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THE MORTGAGE MELTDOWN

Home equity could buoy the economy

Borrowers who have built up stakes could help keep the U.S. out of recession, experts say.

March 21, 2007|Molly Hennessy-Fiske | Times Staff Writer

Steve Nguyen bought his first home, a three-bedroom ranch house in Lakewood, three years ago with a no-interest sub-prime mortgage. Since then, the sub-prime market has virtually collapsed, leaving many nervous about the housing market and the national economy.

But Nguyen, 31, is feeling confident. Though he figures his home's value fell at least $40,000 during the last year, he gained $200,000 in equity during the five-year boom. Thanks to that equity and his earnings as a project manager at UnitedHealthcare, he's qualified for a conventional 30-year fixed-rate mortgage on a $750,000 house he hopes to move to in Orange County after he sells his current home.

"It's at a good state right now," Nguyen said of the housing market. "It didn't completely crash on me."

Analysts say the U.S. economy won't completely crash either as a result of the sub-prime mortgage meltdown, thanks in part to homeowners like Nguyen. Their home equity built up during the boom is among several factors that could support consumer spending and the housing market.

Many other sub-prime borrowers aren't as fortunate as Nguyen and are expected to lose their homes, unable to make mortgage payments. But they are not a big enough part of the overall housing market to harm the entire sector, experts say.

So although failing sub-prime mortgages are likely to slow consumer spending and overall economic growth, they aren't expected to provoke a broader credit crunch or tip the economy into recession -- barring severe disruptions, many analysts say.

"Housing has always sort of been the canary in the coal mine for the economy -- it tends to turn down before the rest of the economy. If you were just looking at this indicator, you would say recession is here, but I think there's enough offsets and optimism to keep the economy out of recession," said Dirk Van Dijk, director of research at Chicago-based Zacks Equity Research.

Among those offsets are relatively low interest and mortgage rates. Although the Federal Reserve is expected to keep its benchmark short-term interest rate unchanged today, it could signal that it is concerned about the slowing economy and housing woes, some economists say. That could lead the way for the central bank to lower rates later this year, which could help ease the housing slump.

Another stabilizing economic force is the job market, with a relatively low unemployment rate of 4.5% nationally last month and 4.8% in California. Although housing-related jobs in construction, carpentry and plumbing have suffered, growth in the service sector offset those losses, and the economy added 97,000 jobs last month.

Wage growth is also steady, with inflation-adjusted average hourly earnings up 0.4% last month and average weekly earnings up 3.8% for the year.

"You've got rising jobs and wages offsetting the fact that people aren't going to be able to take out as much debt. This is probably good in the long run," Van Dijk said.

Many homeowners like Nguyen also became wealthier with the run-up of the housing market, borrowing against their homes and refinancing their mortgages to fuel spending.

Homeowners cashed out $640 billion in home equity last year, according to David Wyss, chief economist at Standard & Poor's. The average home has been selling at 3.2 times average household income, higher than the historic average of 2.6 times, although it is much higher in formerly hot markets such as San Diego, where the figure was 14, Wyss said.

As home prices fall this year, the national figure will drop to 2.8, Wyss said, reducing consumer spending. But Wyss expects the spending slowdown to cut economic growth only about 1 percentage point, down from 2.2% last quarter and an average 3.3% last year.

Other analysts predict even smaller declines in spending and growth. John Silvia, chief economist at Wachovia Bank, says that even if growth in consumer spending slows to 1% this year from 3.2% last year, overall economic growth will fall only 0.2 to 0.3 percentage points.

One of the biggest concerns is that the sub-prime meltdown will result in a surge of foreclosures that in turn will sink home prices and trigger a housing-led recession.

But sub-prime foreclosures will be only a small percentage of total foreclosures and thus "will not break the national economy or the mortgage lending industry as a whole," said Christopher Cagan, director of research at First America CoreLogic, a Santa Ana-based real estate analysis firm.

Failed sub-prime mortgages issued from 2004 to 2006 are expected to lead to 1.1 million foreclosures during the next six or seven years if home prices remain stable, according to a study Cagan released last week.

If average home prices rise 10%, foreclosures would rise by 800,000, the study found. Each 1% fall in national prices would result in an additional 70,000 foreclosures.

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