Zandi Expects Credit Quality to Deteriorate

A prominent economist told investors in mortgage-backed securities recently that even though the economy is improving, he expects mortgage delinquencies to keep rising.

In fact, between now and the end of 2005, Mark Zandi of Economy.com believes the overall trend could be negative.

"There is still more pain to come. I do anticipate mortgage credit quality to continue to erode right through next year and into 2005," Mr. Zandi said during a Web conference sponsored by Fitch Ratings.

He believes the economic recovery remains fragile, but he expects it to become more sustained over time. Both consumer confidence and business confidence have improved, according to recent surveys. And better expectations should help to bolster investment and spending. In addition, the monetary stimulus provided by large increases in federal government spending and lower taxes also is helping to generate economic growth, though the benefit has abated somewhat because of the increase in interest rates, he said.

"The key to continued improvement in the economy now lies in the job market," he said. "I think we are on the cusp of a pickup in jobs."

But while the labor market may be developing a "slightly brighter hue," as Mr. Zandi puts it, that may be too little help too late for some of the currently unemployed. Moreover, slower home price appreciation will make it more difficult for troubled borrowers to avoid foreclosure.

In fact, Mr. Zandi said that rising interest rates are the principal reason for his prediction that mortgage credit quality will erode. While he does not expect the Federal Reserve Board to tighten monetary policy this year or even early next year, by this time next year, he anticipates that the Fed will be tightening monetary policy.

"I think that will be very hard on the housing market," he said.

And this follows a period of historically rapid increases in home prices, Mr. Zandi noted.

Falling interest rates since 2000 have helped drive the rapid rise in home prices, he believes. But that fuel may be running out now that rates seem to have bottomed out. Another factor boosting home prices has been "raw speculation," he said. People believe home prices will rise strongly because they have seen that happen in the recent past.

But most of the factors behind the unusual rise in home prices are temporary, he said. And the end of rapid gains in home prices does not bode well for mortgage credit quality.

In addition, debt consolidation and cash-out refinancing have raised loan-to-value ratios for some borrowers, especially on the subprime side of the market. (See related story, Sept. 8 edition of National Mortgage News.)

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