WHY ARE OIL PRICES FALLING?

The recent plunge in crude oil price futures—at $108 per light sweet barrel at this writing—will help us in many ways. It is one of the main causes of the economic slowdown, since it has taken so much out of consujmers’ pocketbooks as it boosted inflation to double-digit levels, the highest levels since the early 1980s, according to CBS Marketwatch economist Irwin Fellner.

Why are oil prices falling? The U.S. dollar is rising in value—especially against the euro and English pound. And since most oil producers are paid in dollars, a higher dollar value viz other currencies means lower dollar prices for foreigner’s oil.

The dollar is rising in value because other economies are slowing down, which makes the U.S. economy look better. Growth in Germany, Japan and Great Britain has turned negative, while U.S. second quarter economic GDP (domestic) growth was just revised upward from 1.9 percent to 3.3 percent—close to the 75-year growth average.

So this is a chain reaction of sorts that will benefit consumers and real estate as well. A strengthening dollar and lower inflation will keep the Federal Reserve from raising interest rates anytime soon, for one thing, as some inflation hawks have been calling for.

This also strengthens the balance sheets of our ailing banks, because it keeps their cost of funds low. And as banks’ profits increase, they will be able to originate more mortgages again. Real estate lending is down more than 50 percent, according to the Mortgage Bankers Association from its high point in 2005.

Where is our economy at present? We are probably bumping along at the bottom of this recession. Yes, it will officially be called a recession that begun around last November; probably sometime next year after the turnaround has begun. The end of the 2001 recession in November (yes, one month after 9/11) wasn’t called under 11 months later.

This means real estate sales are beginning to stabilize as well. The S&P Case/Shiller index of 20 metro areas is the broadest indicator of regional prices. The number of metro areas with home prices beginning to increase has increased steadily for the past 3 months, as we have said. This hasn’t yet put a dent in inventories, however.

But the wild card is the mortgage industry. Fannie Mae and Freddie Mac are about to be taken over by the Federal government, with details yet to be revealed. The scuttlebutt is that it will make mortgages cheaper. This should give a big boost to real estate, needless to say, since they now buy and package for investors more than 70 percent of all mortgages. And when the new $625,500 loan limit for a single unit kicks in in January, we presume 2-4 unit loan limits will also rise.

I believe we can look to 2009 with some optimism. Mortgage rates have been trending down of late with oil prices. The conforming 30-year fixed rate had briefly dipped to 5.875 percent last week, and the ‘jumbo-conforming’ amount (to $729,750) was just 6.125 percent—both with a 1 point origination fee. They should continue downward once the Fannie/Freddie rescue package is in place. This will bring many more home buyers into the market that has home prices already down some 16 percent, along with oil prices and inflation, of course.

© Harlan Green 2008