Falling home prices hurt borrowers, neighbors

Economist estimates inflation-adjusted value of $23 trillion housing market could fall by $3 trillion by next year.

NEW YORK -- If home prices fall as forecast, the $23 trillion housing market could lose $3 trillion in value by August 2008, a leading housing economist and former mortgage bank president told lawmakers on Wednesday.

Between 1998 and early 2006, when housing prices peaked, home values rose 86 percent on an inflation-adjusted basis, Robert Shiller, a professor of economics at Yale University, said at a hearing about the subprime crisis held by Congress's Joint Economic Committee.

Since that peak, Shiller noted, real home values have fallen 6.5 percent and they're forecasted to fall at least another 7 percent on average in the next year.

That combined decline could translate into a $3 trillion loss of wealth for households, said Alex Pollock, a resident fellow at the American Enterprise Institute and the former CEO of the Federal Home Loan Bank of Chicago, in his written testimony.

Those hardest hit likely would be homeowners with subprime adjustable-rate mortgages (ARMs) whose payments are scheduled to reset to higher levels in the next year - in some cases by as much as 50 percent. Refinancing out of those loans, already made difficult by the recent credit crunch, will be out of reach should a borrower's home price fall below the value of his loan in the next year, said Martin Eakes, CEO of the Center for Responsible Lending, during his testimony.

That's why he and Shiller were urging lawmakers to act quickly to pass measures to aid struggling homeowners saddled with high-cost predatory loans.

Helping them with foreclosure avoidance wouldn't just assist the mortgage borrower but his neighbors, too, Eakes asserted. He cited a study that estimates that for every foreclosure on a block, values on homes within an eighth of a mile are likely to fall 1.14 percent in value.

Lawmakers have been considering what steps, if any, to take both to contain the current subprime contagion and also to prevent another mortgage meltdown in the future.

A number of proposals have been put forth, including one by Sen. Charles Schumer (D-NY), chairman of the Joint Economic Committee and a member of both the Senate banking and finance committees. Schumer's bill is aimed at making it easier for homeowners with subprime ARMs to refinance and to help home buyers in high-cost markets get a mortgage since even those with good credit have been shut out recently.

Among the measures he calls for: temporarily lifting the portfolio caps allowed for Fannie Mae and Freddie Mac by 10 percent, or $145 billion. Those caps apply to the amount of mortgage assets the government-sponsored agencies buy and own directly (as opposed to their other function - which is to buy, pool and sell mortgages as mortgage-backed securities).

Half of the cap increase would be earmarked for the purchase of subprime refis with scheduled interest-rate resets between June 2005 and December 2009. That would potentially encourage lenders to offer them, since they know Fannie and Freddie would guarantee a secondary market in which the lender could sell the refis.

Those who oppose such a move, such as the White House and the Office of Federal Housing Enterprise Oversight (OFHEO), which regulates both agencies, contend that such a big increase would not be prudent given the accounting problems both Freddie and Fannie have had in recent years.

To date, the Federal Housing Administration has already loosened its criteria for refinancing. And eligibility requirements for FHA loans would be further liberalized if FHA reform legislation passes into law, which many are expecting.