The availability of construction funding remains fragile and is a major threat to construction starts and spending in 2008. Commercial developers report increasing difficulty obtaining construction financing with the full impact of this yet to seen in construction starts. The fixed rate subprime and jumbo residential mortgage markets are still short of funds and continue to ration credit with premium mortgage rates and tighter approval standards.

There were four developments impacting the availability of construction funding in the week before Christmas. Three were positive.

First, the Senate passed the FHA modernization plan with a conference committee expected to approve it by year end. This permits the Federal Housing Administration to expand its mortgage loan programs to several hundred thousand additional homeowners in 2008. FHA had been shunted aside in recent years by mortgage brokers offering teaser rate subprime loans. Their offers were too good to be true so now FHA is back to resume the role of mortgage lender of last resort. Congress is permitting FHA to expand its loan limits, permit reduced downpayments and lend to homeowners with higher incomes.

This will be an immediate and measurable boost to housing starts. But to a considerable extend this may only be postponing mortgage defaults. Remember why FHA went into collapse mode several years ago. Their processes are slow and inefficient for borrowers. Many sellers would rather deal with the devil than FHA and will only accept an FHA based offer to buy as a last resort, which for some sellers it now is. Also, recall that FHA insured mortgages have always had foreclosure rates many times higher than commercial mortgages. Taxpayers will soon own several hundred thousand mortgages, many of them refinancings, that commercial lenders do not want.

Second, Merrill Lynch joined a growing list of investment managers announcing a multi-billion dollars capital injection from a foreign government. In this case, Singapore. These foreign equity investments will permit investment managers, to make additional loans, some of which will fund construction.

Third, the Federal Reserve Board held two of the planned four $20 billion auctions of temporary capital for US banks. See the previous posting for more details. Since these auctions accept mortgage backed bonds as collateral for loans, the FRB prices the bonds, substituting for the bond rating agencies that could not do this accurately, which makes the bonds tradable so banks can accept their losses and sell them which raises capital for more loans.

The bad news for construction funding was the outsized 1.1% gain in consumer spending in November. The large gain encompassed all products indicating that consumers both covered their higher energy costs and went to the mall to prepare for a merry Christmas. How is this bad? All measured at annual rates, in the last two months, consumers boosted spending after inflation by 3.8% while their disposable income fell 2.4%. This required consumers to tap their savings for over $100 billion. As investment managers are struggling to find the funds for construction and other loans, consumers are withdrawing funds.

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