Economic woes on the horizon
Source Louis Proyect
Date 07/11/30/15:35
Price tag in mortgage crisis is looking like real money
With effects reverberating throughout the economy, pressure grows for
the Fed to cut interest rates further. But that wouldn't necessarily
prevent a recession.

By Walter Hamilton and E. Scott Reckard
Los Angeles Times Staff Writers

November 30, 2007

THE MORTGAGE meltdown is taking a rising toll on the broader economy,
increasing pressure on the Federal Reserve to slash interest rates for a
third time next month in hopes of averting a recession.

Homeowners will see their property values sink by $1.2 trillion next
year, and 524,000 fewer jobs will be created -- both a result of the
trouble caused by loan defaults and rising foreclosures, according to a
report released this week for the U.S. Conference of Mayors.

The fallout is weakening consumer spending, and auto sales next year
will be their worst since 1998, according to the study by research firm
Global Insight.

Amid widening concern over a sharp economic downturn, Fed Chairman Ben
S. Bernanke suggested late Thursday that the central bank was prepared
to cut its benchmark interest rate when it meets Dec. 11.

"Needless to say, the Federal Reserve is following the evolution of
financial conditions carefully, with particular attention to the
question of how strains in financial markets might affect the broader
economy," Bernanke said in a speech to the Charlotte, N.C., Chamber of

"We at the Federal Reserve will have to remain exceptionally alert and
flexible as we continue to assess how best to promote sustainable
economic growth," he added.

Bernanke's comments echoed those of Fed Vice Chairman Donald L. Kohn a
day earlier, which helped trigger a strong Wall Street rally. Stocks
moved higher again Thursday, but some economists caution that the Fed's
powers are limited.

Cutting interest rates today wouldn't prevent a recession, because it
takes months for businesses and consumers to respond by increasing their
borrowing and spending, said Gary Schlossberg, senior economist at Wells
Capital Management in San Francisco.

"The Fed might mitigate the slowdown," Schlossberg said, "but at this
point if the economy is truly headed for a recession, it would be very
difficult for them to stave it off."

The Bush administration and major financial institutions are close to
agreeing on a plan that would temporarily freeze interest rates on
certain troubled sub-prime home loans, the Wall Street Journal reported
early today, citing sources familiar with the negotiations.

An agreement could reassure anxious investors and strapped homeowners as
interest rates on more than 2 million adjustable-rate mortgages are
scheduled to jump over the next two years, according to the report.

The mortgage meltdown began early this year, as home values leveled off
and adjustable-rate loans began resetting to higher rates. Many
borrowers found themselves unable to make payments or to refinance into
more-affordable loans.

The Wall Street banks that provided mortgage loan funding were among the
early casualties. Merrill Lynch & Co. reported a $7.9-billion loss, and
Citigroup Inc. says it could swallow up to $13 billion in red ink. All
told, Wall Street will take a $400-billion hit because of loan defaults,
according to one estimate. At least one analyst pegs the damage at
nearly $500 billion.

As big as those numbers are, however, they don't begin to cover the
broader damage to the economy from loans gone bad.

Real estate agents and loan officers are out of work, of course, but so
too are landscapers and swimming-pool contractors.

Retailers are feeling the pain too. As rising defaults and foreclosures
push home values down, homeowners are less willing to tap their equity
-- if they have any left -- to finance big-ticket purchases, such as new
cars and kitchen cabinets.

State and local governments will suffer, too, as revenue from sales and
property taxes slows or declines.

Trying to calculate the costs is nearly impossible, economists say, in
part because the crisis is still unfolding.

"We know the sub-prime mess is a wet blanket on the economy. But it's
next to impossible to come up with any precise estimates of the ultimate
job and housing-price impacts," said Ken Mayland, president of ClearView
Economics in Pepper Pike, Ohio.

Side effects

Tracey Williams doesn't need an economist to tell her that the mortgage
meltdown has its costs. The tips she earns as a bartender at Taleo
Mexican Grill in Irvine dropped by $200 to $300 a week after mortgage
lender New Century Financial Corp. collapsed in the spring.

"They were definitely big spenders," Williams said of the New Century
loan agents who once mobbed her bar after quitting time. "They had the
money, they were young, they were big drinkers and big tippers."

Rex Oliver also has seen the collateral damage from the home-loan crash.

Foreclosed homes dot street after street in the Riverside County town of
Murrieta, where Oliver is president of the Chamber of Commerce.

One mortgage business "just went poof" and closed without notice, Oliver
said. So did a pool and spa company that had recently opened a lavish
office to tend to its growing number of customers.

"When you buy a new home, typically it comes without landscaping and a
backyard, so you can make a pretty good living putting them in," Oliver
said. "But when no one is buying homes or fixing them up because no one
is lending money, it's a different situation."

Riverside County was a mecca for new home buyers, many of whom had shaky
credit and used high-cost sub-prime loans to buy their properties. Those
sub-prime loans are the ones most likely to go into foreclosure, as the
low-cost "teaser" rates expire and borrowers struggle to make higher

Although outlying areas such as Riverside County are taking the brunt of
the foreclosure hit, most homeowners will share in the pain, experts
say. As banks seize homes, they add more supply to an already
over-saturated market and push values down by dumping properties at
discount prices. "Sub-prime foreclosures will bring down home prices for
everyone," Goldman, Sachs & Co. said in a recent report.

Another problem: Lenders have tightened their standards, making it
harder for people without a strong credit history to qualify for loans,
which takes potential buyers out of the market.

From 1963 to 1994, sales of new single-family homes averaged 600,000 a
year, according to Goldman Sachs. But from 1995 to 2006, sales jumped to
almost 1 million a year as the U.S. home homeownership rate climbed from
64% to 69%.

The surge was attributable chiefly to the easing of lending standards,
primarily the ability of buyers to borrow 100% of a home's purchase
price, according to a report by the Federal Reserve Bank of Atlanta.

That trend is reversing as banks toughen their lending criteria. From
early 2005 to the middle of this year, homeownership declined from 69.3%
to 68.4%, according to Goldman Sachs.

Ray Constantian, a mortgage broker at Constant Funding in Lake Forest,
says he now struggles to secure loans for clients who would have had no
problem qualifying earlier in the year.

"A few months ago, it would have been a slam-dunk," he said. "Because of
the sub-prime mess, I don't have a good sub-prime product to offer."

The tighter lending market is also preventing some companies from
borrowing money to operate and expand their businesses.

The total amount of outstanding commercial paper -- a widely used form
of short-term loan -- has fallen almost 17% to $1.85 trillion since its
peak in late July before the credit crunch took hold, according to
Federal Reserve data.

That in turn is hurting the market for office and industrial properties.
Commercial real estate prices have fallen about 10% nationwide since summer.

"Rents have flattened out and people are taking a lot more time to
analyze their situations," said Los Angeles real estate broker Gary
Weiss of Madison Partners.

The number of leases being signed for space in office buildings in
Southern California has fallen sharply from the brisk pace of the first
half of the year, he added, and the usual burst of leasing between Labor
Day and Thanksgiving didn't occur.

The dreaded word

The big question for economists is whether all those factors will tilt
the U.S. into recession.

Growth, which was almost 3% last year, could sink to half that level
next year, said Jane Caron, an economist at Dwight Asset Management in
Burlington, Vt.

"Weakness emanating from the sub-prime sector of the housing market is a
significant head wind facing consumers, who are already struggling with
elevated gasoline and food prices and slowing income growth," Caron said.

Dean Baker, co-director of the Center for Economic and Policy Research
in Washington, said the slowdown already has translated into about $200
billion in lost income to American workers, or roughly $700 for everyone
in the country.

Citing the ripple effects from the mortgage meltdown and housing slump,
some economists are now considering the prospect of a recession.

Jan Hatzius, chief economist at Goldman Sachs, projects that total Wall
Street losses of $400 billion could prompt banks to slash their lending
by $2 trillion -- or about 7% of all outstanding consumer, mortgage and
business debt.

Such a big reduction in lending would at best turn economic growth "very
sluggish," Hatzius said in a report. At worst, the banks would pull in
their horns immediately, sinking the U.S. into a "substantial recession."

The economic uncertainty is one of the factors behind recent volatility
in the stock market.

On Monday, stocks plunged sharply on jitters over the financial system,
pushing the major blue-chip indexes into "correction" territory, meaning
a decline of at least 10% from their recent peaks.

Markets moved sharply higher Tuesday and Wednesday, and posted moderate
gains Thursday. Bernanke's comments, made late Thursday, could be a
factor in trading today.

Government officials fear that rising foreclosures could accelerate the
decline in home prices, leading to a vicious cycle of deeper losses for
borrowers, lenders and investors.

Sen. Charles E. Schumer (D-N.Y.), chairman of Congress' Joint Economic
Committee, accused the Bush administration of moving too slowly to
address the crisis.

"You only have to look as far as today's housing news to see that the
administration's response to big economic problems like the sub-prime
crisis has been too little, too late," Schumer said. "They always seem
to be a step behind in responding."

Times staff writers Andrea Chang, Maura Reynolds and Roger Vincent
contributed to this report.

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