March 22, 2007 / 1:26 PM / 12 years ago

U.S. housing, mortgage woes contagion feared

WASHINGTON (Reuters) - For months as the U.S. housing market unraveled, the Bush administration, the Federal Reserve, and most economists maintained the decline did not risk hitting the economy at large, but economists are growing increasingly concerned the broad economy may take a hit.

An abrupt exodus of more than two dozen so-called subprime lenders from the market has heightened fears other lenders may soon start choking off credit to businesses and consumers.

Economists, and the Bush administration, agree falling house prices and rising defaults by borrowers with poor credit in the subprime mortgage market may mean slower U.S. economic growth this year.

“We know that the housing market will have an impact on GDP over the next six months,” Edward Lazear, chairman of the White House Council of Economic Advisers, said this week.

When asked how subprime mortgage market troubles would weigh on the economy, Lazear said the banking sector was still strong, but delinquencies are high and lenders, even outside of the subprime market, have begun to tighten up credit.

“It’s clearly going to increase the cost of capital and on the margin its going to be less conducive of capital spending,” said Richard DeKaser, chief economist at National City Corp. in Cleveland.

According to the Mortgage Bankers Association’s most recent data, the proportion of mortgages in the initial stages of foreclosure during the fourth quarter of last year hit its highest in the 37-year history of the association’s survey.

In addition, commercial banks have tightened their lending standards. According to the Federal Reserve’s most recent Senior Loan Officers Survey released last month, which covered lending business at the end of last year, domestic banks reported tightening standards on all residential mortgages, the highest net fraction seen since the early 1990s.

“The extent of the tightening of credit conditions for borrowers has yet to be fully clarified, and bears continual monitoring,” Citigroup economist Steven Wieting wrote in a report this week.

About 45 percent of bank loan officers in the Fed survey said they expect a deterioration in the quality of the loans they make, ranging from loans for business investment to commercial real estate loans.


“The ball is in the court of businesses. If the corporate sector feels that this will lead to a consumer (spending) slowdown, then they will pull back on investing,” predicts Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University.

Dhawan is among a growing group of economists who say the Fed should start lowering interest rates soon to buffer the economy.

“That risk is definitely there,” he said of the possibility that stress in the subprime mortgage market would spread. “The Fed needs to now start cutting rates in late spring and early summer.”

The central bank on Wednesday held rates steady, but in its statement softened its bias in favor of further rate increases, leading U.S bond yields to fall and stocks to rise.

“Recent indicators have been mixed and the adjustment in the housing sector is ongoing,” the Fed’s policy-setting committee said.

Earlier this week, the chief investment officer at the biggest U.S. pension fund said subprime mortgage lending, sounded an alarm.

The subprime sector “is an important weakness in the economy and it is likely that there will be a measured impact in other sectors,” said Russell Read of CalPERS, which invests about $232 billion for California state workers. “There is likely to be some contagion.”

Falling home prices and higher mortgage payments also pose a constraint on the currently tight U.S. labor market, according to John Challenger of the Chicago-based employment outplacement firm Challenger Gray and Christmas.

“Employers have been in a position of needing to find people, but they may find the candidate unwilling or unable to sell a home,” he said, warning that without the ability to relocate for a job, consumers may be forced to cut spending.

“The economy needs labor flexibility, these mortgages lock people into a very particular spot,” Challenger warned.

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