U.S. Treasury Secretary Henry Paulson is on the wires again, this time predicting that the number of potential home-loan defaults "will be significantly bigger" in 2008 than in 2007.

In an interview with The Wall Street Journal (subscription required), Paulson said, "The nature of the problem will be significantly bigger next year because 2006 (mortgages) had lower underwriting standards, no amortization, and no down payments. He added that "We'll watch carefully mortgages that will be reset."

Home prices fall

Paulson's comments came before the National Association of Realtors announced that home prices had fallen in 51 of 150 U.S. metropolitan areas in Q3, with the median sales price falling to $220,800 in Q3 2007, compared to $225,300 in Q3 2006. The NAR also announced that home sales fell to an annualized rate of 5.42 million units, including single-family homes and condominiums, compared to a 6.29-million-unit annualized rate a year ago.

Analysts say the combined statistics suggest that the housing slump that started in 2006 is likely to continue until at least mid-2008, and most likely considerably longer, and will also serve to restrict U.S. economic growth.

The housing sector is a pivotal component in the U.S. economy not solely for the transaction value of real estate and mortgage financings, but also because housing affects demand in companion sectors: furniture, appliances, home improvement, and home services, among other sectors. As such, increasing house sales almost always stimulates U.S. economic growth; decreasing sales almost always lowers U.S. economic growth.

Seeking better rates

Paulson said the Treasury Department is now aggressively encouraging the mortgage servicing sector to develop criteria that would enable more subprime and near-subprime borrowers who may be headed toward default to qualify for loans with better terms, The Journal reported. Many economists now expect the housing sector's sluggishness to lower U.S.GDP by up to 1 percentage point, or to roughly 1.8%-2.3% GDP growth in 2008.

Further, the specter of an increased number of subprime defaults in 2008 -- if Paulson's prediction proves to be accurate -- suggests that housing's drag-effect may intensify in 2008, particularly if measures are not put in place to help borrowers who to date have represented a considerable portion of mortgage defaults: those borrowers with interest rates that have been reset to higher rates.

Estimates vary industry-wide, but up to two million mortgages are due to reset to higher rates by the end of 2008.
Although Paulson stopped short of endorsing a proposal by Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., to have mortgage companies freeze the interest rates on mortgages due to reset to higher rates between now and the end of 2008, he said that's "one idea," according to the Journal article.

Economic Analysis: Sec. Paulson appears to be bracing the markets -- and possibly the U.S. Congress -- for more housing fallout. The secretary's effort to encourage the mortgage servicing sector to help large pools of at-risk borrowers will help, but as housing and mortgage payment data amasses, it's becoming more-clear that some type of additional mortgage insurance and/or expanded secondary mortgage market purchase program will be needed to both de-concentrate subprime mortgage risk and maintain sufficient mortgage market liquidity.