DOW Giveth, DOW Taketh Away - Part Two
By Carlos T Mock, MD
July 27, 2007
Just as we were celebrating the benchmark of the DOW 14,000, Wall Street pulled back, starting last Friday, retreating from record levels following disappointing results from longtime favorites Caterpillar Inc. and Google Inc. Revelations by Mr. Bernanke that the subprime crisis was spilling over the prime markets and perhaps cost the economy over 100 billion dollars further help the collapse of the average. The Dow Jones industrial average closed today at 13,265.47. The index plunged by more than six percent for the week.
When it comes to the economy, the national mood is a combination of dissatisfaction and fear. A recent Gallup poll found that 66 percent of Americans think national economic conditions are “only fair” or “poor.”
Even though unemployment stands at 4.5 percent, down from the peak rate of 6.3 percent four years ago that does not paint a correct picture of the job market. Six years ago, unemployment was 4.5% also; but the jobs were paying a higher salary. This is one of the painful, personal back stories of the dramatic demise of American heavy manufacturing, especially in the Midwest. In old industrial cities such as Dayton, home of the Wright brothers and creative spark for the electric ignition, shock absorbers and the automatic transmission, thousands of manufacturing workers who lost their jobs are absorbing the bitter reality that their new jobs almost always pay substantially less than their old ones did. In spite of the fact that Mr. and Mrs. Average American are both working, they can barely keep up.
You see, when the Fed rates were at 1.25%, a very large number of Americans refinanced their homes and went on a shopping spree. What’s worse, even under-qualified Americans refinance their homes at subprime rates. Most took ARM mortgages or interest-only mortgages because there was a housing boom and house values kept going up. If they overspent, they went again and took more money out of their homes.
Unfortunately, the Bush Administration went on the same shopping spree. Fueled by low interest rates, they borrowed over one trillion dollars in debt in six years. They issued bonds until every pork bill passed by the Republican Congress was properly funded. Of course, Mr. Bush found his Veto stamp after the Republicans lost the congress.
The results are now beginning to take effect. Ben Bernanke acknowledged for the first time on Wednesday that credit concerns were spreading beyond the subprime mortgage market to a tune of 100 billion dollars as investors showed their worries with a flight to quality, seeking refuge in government bonds and other, safer assets. A surprising increase in late loan payments and defaults among homeowners with good credit is so far coming from traditional woes, such as divorces, job losses and unexpected medical bills. Analysts said the trend could continue, particularly in areas of the country that have been hardest hit by job losses in general or seen a decline in speculation-driven construction, such as South Florida, parts of California and Las Vegas.
This has created a real estate nightmare. Sales of new homes in the US fell by the most this year last month in a sign of continued weakness in the housing market. Purchases fell 6.6 per cent to an annual rate of 834,000 in June, according to the Commerce Department, which also said 22,000 fewer homes were sold in May than previously thought. The glut of existing homes has become an increasing concern for builders, who have cut construction and increased discounts in an effort to clear an inventory of single-family houses now at its highest level since 1992. The median price of a new home fell 2.2 percent last month, to $237,900. The number of homes for sale held at 537,000 during the month, and the supply of homes at the current sales rate rose to 7.8 months' worth, the most since March, up from 7.4 months. Purchases fell 27 percent in the Northeast, 23 percent in the West and 17 percent in the Midwest. Builders Also Thursday, D.R. Horton Inc and Beazer Homes USA Inc posted a third-quarter loss after writing down the value of unused land and warned there was no recovery in sight for the troubled housing industry.
So now, Mr. and Mrs. Average American can’t afford to go back and ask for more money on the value of their homes. They can’t afford to pay their higher mortgage payments, nor can they sell their over-valued homes. They are trapped, and the only alternative is foreclosure.
The share of all mortgages entering foreclosure rose to 0.58 percent in the first quarter from 0.54 percent in the fourth quarter, according to a quarterly report from the Mortgage Bankers Association. Subprime loans entering foreclosure jumped to a five-year high of 2.43 percent from 2 percent in the fourth quarter, and prime loans rose to 0.25 percent, the highest ever, from 0.24 percent. It was worse for subprime borrowers who took out adjustable-rate mortgages. The association said the percentage of payments that were 30 or more days past due for subprime ARMs jumped to 15.75 percent in the first quarter. That's the highest level ever and up from 14.44 percent in the fourth quarter. The percentage of subprime ARMs that started the foreclosure process climbed to 3.23 percent, also a high, from 2.70 percent. People who have taken out subprime mortgages, especially ARMs, have been clobbered as rising interest rates and weak home prices have made it increasingly difficult for them to keep up with their monthly payments. Some lenders in the subprime market have been forced out of business. Analysts estimate that nearly 2 million ARMs will reset to higher rates this year and next. Some subprime borrowers were lured by initially low "teaser" rates offered during the five-year housing boom that ended in 2005. But those rates can spike upward after the first few years, causing payment shocks.
I believe that we have bought the rose-colored view of our current administration to our detriment. The coming catastrophe is not going to surprise everyone, but it will surprise quite a few.