More Mortgage Trouble?

Hello all! 

I haven’t been posting much in the way of politics and/or economics recently, as you may have noticed,  but an article from money.cnn.com caught my attention and I thought it would be good to share.  In the article, Karen Weaver, global head of Deutsch Bank’s securitization research division (responsible for analyzing credit default swaps, collateralized mortgage obligations, “and other exotic Wall Street products”) argues that “48% of U.S. mortgage owners will end up owing more than their home is worth by 2011”. Excerpt:

 

"The figure may have left many Americans wondering how this could be possible. But consider that 27% of U.S. homeowners with a mortgage are already "underwater." And according to Deutsche Bank, home prices may fall another 14% before hitting a bottom.

How many Americans are underwater?

Currently we estimate that 14 million homeowners have negative equity. However, based on our home price forecast, as prices continue to fall we think that number could reach 25 million, or 48% of all mortgagors.

Where does this leave us?

The obvious takeaway of falling home prices and being underwater is what it does for defaults. But there's a bigger implication, which is that when we look at the economy over the past decade or two, it's been very much a consumer economy.

What has been driving the consumer hasn't been gains in incomes. What has been driving them is easy credit and rising home values. And the fact that their home price was rising and they could borrow against that through home equity lines or loans or refinancing, it augurs for a very different economy going forward if people don't have that option….So by creating products that lowered the payment, or lowered the amount of down-payment, it enabled more people to buy a home. It also perpetuated the bubble.”

 

The point of the article is…the after effects of the housing bubble – created largely (more than any other single factor at best) by artificially and unsustainably cheap credit – aren’t going away anytime soon.  Even if the Weaver’s estimates are too high, we should still be concerned.  I don’t personally think the economy will be stabilized until the bulk of these “toxic” loans are gone, and defaulting will probably end up being a major instrument through which the toxic mortgages are ended.  

Ironically, even if our governments attempts to stimulate and stabilize the economy work reasonably well,  Weaver thinks many who are underwater on their mortgages will default anyway just as a matter of common sense – unless of course there is an unprecedented economic boom resulting in a significant income increase for those underwater on their homes or the government bails them out (my words, not hers).  Excerpt:   

 

“At what point of being underwater do homeowners start falling into foreclosure rapidly?

Once you get to the point where negative equity is significant -- for example, 25% or more -- there have been studies that suggest you get more strategic defaults.

People say, "I bought my house for $500,000, it's worth $250,000, there are 10 available for sale in my neighborhood. It makes no economic sense to spend the rest of my life trying to pay off a $500,000 debt when there's no reasonable likelihood to expect this house to go back up to $500,000."

This might sound extreme, but we have borrowers who bought a $500,000 home in California at the peak of the market on $50,000 of income. So for them to devote their gross income for the next 10 years solely to paying off [their] mortgage doesn't make any sense.”

 

If you have time to read the whole article then I would recommend that you do.  It's not very long, and its case is made mostly on the basis of common sense.  

At the end of the day, I think many mortgage holders will tire of the stress that comes from being underwater on their homes, and with the excess of cheap homes available thanks to the recent burst housing bubble, it makes sense that lots of people will sooner or later default on their underwater mortgages and opt for cheaper, more economically sound, affordable, and stable housing.  When and if they do, it's probably either going to prolong the recession we are already in or send us into another mini-depression...at best perhaps. 

Of course, this is somewhat speculative, so ultimately we shall see what we shall see. :-)  Just don’t be surprised if housing and mortgages continue to be a major drag on the economy.

 

God bless and veritas supra!