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Dire situation in U.S.
Nov 30, 2007

It’s not a pleasant time to be a homeowner in the United States. 

U.S. home prices are taking a dramatic tumble — 4.5 per cent annually — and foreclosures are becoming a regular occurrence. It is reported that there will be at least two-million foreclosures in the coming months, although other economists warn that this is a conservative estimate.

With all the bad news, American consumers are at their lowest level of confidence in years. The U.S. Conference Board reported earlier in the week that the consumer confidence index fell 7.8 points in November to 87.3, a 22 per cent decline from July.

A lack of consumer confidence is not good news since consumers are responsible for 70 per cent of the U.S. economy. American retailers fear that confidence is so low that consumers are about to turn into penny-pinching Scrooges and avoid stores during the Christmas season.

For the first time in months, economists are mentioning the “recession” word with greater frequency. Goldman Sachs reported that they have raised the likelihood of a recession next year in the U.S. from 30 per cent to 45 per cent.

While there seems to be little consensus about what constitutes a recession, the standard newspaper definition of a recession is a decline in the Gross Domestic Product (GDP) for two or more consecutive quarters.

 As reported on the front page of this week’s WREN, the collapse of the U.S. housing market was the main topic during a meeting of the U.S. Conference of Mayors in Detroit. A report released by the mayors during the meeting projected a property value decline of $1.2 trillion (the same amount in either US or CDN dollars) in 2008.

Canada’s GDP — the value of goods and services produced by a country — provides an interesting comparison when discussing the report by the U.S. mayors. If the decline in property values is $1.2 trillion, it will equal the annual GDP for all of Canada. Losing the entire economic value of the goods and services for an entire country shows just how dramatic the housing market decline has been in the U.S.

No wonder the mayors are worried that consumer spending will drop, property revenues will diminish and economic growth will be adversely affected. The U.S. has been in a deep economic decline during the Bush years and the housing market collapse exacerbates an already dire situation.

A comment by John Tuccillo, a former chief economist for the Washington-based Association of American REALTORS® perhaps offers the best summation of what has happened in the U.S., when he said, “The system stinks ...”

The system referred to by Tuccillo is the proliferation of mortgage loans to high-risk home buyers — the so-called sub-prime mortgage market.

Essentially, the sub-prime mortgage market had relied upon steadily rising home prices. When home prices began to drop under concern about the liability of such mortgages and rising interest rates, lenders and home buyers were basically in the same boat —  the victims ranged from the little guy to big financial institutions, some of which have declared bankruptcy.

Many of the companies making sub-prime loans were selling the loans to other companies — hedge and pension funds — and as more and more consumers defaulted on their loans, a credit crunch was initiated. Because lenders began demanding higher credit terms which in turn slowed purchases, this is now slowing the economy and hurting the stock of companies involved in the home market, including renovators, home builders, furniture retailers, etc.

In March 2007, one of every eight sub-prime loans was in default. This is a significant figure since just over one-fifth  all mortgage loans in the U.S. were of the sub-prime variety.

“The wave of foreclosures that has rippled across the U.S. had already battered some of our largest financial institutions, created ghost towns of once-vibrant neighbourhoods — and it’s not over yet,” according to the report by the U.S. mayors.

Many Americans unable to make their mortgage payments are simply packing up and walking away from homes they purchased during rosier days — a time when many believed the sky was the limit for the housing market and speculation buying was all the rage.

In 2008, economic activity losses are projected to be spectacular within America’s largest cities: New York is expected to lose $10.4 billion, Los Angeles $8.3 billion, Dallas and Washington $4 billion each, and Chicago $3.9 billion.

Home price declines are projected to be as high as 16 per cent in California and seven per cent across the U.S. in 2008.

The mayors are expressing anger that lenders jumped on the sub-prime bandwagon, while the Mortgage Bankers 

Association reserves most of its blame on worsening unemployment and other economic factors. The MBA said risky loans were not the driving force behind foreclosures in “rust belt” states such as Indiana, Ohio and Michigan. As used by the MBA, “rust belt” states becomes a disparaging term, implying economic deterioration in the heavy industrial sector in car-making dependent states such as Michigan.

“Over the last decade, we lost over 300,000 jobs — that’s an issue we can’t run from,” said Detroit Mayor Kwame Kilpatrick. “But in no way can you subtract or diminish at all the role of the mortgage bankers and lenders” in the current rise of foreclosures.

The mayor even accused some lenders of preying upon Detroit’s minority working class neighbourhoods, adding that 52 per cent of sub-prime mortgage loans were made to African-Americans.

Can it happen here? The simple answer is no. The sub-prime mortgage market failed to take hold in Canada — only five per cent of all mortgage loans are sub-prime. Canadian lenders are also averse to risk-taking and most refused to test the sub-prime market. As well, the Canadian housing market has been thriving because of solid economic fundamentals rather than outright speculation as was the case in the U.S.