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Mortgage Market in ‘Downward Spiral’

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RISMEDIA, August 15, 2007–(MarketWatch)–Problems in the nation’s mortgage and housing markets are feeding off each other and creating a “vicious cycle,” analysts at Stifel Nicolaus & Co. said Monday.

“The rapidly increasing scope and depth of the problems in the mortgage market suggest that the entire sector has plunged into a downward spiral similar to the subprime woes whereby each negative development feeds further deterioration,” wrote analysts Chris Brendler and Michael Widner in a research note.

Investors are uncertain about where the pain in subprime mortgages, which are designed for home buyers deemed greater credit risks, may spread next.

In the view of Brendler and Widner, the U.S. economy may end up in recession.
Secondary mortgage markets where large investors trade debt are “practically frozen,” which has led to “dramatic additional tightening of underwriting standards that will likely serve to only exacerbate the imbalance in the housing market,” according to Stifel Nicolaus.

The analysts said rates on home loans should rise as lenders try to compensate investors of mortgage-backed securities with more yield to make up for the added risk they entail. The mortgage-backed securities market has been crushed with foreclosures on the rise, and hedge funds and investment banks that bought the debt have been feeling the pain in turn.

Underscoring the shaky conditions in housing, Stifel Nicolaus said its earlier forecast calling for home-price deprecation between 10% and 15% may prove optimistic.
The analysts see a worsening tailspin as housing prices fall harder, leading to more credit deterioration.

“With the coming wave of adjustable-rate mortgage resets, foreclosures, and actual MBS defaults, we continue to believe we are far from the bottom,” they wrote. “As a result, we remain bearish on the entire mortgage sector and are increasingly concerned about the broader market as we believe the depth of the mortgage [and] housing and related credit market problems may be enough to tip the economy into a recession.”

For things to turn around, investors need to regain confidence in the mortgage-backed securities market, Stifel Nicolaus said.

“Since credit likely won’t stabilize until housing bottoms, we continue to believe conditions will get worse,” the analysts concluded.

John Spence is a reporter for MarketWatch in Boston

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