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Where�s Real Estate Headed In 2007?

Funky Loans May Hold Answer

In 1998 �liars� loans� (those with little or no documentation required) amounted to 24% of mortgage originations. Last year they accounted for 62%. And interest-only mortgages have vaulted in the same period from virtually no market share in the mainstream lending business to a 50% share.

That�s why Gary Gordon, a member of the investment committee of Annaly Mortgage Management, has build a coherent and persuasive case that a housing downturn will continue, and proceed in three phases:

         Phase I, now under way, where home sales will drop to cure what are politely known as �affordability issues.�

         Phase II, starting soon, will see job growth faltering as the pace of lending and borrowing downshifts.

         Phase III, lingering into 2008, wherein mortgage lenders will relearn the fine art of saying no. The resulting withdrawal of easy credit will add new downward pressure on both home prices and consumer spending.

Gordon says the fundamental problem is that the typical American home buyer can�t afford a home at today�s prices. (Yale economist Robert Shiller says that inflation-adjusted house prices in the past five years logged the second-fastest cumulative growth since the administration of William McKinley 110 years ago.)

And the potent stimulus of above-trend borrowing growth is about to be removed with falling house prices. Americans pulled out over $500 billion of equity in their homes in 2005 in order to buy other stuff. That number shot up from about $100 billion in 2001. When you reduce or reverse this housing appreciation you stymie the borrowing boom.

And yes, Gordon points out, the Federal Reserve can engineer a lowering in mortgage-borrowing costs by trimming the funds rate. Although such actions can invite lenders and borrowers to do business together, the Fed can only do so much. But it can hardly hold a gun to their heads.



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