Financial turmoil restrains on construction ease

Jim Haughey

Overall, the collapse of the alternative residential mortgage market is no longer the principal restraint on construction spending. Slowing spending growth in the economy took over that role several months ago.

Long term rates inched slightly higher in March and through late April bringing all mortgage rates up slightly in spite of a lowering of inflation expectations. The marginal rise in mortgage rates is good news for construction because it signals a more stable financial market with better access to credit for construction financing.

The first phase of the financial crisis is over now that most lenders have recognized their mortgage related losses and obtained new capital to permit them to gradually resume normal lending practices. Phase two has begun. This is the really ugly part when an increasing number of people lose their homes and others cut back on spending to manage their house payments. As ugly as this will be, it is downstream from construction job sites and, if forecasted reasonably accurately, will not feed back on construction job sites.

There is some risk that lenders have underestimated what their mortgages losses will turn out to be. If so, expect a t least a mini repeat of the January-March write-downs and recapitalizations late this year or early 2009 which will again briefly make interest rate volatile and limit credit access for construction and real estate.

There is also a risk that Congress will provide the funds to subsidize home payments to homeowners that can not afford the home they live in. This would accelerate the construction recovery but soon limit the pace of recovery as the subsidized homeowners increasing default anyway because of the poor personal financial management they have already demonstrated. The mortgage rate consequence of Congressional subsidies would be an initial rise in rates as money is borrowed to provide the subsidies.

U.S. Construction Finance Environment – April 2008

	Financial Market Benchmark Rates
	Previous				Annual Average
	Month				Actual		Forecast
	(Mar 08)	Latest			2006	2007	2008	2009
Federal Funds Rate (overnight)	2.61	April 16 08	2.34		4.96	5.02	2.37	2.73
1-Year Treasury Bill (T-Bill) Rate	1.54	April 18 08	1.67		4.93	4.52	1.99	2.60
10-Year Treasury Bill (T-Bill) Rate	3.51	April 18 08	3.67		4.79	4.63	3.49	3.73
Prime Bank Rate1	5.66	April 16 08	5.25		7.96	8.05	5.52	5.75
1 Base for home equity, contractor and business investment loans
	Mortgage Loan Rates
	Previous				Annual Average
	Month				Actual		Forecast
	(Mar 08)	Latest			2006	2007	2008	2009
1-Year Adjustable Rate Mortgage	5.12	April 24 08	5.29		5.53	5.56	5.03	5.13
5/1 Adjustable Rate Mortgage	5.54	April 24 08	5.68
15-Year Fixed Rate Mortgage	5.42	April 24 08	5.62
30-Year Fixed Rate Mortgage	5.97	April 24 08	6.03		6.41	6.34	5.64	5.61
	Previous					Highlights Short rates fell sharply in March in response to weak loan demand and aggressive monetary easing but long rate increased in line with rising inflation expectations.
	Month		Latest
Core Inflation Rate2	1.7% (Jan 08)		Feb 08	1.9%
Inflation Expectations3	2.41% (Mar 08)		Apr 1 08	2.33%
2Based on personal consumption expenditures (less food and energy), year over year. FRB Cleveland 3Based on rates for 10-Year inflation-protected Treasury securities.

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