An Update on Emerging Issues in Banking 

Housing Market Strengths and Risks

March 28, 2002 

A report released today in the FDIC's Regional Outlook evaluates changes in 

mortgage underwriting during the last expansion, and the likelihood that

weakening home price growth could adversely affect home borrowers and

lenders. The authors do not expect adverse mortgage performance trends to 

threaten the capital or earnings of the vast majority of FDIC-insured 

institutions. The report concludes, however, that looser lending standards

during the 1990s may have heightened lenders' overall risk compared to 

previous business cycles, and that a few previously booming locations, such

as the San Francisco Bay Area1, are exhibiting heightened home price risk.

Nonconstruction residential mortgages historically have been one of the 

lowest credit-risk loan types for FDIC-insured institutions. Past experience 

probably understates credit risks during this cycle because the mortgage 

lending business has changed since the last recession. Chief among the 

changes are robust mortgage market competition, which has contributed to 

narrower collateral margins (higher initial leverage); increased reliance on 

non-recession-tested automated underwriting; and expanded involvement in 

the subprime mortgage market (discussed in a prior FYI ). Credit quality 

indicators for insured institution mortgage loan portfolios have shown only

preliminary signs of weakness thus far, although continued strong mortgage

origination activity in 2001 may have masked (in the aggregate) developing 

credit problems for more seasoned mortgage loans.

Construction and Development Lending Risks May Be Elevated in Some

MSAs

Historically, lending to finance housing construction is riskier than mortgage 

lending on existing structures. If markets with an oversupply of housing 

experience weaker economic performance, insured institutions with significant

lending exposures to residential real estate development may be vulnerable 

to weakening credit quality. Last year, some large markets displayed signs

that residential construction activity was accelerating as local economic

conditions were deteriorating, especially Atlanta (see Chart 1).
D

Adverse Home Price Trends Remain Isolated

The risk of significant downward corrections in home prices does not appear

geographically widespread. However, a handful of MSAs that have seen 

several years of rapid home price appreciation and declining affordability are 

now experiencing a softening in economic conditions (see table 1). Home 

prices and insured institutions lending in these markets may be adversely

affected should these weaker conditions persist.

Problems likely would be more pronounced for households that rely on 

multiple incomes to meet mortgage payments or those with limited financial

resources. In addition, increased underwriting of high loan-to-value and

subprime mortgages during the past decade could aggravate any rise in 

delinquencies. Foreclosure risks would be amplified in any markets that see 

outright declines in home prices during 2002.

As of year-end 2001, the San Francisco Bay Area appeared to demonstrate 

the greatest likelihood of a significant overall decline in home prices. The 

area's fourth-quarter, year-ago change in median home prices turned 

negative for the first time in more than six years, highlighting this risk. Further,

a recent analysis from the UC-Berkeley Haas School of Business forecasts

that prices in the Bay Area housing market will decline 15 percent overall (30 

percent for luxury homes) by year-end, when, according to this analysis, the 

recession in the local economy is expected to end. 2

1 As considered here, this includes the following MSAs: San Jose, Santa Cruz-Watsonville, San 

Francisco, Santa Rosa, Oakland,
Salinas, and Vallejo-Fairfield-Napa.

2 "Bay Area Housing Market Will Remain Slow," David Goll, East Bay Business Times, January 23, 

2002.

Last Updated 

03/28/2002 

Chart 1

The title of this chart is "Residential Construction Activity Accelerated in 2001 Despite Declining 

Employment in Some MSAs". It is a scatter plot of dots where the vertical position measures the absolute 

year-ago change in an MSA's nonfarm employment (in thousands) as of December, 2001, and the 

horizontal position indicates that MSA's absolute year-ago change in December 2001 year-to-date singlefamily residential permits. MSAs in the lower right-hand quadrant are those where employment was 

declining last year, but marginal housing supply was increasing, suggesting a potentially growing 

imbalance in housing supply. Atlanta is the MSA where this condition was most significant, followed by 

markets like Phoenix, Portland (OR), and Orlando. 
Housing Market Strengths and Risks 

Table 1 

As Recession Evolved, Home Price Appreciation Waned Through 2001

...Further Deceleration in Growth (or Declines) May Be Possible in 2002 

MSAs Ranked by Deceleration in Home Price Index 

between first quarter and fourth quarter 2001

Annual Percent Changes,

OFHEO Home Price Index

1998-2000, 

Average

2001, First 

Quarter

2001, Fourth 

Quarter

United States 6.3 9.6 6.9

San Jose CA PMSA 17.7 24.4 0.6

Santa Cruz-Watsonville CA PMSA 16.8 25.7 5.9

San Francisco CA PMSA 16.5 19.4 3.5

Salinas CA MSA 13.7 24.3 9.4

Santa Rosa CA PMSA 14.8 22.7 8.6

Oakland CA PMSA 14.7 22.3 8.2

Austin-San Marcos TX MSA 9.4 15.2 5.0

Merced CA MSA 6.4 24.6 15.7

Jamestown NY MSA 4.9 9.9 1.6

Stockton-Lodi CA MSA 9.0 22.8 14.9

Wheeling WV-OH MSA 4.1 10.8 3.7

Goldsboro NC MSA 4.0 7.9 0.9

Cumberland MD-WV MSA 2.7 8.6 1.8

Lewiston-Auburn ME NECMA 4.2 14.0 7.1

Bangor ME NECMA 3.7 13.2 6.5

Fargo-Moorhead ND-MN MSA 4.0 11.1 4.6

Barnstable-Yarmouth MA NECMA 12.8 17.6 12.5

Pine Bluff AR MSA 2.2 6.6 0.3

Dubuque IA MSA 3.9 8.8 2.5

Boulder-Longmont CO PMSA 10.9 14.6 8.3

Denver CO PMSA 11.1 13.7 7.9

Utica-Rome NY MSA 3.5 14.6 9.1

Vallejo-Fairfield-Napa CA PMSA 11.8 20.0 14.7

Bryan-College Station TX MSA 4.8 11.1 5.8

San Diego CA MSA 11.8 15.6 10.4

San Luis Obispo-Atascadero-Paso Robles CA MSA 11.4 19.2 14.2

Tucson AZ MSA 3.3 8.6 3.6

Jersey City NJ PMSA 8.0 11.1 6.2

Clarksville-Hopkinsville TN-KY MSA 3.3 9.1 4.2

Rapid City SD MSA 6.2 8.9 4.1

La Crosse WI-MN MSA 5.7 7.4 2.6

St. Cloud MN MSA 6.9 10.4 5.7