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What Falling Home Prices Mean for Banks

June 6th, 2011 |

skydive.jpgThe most recent S&P/Case-Shiller Home Price Indices declined 4.2 percent in the first quarter of 2011 on top of an earlier 3.6 percent drop in the fourth quarter of 2010. “Nationally, home prices are back to their mid-2002 levels,” according to the report.

If you are a connoisseur of home price data—and the countless expert predictions since the market’s collapse in 2007—you know that the housing market should have bottomed out by now and been well into its long awaited recovery. There was a slight rebound in housing prices in 2009 and 2010 due to the Federal Housing Tax Credit for first-time homebuyers, but that rally pretty much died when the program expired on Dec. 31, 2009. Now, housing prices are falling again like a skydiver without a parachute.

Recently I called Ed Seifried, Ph.D., who is professor emeritus of economics and business at Lafayette College and a partner in the consulting firm Seifried & Brew LLC in Allentown, Pennsylvania, to talk about the depressed housing market and its impact on the banking industry. Seifried is well known in banking circles and was a keynote speaker a few years ago at our Acquire or Be Acquired conference.

“We’re pretty close to a structural change in housing,” Seifried says. You, me and just about everyone else (including, apparently, former Federal Reserve Chairman Alan Greenspan) was taught that home prices always go up—sometimes by the rate of inflation, sometimes more—which made it a pretty safe investment. “That dream has pretty much been shattered,” Seifried continues. “The Twitter generation is looking at the European (housing) model, which is smaller and more efficient. Your home shouldn’t be a statement of your wealth.”

A broad shift in housing preferences could have important long-term implications for the U.S. economy, since housing has been one of our economy’s engines of growth for decades. What is absolutely certain today is that a depressed housing market is hurting the economy’s recovery after the Great Recession, and that has broad implications for the banking industry.

A depressed housing market translates into a depressed mortgage origination industry, which has significant implications for the country’s four largest banks—Bank of America, J.P. Morgan Chase, Citigroup and Wells Fargo—which have built giant origination platforms that might never again churn out the outsized profits they once did. In fact, I wouldn’t be surprised to eventually see one or two of them get out of the home mortgage business if Seifried’s structural change thesis is correct.

Community banks that lent heavily to the home construction industry during the housing boom are either out of business or linger on life support. But even those institutions that did not originate a lot of home mortgages, or lent heavily to home builders or bought lots of mortgage-backed securities are being hurt because housing’s problems have become the economy’s problems.

In a recent article, Seifried points out that for the last 50 years housing has contributed between 4 and 5 percent of the nation’s GNP. In the 2004-2006 period, that contribution rose to 6.1 percent.  In 2010, housing accounted for just 2.2 percent of GDP—and dropped to 2.2 percent in the early part of 2011. Seifried also estimates that the housing market accounts for 15-20 percent of all U.S. jobs when “construction and its peripheral impacts are weighed.”

“It’s difficult to imagine an overall economic recovery that can generate sufficient jobs to return the U.S. economy to full employment without a return of housing to its historical share of GDP,” he writes.

In our interview, Seifried told me of a recent conversation he had with a bank CEO who thought his institution was reasonably well insulated from the housing market’s collapse because it had made relatively few construction loans. But that bank still experienced higher than expected loan losses because of all the other businesses it had lent to that ended by being hurt by the housing downturn.

Indeed, virtually no bank in the country is immune to the housing woes because banks—even very good and very careful ones—require a healthy economy to thrive. The U.S. economy needs a strong and growing housing market to thrive, and that doesn’t seem to be anywhere on the horizon.

 

jmilligan

Jack Milligan is editor of Bank Director magazine, an information resource for directors and officers of financial companies. You can connect with Jack on LinkedIn or follow @BankDirector on Twitter. 

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