Joe Baker: Housing slump threatens global economy

Real estate and energy stocks slumped at year’s end leaving the market little changed. Those two industries accounted for some of the year’s biggest gains, according to

CNN reported new home sales skidded downward by 11 percent in November, the sharpest drop in more than 10 years. The retrenchment was greater than Wall Street economists had expected, and contrasted with record home sales in October. The last time new home sales dropped by 11 percent was in February 1995.

Bloomberg said D.R. Horton, Inc., led the homebuilders retreat, while Anadarko Petroleum Corporation dropped as natural-gas prices declined.

Robert Morris, chief investment officer at Lord Abbett & Co. of Jersey City, N.J., which oversees $101 billion in investments, told Bloomberg: “It’s not terribly surprising that we’re ending the year with a whimper. If you look at the market this year, only a couple groups really performed.”

The federal Census Bureau said the annual pace of new home sales slid to 1.25 million in November from a record high of 1.4 million in October, which was revised downward. Economists had forecasted sales would slow to 1.3 million annually.

The housing market has been cooling down in recent months as mortgage rates rise. Freddie Mac, the federal mortgage financing agency, said 30-year, fixed-rate mortgages averaged 6.33 percent in November, rising more than half a percentage point in two months to hit the highest level since July 2002.

New home sales are viewed as a leading indicator because sales of existing homes are based on closings, which normally take place one or two months after contracts are signed and mortgage rates are locked in. New home sales are based on contract signings, which can occur before construction starts.

Comstock Partners, a mutual fund management firm in New York City, said the National Association of Home Builders Housing Market Index, which covers more than 400 builders, is down sharply. The University of Michigan Survey reported the percentage of people who think this is a good time to buy a house has slipped from 75 to 57 percent in just a few months.

Additionally, the Housing Affordability Composite Index has hit its lowest level in 15 years. The NAHB said about 75 percent of the builders it surveyed encountered buyer resistance to current home prices, and many are offering concessions or incentives in an effort to reduce inventories of unsold houses.

Comstock said: “In our view, the situation is likely to get worse. The Fed recently offered a proposal for more restrictive lending standards, and requested comment from banks. The Fed and other national bank regulators are concerned that interest-only and other types of nontraditional mortgages pose risks to the financial system, and are proposing that the banks tighten lending standards.

“In a joint statement they said that ‘The agencies are concerned that these practices can present unique risks that institutions must appropriately manage. They are also concerned these products and practices are being offered to a wider spectrum of borrowers.’ The new lending guidelines are likely to become effective early next year, and will result in a reduction in the number of new mortgages being issued. In addition, the housing market will be adversely affected by Fed tightening and the high level of energy prices.”

Comstock said any substantial slowdown in the housing market will have strong adverse effects on the economy. A recent Federal Reserve staff study, co-written by Alan Greenspan, said “discretionary extraction of home equity accounts for about four-fifths of the rise in home equity mortgage debt.” The study also estimated about one-fourth to one-third of the mortgage equity withdrawals went to finance personal consumption costs. There are other estimates as high as 60 percent.

Greenspan said if mortgage rates rise and loan affordability further declines, then equity withdrawal will fade along with consumer spending and imports of consumer goods.

That means a sharp drop in home prices would have an adverse effect on the global economy as well. For the past few years, the global economy has been bound together by a tenuous balance in which rocketing U.S. home prices supported domestic consumer spending that drew imports and prompted ballooning trade deficits for the U.S. and big trade surpluses for the rest of the world. Most of that fat pile of dollars, as is well known, was invested in U.S. Treasury securities, making possible very low, long-term mortgage rates.

The question now is, how long can this arrangement survive?

From the Dec. 28, 2005-Jan. 3, 2006, issue

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