For bailout to work, US housing recovery is vital

Source : Business Times - 6 Oct 2008

A housing upturn may induce banks to lend again: analysts

Washington’s financial bailout plan is now law. So the credit spigot will start flowing again, banks will resume lending, and an economic recovery can begin, right? Wrong.

Experts say the most important thing that needs to happen before the US$700 billion bailout even has a chance of working: Home prices must stop falling. That would send a signal to banks that the worst has passed and it’s safe to start doling out money again.

The problem is the lending freeze has made getting a mortgage loan tough for everyone except those with sterling credit.

That means it will take several months or longer to pare down the glut of houses built when times were good - and those that have come on the market because of soaring foreclosures - before home prices start appreciating.

Housing is a critical component to the US economy and by extension the availability of credit. Roughly one in eight US jobs depends on housing directly or indirectly - from construction workers to bank loan officers to big brokers on Wall Street.

A turnaround in housing prices would boost confidence in the wider economy and, experts hope, goad banks into lending again.

‘Housing traditionally does lead the economy through a recovery. I think it’s going to be critical for a sustained recovery in this cycle, too,’ said Gary Thayer, senior economist at Wachovia Securities.

Sung Won Sohn, an economics professor at California State University, Channel Islands said the near certainty of a recession makes it too risky for the thousands of small and medium-sized banks across the country to lend to small borrowers.

‘Banks know the economy is getting worse, so … they will keep being cautious,’ said Prof Sung.

Still, the government hopes that by scooping up bad mortgage debt and other toxic assets, banks eventually can clean up their shaky balance sheets, crack open the vaults and send money washing through the system again. The rescue plan also raises the federally insured deposit limit to US$250,000 from US$100,000, a move that could boost banks’ reserves and further grease the lending wheels.

Representative Barney Frank, the Financial Services Committee chairman said the measure was just the beginning of a much larger task Congress will tackle next year: overhauling housing policy and financial regulation in a legislative effort comparable to the New Deal.

Meanwhile, the Treasury Department is moving swiftly to get the plan started. Treasury Secretary Henry Paulson said on Friday he has been lining up outside advisers as his staff works out details on a multitude of complex issues.

But several hurdles could trip up the plan. For starters, even when the Treasury starts buying bad assets, some banks may hoard the cash they receive in return until they see how the plan pans out.

That has the potential to make the lending logjam worse, said Vincent R Reinhart, former director of the Federal Reserve’s monetary affairs division. ‘They may sit on the sidelines and wait to see (the bailout) get some traction. The problem is if everybody sits on the sidelines, nobody gets in the game. It’s a risk.’

But Jim Gillespie, chief executive of Coldwell Banker Real Estate, said he hopes that lower prices, combined with the government’s actions will jump-start stagnant demand. The federal bailout plan ‘will give people reassurance that mortgage money is available.’ - AP