IN MY COLUMN LAST MONTH (“LAX LENDING,” April, page 70), I discussed the relaxation of mortgage lending standards that fueled the unsustainable housing boom of 2004–2005, the snapback of lending standards that began late last year, and the threats posed by tightening standards to the NAHB's projected housing recovery in 2007–2008.
The situation in mortgage markets has severely worsened during the past month as the subprime mortgage sector has virtually melted down and other parts of the mortgage lending structure have felt the intense heat. The NAHB's surveys of single-family home builders already show significant negative impact on new-home sales, and the outlook for the balance of this year and 2008 has become worse because of evolving mortgage market conditions.
SUBPRIME QUALITY PLUMMETS Delinquency rates on subprime mortgages moved up substantially late last year and further deterioration of loan quality is inevitable—particularly for sub-prime ARMs. Many of these loans not only were made to high-risk borrowers, but also contained risk-layering loan features, such as “piggy-back” seconds, along with the absence of documentation of borrower income, assets, or debt burden.
Very large numbers of high-risk sub-prime ARMs were made in 2005–2006, and these loans generally had fixed-payment periods of only two years. Thus, a major wave of interest-rate and monthly-payment resets are welling up at this time and will crest later this year and in 2008. There's no doubt that delinquencies, defaults, and foreclosures on this book of business will rise substantially from already elevated levels. Indeed, lenders, regulators, and securities market participants now understand the dark side of the subprime-lending boom. As a result, standards for new loans already have tightened considerably.
NAHB SURVEYS The NAHB surveyed more than 400 single-family home builders in March in order to get a handle on the early impacts of the subprime meltdown on home sales. One-third of all builders in our survey said that tightening lending standards had taken a toll on their home sales in the early part of 2007. For those impacted, the median loss was an estimated 10 percent of sales volume.
Our survey also showed that big builders, as a group, had been more dependent on subprime mortgage financing than small companies, and relatively high proportions of big companies said that tighter mortgage lending standards had taken a toll on their sales volume early this year.
Two-thirds of builders in a supplementary sample of 44 very large companies (those in the BUILDER 100 and Next 100) said they have finance subsidiaries that offered subprime loans to their buyers, and those without finance subs generally referred subprime borrowers to mortgage bankers, mortgage brokers, or commercial banks. Not surprisingly, a large majority of companies in this sample (84 percent) said that tightening mortgage lending standards had taken a toll on their sales early this year.
FORECASTS AND RISKS The subprime-related tightening of mortgage lending standards has prompted significant downward revisions to the NAHB's forecasts of home sales and housing starts for the balance of this year and in 2008. We're still showing a modest recovery process, beginning around the middle of this year, although projected housing starts remain well below our estimate of the sustainable trend level of production. In these terms, the major “correction” process that began in the fall of 2005 will extend at least through 2008.
It's fair to say that the range of uncertainty around the NAHB's recently revised baseline (most probable) housing forecast is quite wide. Indeed, the key downside risks to the overall economic outlook now reside in the mortgage and housing markets—a point made on March 28 by Federal Reserve Chairman Bernanke in testimony before Congress.
CHIEF ECONOMIST, NAHB WASHINGTON, D.C.