Published March 14, 2007
The US housing market: A wild card
THE ongoing troubles of the second largest US sub-prime lender, New Century Financial, are but the latest tremor in the now-decidedly-wobbly US real estate market. And there may be many more to come. With over two dozen US sub-prime lenders (which lend to borrowers at the low end of the creditworthiness scale) having already gone under and several more in dire straits, questions are being raised as to whether the financial woes will spread, how far, and with what consequences.
The verdict from economists is mixed. Some suggest that with US unemployment still low and household balance sheets holding up, the problem is well contained. They add that, while some air has indeed come out of the housing bubble, with new home starts and new home sales now converging, the worst is over. The US Federal Reserve, too, is showing few signs of concern. In his testimony to the Senate Banking Committee on Feb 14, Fed chairman Ben Bernanke said that he didn't think the losses within the sub-prime sector have implications for the aggregate economy 'at this point'. Fed governor Susan Biers also said: 'We're watching for contagion, we haven't seen it.' But she did acknowledge that 'what we're seeing in this narrow (sub-prime) segment is the beginning of the wave.'
Others are less sanguine. For instance, UBS mortgage analyst David Liu has pointed to rising default rates for so-called Alt-A mortgages (where borrowers are more creditworthy than sub-prime, but less so than prime borrowers). It is widely noted that many of the questionable lending practices prevalent in the sub-prime sector (such as teaser-rate, and interest-only loans, and loans given without income verification) had spread to other sectors as well, so it's only a matter of time before serious problems start to show up outside the sub-prime segment.
There is evidence, too, that pain is being felt in the broader financial sector. Many big-name Wall Street firms, including Morgan Stanley, Merrill Lynch and Goldman Sachs have either invested in sub-prime lenders, lent to them or packaged and sold securities with sub-prime housing loans as the underlying asset. Many hedge funds, too, are reckoned to be exposed, as well as some money-centre banks. Most visibly, HSBC was, last month, forced to set aside more than US$10.5 billion to cover losses on its US sub-prime business. And across the banking industry, there has been a tightening of mortgage loan standards.
As to how much further the rot will spread, there remain many unanswered questions that will remain high on analysts' (and, no doubt, the Fed's) radar screens: how far up the housing value chain will the ripples be felt? Will there be a broader credit crunch? How will investment be affected? And above all, will US consumption demand take a major hit, given the extent of home equity-based borrowing? These questions are very relevant to Asian economies - many of which, like Singapore, are sensitive to movements in US economic growth and consumption. The wild card that is the US housing sector warrants close scrutiny, even from this distance.