Tighter credit standards among mortgage lenders might lower U.S. home prices by 10 percent this year and push the economy into recession if the Federal Reserve doesn’t respond by lowering interest rates, Merrill Lynch & Co. said in a report.
Merrill analyst David Rosenberg, who previously forecast the Fed would lower interest rates in the second half of 2007, said there are two possible scenarios. With a rate cut, economic growth will slow to about 1 percent. If rates are left unchanged, and housing prices fall 10 percent, the probability of a recession is “very close to 100 percent,” Rosenberg wrote.
“There could well be potentially significant further drags on home prices, construction activity and of course consumer spending,” he said in a March 13 note to investors.
New Century Financial Corp., the second-biggest subprime lender in the U.S., and other mortgage companies are facing possible bankruptcy as the number of borrowers in the U.S. falling behind on payments has risen to a four-year high. More than 20 subprime lenders have closed or sought buyers since the start of 2006 and bank regulators are pushing lenders to raise credit standards.
Declines in home prices would have an effect on everything from furniture and appliance sales to landscaping and the price of copper. That would drive unemployment above 5 percent by the end of the year and make an “outright recession” more likely unless the Federal Reserve cut benchmark interest rates by a full percentage point, Rosenberg said.
“What we are concerned about most are the knock-on effects from the pullback,” he wrote.
Analysts at Credit Suisse Group, Switzerland’s second-biggest bank, said in a note to investors yesterday that stocks worldwide will weather a surge in U.S. subprime loan defaults.
“The key to whether or not fears of an economic recession and a far more severe correction in equity markets materialize rests on the shape of the labor market and the corporate sector,” Credit Suisse said.
The Federal Reserve raised its benchmark rate to 5.25 percent in June, compared with an average target of 3.2 percent in 2005, a year when net new mortgage borrowing soared by a record $1 trillion.
Chairman Ben Bernanke has identified 1 percent to 2 percent as his preferred range for the inflation gauge most closely monitored by the central bank. The measure, which excludes food and energy costs, rose 2.3 percent in the 12 months to February.
Rosenberg, who wrote, “It would come as no surprise to our readership that we are more concerned than most others on the outlook for the economy, housing and credit,” predicted in May 2005 that the Fed would stop lifting interest rates at 3.25 percent and be forced to reduce them by the end of 2006. The Fed paused last August with rates at 5.25 percent. In October, Rosenberg forecast the Fed would cut rates by 50 basis points before the end of March.
Economists surveyed by Bloomberg News forecast the Fed will hold the rate through the third quarter, according to the median estimate. The board has not lowered the rate a half percentage point in a single stroke since November 2002.
Rosenberg estimated that subprime loans boosted home sales by at least 20 percent annually and the loss of that market might shave half a percentage point from the Gross Domestic Product.
