By Andrew Jakabovics
Federal Reserve Board chairman Ben Bernanke has argued for some time that the problems in the subprime mortgage market—rising delinquency rates and foreclosures—is unlikely to spill over to the broader housing market. The latest data, however, including releases of new and existing home sales, delinquency surveys, senior loan officer surveys, and quarterly reportsfrom the Federal Deposit Insurance Corporation, all point towards a broad downturn in housing markets.
All the data suggest that Bernanke might be overly optimistic. Homeowners with prime mortgages may be at risk from their neighbors’ subprime loans. When the Fed chairman and his colleagues on the central banking Open Market Committee sit down later this week after leaving interest rates unchanged today, they should all take into consideration the impact of that decision on the deteriorating housing situation.
Rising delinquencies and foreclosure rates on subprime loans are too often thought of as separate and apart from prime loans. This tendency obscures the close relationship of the two markets, which are better considered geographically rather than as aggregates. Neighborhoods with high concentrations of subprime loans are at greater risk of property-value erosion—foreclosure sales and rushed sales in anticipation of foreclosure affect all property values, including those of homeowners who are current on their prime loans.
Slowing sales and declines in sales prices, both of which have been seen in most markets in recent months, affect prime borrowers as well as homeowners without mortgages who may need to sell their homes to help finance their retirement or because they have to relocate for their jobs. The most vulnerable, though, are homeowners in minority and low-income neighborhoods.
Homeownership rates among minority and low-income families have risen significantly over the past decade, but many of those gains came about via non-traditional mortgage products. More than half of all recent low-income African-American and Hispanic buyers had first mortgages in excess of 90 percent of the value of their homes. They and their neighbors stand poised to suffer significantly from widespread delinquencies and foreclosures.
Nationally, the “noncurrent” (more than 90 days past due) rate on mortgages is at a record high since tracking began at the height of the 1990 housing crunch—a key indicator of stress in the home loan marketplace. That stress, however, is already apparent in actual foreclosures within select geographic regions. Activity in only seven states accounts for the overall rise in delinquencies nationally, according to the Mortgage Bankers Association.
Four states with significantly increased delinquency rates are California, Florida, Nevada, and Arizona. The MBA attributes the rise in delinquencies there to speculators walking away from adjustable-rate mortgages in places with declining home prices. Yet these states also have high percentages of Hispanic homeowners who spend an above average share of their income on their mortgages.
Ohio, Michigan, and Indiana accounted for 19.9 percent of loans in foreclosure, despite having only 8.7 percent of all mortgages. Even within these states, however, the foreclosures are not evenly distributed. For example, in the first five months of this year, Cuyahoga County, which includes Cleveland and its suburbs, recorded more than 4,000 sheriff’s deeds—properties repossessed by banks or sold off to the highest bidder. Cleveland zip codes with the highest numbers of sales are characterized by above average poverty levels and older housing stock, which tend to have high maintenance costs that can leave homeowners with the dilemma of paying the mortgage or making repairs.
And the pain is spreading. Overall, the Federal Deposit Insurance Corporation’s Chicago region reported that 1.68 percent of its home mortgages were noncurrent, with another 1.38 percent 30 days to 89 days late. Of even greater concern is the shocking 3.41 percent of noncurrent loans reported by FDIC-insured institutions in the Kansas City region, which includes Iowa, Kansas, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota.
This geographic concentration of delinquencies and foreclosures has broader implications for borrowers. Spikes in the delinquency rates, particularly for subprime adjustable-rate mortgages (15.75 percent of these loans are delinquent), have led banks to tighten credit, even for prime mortgages. This in turn has led to a drop in home sales and sales prices in many markets.
As the months of inventory of unsold homes increases, homebuilders cut back on construction activity. The decrease in construction activity means fewer construction jobs and less money (in the form of wages or materials bought) flowing through local economies. In parts of the country already suffering job losses, the effects of the housing market decline may exacerbate the downturn.
Although interest rates on prime mortgages remain historically low (up slightly in May over April but still below rates from a year ago), there is mounting evidence that lenders are reducing the amount of credit offered. Senior loan officers from the country’s largest banks surveyed on their lending practices reported continued tightening of their standards for prime mortgages as well as for nontraditional and subprime offerings.
To put lenders’ responses to the subprime mortgage crisis in context, the net percentage of banks tightening their standards has not been this high since the tail end of the 1991 credit crunch. Subprime lending by major banks has all but dried up, with 56 percent tightening standards, which has the potential to shunt marginal buyers to lenders with shady practices. Moreover, while interest rates on new loans remain attractive, those loans are becoming harder and harder to get.
If these trends in the loan officers’ survey are any indication, credit may tighten further before being eased. Tighter credit translates into fewer buyers, which can mean a greater supply of unsold inventory, both of existing homes and new construction.
Nationally, sales in May were 0.8 percent below April and, more significantly, down more than 10 percent from last year, according to the National Association of Realtors. The slowdown in existing sales has been reflected in the median sales price (2.4 percent below May 2006) and in the supply of houses listed for sale (up 5 percent since April).
Of greater import for the broader economy is the fact that residential sales in May 2007 fell nearly 16 percent from the previous May. While some analysts pointed to a sharp jump in new home sales in April over March to indicate that the housing slump was finished, April’s annualized numbers were revised downward by 89,000 units in the latest release.
Even taking relatively strong April sales into account, new residential sales year-to-date are dramatically off—more than 21 percent as compared to the same period in 2006. At the regional level, the South and West showed the greatest declines, sharply down 18 percent and 21 percent, respectively, compared to May 2006.
The drop in new home sales corresponds to a drop off in housing starts; there were 220,000 fewer houses started in the first five months of 2007 as compared to 2006. And while the overall housing starts in May were up 3 percent over April, the jump stems from a spike in multifamily (largely rental) construction. Single family starts fell 1.8 percent from April to May and were significantly down nearly 28 percent on a year-over-year basis.
The release of employment data next week will indicate the degree to which the slowdown in new home sales and residential construction impacts jobs. The construction sector accounted for 8.1 percent of all jobs in 2006. The Hispanic population in the South and West may be most vulnerable to the decline in housing construction. Hispanics are highly concentrated in the construction sector, with 15 percent of all Hispanics working in construction, and those two areas of the country account for 86 percent of the 2.9 million Latino construction workers.
We should not be too surprised, then, if it emerges that Bernanke displayed less certainty about the limited impact of subprime delinquencies at the Federal Open Market Committee meeting this week once the minutes of the meeting are publishing sometime in mid-July. Overall, far too much data has accumulated to avoid the conclusion that the subprime loan crisis has the potential to have serious implications at the neighborhood and national levels.
Andrew Jakabovics is Associate Director for the Economic Mobility Program at the Center for American Progress.