Perfect Financial Storm

The Arizona Republic is reporting the Housing boom is no longer a credit lifeline for many in Valley.

Homeowners caught between higher bill payments and flat incomes have been able to tap their rapidly rising home equity to stay afloat or even buy new cars and furniture. Others have been able to refinance using adjustable-rate loans to cut their payments. Those with too much debt have been able to evade foreclosure and bankruptcy, and even pocket some cash, by selling their homes quickly.

The 55 percent run-up in Valley home prices during the past year hurt people trying to buy a home but helped those struggling to keep one. But now, Phoenix's home appreciation rates are leveling off, and it's taking longer for homes to sell.

A growing number of people are so stretched that they are spending more than they earn. Valley homeowners who have already tapped most of their equity can't count on another huge jump in values to get by.

Consumer-credit and housing agencies providing help are starting to get a lot more calls from people who can't afford to make their mortgage payments or even pay their utility bills.

"The Valley's housing appreciation is masking problems in the economy," said Terry Turk, president of Mesa-based Sun American Mortgage.

To afford a house as prices rise, more home buyers have been opting for interest-only and adjustable-rate loans, which keep payments low initially because borrowers aren't paying toward principle. Buyers count on rising equity to save them from the risky loans: They plan to either sell or refinance before the loans adjust and their payments skyrocket.

Almost 45 percent of all homes purchased in metro Phoenix through August were financed with interest-only loans, according to San Francisco-based LoanPerformance, compared with 29 percent nationally. And almost 28 percent of all Valley homeowners who refinanced this year switched to interest-only loans, signaling they wanted to cut their payments. The U.S. rate was 10 percent lower.

Regulators worry the loans could make the housing market more volatile and are cracking down on lenders offering them to people on the bubble financially.

Boom over, costs rising

The rampant run-up in metro Phoenix housing appreciation is over, and prices have even dipped in some areas. At the same time, inflation, interest rates and debt are climbing.

Nationally, credit-card delinquencies have climbed to 5 percent, causing banks and regulators consternation. Many card issuers have upped the minimum required payment from 2.5 percent to 4 percent of the balance. That means the typical family, which has $9,000 in credit-card debt, now must make a minimum monthly payment of $360 instead of $240.

Almost 34 percent of all Arizona homeowners were paying more than the recommended 30 percent of their incomes to cover their mortgages, according to 2004 data from the U.S. Census Bureau. And that figure doesn't take into account the recent boom in home prices and rising interest rates.

Compounding the problem for some are the rising costs on more than one home. A record number of metro Phoenix homeowners tapped equity in their primary residence to invest in houses. At least one of every four houses sold in metro Phoenix this year went to an investor.

Almost half of metro Phoenix's employment growth during the past year came from construction and retail jobs.

Lee McPheters, an economist with ASU and director of the Bank One Economic Outlook Center, said that as home building cools, states that have seen construction hiring booms like Arizona will record job losses.

"It's like the perfect financial storm," said Mike Stephenson of the Phoenix-based credit counseling firm Take Charge America. He estimates the typical Arizona family's monthly household costs are now $500 higher than last year.

Recipe for the Perfect Financial Storm

• Employment Tied to Housing
• Housing Prices Falling
  
• Delinquencies Rising
• Credit Tightening
• Rampant Investor Speculation
• Rising Minimum Payments
• Rising Inventories
• Rising Household Costs
• Interest Only and Pay Option Loans
• Builders Still Building
• Negative Amortization
• Falling Demand for Goods and Services
  

Concern over Nontraditional Mortgage Products by the FED and the Office of the Comptroller of the Currency was noted in this Joint Press Release. A more detailed 42 page PDF on the Proposed Guidance can be found Here. Following are snips from the Press Release:

While innovations in mortgage lending can benefit some consumers, the agencies are concerned that these practices can present unique risks that institutions must appropriately manage. They are also concerned that these products and practices [interest only loans and pay option loans] are being offered to a wider spectrum of borrowers, including subprime borrowers and others who may not otherwise qualify for more traditional mortgage loans or who may not fully understand the associated risks of nontraditional mortgages.

The proposed guidance discusses the importance of carefully managing the potential heightened risk levels created by these loans. Toward that end, management should:

• Assess a borrower's ability to repay the loan, including any balances added through negative amortization, at the fully indexed rate that would apply after the introductory period. The agencies recognize that this requirement differs from underwriting standards at some institutions and are specifically requesting comment on this aspect of the guidance.
• Recognize that certain nontraditional mortgage loans are untested in a stressed environment and warrant strong risk management standards as well as appropriate capital and loan loss reserves.
• Ensure that borrowers have sufficient information to clearly understand loan terms and associated risks prior to making a product or payment choice.
  

Clearly the FED and OCC are now worried about lending practices. That is as it should be. However, they should have been more worried about the rampant increase in money supply they used in foolish attempts to defeat normal business cycles. It was their practices that allowed the housing and credit lending bubbles to get this far out of hand.

When the storm hits full force, the FED will have no one to blame but itself. Batten down the hatches.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/