The Statewide Title Newsletter and Legal Memorandum

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Issue  150  Article  252
Published:  1/1/2008

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Winter/Spring 2008 Economic Outlook
John Dillard, Vice President and Legal Counsel

            Depending on whom you ask these days America is either beginning a recession, will enter one later in 2008 or has just narrowly avoided one.  Regardless of whether any of these statements are true or not there are some very serious black clouds on the country’s economic horizon.  Much of what is causing concern in economic circles is the fact that we have been driving the economy on credit for the past six or seven years and the bill collectors are now standing at the door. Consider some of these troubling indicators for a moment:

•          New home starts have fallen from 2.1 million in 2005 to just over 1 million.

•         Home prices have declined 11% from their peak.

•         Car and truck sales have fallen to their lowest levels since 1998.

•         Unemployment has risen to over 5% and that figure only counts unemployed actively drawing unemployment benefits, not the actual number without work.

            Our economy has been extremely resilient since coming out of the last recession 15 years ago, but oil and the subprime mortgage debacle are poised to end that good run.  Although the price of oil is expected to stabilize in 2008 the U.S. needs to begin supporting the dollar.  Oil is traded in dollars, for the present anyway, and each time the dollar is allowed to devalue the price of oil goes up in America.  And as the price of oil increases the cost of consumer goods here rises due to the absorption of transportation costs, heating and cooling costs, plastics and other materials made from petroleum.  It is estimated that each $10 increase over the baseline price of $76 a barrel costs our economy 100,000 jobs.  In addition, each time the dollar loses value the cost of all the imported goods from China and other trading partner nations increases.  The dollar has lost half its value during the past six years. 

            Besides the impact on oil prices and consumer goods why else should we be concerned about the declining dollar?  Because every time the Federal Reserve lowers interest rates the dollar is inversely impacted.  The Federal Reserve during the past two quarters has been cutting rates in an attempt to hold off a recession while at the same time priming the markets with liquidity hoping to avoid a collapse of the banking industry because of the subprime losses that have begun manifesting.  In other words, the Federal Reserve’s remedy for an economy that’s already over leveraged with credit is to offer it more credit.  Lowering interest rates devalues the dollar thereby triggering an increase in the price of oil here as well as imported consumer goods and raw materials. The Fed’s prescription is a two edged sword with serious side effects. 

            And if the falling dollar poses serious problems we haven’t even begun to experience the full impact the subprime loan debacle, but now is the time to hit it head on before it explodes and becomes uncontrollable.  Cutting interest rates and flooding the  markets with more easy credit is only adding fuel to the fire.  And as mentioned above, cutting rates adversely impacts the value of the dollar.  But there is a much larger reason to be concerned with the subprime loans.  These loans have been securitized, that is, packaged into financial investment bundles and sold in the secondary market to pension funds, mutual funds, insurance companies and other banks.  And when they were added to these “investment” packages the banks bundling the subprime loans failed to tell their investors that they contained some very high-risk loans.  If the measure of defaults occur that is expected in the subprime market it could conceivably bring down our pension funds and life insurance companies who have invested heavily in them doing the economy deep and grave damage.  To date banks have been slow to react and come up with a solution.  They are geared to foreclosing when default occurs and getting them to think outside the traditional box has been problematic.  But that is beginning to change.

            Currently there are a number of solutions on the drawing board that may help us work our way out of this morass and avoid a meltdown of our financial systems.  The Treasury Department has put forth a solution that has been accepted by the banking industry that will allow a small number of homeowners to have their variable rate mortgages not reset.  Sheila Bair, Chair of the Federal Deposit Insurance Corp., has offered an extended version of that plan that has the banks automatically modify every subprime loan if the borrower has lived in the house and has been making payments on time.  The modification keeps the borrower’s variable rate where it presently is for another two years.  There are several other options being considered in Congress, one of which would give the bank a tax credit if they would allow homeowners with subprime loans and who have been making their payments on time to refinance at a fixed rate with no cost to the borrower.   Many lenders have already been quietly doing this for the past three months.  If the idea spreads among the banking community there may not be a need for a bill to be passed.  And this is good news for our industry.  Refinancing these variable rate mortgages will generate business for the real estate industry as well as avoid the financial crisis that would come from mass defalcations of variable rate mortgages.  North Carolina ’s real estate economy is much healthier than the nation as a whole.  While the average value of homes decreased nationally for the first time this year since the Great Depression home values have held up in our state.  And in some areas such as the Charlotte metro area and the mountains, they have actually bucked the trend and increased.  Because home values spiral upward during the last decade as they did in the rest of the country houses here remain attractive to retirees from other states.  It is estimated that the migration from other states that began two decades ago will continue for the next decade.  North Carolina doesn’t have as much excess housing inventory as other states either.  Again, this is good news for those of us in the real estate industry.  Combine a healthy real estate economy with an overall healthy economy in our state with steps being made on the national level to find a cure for the subprime mess and you have a prescription for a decent real estate market in North Carolina for the upcoming year.

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