“No Money Down” Mortgages Reverberating Throughout Financial Markets
Financial markets continued to boil this past week. Volatility reigned, as investors seemed reticent to keep the great bull market of 2006 and 2007 going. I think it was Newton who said something about “what goes up comes down.” The unfortunate part of that in 2007 it would seem is investors no longer believe in it.
That can be a tough lesson for people. Take the US versus the Canadian housing market for example. In Canada house prices are hot, so hot they set a record in the month of July. The following statistics are from the Canadian Real Estate Association via the Financial Post.
In June 2007, the average house price was $315,332, a rise of 11.2% from a year earlier, the Canadian Real Estate Association (CREA) said. This was the greatest yearly increase since August 2006.
According to CREA, average prices in June broke all previous monthly records in Alberta, Saskatchewan, Ontario, New Brunswick, Nova Scotia, and Newfoundland and Labrador.
At $446,893, the average price of a house in British Columbia rose 11.2% in 12 months maintaining the province’s position at the top of the table well ahead of Alberta at $364,072. But Alberta is making rapid gains with an increase of 24.7% since June 2006 only just behind the increase in Saskatchewan where the average price of a house rose 34.9% to $180,934 and a 28.8% increase in the Northwest Territories.
Sales activity set records in the first and second quarters. Sales for January to June of this year were ahead of levels for the same period last year in almost every province. According to CREA, sales activity in the first half of 2007 rose by 8.2% compared to the same period in 2006 to 287,862 units. If current trends continue, 2007 will be a record year for sales.
(Financial Post, July 31, 2007)
In the US housing prices have plummeted especially in specific markets, partly due to the shaky “no money down” mortgage craze that took over in the low interest era. The market got wobbly in 2005 and has been on shaky ground ever since. Rising interest rates and tightening credit standards have added to its woes. Countrywide Financials Corporation which is one of the largest mortgage holders in the US recently reported very weak second quarter earnings. They have projected borrowers will continue to fall behind in payments. They expect weak US housing market conditions are expected to continue into 2009.
This past week the situation in the United States became even more tenuous. The American Home Mortgage Investment Corporation filed for Chapter 11 bankruptcy. They said they had fell victim to “extraordinary disruption” in the housing market, which supports the mortgage industry. Essentially payment defaults and lower housing prices have dried up cash flow for American Home Mortgage Investment Corporation. With many of their creditors being major Wall Street creditors the reverberations in financial markets have been considerable. Unlike other mortgage companies American Home didn’t have any “no money down” mortgages. So their demise shows just how much things have deteriorated in the US compared to Canada.
I think this whole deal is scary stuff. It was built up during the past decade of easy credit and low interest rates. The “no money down” American mortgages came into play a decade ago for wealthy people with good credit who didn’t want to liquidate other assets to buy homes. However, this became available to everyone. The theory was as long as home prices kept climbing, borrowers who got in trouble with payments could see and refinance. However, when American housing prices went south, this whole model started to come unraveled.
What’s scary about this is we’re talking about billion dollar debts. This is not as simple as looking the other way and putting it in your rear view mirror. According to Merrill Lynch, the US Federal Reserve may have to cut interest rates this fall just to stem the tide. Ramifications from that would be enormous. While it might stem the tide of bank defaults it would also be a stimulus on the economy setting up the spectre for price inflation. It would also send the greenback’s value down further strengthening an already strong loonie. Canadian manufacturing jobs in places like Chatham, Windsor and Sarnia would hang in the balance.
At the end of the day, there will be some that say the apocalypse is upon us. Hardly. In Canada despite what is going on down south our economic numbers are solid. However, we still export 80% of what we produce down south. See last week’s column. Who would of thought problems might arise from “no money down”? The reverberations from that unfortunately, seem to be just getting started.