On Housing, ‘Worst Is Yet To Come'

The latest real estate message we're getting from one economist after another is like a broken record — in brief, that the housing slump is pretty much history, the market is stabilizing, and a lively rebound in home prices is in the cards for the second half.

Economists are known to be wrong at times, which is precisely the real estate read I get from housing expert Steven Krystofiak, who tells me: "The downturn is far from over. The worst is yet to come."

Not only that, Mr. Krystofiak, the president of the consumer advocacy group the Mortgage Brokers Association for Responsible Lending, predicts that housing prices — which were relatively flat in 2006 — will begin to undergo an extreme dive soon, spurred by more than $2 trillion worth of short-term fixed mortgages resetting at higher interest rates in 2007 and 2008.

Overall, he says, he expects home prices nationally to fall between 5%and 10% from current levels by year's end and to extend those declines to between 15% and 20% by the end of 2008.

Our housing bear says he thinks double-digit declines will be especially conspicuous in the hottest real estate markets, among them San Diego, Phoenix, Boston, and Sacramento, and three states, Nevada, Florida, and New York.

Mr. Krystofiak should hardly be viewed as an alarmist. I last caught up with him late last year, when in an interview he accurately warned of a potential outbreak of severe problems arising from the surge in subprime mortgages (about $1.2 trillion, or 7% to 8% of the mortgage market).

In the mid-1700s, an American lawyer, James Otis, uttered a now famous saying: "A man's home is his castle." Mr. Krystofiak takes a different stance. "That castle," he quips, "will crumble or be vacant because of no king."

How does he figure that? Because of his belief that vacancies — now at about the mid-2 million mark, the highest level ever recorded in America — will rise even further, spurred in part by a number of wildly questionable mortgage loans, which has greatly heightened the vulnerability of the real estate market.

One of the worst such loans is said to be the negatively amortized loan. That's basically a loan for which the consumer's monthly mortgage payment doesn't cover the entire interest. Let's say, for example, a bank charges an interest equivalent to $2,000 a month, but the borrower is paying only $800. That means the $1,200 difference is being added to the balance each month, which could make the loan untenable.

Other faulty loans include the teaser loan, which involves extremely low interest rates for one, two, three, and even five years; the short-term suicide loan, for which the fixed loan period is only two or three years, and the liar's loan, which is based on false and unverified income and zero down payment.

However, it's now catch-up time, Mr. Krystofiak says. In recent weeks, he notes, underwriting standards have tightened considerably; it has become harder to borrow, and banks have started to pull out of loans of 100% financing. "We're getting a sneak preview of what's to come; it's the tip of the iceberg," he says.

To Mr. Krystofiak, it's all likely to lead to the following:

• Investors will withdraw hundreds of billions of dollars out of mortgage-backed securities, which will trickle down to residential home mortgage lending.

• Investors will seek higher interest rates to compensate for greater mortgage lending risks.

• After a disappointing spring selling season, there will be a substantial pullback in residential construction activity — hundreds of thousands of units fewer than were built in the hot housing years of 2004 and 2005. In turn, Mr. Krystofiak believes, this pullback will produce growing job losses, reduced consumer spending, greater home depreciation, a serious credit crunch, and a weakening economy.

It may be, he says, that "we're heading into a period where we could well hear someone say, ‘I haven't seen home appreciation in years.'"