Housing crisis -- no end in sight

Economy was good, danger signs were ignored. Then came the cliff.

By Dale Kasler - Bee Staff Writers
Published 12:00 am PDT Sunday, August 26, 2007

Summoned to the Legislature in late January for a hearing on subprime mortgage lending, Marc Lowenthal struck a confident tone.

Lowenthal, a senior executive at Irvine subprime lender New Century Financial Corp., told lawmakers that the industry was in solid shape -- and an asset to the nation. Clamping down on subprime loans would only bring "severe, negative consequences for consumers, the real estate market and the economy," he said.

Outside the Capitol, in the neighborhoods of Sacramento and beyond, mortgage defaults were already climbing. But New Century was still all pedal and no brakes. Loan volume remained brisk, and the company seemed headed for another blockbuster year.

Just a couple of weeks later, New Century was essentially kaput, done in by runaway loan defaults and a panic among investors. Its shocking demise marked the start of a crisis in the mortgage industry that has rattled Wall Street and raised fears of a recession.

In a sense, New Century and other fallen lenders -- as well as homeowners who are losing their properties -- are victims of history. Until now, most experts say, the housing market had never undergone a serious swoon as long as the economy was still growing. Lenders took comfort in the argument that only a recession could do major harm to the housing sector and ignored signs that the market was going cold.

"The hubris of the period was driven ... by the thought that the economy was on sound footing," said Mark Zandi, chief economist at national consulting firm Moody's Economy.com. "That argument convinced the homebuilders and the lenders and added to the frenzy."

Zandi and others say the slump's peculiar nature contributed to the severity of the problem. The absence of a recession kept lenders running nearly full tilt until it was too late.

The total volume of subprime loans nationally fell less than 4 percent in 2006, even as defaults and foreclosures were starting to spike, according to data compiled by Credit Suisse. Some big lenders never really did apply the brakes: New Century's loan volume was down a mere 1.3 percent through the end of February, or about two weeks before trading in the company's stock was suspended.

"The mentality was ... the economy's great and everything's fine," said Chris Thornberg, head of Beacon Economics consulting firm in Los Angeles. "That was the mentality that to some extent drove these excesses."

For now, unemployment remains relatively low. But the lack of historical precedent has lent an ominous feel to the housing slump, making it harder to predict what the impact will be on the overall economy.

"We haven't faced this before," said Howard Roth, chief economist at the state Department of Finance. "It may well be a new phenomenon that we're seeing -- a downturn in the housing sector slowing down the overall economy."

Mortgage specialist Heather Fern-Luzzi, with two decades of experience in the business, thought she'd seen it all. But this downturn, which just claimed her job, has her baffled.

"There's nothing to compare it to," said Fern-Luzzi, the Roseville branch manager of recently collapsed mortgage lender First Magnus Financial Corp.

"I've seen it since the 1980s -- I've been in downward markets and there's always been the light at the end of the tunnel," she said as she packed files for shipment to First Magnus' headquarters in Arizona. "This one seems to be different."

This year several hundred people in the capital region mortgage industry already have found themselves out of jobs. Many are having to go outside their industry for work or to switch careers.

"They might have to look at other areas of finance," said David Lyons, labor market consultant at the state Employment Development Department. "There are probably opportunities in the commercial and industrial side. They'll want to look at their skills and other industries that may be growing. They're out there. They just have to do a little job searching."

The ongoing rash of foreclosures has spooked potential homebuyers even though the job market is in decent shape, said veteran Sacramento real estate agent Leigh Rutledge. The dark cloud won't lift soon.

"We've just got a long ways to go with all this subprime stuff," she said.

The last great housing downturn in California, begun in the early 1990s, followed a more recognizable pattern. The end of the Cold War clobbered California's aerospace and military sectors, causing massive layoffs.

In Sacramento, all three military bases ultimately closed, and unemployment topped 9 percent. Skilled construction workers deserted Sacramento for cities like Phoenix and Las Vegas. No wonder home prices went into a tailspin that lasted eight years.

This time, housing experienced a once-in-a-lifetime boom caused by excessively loose lending standards. Interest-only loans and other exotic products made homeowners out of millions with iffy credit histories. The exploding secondary market -- made up of institutional investors, many of them from overseas, willing to purchase those loans -- provided the fuel.

"Globalization had a lot to do with this," said Greg Sandler, founder of Roseville-based 1st National Home Loans. "Essentially, we're not playing with the same road map here. This is a different downturn than ever before."

Loose loans have made the collapse unusually swift. Defaults and foreclosures have increased at a much faster pace than in previous slumps. In the 1990s, even with unemployment soaring, it took five years for defaults in Sacramento County to double, according to DataQuick Information Systems. This time, the default volume has more than tripled in a little over a year. Defaults are the first step toward foreclosure.

"It's more severe now; it's much faster," said Michael Carney, a professor of finance and real estate at California State Polytechnic University, Pomona, and director of the nonprofit Real Estate Research Council.

The meltdown in the mortgage business could take the economy into a recession, said Stuart Gabriel, director of the Ziman Center for Real Estate at UCLA.

"This credit crunch is terribly exacerbating the downturn in housing," he said. "The longer this credit crunch persists, and the wider the implications, the more likely we will have a general economic downturn."

Unemployment has edged up to 5.3 percent statewide. But that's well below the 6.9 percent recorded in 2003, during the last economic downturn, or the 9.9 percent in 1992, the peak of the 1990s recession.

The current slowdown has been offset by strength in commercial and industrial construction. State government is hiring again, a boost for Sacramento.

"Fundamentally, I think we have good job growth in other sectors," said EDD's Lyons.

Richard Brown, chief economist at the Federal Deposit Insurance Corp., said he believes a recession can be avoided. "I would say the economic fundamentals ultimately win out," he said.

But with housing clearly stressing the economy, there's cause for concern. Many believe the housing market won't improve until late 2008, at the earliest. The slump is hurting retailers, particularly home-improvement chains. Car sales are affected, too, as consumers are less apt to borrow against their home equity to make big purchases.

"First, we had construction, then financing, now furniture," said economist G.U. Krueger of Institutional Housing Partners, an investment firm in Irvine. "It's now spreading into the broader segments of the economy.

"We're still fortunate that the part of the economy that has nothing to do with real estate is still relatively strong. We're lucky the consumer (spending) is holding up as much as it has. We're lucky the jobs are holding up as much as they are. That's, of course, the thing to watch."