Further US Housing Price Declines In The Cards

US house price falls would wreak more havoc for banks
By Gillian Tett
Published: July 10 2009 03:00 | Last updated: July 10 2009 03:00
A couple of weeks ago I visited West Virginia, USA, where some friends of mine run a small real estate business. As we sat in their yard on a balmy summer evening, I heard how realtors in this pretty, small town had been devastated by the housing crash.

So far my own friends have dodged the worst with canny financial footwork. And they cheerfully insist that the town can survive the wider damage, as long as prices stabilise or rise. "But if prices fall further, it will be terrible," one realtor declared - before insisting "we really don't think that's likely. Nothing can keep going down for that long."

Is that assumption justified? That is the $6,000bn dollar question, not just for West Virginia, but the wider financial system. After all, it was a turn in the US real estate market that triggered the financial crisis. And while many other financial disasters have since followed, the state of the US real estate market remains crucial to the banking world as a whole.

For not only does the health of the US consumer - and thus economy - remain tied to housing, but western bank balance sheets are tightly tangled up with property too. Most notably, America's largest banks, such as Bank of America, JPMorgan and Citi, continue to hold vast quantities of residential and commercial property loans on their books, in addition to all those loans that they previously repackaged as bonds, and sold on. So do numerous small banks.

And while the prices of mortgage-linked bonds have already slumped to reflect house price falls, the value of many tangible loans have not been fully marked down, because they are lodged in hold-to-maturity books - and the banks do not believe that prices will continue to fall. Indeed, in the town that I visited in West Virginia, some local bankers are refusing to sell foreclosed properties, because they think prices will soon rise. Thus, if prices fall instead, it can only mean one thing: yet more bank pain.

So will US property prices stabilise? Not if you believe a startling presentation I saw this week from a large, global financial group. This particular bunch of analysts - who have done a remarkably good job at predicting the credit crisis during the past four years - are currently warning their clients to expect a peak-to-trough fall in US residential prices of more than 40 per cent in this cycle.

The good news is that in some US regions, prices have already fallen so sharply - often by more 30 per cent - that property is already very affordable, relative to incomes and on a historical basis.

But the bad news is that houses are not yet cheap enough to prevent more price falls. On the contrary, this particular team of analysts thinks that when the problems of excess house inventory and rising unemployment are added into the model, average US house prices will still fall by another 14 per cent in the next few years - on top of the declines seen so far.

That headline figure conceals some startling regional discrepancies. Colorado is reckoned to be through the worst. In New York, though, the pain has barely started. Prices there are projected to decline by another 30 per cent or so. Taken as a whole, these projections imply that about 25m households in America end up in negative equity.

This projection is gloomier than those made by the US government and many large US banks. But the 25m number is currently being echoed by other investment groups, such as Pimco. If it turns out to be correct, it raises two crucial questions. One is the degree to which the western banking system could face a secondary round of real estate losses (particularly as these analysts are even more alarmed about the commercial real estate outlook than the residential sector).

But the second fascinating question is what further house price falls might do to consumer psychology. America has never experienced negative equity on this scale before. Thus nobody is entirely sure how households might respond. Will they default en masse? Will voters become so angry that they demand more populist public bail-outs of the housing sector (or financial reform)? Will consumers cut spending further?

Or will households instead act like my friends in West Virginia - namely shrug their shoulders and display that all-American sense of optimism and resilience, and just assume that somehow things will work out in the end, or that President Obama will ride to the rescue somehow?

Frankly, I am unsure. But it is clear it will be difficult for the Obama administration to stave off any looming price falls, given the variegated nature of the mortgage market and rising debt. That, in turn, leaves me feeling it is too early to believe "green shoots" could presage a full blown recovery anytime soon - either in the verdant pastures of West Virginia, or anywhere else linked to the US mortgage world.

gillian.tett@ft.com

Copyright The Financial Times Limited 2009

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