- The Washington Times - Wednesday, September 13, 2006

Homeowners face a long period of stagnation in housing sales and prices — perhaps as long as a decade — in the aftermath of the five-year housing boom that doubled or tripled home prices in Washington and other coastal cities, federal officials testified yesterday.

In addition, the proliferation of risky mortgages with payments that balloon in the out years raises the possibility that the housing bust will result in serious economic dislocation, officials told the Senate Banking, Housing and Urban Affairs Committee.

“Periods of stagnation can be painful for homeowners, real estate investors and others who make their living in real estate,” said Richard Brown, chief economist for the Federal Deposit Insurance Corp., which insures banks holding trillions of dollars of mortgages made in the housing boom and whose financial health also rests on the stability of the housing market.

“In places like metropolitan New York, where prices fell by 9 percent between 1988 and 1991, or Washington, D.C., where home prices stayed essentially unchanged between 1990 and 1995, many can still recall the difficulties and disappointments they experienced trying to sell properties,” Mr. Brown said.

Still, the frustrations caused by housing stagnation are small compared with the “severe” financial and economic consequences of a pronounced fall in home prices, Mr. Brown said.

That more dire scenario — which could lead to widespread defaults, foreclosures, bank failures and recession — might occur if the backloaded mortgages that millions of buyers took out to purchase or refinance homes turn out to be time bombs that force homeowners to sell at a loss or go into default, he said.

The FDIC judges the risk of widespread foreclosures, while small, to be one of the principal dangers to the economy and banking system.

Foreclosures have been on the rise this year. RealtyTrac, an online marketplace for foreclosed properties, yesterday reported that foreclosures jumped to 115,292 in August, 24 percent higher than July and 53 percent higher than a year ago.

Financial analysts say that economic distress, such as the loss of a job or a disabling medical problem, was the primary cause of foreclosures in the past. But the recent rash of foreclosures has been tied more to the spread of backloaded mortgages given to homeowners who cannot handle monthly payments that suddenly double in size.

Mr. Brown noted that lenders and homeowners alike have had little experience with such “exotic” loans, although about 10 percent of mortgages taken out in 2004 and 2005 included risky features like interest-only payments for the first several years or payments so low initially that the amount of principal owed actually increases rather than decreases each month.

Buyers who flocked to the housing market in recent years often took out these loans while making little or no down payment — often with the expectation they could quickly sell or refinance when their loans adjusted upward. Their options may be limited, however, in a stagnant housing market.

With home-price inflation far outstripping income growth in recent years, “borrowers who took on nontraditional loans as a means to afford a more expensive home may be particularly vulnerable,” Mr. Brown said.

Patrick Lawler, chief economist of the Office of Federal Housing Enterprise Oversight, said that while nominal house prices have never fallen in the United States, as measured by his agency’s home price index, they have dropped after adjustment for inflation during long periods of stagnation.

Inflation adjusted prices fell by 11 percent in the early 1980s and took eight years to attain their earlier peak, he said, while they fell by 9 percent in the early 1990s and took almost a decade to recover.

“Certainly a similar event is quite possible now,” he said.

In any case, a prolonged stagnation of prices is likely because prices in many areas vaulted well beyond what average households could afford, he said.

Both federal officials said the recent housing boom eclipsed all previous booms in significant ways — which is why many have dubbed it a housing “bubble.” In addition to the introduction of risky and untested mortgage products, the magnitude of the price increases and the number of local real estate markets that participated in the boom were unprecedented, said Mr. Brown.

While outright declines in home prices in the past primarily occurred in distressed areas where people lost jobs, Mr. Lawler said the “exceptional size” of the price increases during the 2000-2005 boom may lead to drops in prices even without a local recession — simply if interest rates go higher or the investment climate sours.

“In the long run, I expect housing markets to perform well, especially if immigration continues at recent rates,” he said. “An important caveat, though, is that healthy housing markets could soften seriously from an unexpected disruption in the ability of Fannie Mae and Freddie Mac to function effectively in secondary mortgage markets.”

The housing agency is the overseer of the two government-sponsored enterprises, which repackage mortgages for sale to investors.

David F. Sieders, chief economist with the National Association of Homebuilders, said he expects a shorter retrenchment in the housing market, lasting about two years through 2007.

He said the rush of home sales and price gains during 2004 and 2005 was particularly unsustainable and resulted in this year’s nose dive in home-building activity, which has been a drag on economic growth.

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