Success of bailout to depend on housing turnaround

Experts say as banks keep watch for signs of improvement, loans will be more difficult to obtain

By Stevenson Jacobs
Associated Press

Published on Sunday, Oct 05, 2008

NEW YORK: 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 before the $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 U.S. economy and by extension the availability of credit. Roughly one in eight U.S. 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.

In the meantime, people like Alicia Elliott
are adjusting to a new American reality: Life without credit.

The 21-year old Morgantown, W.Va., resident just bought a used mobile home, borrowing $4,000 from friends and family because she couldn't get a bank loan.

''I tried to. Couldn't do it. It's just hard to get a loan,'' said Elliott, who works as a cashier at a Lowe's Cos. store.

She used to get bombarded with offers for credit cards. Now she can't even get one.

''I get denied one after another after another. It doesn't matter if you have a co-signer or not,'' she said.

'Credit is a privilege'

Trey Simmons, 31, a barber at a Dallas hair salon, said he worries tighter lending standards will squash his goal of buying a home next year.

''Credit is a privilege everybody can't get,'' Simmons said. ''I had credit at a young age and messed up.''

He now operates on a strictly cash basis.

''If I don't have it,'' he said, referring to cash, ''I don't spend it.''

The dilemma boils down to a matter of trust.

''Credit, by definition, means trust and faith, and for many reasons trust and faith have been damaged,'' said Sung Won Sohn, an economics professor at California State University, Channel Islands.

Sohn 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 people like Elliott.

''Banks know the economy is getting worse, so . . . they will keep being cautious,'' said Sohn.

Still, the government hopes that by scooping up billions of dollars in 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.

Paulson gets ready

In the meantime, the Treasury Department is moving swiftly to get the plan started. Treasury Secretary Henry Paulson said Friday he did not wait for final approval of the measure to begin preparation. 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 might 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 unit.

''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,'' he said.

It also creates a vicious cycle: No trust means no lending; tight credit means it's harder to buy a home; the more difficult it is to buy or sell a home, the further home prices will fall; and the further prices drop, the more foreclosures there will be.

U.S. home prices — down 20 percent from their peak in July 2006 — still have further to fall, and must hit bottom before demand picks up. The long-awaited bottom in prices could be a year or more away.