Bleak Market Outlook

“Put bluntly, the credit crunch in the subprime mortgage market will likely trigger a second leg down in the housing market in terms of output and prices,” according to the UCLA Anderson Forecast quarterly report released Monday.

Senior economist David Shulman highlighted how easy it was for subprime borrowers to get mortgages with “no income, no assets” loans and sometimes “no job.”

Subprime loans accounted for one-fifth of the mortgage market, representing $1.2 trillion subprime loans held in the securitized pools, Shulman said.

And another 13 percent of mortgage lending is comprised of borrowers with only slightly better credit than subprime, according to Steve Hanke, professor of applied economics at Johns Hopkins University.

“With default rates on the rise, mortgage-lending standards being tightened and $500 billion in adjustable-rate mortgages to be reset in 2007, we can expect the return of a half-million houses to a bloated inventory of unsold homes in the next six months,” Hanke said in a report for the Cato Institute — also announced Monday.

“Expect a continued slump in residential construction activity and employment, lower house prices that will force more subprime lenders to the wall and put strains on the most leveraged parts of the financial system and a slowdown in consumption expenditures,” Hanke said.

More than 25 subprime lenders have closed their door in just a few months time, UCLA’s Shulman noted, adding that “for all practical purposes the subprime market is in the process of shutting down,”

With a high number of foreclosures on the books already and estimated defaults of $225 billion, more can be expected.

And regulators are applying much stricter credit standards for loan applicants while Freddie Mac announced it would cease buying subprime loans as of September, the report said.

“The new credit environment will make it more difficult for homeowners to refinance their existing subprime loans leading to more foreclosures,” Shulman says. “More importantly, with the newly tightened lending standards new homebuyers will not have the financial firepower to buy homes at the existing price structure.”

On the brighter side, Shulman says consumption is holding up better than they had thought, there is a less negative trade picture, and it is likely the Feds will ease up on their policy and make two or three rate cuts in the near future.

“If we are wrong here, it is our guess that the economy will be weaker than what we have forecast because it is the pre-emptive policy that will soften the impact of the deterioration in the housing and housing credit markets,” Shulman said.

“The days of wine and roses for the mortgage market are over.”