Economists for the Mortgage Bankers Association were the bearers of bad news at the MBA's annual convention in Boston last week, as they predicted a cyclical downturn in the U.S. mortgage market through the fourth quarter 2000, despite an overall optimistic outlook for the economy as a whole.

"Please don't blame the messenger for the message," warned David Lereah, chief economist at the MBA, as he prepared the audience of mortgage bankers, lenders and servicers for the grim news he was about to present.

According to Lereah, the downturn began during the third quarter 1999 and was a result of higher interest rates. After two record-breaking years for the mortgage industry, the number of new mortgage originations is expected to shrink more than 27% for 2000, from $1.3 trillion in 1999 to $940 billion next year.

Additionally, Lereah predicted that the mortgage industry will lose approximately 20% of its work force, or about 75,000 workers, mainly through layoffs. With interest rates rising by 112 basis points and purchase originations down 13%, the economist spoke of an "interest-rate sensitive" downturn that will produce a "double-digit contraction in the industry."

Lereah also compared the current downturn with the last one, which befell the mortgage market in 1994. During that downturn, interest rates spiked 205 basis points and total originations were down 63%. Since 1973, there have only been four such downturns for the market, with the worst one being fiscal years 1980 to 1982, when total home sales dropped 51%.

Still, 1998 and 1999 proved to be "the good ole days" for mortgages, with purchase originations reaching a record-breaking $838 billion in 1999.

Lereah expects mortgage rates to hover around 8% by the end of 2000, he told the crowd. According to the economist, a 1% increase in mortgage rates prices 450,000 homebuyers out of the housing market and increases mortgage payments by $6 billion annually. Additionally, it will reduce cash-out refinancings from $95 billion during 1998 and 1999 to less than $20 billion in 2000, and also reduce realized capital gains from the sale of existing homes by $10 billion.

Despite the gloomy outlook for the mortgage market, the country as a whole has entered its ninth year of economic expansion, said Lyle Gramley, consulting economist for the MBA and former governor of the Federal Reserve.

The only threats to the economic expansion are inflation and the international sector, which has "been a drag on economic growth," Gramley said. He predicted that real gross domestic product (GDP) would drop from 3.4% for 1999 to between 2.75% and 3% for 2000.

"But if the Fed is vigilant, it won't be a major problem," he added. "Otherwise, consumers have been spending aggressively, and recent economic indicators have been encouraging. Although the housing industry has been erratic, it still has been a significant contribution to growth."

"The last two years have been good years in the lending markets," Lereah said, adding that existing home sales reached a peak of more than 5 million during the third quarter 1999, as did new home sales, which hit 926,000. "But it is more fiercely competitive now, and we are dealing with a changing marketplace."

Ch-Ch-Ch-Changes

Lereah attributed the current cyclical downturn to the changing landscape of the mortgage market, including the domination of wholesale activity, increased consolidation, the dominance of the government-sponsored agencies and a change in homebuyer demographics.

"The GSEs are out there full throttle," Lereah said, while noting that he did not want to get into the deeper political ramifications of the criticisms recently leveled against the agencies. "The GSEs, over time, have certainly played a major role in all our businesses. But as for the politics, I won't get into that today."

Still, the economist foresaw a major downturn in MBS issuance for next year, in line with the overall downturn in the market.

Additionally, the economists said that lenders will be looking for alternative distribution channels going forward, especially the Internet, which "will take 10% to 25% of the market," Lereah estimated.

Moreover, there will be a trend toward more consolidation, Lereah and Gramley said. Lereah predicted that within 10 years, the top 25 lenders will control 91% of the mortgage business.

Lereah also stated that the mortgage market is poised for growth in subprime lending and high loan-to-value loans going forward, and that the market needs to accommodate nontraditional borrowers, such as immigrants and minorities, more than ever.

"We need to bring them into the homebuyer process," Lereah added.

In conclusion, the MBA chief economist left the audience with a glimmer of optimism, noting that such cyclical downturns are expected and eventually correct themselves.

"This is an industry of survivors, and we prove it again and again," he said. "Hopefully this downturn will be short-lived, and we will live happily ever after...until the next downturn."

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