The September financial tsunami hit Puerto Rico quite hard, and it will continue to be felt.
Start by checking your mailbox. A couple of years ago it was bursting with credit card offers. Now you barely see them. Check the advertisements for mortgages. Check out how many offer 100% financing. Check out how many offer interest only payments with a balloon after seven years.
Car sales were running at 6% below last year up to August. During the month of September they were 20% below last year as both banks and consumers became more cautious. Open your mutual fund statement, your IRA accounts tied to the stock market, and you will read a sad story. Even PR government bond issues such as the pension recapitalization issue are trading below par.
One of the consequences of the financial tsunami is to deepen the problem of the real estate market and in particular the high income units. Financial institutions in the past were very flexible on their credit standards and their policies have become increasingly restrictive.
As opposed to the United States, the mortgage market in Puerto Rico was predominantly a plain vanilla 30 year fixed interest rate. However, it was a market in which non-conforming loans were the norm. Highly indebted consumers, individuals who obtained income from the informal economy and therefore could not document their income, individuals who did not put a cent of downpayment, they all got mortgage loans.
In the second quarter of 2005, over three quarters of the mortgage market was non-conforming. Three years later it was only half. It will be even less by the end of this year. When comparing the second quarter of 2005 with 2008, FHA loans plus conforming loans increased by $165 million. Meanwhile, non-conforming loans declined by $1,487… and will continue its downward trend.
The figures are still not in for the third quarter of 2008, but the resale markets for these mortgages dried up. Add the fact that real estate in Puerto Rico is not perceived as good as collateral as it was last year. Therefore, local financial institutions must have restricted the issuing of non-conforming loans over and beyond the experience of June 2008.
The financial tsunami washes away one of the routes usually used by the Puerto Rico economy in order to get out of a recession. When the US and Puerto Rico are in recession at the same time, the Federal Reserve reduces interest rates. Puerto Ricans, whose savings are mostly in real estate, refinance their mortgages. The refinancing generates consumption capacity either because the consumer keeps some cash in the transaction or because he/she lowers monthly payments.
But this time, both highly indebted individuals and persons whose income comes from the informal economy, will have difficulty in order to refinance. Regrettably, many Puerto Ricans are in either one of these categories. In addition, the new notary law setting a 1% transaction payment raises the bar when considering whether to refinance.
The best thing when a tsunami strikes is to be far away from the beach. For the economy of Puerto Rico, the only alternative is to hold its breath until the tsunami goes away.
