Interest Rate Roundup

Tuesday, June 05, 2007

Bernanke muses on the housing and subprime mortgage mess

Federal Reserve Board Chairman Ben Bernanke is speaking via satellite to the 2007 International Monetary Conference in Cape Town, South Africa conference this morning. Housing is a major focus of his address. Here are some pertinent comments, as well as his general comments on the economy:

* "The adjustment in the housing sector is still ongoing, and the slowdown in residential construction now appears likely to remain a drag on economic growth for somewhat longer than previously expected. Thus far, however, we have not seen major spillovers from housing onto other sectors of the economy."

* Bernanke notes that existing home sales are off by more than 10% from their mid-2005 peak, while sales of new homes have plunged 30%. And he confirmed the accuracy of my view, laid out several months ago (here's one and here's another), that the "bottom" was NOT yet in for housing. Specifically, he said that: "A leveling-off of sales late last year hinted at a possible stabilization of housing demand; however, once one smoothes through the monthly volatility of the data, more-recent readings indicate that demand weakened further, on net, over the first four months of this year."

* On construction, he had the following to say: "Homebuilders have responded to weak sales by curtailing construction. Single-family housing starts have declined by a third since early 2006, sufficient to subtract about 1 percentage point from real GDP growth over the past four quarters. Despite the drop in homebuilding, the inventory of unsold new homes has risen to more than seven months of sales, a level well above the average observed over the past decade. Accordingly, and as reflected in the continued downward trend in permits to build single-family homes, residential construction will likely remain subdued for a time, until further progress can be made in working down the backlog of unsold new homes."

* Bernanke also addressed the abandonmen ... er ... "loosening" of lending standards in the mortgage industry: "Some of the increased difficulties now being experienced by subprime borrowers are likely the result of an earlier loosening of underwriting standards, as evidenced by the pronounced rise in 2006 in 'early payment defaults'--defaults occurring within a few months of mortgage origination. All told, the rate of serious delinquencies for subprime mortgages with adjustable interest rates--corresponding to mortgages in the foreclosure process or with payments ninety or more days overdue--has risen to about 12 percent, roughly double the recent low seen in mid-2005."

* He said that subprime purchase originations peaked in late 2005 and have been falling sharply since then. He also notes that while subprime and Alt-A lending has dropped, it hasn't disappeared. But he added that "the tightening of terms and standards now in train may well lead to some further contraction in nonprime originations in the period ahead. We are also likely to see further increases in delinquencies and foreclosures this year and next as many subprime adjustable-rate loans face interest-rate resets."

* Bernanke also addressed inflation, saying that it remains "somewhat elevated" but that "we have also seen a gradual ebbing of core inflation." He claimed that shelter costs won't increase as quickly in the future, and that energy prices are still below last year's peak, despite recent increases. But he reiterated that "the risks to this forecast remain to the upside."

* Lastly, Bernanke addressed the ongoing efforts at the Fed and in Congress to better regulate and/or police the subprime lending industry. I have been studying this issue myself and hopefully will have some more details to share in the coming days and weeks.


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