Falling Property Could Cost US$4t

Source : The Business Times, October 26, 2007

Financial firms could face aggregate losses of some US$400b says NYT

(NEW YORK) US real estate wealth is expected to fall anywhere from US$2 trillion to US$4 trillion when the total costs of the recent credit crunch are tallied, the New York Times reported yesterday, citing economists.

Household real estate wealth - the equity people own in their homes, rather than what they owe lenders - currently totals about US$21 trillion, according to the Federal Reserve.

And financial firms could face aggregate losses of some US$400 billion from expanding troubles related to the sub-prime mortgage market fallout, the paper said.

That is higher than the roughly US$240 billion in financial institution losses from the savings and loan crisis of the early 1990s, adjusted for inflation, the paper said.

The losses in real estate wealth, while large, are substantially less than what investors suffered in the stock market collapse earlier this decade, which erased more than US$7 trillion, or about 40 per cent of market value, the paper said.

However, the recent declines are likely to have a significant impact on consumer spending, since owners will not be able to cash out as much equity from their property, the paper said.

It said the economists' loss estimates for both real estate and financial firms are preliminary and could get much higher.

The Joint Economic Committee of Congress, in a report issued yesterday, predicted about two million foreclosures by the end of next year in homes purchased with sub-prime loans, the paper said.

That's much higher than the Bush Administration forecast in September of some 500,000 foreclosures, the paper said.

In recent years, the rise in real estate values has helped propel consumer spending, as homeowners refinanced mortgages and took out home equity loans.

'There weren't a lot of people living off their capital gains from stocks,' said Jane Caron, chief economic strategist at Dwight Asset Management. 'There were a lot of people using their home as a piggy bank.'

Of course, many people who bought their houses several years ago are still ahead financially, because the sharp run-up in home values is still far greater than the expected decline. Those who bought close to the peak stand to lose the most if they have to sell in the near future.

The Joint Economic Committee estimates that the loss of real estate wealth just from foreclosures on sub-prime loans will be about US$73 billion.

Another US$33 billion would be lost because foreclosed homes tend to drive down the prices of other houses in the neighbourhood.

Those figures include US$951 million in lost property tax revenue to state and local governments, which will also have to spend more on policing neighbourhoods with vacant homes.

The states most likely to be hard hit fall into two categories: those where prices had been rising fastest, like California and Florida, and Midwestern states with weak economies, like Michigan and Ohio, where people with low or moderate incomes made heavy use of sub-prime loans to become homeowners and consolidate debts.

Global Insight, a research firm, predicts that the national average for housing prices will drop 5 per cent over the next year and 10 per cent before mid-2009, for a total of about US$2 trillion.

Economists at Goldman Sachs have predicted prices will drop by 15 per cent, meaning an overall decline of more than US$3 trillion; other forecasters have said the decline could be 20 per cent or more.

Economists continue to update their predictions on how the loss of housing wealth might affect the overall economy.

Nigel Gault, chief domestic economist at Global Insight, said he assumes that consumers reduce their spending by about six US cents for every dollar of lost wealth.

If prices drop 5 per cent next year, that would mean a decline of US$60 billion in spending, all else being equal.

That would be a noticeable slowdown, but not enough to cause a recession. -- Reuters, NYT