Will Subprime Problems Spill Over Into Conventional Markets?

Two days, two economic forecasts; the first which we reported on earlier from the National Association of Realtors (NAR) showed a rapid deterioration in the confidence that association's economic advisors have in the near future of the housing industry. Now we have the June Economic Outlook from Freddie Mac.

Freddie Mac's monthly offering always has a theme and it is more than a little disquieting that the motif for June appears to be "not every house needs to be foreclosed."

This is really not an overstatement. The Outlook states that, in the subprime market, 1 in 13 homes are candidates for foreclosure. It further quotes the National Delinquency Survey as saying that in the second half of 2003, approximately 670,000 homes entered foreclosure, 37 percent of which were covered by subprime mortgages. This year the projection is that over a million homes will enter foreclosure, a 30 percent increase over last year and 60 percent of those homes will have subprime mortgages.

Freddie hastens to add that these figures do not appear to be spilling over into the prime mortgage market. "According to the Fed's (Federal Reserve's) most recent Senior Loan Officer Survey, while a considerable number of institutions tightened their lending standards on nontraditional and subprime mortgages, credit standards for prime mortgages have remained basically unchanged."

The report, issued by the office of Freddie Mac's chief economist, spoke of the reciprocal relationship between house prices and subprime delinquencies. If prices are on the rise then borrowers with financial problems can refinance, perhaps at lower rates and possibly withdrawing cash. But when prices fall that opportunity evaporates and troubled borrowers confront the increasing possibility of foreclosures. This will in turn contribute to the already large inventory of unsold homes and further depress home prices. The report cites the new Conventional Mortgage Home Price Index Purchase series findings that, in the Midwest, Illinois, Indiana, Ohio, and Michigan experienced a 4.3 percent decrease in home values in the first quarter of 2007, the highest in the nation. These are also the states with the highest exposure to subprime delinquencies.

However, Freddie says, lenders reportedly have stepped up efforts to modify loans and provide other alternatives to troubled borrowers and Federal bank regulators have encouraged this trend. However, there remain legal obstacles to modify those subprime loans that have been placed in securitized pools. The corporation pats itself on the back for taking the lead in the prime markets in efforts to help keep financially strapped borrowers in their home. "While not every subprime mortgage will avoid foreclosure, experience has shown that these efforts can go a long way in helping homeowners keep their homes," the report stated.

In the details of the Economic Outlook, Freddie Mac has revised its projections for home sales, saying that demand has sagged "a bit more" and that total sales are not expected to bottom out until the second half of the year. Weak demand is also expected to pull down prices which are now expected to accelerate at or below the rate of inflation for the next few quarters. An appreciation of 1.5 percent is expected for the year compared to 6.3 percent in 2006.

Housing starts will probably stay well below 2006 levels through the first half of the year; totaling 1.48 million for the year compared to 1.81 last year, but should rise to a total of 1.6 million units in 2008.