use."

While some homeowners earmark home equity money for pricier projects, Lawlor says even less ambitious projects are prime uses for home equity funds. "Consider home equity for smaller projects," she says, defining smaller projects as $1,500 and up.

Consumers tempted to whip out credit cards at the local building supply center might pause to weigh card payments against home equity. As any credit union lender knows, interest rates on unpaid credit card balances can easily be near 20%, while home equity rates are still in the single-digit range.

Lawlor also reminds consumers that most home equity loans can be a pleasant tax write-off. "That's the real benefit of using the value of your home to fund projects and other uses," she says. "It has tax benefits normally not associated with other forms of payment."

This story first appeared on http://cu360.cuna.org and is reprinted with permission.