Housing: Where The Market Is Most Vulnerable

Hardly a week goes by without some new sign that the housing boom is finally over. Most recently, October housing starts dropped, and permits to begin new construction posted the largest monthly decline in six years. And in November, builders' assessment of market conditions sank to a two-year low, says the National Association of Home Builders.

The size of the drop-off in activity and the broader impact on the economy are still anybody's guess. But one area -- the subprime mortgage market -- is causing some nail-biting among economists. The explosion in subprime lending, aimed at borrowers who do not have the income and credit standing to qualify for a conventional loan, accounted for an unusually large chunk of housing demand over the past five years. Now, with interest rates rising and home prices cooling, that boom is about to become a bust.

Exact data on subprime lending is hard to come by, but according to Bond Market Assn. figures on mortgage securitizations pulled together by analysts at JPMorgan Chase (JPM ), subprime mortgage originations grew sevenfold from 2000 to 2005. Subprime loans now account for nearly 9% of all securitized mortgage debt, and the average loan is now nearly $200,000.

The Boom In Subprime Mortgage Lending
What's more, some 82% of that debt is in adjustable-rate loans, where rates can rise more rapidly than long-term fixed rates. Morgan estimates that if the Federal Reserve lifts its target rate to 5%, then fixed mortgages will rise about a percentage point by the middle of 2006, to about 6 3/4%, but the initial rate on subprime loans would jump by three points, into the 9.5%-10% range. The adjustment for existing subprime borrowers would push up monthly payments by some $250 dollars, on average.

How much added pressure will the end of the subprime lending boom exert on the housing slowdown? "It is clear that this part of the market would be especially hard hit and would amplify the expected slump in home sales in the part of the market financed by conventional mortgages," says Morgan economist Robert E. Mellman. Where will the blow be the hardest? California. The state accounts for nearly 30% of U.S. subprime lending.

By James C. Cooper & Kathleen Madigan

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