Tighter credit standards among mortgage lenders might lower U.S. home prices by 10 percent this year and push the economy into recession, a Merrill Lynch & Co. analyst said in a report.
New Century Financial Corp., the second-biggest subprime lender and other mortgage companies may fail as the number of customers falling behind on payments rose to a four-year high. More than 20 subprime lenders have closed or sought buyers since the start of 2006 and bank regulators are pushing lenders to raise credit standards.
“Even if the pullback is only aimed at the subprime market, there could well be potentially significant further drags on home prices, construction activity and of course consumer spending growth,” Merrill’s David Rosenberg said in a note to investors.
Declines in home prices would have an effect on everything from furniture and appliance sales to landscaping and the price of copper. That would drive unemployment above 5 percent by the end of the year and the probability of a recession to “very close to 100%” unless the Federal Reserve cut benchmark interest rates by a full percentage point, Rosenberg said.
“What we are concerned about most are the knock-on effects from the pullback,” Rosenberg said.
Rosenberg has long had a pessimistic view of the U.S. economy. In May 2005, he predicted the Fed would stop lifting interest rates at 3.25 % and be forced to reduce them by the end of 2006. The Fed didn’t pause until August last year — at 5.25%. In October, Rosenberg forecast the Fed would cut rates by 50 basis points before the end of March.
In a March 1 report, CreditSights Inc. said rising mortgage defaults by subprime borrowers may add more than 533,000 homes to the market. That would increase inventory of new and existing of homes by about 13%. The National Association of Realtors and the U.S. Commerce Department said 4.09 million homes were for sale in January.
Rosenberg estimated that subprime loans boosted home sales by at least 20 percent annually and the loss of that market might shave half a percentage point from the Gross Domestic Product.
The Fed raised its benchmark rate to 5.25% in June, compared with an average target of 3.2% in 2005, a year when net new mortgage borrowing soared by a record $1 trillion.
Federal Reserve Chairman Ben Bernanke has identified 1% to 2% as his preferred range for the inflation gauge most closely monitored by the central bank. The measure, which excludes food and energy costs, rose 2.3% in the 12 months to February.
Economists surveyed by Bloomberg News forecast the Fed will hold the rate through the third quarter, according to the median estimate.
David Nissen, who as chief executive officer of GE Money oversees WMC Mortgage, the fifth-largest subprime lender in the U.S., said tightening credit solved the structural issues that caused the current mortgage crisis. WMC contributed less than $100 million of the parent company’s $20.8 billion in net income last year.
“This is a short-term shock,” Nissen said. “By the end of 2007 this will have played out.”
Burbank, California-based WMC Mortgage, General Electric Co.’s U.S. mortgage unit, fired 20 percent of its staff last week and stopped making loans to borrowers with low credit scores.
“Borrowers will feel the pinch over the next couple of years,” Nissen said. “There’s lots of liquidity in the market and as long as jobs hang in there and there’s low unemployment, the economy will be good in the United States, not great.”
Mortgage borrowing rose by $792.5 billion last year, the smallest gain since 2002, according to the Fed’s quarterly Flow of Funds report. The increase last quarter was the smallest since 1998, as two years of Fed interest-rate increases depressed loan demand and slowed the housing industry.
“The market is working,” Doug Duncan, chief economist for the Mortgage Bankers Association, said yesterday as the Washington-based group released is quarterly report on delinquencies and foreclosures.