Wednesday, January 16, 2008

Housing Market Monitor

Housing Market Monitor
Credit Card Debt Soars as House Prices Plunge

By Dean Baker | 10 January 2008

"The current rate of house price decline will destroy $2.2 trillion of wealth this year."

The Federal Reserve Board reported yesterday that credit card debt rose at an 11.3 percent annual rate in November after rising at an 8.5 percent rate in October. By comparison, credit card debt rose at a rate between 2 percent and 4 percent from 2003 to 2005.

The explanation for this surge in credit card debt is that millions of homeowners are losing the ability to borrow against their home. In the last Flow of Funds release, the Fed reported that the ratio of homeowners’ equity to value stood at just 50.4 percent, down from 54.2 percent at the end of 2005, and 57.3 percent at the end of 2001. The ratio will almost certainly cross below 50 percent for the first time in history when the fourth quarter data is reported. This is a remarkably rapid decline, especially since the soaring home prices of recent years translated dollar for dollar into additional equity.

This aggregate number conceals vast differences among homeowners. More than one-third of homeowners have completely paid off their mortgages and many others are close to having them paid off. This means that a large number of the remaining homeowners have little or no equity in their home. These people are now running up credit card debt at near record rates. Of course, credit card debt cannot offset the ability to borrow against home equity for long. Total outstanding credit debt is less than $940 billion; mortgage debt was increasing at a $730 billion annual rate in the third quarter. Millions of households will soon have little choice but to sharply curtail their consumption.

The latest Case-Shiller indexes, which received little attention because they were released on December 26th, showed that house prices in the aggregate index were dropping at an annual rate of 11.7 percent in the most recent three months from July to October. At this pace, households will lose more than $2.2 TRillion in housing wealth over the next year. Some of the really big losers in the latest data were Las Vegas, where house prices were falling at an 18.9 percent annual rate over the last three months, San Diego, where they declined at a 20.3 percent rate, and Miami where they dropped at a 22.0 percent rate.

Many homeowners in these formerly hot markets put little or nothing down when they purchased homes in the last two or three years. As a result, a large percentage of recent homebuyers will soon find themselves with negative equity. This is the reason that the foreclosure crisis is spreading from the subprime segment of the mortgage market to the Alt-A and prime segment. Homeowners who find themselves owing more than the value of their home have enormous incentive to default.

The pending home sales data for November are somewhat better than most analysts had expected. While they are down slightly from the October levels, the latter were revised up to show a gain of 3.7 percent from September instead of 0.6 percent. The improvement from the August-September trough is concentrated in the West, where sales have risen by almost 8 percent from the lows hit in the summer. This probably is due more to the extraordinary weakness of the summer sales levels (down almost 40 percent from 2005) than to any real upturn in the market.

The mortgage applications index continues to give erratic readings, jumping 32 percent from last week’s seasonally adjusted measure. The recent mortgage application data is hard to interpret for two reasons. First, the subprime segment of the mortgage market is underrepresented in the Mortgage Bankers Association (MBA), which constructs the index. This means that the index will not fully capture some of the falloff in subprime loans. Also, as borrowers switch from defunct subprime lenders to MBA members, it will appear in the index as an increase in lending. The other problem with this data is that a far higher portion of applications are turned down now that a year ago. Even with these factors inflating the index, the four-week average for the purchase index was just 397.9. It had been over 500 at its peaks in 2005.



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