Housing Woes A Recession Catalyst?

Still More Foreclosures, Falling Home Prices And Sales Expected In 2008

(AP) 
Both Moody's and Banc of America Securities forecast home prices will tumble 15 percent from peak to bottom, accounting for nonprice discounts like upgraded kitchens or new swimming pools. Some worst-case scenarios don't have home prices picking up until as late as 2012. Prices this year have dropped between 0.4 percent to 5.7 percent nationwide, depending on the measure.

Adding more pressure to pricing is the ballooning supply of unsold homes, even as builders curb new construction. Right now, inventories are at the highest levels since the post-World War II period and surging foreclosures from resetting interest rates on certain mortgages will contribute more supply.

Defaults and foreclosures have skyrocketed this year as subprime borrowers struggled with too-high payments and resetting interest rates. Banc of America Securities estimates that $361 billion in subprime loans are scheduled to reset next year, and falling home prices and tighter lending standards will keep these borrowers from refinancing into more manageable loans.

The dismal performance of these loans has clobbered Wall Street, which has reined in the capital it invests in the credit markets. Investors buy mortgage-backed securities from lenders, who, in turn, use that money to fund new home loans. Without investor capital, mortgage originations will stay low, costing lenders millions of dollars in business.

Meanwhile, assets backed by home loans are rapidly falling in value as foreclosures rise. Financial institutions that hold these assets are taking larger-than-expected hits as they write down their values. So far this year, foreign and U.S. financial institutions racked up an unexpected $100 billion in credit-related charges.

"We need to stop having so many negative surprises about the balance sheets of large financial institutions. It just heightens people's anxiety about what will happen next," said Doug Elmendorf, an economist at the Brookings Institution.

Yet, bigger write-downs are expected. Goldman Sachs expects more than $100 billion in bank write-offs on the horizon, while Moody's estimates a total loss of $275 billion to investors.

"Under some dark scenarios, these write-downs could spook investors and revive the turmoil in the credit markets, resulting in a broader credit squeeze," said Mark Zandi, chief economist at Moody's Economy.com. "This is likely if a commercial bank took a major write-down that resulted in its insolvency or put it very close."

Lenders and homebuilders are also at risk of bankruptcy if market conditions worsen. This year saw the demise of dozens of subprime lenders, while the credit squeeze punished the remaining mortgage lenders. At the same time, the large, national homebuilders booked record losses, while smaller, private builders shuttered their operations.