Too Much Fed Tightening Could Jar Soft Housing Landing 
With boom times starting to fade, the nation’s housing industry appears headed for a soft landing, but the Federal Reserve could inject some unexpected turbulence into the unwinding process now underway if it becomes overly aggressive in its inflation fighting efforts, according to panelists participating in a July 11 NAHB teleconference on the mid-year economic outlook. NAHB Chief Economist David Seiders said that he has alerted the Fed to the downside risks for housing if interest rates are pushed up too far. The Fed’s mission of clamping down on inflation before it gets out of control is already having results, he said, with growth of the Gross Domestic Product slowing in the second quarter and the unemployment rate stabilizing and poised to inch upward in the period ahead. Ironically, by helping to slow home buying demand the Fed’s policies have created upward pressure on market rents and that is driving up the “owners’ equivalent rent" components of the core inflation measures the central bank has been watching hawkishly. With the federal funds rate now at a “slightly restrictive” 5.25%, Seiders said, “our hope and expectation is that the Fed has gone far enough and will stop here and eventually feel the need to ease back a bit to 5% by the end of next year,” when core inflation most likely will be receding “a bit.” For the time being, at least, Seiders said that interest rates for both fixed- and adjustable-rate home mortgages “look remarkably peaceful” and won’t move up much further. David Berson, chief economist for Fannie Mae, said that he expected one more round of Fed tightening this year, bringing the federal funds rate to 5.5%. Then, if economic growth remains subpar, there could be some easing in 2007, he said. However, he also noted that there is a near-term risk of more Fed tightening. If the Fed is at or near the end of its interest rate hikes, then interest rates on fixed-rate mortgages should remain below 7% by the end of this year, and average 6.8% this year and next, he said. Berson also noted that mortgage rates remain at relatively low levels and even if they do rise to 7%, as some are predicting, “the difference between 6.8% and 7% will only affect affordability modestly.” Berson said that he expects economic growth to fall a bit below the 3.5% trend line for the balance of this year and 2007. New home sales should decline 9% to 10% this year, he said, primarily because investors are abandoning the hot markets on the East and West coasts. Home price appreciation is headed down this year, Berson said, and he expects to see it slow to an annual rate of 3% from the fourth quarter of 2005 to the fourth quarter of last year, which would move it down to an inflation-adjusted rate of increase of about 1%. Seiders said he is expecting to see real increases in home prices slow to a 2% annual pace by late next year, down from about 10% at their peak in last year’s third quarter, but he foresees no “national house price decline despite complications in certain markets.” “There is a risk over the next year or two that we could see real home price declines,” said Berson, “but it would be a stretch to get there.” Families Face Higher Loan Payments While rising mortgage interest rates are less of a problem for home buyers than high prices, Frank Nothaft, chief economist for Freddie Mac, said that higher financing costs will have repercussions for home owners with adjustable-rate mortgages that are being reset. “There will be a significant number of families making higher loan payments,” Nothaft said. About $500 billion in first lien ARMs will reset this year, he said, which is roughly 6% of all outstanding mortgage debt on single-family homes, and the amount will approach $690 billion in 2007. Factoring in home equity lines of credit and second liens, there will be repricing on $1.2 trillion of single-family mortgage debt this year, or 15% of the total $9 trillion outstanding. Whether higher loan payments for existing home owners turn problematic depends greatly on individual family circumstances, Nothaft said. Two-thirds of delinquencies stem from “something unforeseen and unfortunate,” he said, such as unemployment or a death or illness in the family. Markets in localities that are experiencing recessions have the highest default rates, and areas of the country fitting that description are currently limited to parts of Michigan, Iowa, Ohio and Pennsylvania, he said. The volume of single-family mortgage originations will decline 12% this year, Nothaft said, almost entirely because of a decline in refinancing. From a 50% share of originations in previous years, when the amount of lending set records, refinancings slipped to a share in the mid-40% range during the first quarter of this year; have dipped to about a 40% share now; and are headed down to about 30% by the end of this year, he said. During this year’s first half, 90% of home owners refinancing their mortgages took cash out, he said, compared to only 20% in 2003. And although levels of cash-out home equity extraction will be “solid” this year, it will be less than in 2005, “reducing the impetus to consumer spending.” Single-family mortgage debt is well protected in relation to the total value of the housing stock, he pointed out, with home owners having $11.4 trillion in equity on housing worth a total of $20.4 trillion. | 
