Although extensive fourth-quarter information on the financial state of US homeowners has yet to fully arrive, it has been clear for awhile that the most serious problems are concentrated in the market for adjustable rate mortgages (ARMs), and sub-prime ARMs specifically:
From a macro policy point of view, the largest concern is that problems in the housing market might spill over into consumer spending or, what in my opinion would be more troubling, financial markets, which provide the necessary support for both consumption and investment activity going forward.
Despite lower-than-expected retail sales in January, I think it hard to argue with Federal Reserve Chairman Ben Bernanke's assessment:
The principal source of the ongoing moderation has been a substantial cooling in the housing market, which has led to a marked slowdown in the pace of residential construction. However, the weakness in housing market activity and the slower appreciation of house prices do not seem to have spilled over to any significant extent to other sectors of the economy. Consumer spending has continued to expand at a solid rate, and the demand for labor has remained strong.
And of spillovers into the health of the financial sector? So far, so good, but this, from today's Wall Street Journal (page A4 in the print edition) is worth watching:
Efforts by major banks and Wall Street firms to unload bad U.S. housing loans are speeding up a shakeout in the subprime mortgage industry.
As more Americans fall behind on mortgage payments, Merrill Lynch & Co., J.P. Morgan Chase & Co., HSBC Holdings PLC and others are trying to force mortgage originators to buy back the same high-risk, high-return loans that the big banks eagerly bought in 2005 and 2006...
As more subprime lenders face losses or bankruptcy, big banks also face another problem: Many lent money to small firms like ResMae so that those firms could make more mortgage loans to borrowers. It isn't clear how much of these loans will be paid back to the banks. Wall Street firms also are increasing their own internal generation of subprime loans by acquiring smaller mortgage loan originators or processing companies.
In 2005 and 2006, banks such as HSBC and brokerage firms like Merrill Lynch went on a buying spree, snapping up subprime loans from typically small mortgage banks that had lent money to homebuyers. At the same time, many lenders were loosening their credit standards and making riskier loans.
That risk is getting its due attention now:
As I said, worth watching.
UPDATE: XP77 econ master Ken Sutton reminds me of this from Caroline Baum, appearing at Bloomberg earlier this week:
The issue isn't whether loans defined as risky carry risk; they do. The real question is whether the risk was priced correctly; whether rising delinquency rates on subprime loans, sometimes made without proper documentation, will spill over into the rest of the home-loan market; whether borrowers will default when teaser rates on adjustable-rate mortgages reset higher at a time when home prices are falling; and -- the big kahuna, the one that matters to the Federal Reserve -- whether any of the bad- loan problems will affect financial institutions' ability to lend.
In its January survey on bank lending practices, the Fed said that a net 15 percent of domestic banks reported tightening credit standards on residential mortgage loans over the past three months, the biggest net increase since the early 1990s. That was the last time banks were saddled with -- guess what? -- bad real-estate loans.
Still watching.