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Easing of Jumbo Loan Crunch Key to Recovery in California
Looking a year or two down the road, California’s beleaguered home building industry should be settling back into normal growth patterns, analysts from the University of Southern California's Lusk Center for Real Estate told a PCBC audience in San Francisco last month.
In the meantime, builders in the state have just about seen the worst of the current downturn, the economists said, and barring any further major erosion of the capital markets or the economy, housing appears poised for recovery.
In general, they said they expected markets along the coast to revive faster than inland locations where the reverberations from the slump have been more pronounced.
The mortgage credit crunch has hit California’s high-priced housing markets particularly hard, the economists said, and the challenge is to get credit flowing again for jumbo loans, which are significantly less risky than their current pricing would suggest.
But rising gasoline prices could hold particularly negative consequences for more remote parts of the state that had seen a surge in development during the housing boom, they warned.
“The resilience of the U.S. economy and the financial markets is remarkable,” said Richard Green, the newly appointed director of the Lusk Center. “We have been through periods of pronounced turbulence in our financial markets only to see them return much more rapidly than people expected.”
While conceding a gloomy short-term outlook and a “tough” next couple of years for housing, Green said that he was bullish about the long-term outlook for the home building industry in California and confident about the strength of the state’s economy.
Previous periods of turbulence in the financial markets suggest that the amount of losses in mortgage securities stemming from last summer’s subprime mortgage meltdown has probably been overstated, he added.
Green said that those watching the housing market could get a good indication of how bad, or good, things are by making two statistical comparisons, neither of which is providing much encouragement at the present time.
Watching Interest Rate Spreads
To gauge the health of the credit markets, Green looked at the spread between LIBOR interest rates and the three-month Treasury yield. An indicator of a return to normalcy is a LIBOR rate about half a percentage point higher than the Treasury rate, he said. The spread has spiked above one percentage point in the aftermath of recent crises in the financial markets. While the spread was below 100 basis points shortly before his presentation, it was still far above 50 basis points, “so there is still a crisis in confidence,” he concluded.
A spread of 20 to 40 basis points between jumbo mortgage interest rates and rates on conforming 30-year fixed-rate mortgages is normal, Green said; the spread at Wells Fargo on June 20 was 156 basis points, he said.
On the same day, Citibank was charging a five percentage point premium for jumbo loans, with the implication that it was projecting a 5% default rate on prime jumbo loans with healthy downpayments, he said, which was an unreasonably negative expectation. And some other large banks won’t even quote a rate for jumbo mortgages, he added.
The lenders are not pricing these mortgages in line with market fundamentals, Green said. “We need to see these spreads decline for a return to normalcy,” and for that to happen Congress needs to permanently increase the loan ceilings for Fannie Mae, Freddie Mac and the Federal Housing Administration, he said. The loan limits were increased by the Administration’s stimulus bill this spring, but those higher amounts expire at the end of this year.
Changes in Consumer Behavior
One more problem especially pronounced in California is the price of gas, which is the highest in the country, he said. So much of the state’s residential settlement patterns have been driven by automobile traffic that the $2 increase in the cost of a gallon of gas over the last 18 months could have consequences for new development, he said.
Green estimates that each mile from “the center of convenience” equals a $3,000 to $4,000 erosion in the price of a home, which helps explain why home prices in urban cores are holding up better than those in the far-flung suburbs. “This is something to look at,” he said.
Raphael Bostic, a director of the Casden Real Estate Economic Forecast, said that his sense is that “things are changing” when it comes to consumers’ spending and commuting habits in the face of today’s rising gas prices.
“Consumers are thinking differently about how they live,” said Bostic, and that is translating into “changes in their preferences for housing,” including how it is configured and where it is located.
Bostic said that builders need to be on the lookout for where economic growth will occur and how it will be driven, and they need to watch for a shift in the financial markets and regulatory policy.
“It’s a problem for a transactional economy when creditors are not willing to lend,” he said, “but once the doors open, [financing] will come in like a flood.”
Taking an overview of the housing market, Bostic said that “the pain we’re feeling today” in California is the result of the tremendous run-up in prices that occurred during the boom.
“Although the overarching story is not positive, there is variation” across locations, he noted. “Decisions to purchase are driven by psychological factors. Economists don’t understand every facet of American consumers.”
With jumbo loans prices high above their historic average, there is a psychology at work in the financial markets that doesn’t make sense, Bostic added.
A Fast Slide in Home Sales
While California has seen sizable declines in home sales and prices before, the big difference is how quickly the slide has occurred during this downturn, said Delores Conway, who is also a director of the Casden Real Estate Economic Forecast.
Looking at price performance in Los Angeles County, it has taken only two years to see a roughly 20% decline today from a 2006 peak, compared to the six years from a peak in 1990 that it took to reach this level of decline, she said.
The gap between the cost of owning and renting, which widened significantly during the housing boom as home prices surged more rapidly than rents, has narrowed dramatically, Conway said, with a sharp and swift decline in home prices and a reduction in the monthly mortgage payment.
“We are moving toward convergence,” she said. “There is not a lot further to go,” and this is providing “a glimmer of hope that we won’t continue to see a sharp price decline.”
A major challenge for California is that “the secondary markets have dried up and it’s difficult for home owners to get loans,” Conway said. This is especially true for the high end of the market, with inventories of homes priced at $1 million and above mounting because of the difficulty of finding jumbo loans.
Job growth has been falling in the state and is now negative in Southern California, with unemployment more serious in Orange County, where the mortgage financing industry was concentrated, she said. The northern part of the state had already experienced job losses with the bursting of the dot.com bubble.
However, the state’s joblessness is now running only about half as high as it was in 1990, she said.
 Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2008 to 2009 Metro Forecast (free preview).
Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.
To learn more, visit www.HousingEconomics.com.
 Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
To help members navigate the uncharted waters of this slowdown, NAHB has compiled a comprehensive “Back to Basics” online toolkit — the best of the basics, the tried and true and the truly new. To access the toolkit, click here.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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