Academic journal article ABA Banking Journal

The Subprime Credit Crunch

Academic journal article ABA Banking Journal

The Subprime Credit Crunch

Article excerpt

THE CURRENT HOUSING RECESSION in the United States got under way in the fall of 2005. Most economists saw it coming and anticipated a sharp decline in home building. Where opinions tended to vary was on how much house prices would retreat and how much of an impact that would have on consumer spending.

Homebuilding as measured by residential investment in the GDP accounts has now declined for five consecutive quarters in real terms, falling cumulatively 13% from third-quarter 2005 to fourth-quarter 2006. But homebuilding only accounts for about 6% of GDP. Thus, it only subtracted an average of 3/4% from real GDP growth over the course of 2006. And so far, with house prices adjusting relatively gradually in most markets, consumer spending has held up remarkably well. It has contributed an average of 2 1/2% to real GDP growth over the past four quarters, 1/2% more than in 2005.

So far, so good, but the housing sector is still the biggest risk to the economy. For one, housing starts and building permits have remained weak, virtually guaranteeing that homebuilding will continue to be a drag on real GDP over the first half of 2007.

The bigger worry, however, is turmoil in the subprime mortgage market. The key question is whether troubles in that market have the potential to provoke a renewed drop in home sales, prices, and building activity.

At this point, my judgment is that the troubles in the subprime mortgage market will not seriously undercut the economy and cause the Fed to ease. Clearly, subprime mortgages have become less available and more costly. But most seasoned observers indicate that a substantial volume of subprime mortgages are still being underwritten where credit scores and loan-to-value ratios make sense. …

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