Friday, February 11, 2005

FDIC Study: US Housing Market Entering Unknown Territory

By Campion Walsh


WASHINGTON -(Dow Jones)- U.S. homeowners are entering the "uncharted territory" of a residential real estate boom that has fostered surging subprime mortgage loans and increased mortgage leverage, according to a Federal Deposit Insurance Corp. study released Thursday.

Few metropolitan area residential real estate booms since the late 1970s have ended in busts, but several factors suggest past may not be prologue in the current environment, the study says.

"Foremost among these are changes in credit markets that are pushing homeowners - and housing markets - into uncharted territory," it says.

Subprime mortgage lending - made to borrowers with impaired credit histories - surged 25% between 1994 and 2003, and subprime mortgages currently make up just over 10% of all mortgage debt outstanding, the study says. Subprime lending has been associated with higher levels of delinquency and foreclosure, and subprime borrowers could be particularly vulnerable to rising interest rates or economic stresses such as job loss, it says.

Another risk factor is an increase in high-leverage mortgages, the study says. In 2003, mortgage loans exceeding 80% of a home purchase price accounted for 30% of all purchase mortgages underwritten, and in a few cities these highly leveraged purchases accounted for more than half of purchase mortgage lending.

The report says more borrowers are using "piggy back" loans, which combine a first mortgage, usually for 80% of a home's value, with a second one for 10% to 15% of the home's value. As a result, borrowers may be more likely to default in a housing market downturn.

"An increased incidence of default and foreclosure could, in turn, contribute to downward pressure on home prices as distressed properties are liquidated by lenders," the report says. "However, little is known yet about the effects these credit-market changes might have on the dynamics of boom-bust cycles," it says.

Report Follows CBO Forecast Of Cooling Market

The report, by FDIC economists Cynthia Angell and Norman Williams, identifies 33 metro area booms as of 2003 in areas where about 40% of the U.S. population resides - the highest number regional booms in the past 25 years.

Regional housing market busts that have occurred in the past quarter century have tended to be preceded by economic shocks, such as falling oil prices that hit oil-producing areas of the country in the mid- to late-1980s and post-Cold War defense contractor downsizing in California in the early 1990s.

"Should a shock occur, it seems reasonable to expect that home prices would be more likely to decline, and perhaps even bust, in those markets where prices have recently boomed," the report says.

The study defines a "boom" as an increase of 30% or more in inflation-adjusted home prices during any three-year period, and a "bust" as a 15% or greater decline in nominal home prices over five years. It uses a lower threshold for busts partly because home prices tend to fall more slowly than they rise, as homeowners tend to avoid selling in a very weak market.

The FDIC economists found that only 17% of 54 regional housing booms in the 20 years prior to 1998 ended in busts. "So for 83% of our post-boom cities, nominal prices continued to inch up and any declines after inflation were very modest," they say. The most common post-boom experience is stagnation.

The FDIC study follows a report last month by the Congressional Budget Office that found the housing market is likely to cool for the next two years as mortgage interest rates rise.

The CBO's Budget and Economic Outlook report noted that housing investment surged last year to near-record levels, reaching 5.7% of gross domestic product by mid-year.

While acknowledging concerns that speculative overheating of the housing market could lead to a collapse, the CBO cited a December report by the Federal Reserve Bank of New York indicating the rise in house prices for the nation as a whole reflects positive fundamentals rather than speculation.

"In CBO's estimation, a general collapse of prices for houses is unlikely because stronger income growth in the next two years will probably counteract the anticipated rise in mortgage interest rates," it said.

Prices could fall in in areas like the Mid-Atlantic, New England and the Pacific Coast, which have seen especially sharp growth, but these declines would be unlikely to threaten the nation as a whole, the CBO said.