My Two Cents

With Real Estate, Watch the Unemployment Rate

Chris Farrell Aug 26, 2007

The housing market is nowhere near bottom. The Wall Street Journal had a good story on the meltdown in the condominium market on Saturday.

For the nation’s real-estate lenders, the other shoe may be about to drop: condominiums.

Already plagued by rising home-loan defaults and foreclosures among overstretched consumers, major markets across the country — including parts of Florida, California and Washington, D.C. — are seeing rising foreclosures and bankruptcies of entire condo projects

Today, the New York Times had a story predicting that median home prices would drop for the first time since the government started collecting price data in the 1950s.

Economists say the decline, which could be foreshadowed in a widely followed government price index to be released this week, will probably be modest — from 1 percent to 2 percent — but could continue in 2008 and 2009.

And Martin Fridson, a superb Wall Street analyst and publisher of the Leverage World newsletter, has some ominous thoughts about the upcoming adjustable rate mortgage reset.

Under the direst ARM-reset scenarios, a flood of homeowners who took out mortgages with low, “teaser” interest rates will be forced to sell their homes when their monthly payments reset higher. Because more people stretched to buy homes as the housing market peaked in late 2005, some expect the ARM risk to be most acute this autumn, when the loans trip their two-year reset provisions.

About $800 billion of ARMs are scheduled to reset over the next couple years, including almost $200 billion in the remaining months this year, according to one frequently cited Wall Street estimate. At least one industry source pegs a higher number, almost $1.5 trillion for the calendar year 2007. Whatever the number may be… have the potential to pinch household wealth and weaken consumer spending, which would have negative ramifications for the U.S. economy and the high yield market as a whole.

That’s bad enough. But a parting thought from a conversation with Chris Thornberg, founding partner of Los Angeles-based Beacon Economics, emphasized just how long it will take for the housing market to emerge from its financial woes.

The broader, contextual problem for the real estate market is that home prices are still too high compared with income levels, Thornberg opined. For instance, the average home price in Los Angeles County was recently about 11.1x the average annual income in the area, up almost threefold from a 4.1x ratio at the turn of the decade. Such levels are not sustainable, he said.

They are especially not sustainable if the unemployment rate rises from it current 4.6%. If the unemployment rate goes higher, the housing markets spirals lower.

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