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Recession Scenarios And Other Observations To Bank On From FDIC

To their credit, the FDIC writes in a good summary on the economy and some possible concerns for a recession in FYI: An Update on Emerging Issues in Banking: Scenarios for the Next U.S. Recession [FDIC] [1]

Its a surprisingly good narrative on banking as it relates to housing as these industries go hand-in-hand in estimating when we may see the next recession.

Housing

The risk of a housing slowdown is another area of concern going forward. The recent housing boom has been unprecedented in modern U.S. history.2 It has been suggested by many analysts that the housing boom has been a significant contributor to gains in consumer spending in recent years. Indeed, a number of the FDIC roundtable panelists pointed to the apparent connection between rising real estate wealth during the past four years and the sustained strength in consumer spending during that period. Because consumer spending accounts for over two-thirds of U.S. economic activity, any shock to consumer spending, such as that which might be caused by a housing slowdown, is a concern to overall economic growth.

Housing analysts are in disagreement as to whether or not recent signs point to a moderation in housing activity or the beginning of a more significant correction. Currently, inventories of unsold homes and sales volumes are among the indicators pointing to a housing slowdown. Inventories of unsold existing homes rose from under four months of supply at current sales volume in early 2005 to 5.3 months of supply as of January 2006. Meanwhile, the pace of existing home sales has been trending lower since last summer. A clear trend in the direction of home sales and prices may not be evident until the completion of the peak spring and summer selling season later this year.

Many analysts argue that home prices in the hottest coastal markets, especially in the Northeast and California, could be poised to decline in the near future. For example, PMI Mortgage Insurance Company analysts place essentially even odds that home prices will decline during the next two years in a dozen cities in California and the Northeast.4 Should home prices either stop rising or begin to fall in these areas, local banks and thrifts would need to look to non-residential loans to support revenue growth.

Banking

There are concerns, however, that changes in the structure of mortgage lending could pose new risks to housing. These changes are most evident in the rising popularity of interest-only and payment-option mortgages, which allow borrowers to afford more expensive homes relative to their income, but which also increase variability in borrower payments and loan balances.

Credit

10 percent of U.S. households may be at heightened risk of credit problems in the current environment. This group mainly includes households that gained access to mortgage credit for the first time during the recent expansion of subprime and innovative mortgage loan programs.