Housing prices and news coverage of the subprime crisis.

In an interview with Newsweek's Daniel Gross last week, one of the hosts of NPR's All Things Considered, Robert Siegel, described a hypothetical family that had their home appraised at $300,000 last year. He went on to ask Gross to explain the effect of the value of this family's home falling to $250,000 , rather than rising to $350,000 as they might have expected. Mr. Siegel's line of questioning is typical. We accept the notion that across the country housing prices are falling and falling sharply. Given this, we conclude that consumer spending will weaken in the months ahead, perhaps significantly enough to push the economy into recession. The current situation is serious. On the one end of the spectrum you have poorer families - only recently becoming homeowners- who are now losing their homes. In the face of higher interest rates they are unable to make payments. Banks have either abandoned the subprime market entirely or have tightened their lending standards. Either way, other families who might buy these homes cannot raise the money needed. The two forces combined have led to an increase in foreclosures and a glut of inexpensive homes for sale. Not coincidentally, at the other end of the spectrum, there have been increased requirements for those borrowing to fund the purchase of homes with values well in excess of $400,000. What subprime mortgages and jumbos have in common is that Freddie Mac and Fannie Mae refuse to touch them. Borrowers taking out "jumbo mortgages" have typically been asked to pay a minimum of 5% as a downpayment and a premium in interest over what conventional conforming mortgages charged. It is because luxury homes are less liquid (because they are hard to sell quickly without a fairly substantial cut in price) and because of a general desire to limit risk until a clearer picture emerges that lending standards on these sorts of loans have tightened as well. (See "Subprime Mortgage Woes Spreading : Subprime Mortgage Crisis Spreading to High-End Housing Market" AP Wednesday August 29). Therefore the trouble is at the two extremes of the market, where the supply of homes on the market has increased while at the same time, and for the same reasons, the demand for such homes has been depressed. Many banks, formerly in the business of originating these mortgages and then selling them, have seen demand plummet. Where does this leave Mr. Siegel's middle class family with a very nice, fairly new home? They are probably okay. Rather than a home that was worth $300,000 last year selling for only $250,000 today, it would more than likely sell for $308,000-$310,000. (See OFHEO's website) The present crisis as serious as it is, is largely confined to the two extremes of the mortgage market already mentioned. to banks originating such mortgages, and to institutions such as Countrywide that have become more heavily involved in both extremes of the mortgage market. It is an old story, one reminiscent of the junk bond market, where tempted by the higher yields on riskier investments investors convince themselves and others that the market's assessment of risks have been too high. In short, the impact on the consumer spending of middle class America should not be as great as one might imagine. There are if you will several leaks in the roof and serious repairs are needed but the roof is still basically sound and if we patch the roof it should be okay. Pick a different housing price index and you will get a very different number: Estimates of what has happened to housing prices vary enormously. It is indeed confusing. The NAR (National Association of Realtors) suggests that in the second quarter of this year housing prices declined (in fact, NAR sugggests that it is the fourth successive quarter of such declines ). The decline in housing prices according to the NAR number was not as severe as the drop year-over-year in the fourth quarter of 2006 when prices fell by their reckoning 2.7% but still in the second quarter of 2007 they were 1.5% lower than a year earlier. According to the Case-Shiller index however in the second quarter of 2007 there was a "record fall" in housing prices in the second quarter of 2007 with prices falling on average by 3.2% between April-June of this year. Finally, the numbers I used to adjust Mr. Siegel's example are based on the housing price index (HPI) reported by the Office of Federal Housing Enterprise Oversight (OFHEO) which indicated that housing prices rose between 2.6% to 3.2 % over this same period of time. The reason for these discrepancies is, of course, due to the fact that each statistic reported includes or excludes different numbers. (For more detail see "Consider the Source" by Lasalle Bank Associate Economist Adolfo Laurenti) Out of the three just mentioned, the Case-Shiller and OFHEO HPI are far more reliable. Both are to be considered to be so because they are paired-sales statistics. This means that it is the price of particular properties that are tracked over time. Other indices, such as the figure given by the NAR are not paired and as a result are sensitive to not only what is happening to the price of homes themselves but to the types of homes being sold. A drop in the NAR statistic could just as readily mean that proportionately more modestly priced homes are being sold than that the price of houses in general are going down. Say that previously 50% of homes being sold over a three month period were sold for $50,000 and 50% for $200,000. If the proportion of homes being sold in the $50,000 range rises it would not take much to generate a huge decline in the average price of homes being sold (a shift to from a 50% to 60% share would cause the average to fall by 12%!). Nonetheless while OFHEO's HPI indicated an increase in hokme prices, Case-Shiller indicated a decline. The difference between Case-Shiller and the OFHEO's HPI can be explained by the fact that the HPI only considers what is happening to the price of homes being purchased with conventional conforming mortgages while Case-Shiller includes jumbo mortgages. In short, the clearest picture we get nationally for the great middle section of the housing market is not a decline. Rather what is happening to the value of many middle class families' homes is that they are still increasing, albeit at a much slower rate (3.2%) than they had over the last five years overall (an annual rate of about 8.5%) So Why Does This Matter? There is first and foremost the impact of of all of this on poorer families that is going largely unreported. (See however the dicussion of turning properties that would otherwise go into foreclosure into rental properties on Marketplace Morning Report September 6th, 2007. Click here ) There is also the fact that the recent crisis has increased the number of individual financial investors who wish to sit on the sidelines with their cash and wait to see if a clearer picture emerges . This flight into liquidity has inadvertently dampened the demand for commerial paper as well as restricting poorer families' access to credit [(1.) For the significance of commercial paper see "Commercial paper market still shrinking: Asset-backed securities fall 15.6% in past three weeks" by Rex Nutting for MarketWatch Aug 30, 2007. (2) For the reasons behind this shift away from commercial paper see "Subprime `Tsunami' Hits Asset-Backed Commercial Paper Market" by Mark Pittman and Elizabeth Stanton for Bloomberg.com August 8, 2007]. What the Fed has done and promises to do is,simply put, a move to provide the extra cash to satisfy an increased desire for liquidity and therefore quite necessary. And President Bush's promise to assist families caught up in the subprime crisis, if sincere, is also a move in the right direction. However, it is debatable in the extreme that the majority of middle class families have anything immediately to fear in terms of falling home prices and higher mortgage interest. In point of fact, Countrywide and other mortgage brokers are trying to redeem themselves financially. They clearly intend to do this by sharply limiting their investments in mortgages that Fannie Mae and Freddie Mac will not purchase: subprime and jumbo mortgages. Middle income households represent the salvation of mortgage lenders as they turn their backs of higher risk, poorer borrowers. (for more click here.) To focus on falling home prices and the possible impact on middle-class consumers diverts our attention away from the real issues involved. For a previous blog on related issues click here.