No Early End to Housing Doldrums

The housing market won't recover until well into next year, thanks to the meltdown in subprime mortgages.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

Matthew Mogul, Associate Editor, The Kiplinger Letter

April 30, 2007

The subprime mess has a very long tail, long enough to keep home sales down for many more months. The number of subprime loan holders who face higher interest rates has yet to peak. It will stay high through fall of next year, keeping foreclosures -- and home supply -- on the rise.

Leading home builders are downbeat, despite March's surprise gain in housing starts. The figures are distorted by a surge in building in the Midwest after the snow and cold weather of February. Other regions showed significant slowdowns. Inventory levels are worrisome, with a 7.8-month supply of new homes, a level not seen since the severe housing slump in 1991. "We built 750,000 more homes than the demographics indicate we needed," says Mark Vitner, senior economist with Wachovia Corp.

Borrowers may get some help from state governments, even as Congress is refusing to seriously consider a bailout. Foreclosures, now nearly 130,000 homeowners a month, hit states hard because they rely on property taxes to pay for all sorts of local government programs, including education. More so, a slumping mortgage market punishes existing homeowners. Industry estimates show that every vacant home in a neighborhood causes values to decline by 1%. And every foreclosure costs households, banks and local governments an average of $80,000, while refinancing can be done for as little as $3300 per loan.

Ohio is leading the push to come up with solutions. The state's slumping manufacturing sector and its high unemployment are fueling the nation's fastest foreclosure rate. So Ohio is selling $100 million in taxable bonds and will use the proceeds to refinance 1000 shaky adjustable mortgages into 20-year and 30-year fixed-rate loans at 6.75%. If the demand is high enough, the state might borrow as much as $500 million.

Some states are following Ohio's lead. Connecticut and Massachusetts are considering similar bailout funds. Colorado is offering free counseling, while Texas is mulling a new state law requiring home buyers to seek counseling before taking on a risky mortgage. Other states considering subprime mortgage-related measures include California, Maryland, Minnesota, Rhode Island, Virginia, Washington and Wisconsin.

While Congress can't afford to do much for borrowers, it will put credit-rating agencies in the hot seat soon. Lawmakers will probe for conflicts of interest, such as deliberate slow reactions in downgrading bonds backed by subprime loans. Standard & Poor's, Moody's and Fitch, for example, all made plenty of money rating subprime-backed securities, which are packaged by mortgage banks and sold to Wall Street investors. Downgrades would hurt that business and their bottom line.

Take New Century Financial, now in bankruptcy and the poster child for subprime woes. S&P didn't lower the ratings on its bond until February when its troubles were already well known. And consider that many subprime securities assigned investment-grade ratings as late as last year are now trading at prices that suggest they could be as risky as junk bonds, even though those securities have yet to be downgraded.

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