by Calculated Risk on 4/20/2007 01:30:00 PM

Here are some excerpts from Governor Frederic S. Mishkin speech today: The U.S. Economic Outlook

Regarding the housing adjustment ... At the beginning of the year, the ongoing cutbacks in starts of new homes, together with a lowered but fairly steady pace of home sales, were beginning to reduce the elevated backlog of new homes for sale. However, a further weakening in sales of new homes in January and February reversed some of the progress in reducing those inventories. As a result, cutbacks in new residential construction may well persist for a while.

Towards the end of last year, the Fed's view was that the housing market was near the bottom for this cycle. That viewed seemed to ignore housing fundamentals (like, say, record supplies and falling demand), and now the Fed is finally acknowledging that problems in housing "may well persist for a while."

More recently, developments in the subprime mortgage market have raised some additional concern about near-term prospects for the housing sector. The sharp rise in delinquencies on variable-interest-rate loans to subprime borrowers and the exit of a number of subprime lenders from the market have led to tighter terms and standards on such loans. While these problems have caused undeniable hardship for many families and communities, spillovers to other segments of the mortgage market or to financial markets in general appear to have been minimal.

The spillover is minimal if you ignore Alt-A, prime HELOCs, and C&D loans to condominium developers. As an example, here is an excerpt from Corus Bankshares' press release this morning:

"With a loan portfolio consisting, almost exclusively, of condominium construction and conversion loans, the nationwide slowdown in the residential housing market is impacting Corus' business. Evidence of this slowdown is clear from the decline in loan originations, the resulting decline in loans outstanding and an increase in problem loans. The current quarter's earnings declined as a result, and it would not surprise us to see an even greater impact on earnings over the next several quarters, or even years, depending on when the market improves," said Robert J. Glickman, President and Chief Executive Officer.

And back to Mishkin:

I should note some positive news for the housing sector. Sales of existing homes strengthened a bit during January and February, and the Mortgage Bankers Association index of applications for home purchase suggests that demand has been fairly steady through early April. Also, mortgage rates are still at historically low levels, and mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to show low rates of delinquency.

The MBA index has held up pretty well, probably due more to how their survey is conducted than any real strength in the housing market. On the existing home news, Mishkin is simply looking at the data incorrectly. And yes, delinquency rates are rising for all borrowers, including prime borrowers and those with fixed rate mortgages.

And away from housing:

The second major area of concern in the near-term outlook, and one that perhaps could pose noticeable downside risks, is business investment.

A downturn in business investment definitely wasn't a surprise since that is the normal historical pattern (non-residential investment follows residential investment). There is much more in the speech, especially concering inflation expectations.