Housing, Bank Troubles Deepen

Reno, NV Attorney serving Nevada & California

Author Name: 

Two crucial barometers of the nation's housing market have worsened markedly in recent months, ratcheting up pressure on policy makers in Washington for action to stem the growing housing crisis and its widening impact on the nation's financial system.

Among the latest trouble signals, the number of American homes entering foreclosure rose to the highest level on record in the fourth quarter of 2007. Meanwhile, homeowners' share of the equity in their homes fell to a post-World War II low.

The unwelcome contrast provides stark evidence of how falling home prices are weighing on consumers. And it could add urgency to efforts by Federal Reserve officials to avert a larger wave of foreclosures by prodding lenders to reducing the principal -- or total amount owed -- on troubled mortgages.

Perhaps most troublesome for policy makers: The deterioration in household finances is expected to continue throughout the year as housing prices fall further. "We are likely to be living with a high degree of uncertainty for some period of time about the ultimate magnitude and duration of the slowdown under way," Federal Reserve Bank of New York President Timothy Geithner said in a speech.

Yesterday, the government took a major step aimed at jump-starting the housing market by raising the cap on the size of mortgages that can be bought by government-sponsored mortgage giants Fannie Mae and Freddie Mac or insured by the Federal Housing Administration. The move was mandated by the recently enacted economic-stimulus law.

With home values declining, last year marked the first time American homeowners, in the aggregate, owned less than half the value of their houses. Their share of home equity -- the market value of a home minus the size of its mortgage -- dropped to 47.9% in the final three months of 2007, down one percentage point from the third quarter, the Fed said in a quarterly report.

Equity as a percentage of home values has been falling from a high of more than 80% since 1945, when the data started being recorded, but that decline generally has been a result of mortgage debt rising faster than home prices.

Lately, the downturn in homeowners' equity has accelerated, and it is being driven by falling home prices, which is more ominous both for consumers' net worth and for the loans collateralized by those homes. The decline could portend an increase in the delinquencies and foreclosures that have roiled global credit markets.

"There are more homeowners who are getting pushed to the limit, where they have little equity left in their homes," said J.P. Morgan Chase economist Michael Feroli. "That makes it difficult to refinance."

Drop in Wealth

The total wealth of American households slipped about $533 billion to $57.7 trillion in the fourth quarter, the first drop since 2002, the Fed said. Central to the decline: The value of housing-related assets -- including those that are mortgaged -- fell by $170 billion to $20.2 trillion while the value of other financial assets, such as stocks, dropped by $254 billion to $45.3 trillion.

The Fed uses a home-price index compiled by the Office of Federal Housing Enterprise Oversight that some critics say understates the drop in home values. Using the popular S&P/Case-Shiller index of home prices, total household wealth would have dropped by $1.4 trillion during the quarter, said J.P. Morgan's Mr. Feroli.

According to the Mortgage Bankers Association, more than 2% of the nation's about 46 million mortgage loans were in the foreclosure process in the fourth quarter, and 0.83% of loans entered the process. Both figures are the highest since the industry group started keeping track in 1972.

Delinquency Rate

The delinquency rate for home loans hit 5.82%, up almost a quarter percentage point from the previous quarter and the highest since 1985, when the rate topped 6%, as many regions of the country were hurt by slumping oil and farm-product prices.

The latest increases affected almost all loan types, but were most pronounced for subprime, adjustable-rate mortgages. One out of five of those riskier loans were past due in the fourth quarter, while an additional 13% were in foreclosure.

The data explain the growing attention paid in Washington to proposals aimed at encouraging lenders to write down the value of troubled loans, a shift from the current focus on aiding cash-strapped homeowners by rescheduling mortgage payments or reducing their interest payments.

Fed Chairman Ben Bernanke on Tuesday urged lenders to reduce the principal amount of troubled mortgages and proposed that the FHA's authority be expanded so that it can then insure the written-down loans.

The mortgage industry has been cool to the Bernanke proposal, noting the difficulty of separating deserving borrowers from those at no risk of default or who borrowed recklessly.

Yesterday, a fellow regulator also counseled caution on expanding the FHA's exposure to risky mortgages. Federal Deposit Insurance Corp. Chairman Sheila Bair, who has generally advocated more aggressive steps to ease foreclosures, said the plan could expose the government to significant losses by guaranteeing mortgages on homes that are barely worth more than their mortgage.

"We need to make sure we have low loan-to-value ratios," she said, adding that the industry should be assessed fees to cover government losses.

But the Fed chief's proposal has been welcomed by Democrats who are more enthusiastic than the Bush administration about using public resources to absorb or insure against losses on defaulted mortgages. Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat who has pressed for federal purchases of troubled loans at steep discounts, called Mr. Bernanke's ideas "encouraging" and yesterday called for more aggressive action to address the housing crisis.

Meanwhile, the government announced that 250 areas of the country will be eligible for higher caps on the size of mortgages that can be bought by Fannie Mae and Freddie Mac or insured by the FHA. Of those, more than 70 high-cost areas will be eligible for the highest cap -- $729,750.

The limits will apply to mortgages originated from the beginning of last July through the end of this year. Previously, Fannie Mae and Freddie Mac, which buy mortgages in the secondary market, couldn't purchase loans larger than $417,000. For FHA, the loan limit had been $362,790.

Areas that will qualify for the highest loan limits include New York's Nassau and Rockland counties as well as areas in New Jersey, Virginia, Maryland and Washington, D.C. Fourteen counties in California, including Los Angeles and Orange, also are eligible for the highest loan caps.

The ceiling for FHA-insured loans for the lowest-priced areas was raised to $271,050, up from $200,160.

The stimulus law sets the new loan limits at 125% of a region's median sales price up to $729,750. To calculate the sales prices, the FHA used government and commercial data for metropolitan statistical areas and regions lying outside of metropolitan areas. If multiple counties were involved in a single area, the FHA used the county with the highest median sales price.

Skeptical Investors

By raising the loan caps, the government hopes to lower interest rates and jump-start the housing market. But David Berson, a senior vice president of the PMI Group Inc. and former vice president and chief economist at Fannie Mae, said the number of new loans is likely to be "relatively small" because the initiative expires at the end of the year. Investors may be skeptical of stepping into an uncertain market within such a short time frame.

In recent months as credit has tightened, the interest rates on home loans that were too large for Fannie or Freddie to buy have exceeded the rates on other mortgages by about one percentage point. Even with the new housing initiative, the rates on those larger loans could end up as much as a half point higher.

Questions also remain about how many of the bigger loans Fannie Mae and Freddie Mac will be able to finance. Their capital remains tight, despite fund raising last year. That could prevent them from buying large volumes of loans, but they could still afford to insure the loans for banks, said Ajay Rajadhyaksha, head of U.S. fixed-income strategy at Barclays Capital.