(by Julia Jenson)

The property market continues to be a pillar propping up the US economy considering the fact that the majority of homeowners have more wealth in their homes than in financial assets such as stocks and bonds.

Mortgage debt has achieved looming proportions almost twice surpassing US federal debt. The number of US consumers rushing to the financial institutions to take advantage of the lowest in 34 years mortgage rates helps to explain the weird phenomenon of the housing prices rising in a period of economic downturn. The national average rate on the benchmark 30-year fixed loan fell to 5.69% in the week ended Thursday, down from 5.74% a week earlier. In comparison, a year ago the 30-year fixed loan rate was at 6.05% according to Freddie Mac. The drop was partially caused by the decrease in the yield on the 10-year US Treasury note reaching 3.96% and sparked a boom in home purchasing and refinancing activity raising application volume 7.9% compared with the previous week. The utter incentives for a homebuyer are the monthly payment which is at a historic low and the expectation of the continued rise in house prices. The last factor, experts warn, may no longer be valid. Housing bubble might eventually burst dragging the economy now largely dependent on the housing sector further into recession.

Fed’s chief Alan Greenspan in his Tuesday speech tried to alleviate fears that the unprecedented level of household debt may start a string of bankruptcies. Admitting “persistently high” household bankruptcy level, Greenspan reassured the public saying that Americans did a good job of managing their debt and brushing away allegations of the potentially disastrous house bubble. He conceded that "the ratio of household debt to disposable income has risen especially steeply over the past five years and, at 1.2, is at a record high”. In his opinion, the very size of the US property market is enough to keep out the danger of a drastic overall drop in prices. Greenspan predicted that the mortgage rates are likely to remain low despite a rising interest-rate environment. Disappointing September job growth report sent the mortgage rates tumbling once again.
Distrustful analysts, however, continue to suspect the bubble pointing to the rising home price/income ratio and the home prices outpacing rents as the ratio of home price to rent continues to increase. American consumers who recently survived the burst of the tech stock market may be in for another market downturn.

The picture of the mortgage market is made even more complicated by the Securities and Exchange Commission starting official investigation of the Fannie Mae’s accounting practices. Industry watchers remember all too well the accounting scandal concerning the use of derivatives to manipulate earnings at Fannie’s smaller counterpart Freddie Mac that led to a $4.5 billion earnings restatement, executive shake-up and a record $125 million fine. Many say that the top management of the nation’s second largest financial institution (behind Citigroup Inc.) should have foreseen the probe of its regulator, the Office of Federal Housing Enterprise Oversight, into its accounting procedures for derivatives. According to the regulators, CEO Franklin Raines and CFO Tim Howard excluded $12 billion losses on derivatives from the income statement in violation of the SFAS 133 rule to boost executive bonuses. The regulator also demanded a rise in the capital reserves resulting in an agreement which might force Fannie to raise $5 billion or even more in new capital. Major top management shifts are expected by some including the possible oust of the CEO Franklin Raines.

The probe into the mortgage giant that is involved in buying home loans from banks and other lenders and transferring them into mortgage-backed securities later sold to large investors might drive mortgage rates up although probably to an insignificant extent. By guaranteeing the return of the loans they buy from lenders, both government agencies allow financial institutions to charge lower interest rates. If Fannie cuts back its mortgage purchases, this could raise the rates. Fannie and Freddie also facilitate homeownership by providing liquidity in the market. They step in when banks and other institutions lose their appetite for loans. With activity at Fannie slowing down, it may not be there to balance the situation, if rates rise and demand falters, although at the current rate level this scenario seems to be a remote probability. Fed officials have also voiced concerns about the growth in the companies’ retained mortgage portfolios posing a risk to the financial system unless monitored properly. Evident need for better supervision has led some to call for a stronger regulating agency while Scott Frame of the Atlanta Fed and Lawrence White of New York University insist that the optimal course of action would be the complete privatization of both companies.

The UK seems to be entering the next phase of the housing market overheating with the asking price growth slowing from 16.4% in September to 13.4% in October. Agents report a drop in house prices that has been observed for four months now. This is partly accounted for by the rise in interest rates caused by the Bank of England raising its base rate to 4.75%. Even with the number of first-time buyers dropping to 8.9% in September as opposed to 21% at the beginning of the year and the lowest number of 64,000 loans approved in September compared to any other month of the year, optimists claim that until the base rate rises to 9%, there is no fear that mortgage payments will exceed affordability constraints, which might possibly lead to a price crash similar to the burst that occurred in the ‘90s. Analysts have already indicated that the staggering annual house value growth of 15% in the past 5 years has by far outstripped rise in consumer income. As a result, the typical value has hit 5.3 times the average salary compared to the long run average of 3.8. Despite the drop in proportion of the average monthly payment to the average wage from 40% in the 80’s to 20% due to reduced mortgage rates, pessimists assert that house prices are out of line with reality. Relative ease of demand for housing over the summer months appears to support their view. Advisors at Ernst and Young’s Item Club predict a “soft landing” in the UK house prices rather than a sharp downfall.

Alleged house bubble in a number of countries like the US, Australia, the UK, France, Ireland, Ireland, Holland, New Zealand and Spain has become the subject of the International Monetary Fund investigation. IMF experts do not envisage an imminent price crash pointing to the exceptional strength in financial markets since the late 1990s bubble burst and the ability of the households to lock in long-term low rates. Regardless of the admittedly sharp rise in the house prices relative to income growth, they believe the immediate steep decline unlikely.

It remains to be seen whether the reassuring optimists or the gloom-mongers will prove to be right. If some of the world’s most affluent nations are to face a plunge in housing prices, their citizens will be exposed to large amounts of mortgage debt that is secured against the dwindling value of the collateral. This could aggravate the households’ debt burden, raising the number of bankruptcies and sending home prices further down. Downturn in the real estate market will affect income levels and employment rates in this sizable industry. Nevertheless, this looming scenario does not keep many consumers from investing in the rapidly appreciating real estate rather than in the volatile stock market.