The current crisis in the sub-prime mortgage market has pundits wondering what
the effect of the turmoil in the financial markets could be. Will it result in
a recession, a crisis in consumer confidence or the failure of a major financial
institution? While the future is uncertain, effects will certainly appear within
a few months. And one vulnerable spot is likely to be the real estate market,
even in previously immune Manhattan.
The immediate problem has been created by homeowners taking out mortgages that
were ill-suited for their needs. Many were adjustable with sweet interest rates
for the first several years - designed to entice homebuyers with low rates -
that adjust higher in the future. A number of the banks creating those mortgages
sold them to Wall Street firms that packaged them as bonds and resold them to
Since interest rates fell sharply in the early 2000s, the Federal Reserve has
raised them. Investment bankers doing the packaging have reaped enormous rewards
from all of the activity. Those rewards have benefited the economy in the major
financial centers around the country, especially New York City.
Now, though, more and more homeowners cannot meet their higher monthly payments.
Adding to the problem, many of those mortgages were awarded to individuals with
less than decent credit. Compounding the misery, lenders doled out incentives
not normally available to those with even good credit ratings. The result is
what is currently called the sub-prime mortgage crisis â€“ mortgages are
going into arrears in record numbers with no end in sight. This has caused a
glut of houses waiting to be sold and falling prices. But the problem extends
beyond those with sub-prime mortgages.
The major danger in plummeting real estate prices is what economists refer to
as "negative equity." A drop in prices means that the current market
price of a home is less than the mortgaged amount, suggesting that the homeowner
cannot pay off the mortgage even if the home is sold. This situation has occurred
rarely, if ever, in the United States, but the current mortgage market crisis
suggests that it is beginning now. The situation is ideal for the potential buyer
willing to pay higher interest rates than those that prevailed over the last
five years. It is, however, a potential disaster for many sellers.
New York’s Real Estate Boomâ€¦.
The New York property market has remained aloof to troubles in the rest of the
country. A limited amount of housing, especially in Manhattan, has kept prices
stable while the boom on Wall Street has propelled the market forward in more
desirable residential areas. But even a limited supply of housing does not explain
the $1.5 million two-bedroom co-op or condo. Wall Street salaries and record
bonuses have contributed to the dizzying levels witnessed over the last five
years. The spillover has affected all levels of housing in the metropolitan area,
most severely in Manhattan.
A similar effect has occurred in London, where the financial services industry
has triggered a record boom, sending property values to levels that make Manhattan
actually seem sensible. But the run-ups can only be sustained if Wall Street
earnings continue to increase at record levels. The current market crisis suggests
that the boom is over.
Wall Street salaries and bonuses are only part of the story behind the giddy
housing market. Many brokers and bankers benefit from generous mortgage packages
provided by their employers. While those packages differ, they need to continue
if the market is to remain robust. Without them, trouble will appear quickly.
And the spillover effect here should not be underestimated. Wall Street traditionally
contributes about 20 to 25 percent of New York City’s economic output.
(No wonder Mayor Michael Bloomberg worried about the U.S. markets losing business
to London and other overseas markets.) Jobs are at stake, and less employment
on Wall Street has consequences for the city.
The phenomenon has happened before. After the 1987 stock market rout, the market
for one and two bedroom condos and co-ops in Manhattan was hard hit, with prices
falling significantly. It took several years before they recovered and began
an upward spiral fueled by low mortgage rates. Apartments of that size were frequently
bought by younger traders and investment bankers - the first casualties of securities
firms feeling the pinch of losses and lower revenues. That market problem also
caused many securities firms to trim back their staffs, contributing to the recession
The problem lasted a few years and was felt across the board in the real estate
market. The popular joke circulating at the time was that pigeons were leaving
the only deposit on BMWs in Manhattan. Today the problem is a bit more complicated,
just like the markets themselves.
So far, the major damage has been in the market for sub-prime mortgages and all
of those who make a living from it - from investment bankers to securities lawyers
and accountants. The junk bond market has also felt the pain as investors who
once bought every new security in sight quickly readjust their risk tolerances.
These bonds have been among the most profitable lines of business on Wall Street
over the last five years. It is no coincidence that during the same period the
amount of mortgage debt outstanding in the U.S. has exploded exponentially as
Recent government statistics show that Wall Street and Fairfield, Connecticut,
have income levels 10 times the national average. A week or two's salary in those
places can easily equal a year’s salary in other parts of the country where
people do not work in the financial services industry. That multiple is about
to fall due to the current crisis, and the real estate market undoubtedly will
feel the pinch. Whether the higher end of the market is affected remains to be
seen, because its values are attainable by only relatively few investment bankers,
traders and hedge fund managers.
After the 1929 crash, a photo of a Wall Streeter trying to sell a car with a
sign requesting $20 has become an enduring memory. Real estate brokers tend to
be a bit subtler, but the fire sale prices will soon start appearing in Manhattan
as the fall in prices whipsaws on many who helped create the problem in the first
Charles Geisst is a professor of finance at Manhattan College and
an author of several books about Wall Street, including the New York Times
Business Bestseller, "Wall
Street: A History."
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