Real Estate & Mortgage Insights

Fed Says Housing Market Not Likely to Quickly Return to Normal

Sales rose in the latest recorded figures and prices are down, but what is the true state of the U.S. housing market?

According to a new paper from the Federal Reserve Bank of San Francisco, the dynamics of the mortgage market have changed so much in the past year that it may take some time before things truly normalize again.

According to the San Francisco Fed and the paper's author, Senior Economist John Krainer, "Fannie Mae, Freddie Mac, and Ginnie Mae are providing unprecedented support to the housing market - owning or guaranteeing almost 95 percent of the new residential mortgage lending."

"This shift in mortgage finance has had a profound impact on the types of borrowers receiving loans," he said, mainly in regards to subprime or poor credit borrowers. The housing market collapse was basically a result of a large percentage of these borrowers defaulting on their loans and lenders backed off almost immediately on making anymore such loans. In fact, the subprime market share was virtually non-existent in the first quarter of 2008, as investors for subprime securities vanished.

Now subprime loans are resurfacing on the mortgage scene again, but that is due largely to government efforts by the Federal Housing Administration (FHA).

Since the first quarter of last year "increased FHA lending...has revived this segment of the market," Krainer said. "After plummeting in early 2008, the share of borrowers with FICO credit scores lower than 660 has returned to just higher than 20 percent, the same share as when subprime securitization peaked in 2006," he said.

The difference now is that most of the subprime loans today are backed by the government, rather than by the private sector. The ultimate responsibility for these loans now lies with the taxpayer. Private subprime lenders are still few and far between.

"With the vast majority of current mortgage lending now intermediated in some form by the GSEs (government-sponsored enterprises), it will be difficult for the housing market to return to normal," the Fed paper said.

Low interest rates may be one of the high points for the market for the foreseeable future though. After its late September meeting, the Fed made it clear that inflation is of such little concern that "the Committee will maintain the target range for the federal funds rate at zero to a quarter percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

So rates are low, non-government lenders are few, and sales have been up. Although by all accounts, a large part of those are due to the first-time homebuyers' tax credit set to expire December 1. While there is a good chance that credit will be renewed for at least a few months, it is hard to say when the housing market will return to a "normal" rate of activity.