The Flexner Report

Market Update

No Surprises from the Fed

The Fed held center stage last week, with investors eager for hints about future policy. As expected, the Fed held interest rates unchanged on Wednesday, and the accompanying statement was essentially the same as the prior one from the March 21 meeting. Given the general weakness in recent economic data, some investors had been hoping for signs that the Fed would begin to ease interest rates soon, but they were disappointed. Instead, a consensus emerged that the Fed is on hold, and investors do not price in a rate cut until very late in the year. Meanwhile, mortgage rates ended the week at the same level as they were on May 1, and they have moved very little during the month.

Most economists now believe that Fed officials want to see an increase in the Unemployment Rate before they will cut interest rates. A tight labor market, as we have seen lately, means that companies are prone to raise wages to attract and retain workers, possibly leading to higher inflation.

The rate of new job creation has begun to decrease, but an even slower pace may be required to ease the Fed's inflation concerns. As has been the case for many months, incoming economic data will hold to the key to the timing of a change in rates by the Fed.

In the housing sector, the National Association of Realtors (NAR) released a revised economic outlook, which predicted slightly lower levels of activity this year due to stricter lending standards. Specifically, they expect the number of Existing-home sales to be modestly lower in 2007, before returning to 2006 levels in 2008. They also believe that home price appreciation will resume during the second half of 2007. Finally, their forecast includes a gradual rise of about forty basis points in mortgage rates by the end of the year.

Also Notable:

*    As expected, the Fed held interest rates unchanged at 5.25%

*    In March, the amount borrowers owe on their home-equity lines of

credit decreased for the first time since 1999

*    Several Congressman proposed a bill reducing the authority of the

regulators of Fannie Mae and Freddie Mac

*    The Wall Street Journal reported that many cities which saw below

average home price gains over recent years are now the fastest risers

Week Ahead

The upcoming schedule kicks off on Tuesday with the week's most influential economic report, the Consumer Price Index (CPI) inflation data. Almost without exception, higher inflation leads to higher interest rates, and CPI is the most widely watched indicator. CPI looks at the price change for those finished goods which are sold to consumers. Wednesday will also be a big day with Housing Starts and Industrial Production, both important indicators of economic activity. In addition, two regional manufacturing indexes will come out during the week, and Consumer Sentiment will be released on Friday.

Wealthy housing markets shrug off subprime woes

By Jim Christie Sun Apr 29, 11:02 PM ET

SAN FRANCISCO (Reuters) - Manhattan real estate broker Dennis Mangone is in a position many in his profession would envy: clients are rushing to buy as Wall Street money piles into the upper reaches of the island's housing market.

"People come to me and say, 'I need a two-bedroom for $4 million,"' said Mangone, a broker with the Corcoran Group. "The higher the price for the apartment the stronger the demand ... Penthouses are the first to sell."

By contrast, Main Street real estate brokers in many U.S. markets are waiting for the phone to ring as buyers bide their time -- partly because subprime mortgage borrowers are defaulting at a brisk pace. Many analysts predict those defaults will prompt foreclosures, which will pull down home prices that had a huge run-up in recent years.

March saw a 7.3-month supply of existing single-family homes for sale in the United States, up from 6.8 months in February, and the national median home price ticked down 0.3 percent from a year earlier, marking eight consecutive falls, amid annualized sales falling 8.4 percent from a year earlier.

Optimists say the data show housing is near a bottom. Pessimists say housing is in store for more slow-going at best.

However, they concede some markets will remain resilient, with lofty asking prices persisting despite the potential drag on the overall housing market from subprime mortgage defaults.

Analysts expect that, like Manhattan, San Francisco, parts of Los Angeles, Seattle and a handful of other affluent urban markets for homes will evade the housing slowdown.

Their economies are strong and demand for housing from higher-wage earners there remains buoyant. Also, those markets have few subprime borrowers.

'BUYING FOR LONG RUN'

Subprime mortgages allowed borrowers with blemished credit and limited resources to buy homes, typically entry-level homes in fast-growing regions with affordable housing such as the Inland Empire region east of Los Angeles. By contrast, subprime borrowers are rare in affluent markets such as West Los Angeles because affordable homes are in short supply.

"To be living in West L.A., to be able to afford it, you have to have a fairly high wage," said Stephen Cauley, research director at the Ziman Center for Real Estate at the UCLA Anderson School.

As in West Los Angeles, San Francisco home prices are holding at astronomical levels because its housing stock is small while demand from affluent buyers is persistently high.

"Those are not subprime people," said Christopher Cagan, director of research and analytics at First American CoreLogic in Santa Ana, California.

While the national median home price has ticked down, San Francisco's wealthy home buyers pushed the local median price paid for a home in March up 5.6 percent from a year earlier to $785,380, according to the California Association of Realtors.

"It's simple supply and demand, just like what's happening in Manhattan or Los Angeles or other large urban areas where you have high-wage earners who don't want to leave," said realtor Jackie Cuneo of Zephyr Real Estate in San Francisco.

Home prices in California's Central Valley, where subprime mortgages helped fuel a building boom for entry-level homes in recent years, are heading in the opposite direction.

The median price paid last month for a Central Valley home fell 5.6 percent from a year earlier to $331,450. The region's March home sales fell 32.3 percent from a year earlier.

While San Francisco home prices press higher, sales are down -- nearly 17 percent in March from a year earlier.

Such a drop in many markets would underscore sharply weaker demand. But in San Francisco it shows buyers are being picky, in contrast to the frantic buying of recent housing booms.

"We're definitely not back to that dot-com race where people are earning more money per minute than they can count and just throwing it at properties," Cuneo said. "People are buying for the long run."