The slow unwinding of the US housing crisis

The slow unwinding of the US housing crisis


IT is becoming increasingly evident that the US housing crisis – the root cause of the US economic slowdown and the turmoil in the financial markets – is getting worse by the day. Any hopes for an economic recovery and a restoration of market stability will turn on how this crisis unfolds, and how it is dealt with.


Recent statements and actions by US policymakers provide some clues of what is to come. In a widely reported address to American community bankers on Tuesday, US Federal Reserve chairman Ben Bernanke drew attention to rising delinquency rates on mortgages (and not only the sub-prime variety) and the likely persistence of this trend. Foreclosures too will rise, he said, as house prices decline further and interest rate resets on mortgages take effect.


Suggesting that ‘this situation calls for a vigorous response’, Mr Bernanke stressed the urgency of reducing ‘preventable foreclosures’. And then he dropped what many view as a bombshell: he asked for banks to not only provide interest rate relief to borrowers, but also to write down principal in some cases – in other words, to forgive part of the mortgage loans. If not, there would be a stronger incentive to default among homeowners who are in negative equity on their mortgages. And that, in turn, would accelerate the decline in housing prices and make things even worse for already beleaguered mortgage lenders.


A day earlier, US Treasury Secretary Henry Paulson – who also acknowledged that housing ‘poses the biggest downside risk’ to the economy – urged homeowners (including those ‘underwater’ on their mortgages) to continue servicing their loans, if possible. While this might not be a wholly realistic suggestion, it underlines US officials’ anxiety to stave off foreclosures.


Whether such exhortations will succeed, however, is moot. Bankers are generally loath to take ‘haircuts’ on loans except as the very last resort; and one can hardly count on most homeowners in negative equity being content to continue servicing huge mortgages when they’re better off walking away and handing their house keys to the bank.


Absent such voluntary market-based solutions, there would appear to be a strong case for government intervention. Mr Paulson and other lawmakers have publicly maintained that they oppose any bailouts. However, at the same time, the scope and mandate given to US government agencies such as the Federal Housing Administration, Fannie Mae and Freddie Mac to guarantee or take over mortgages have been significantly expanded. US lawmakers are also examining bolder options. It is probably inevitable that some of these will involve an element of bailout, even if politicians are reluctant to admit as much. However, whether bailouts are involved or not, US policymakers need to address the US housing market bust urgently, despite the distractions of an election year. For it is now obvious that there is a systemic risk facing the US financial system – and that market mechanisms alone cannot deal with it.


Source: Business Times

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