September 12, 2008
Source: Wall Street Journal (wsj.com)
By: Justin Lahart
Wellesley College economist Karl Case, the “Case” in the widely followed S&P/Case-Shiller index of U.S. housing prices, says he thinks that the housing market may be near a bottom. If he is right, financial firms may be able to breathe a sigh of relief.
At its most recent reading for June, the Case-Shiller index was 19% below its July 2006 peak, and many analysts say the decline is far from over. The inventory of unsold homes on the market is still very high, they point out, and until that excess is absorbed, it is a buyers’ market. Moreover, financial firms, hobbled by mortgage debt gone bad, are trying to rebuild cash reserves, making the firms less willing to extend loans to would-be buyers.
And the combined effects of the housing and credit crises have damaged the balance sheets and credit-worthiness of many households, leaving them a high hurdle to buying a new home. Yale University professor Robert Shiller, the co-creator of the Case/Shiller index, is among those who think it will be some time before prices stabilize.
But in a paper presented before the Brookings Institution in Washington yesterday, Mr. Case argues there is cause for optimism. He notes that of the 20 metropolitan areas covered by the Case/Shiller index, nine have shown prices slightly improving in recent months. He also says that the relationship between incomes and home prices has neared a level seen at the end of past housing slumps.
How far home prices fall matters greatly for financial institutions, Goldman Sachs economist Jan Hatzius argues in another paper presented at Brookings. If the Case/Shiller index stays at its June level, total mortgage losses will come to $473 billion, Mr. Hatzius estimates. That is more than the $400 billion in losses he projected in an earlier study conducted with economists David Greenlaw at Morgan Stanley, Anil Kashyap at the University of Chicago Graduate School of Business and Hyung Song Shin at Princeton University. Mr. Hatzius estimates that a further 10% decline in home prices would lead to losses of $636 billion and a 20% decline would lead to $868 billion in losses.
Mr. Hatzius used state-level data from the Mortgage Bankers Association from 1998 through the second quarter of this year to analyze the relationship between home-price declines and foreclosures in the current environment. That means he isn’t extrapolating from earlier periods, as he did in his previous study, when lender and borrower behavior may have been different. It also allows him to account for differences in the performance of different types of mortgages.
Under the scenario in which home prices fall another 10%, leading to $636 billion in mortgage losses, Mr. Hatzius calculates lenders will cut the credit they extend to final borrowers by nearly $2 trillion, knocking 1.8% off of gross domestic product growth. A weak dollar, low overnight rates and fiscal stimulus help mitigate the damage, he says.
The situation would be much more dire if Fannie Mae and Freddie Mac cut back on the amount of mortgages they guaranteed. One virtue of the government takeover of the two mortgage titans this week is that business doesn’t look as if it will be curtailed, Mr. Hatzius says.
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