By Dean Baker
The decline in mortgage applications shows that the problem is not the credit crunch.
The National Association of Realtors’ pending home sales index fell 4.6 percent for the country as a whole in September. However, this decline was dampened by a 3.7 percent increase in the West. Sales fell by 0.7 percent in the Midwest, 7.9 percent in the South, and 16.8 percent in the Northeast. September sales in the Northeast were the lowest on record for this index, which only dates back to 2001.
The increase in sales in the West is almost certainly due to a jump in distress sales, with banks anxious to offload their backlogs of foreclosed homes. Zillow.com reported that foreclosures accounted for 18.6 percent of all sales over the last year. Clearly, the percentage would be much higher in the last few months and also in states like California that were at the center of the housing bubble. It would not be surprising if distress sales lead to further increases in sales in some of the former bubble markets over the next few months, albeit with sharp decline in prices.
The new plans for workouts announced in the last week by Citibank, J.P. Morgan, Fannie Mae and Freddie Mac provide hope that more efforts will be made to allow homeowners to stay in their homes. In many cases, workouts will likely prove to be the most profitable routes for the lenders, also. They will inevitably take large losses when they get possession through foreclosure of another home in an already glutted market.
As always, everything will depend on the details. In the case of Fannie Mae and Freddie Mac, the details released thus far do not sound encouraging. The relief appears to center on lowering interest payments and dragging out the terms of the loan, in some cases to 40 years. Homeowners will still be left paying 38 percent of their income for mortgage costs.
This ignores the reality of homeownership in the United States. The median period of ownership is just over 5 years. Many of the people helped by this program will be looking to sell their home in two or three years and will still be hugely underwater. This means that they will still end up with no equity and a big strike on their credit record. In the meantime, they may have struggled with a mortgage payment that is far more than the rent that they would have paid for a comparable unit. Having people throw good money after bad is not helping them.
Any serious housing program must distinguish between markets and look to different solutions for the still-deflating bubble markets and the markets which either did not have a bubble or have already seen it deflate. For whatever reason, most people in Washington, DC, still do not want to acknowledge the housing bubble.
There is considerable effort by many analysts to blame the current downturn on a credit crunch, implying that if we could somehow fix the financial sector, then the economy would be back on its feet. While the troubles in the financial sector are certainly exacerbating the economy’s problems, the main cause of the downturn is the loss of more than $5 trillion in housing wealth, coupled with a loss of an even larger amount of stock wealth over the last year. The disappearance of so much wealth is the main reason that the economy is crashing, not difficulties that individuals and businesses face getting credit.
One measure that demonstrates this fact clearly is the sharp decline in the mortgage applications index over the last couple of months. Mortgage applications are down by roughly a third from their year-ago level. If people with good credit were being turned down, we would expect the number of applications to be rising, as they apply to several banks before finally finding one that will issue a loan.
The fact that applications are actually declining by as much as sales is solid evidence that the problem is not that otherwise creditworthy borrowers can’t get loans. The problem is that people are not creditworthy.
For more analysis on the prospects of equity accrual over the next four years, please click here.
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