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Housing problems far from over

August 4th, 2008 · 3 Comments

The housing market is key for an economic recovery in the US. But it’s not happening yet. Some disturbing news..

Two pieces of disturbing news, actually:

  • People with negative equity (their mortgage debt exceeding the value of their house) are walking away in record numbers even if they do not have problems paying for their mortgages
  • Defaults on good mortgages (‘prime loans’ for people with good credit standing) are now rising fast, just as the sub-prime ones (for people with bad credit ratings) seem to stabilize.

Before we get into that, let’s deal with why the housing market is so important:

  • If the housing market stabilizes, the financial sector can stabilize, housing is key here
  • Consumers will feel their wealth is no longer spiralling down. Although the good times in which equity could be withdrawn from properties like a depositless cash machine will not return any time soon, at least some fear will be taken out of consumer spending
  • Housing (and related sectors) is actually a pretty substantial part of the economy which is really shrinking right now and adding to unemployment. Stabilizing that would stop a significant source of increasing unemployment.

Now, from today’s New York Times:

  • The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is quickly building. Homeowners with good credit are falling behind on their payments in growing numbers, even as the problems with mortgages made to people with weak, or subprime, credit are showing their first, tentative signs of leveling off after two years of spiraling defaults.
  • The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time. The mortgage troubles have been exacerbated by an economy that is still struggling.
  • Subprime was the tip of the iceberg,” said Thomas H. Atteberry, president of First Pacific Advisors, a investment firm in Los Angeles that trades mortgage securities. “Prime will be far bigger in its impact.”
  • In a conference call with analysts last month, James Dimon, the chairman and chief executive of JPMorgan Chase, said he expected losses on prime loans at his bank to triple in the coming months and described the outlook for them as “terrible.”
  • Delinquencies on mortgages tend to peak three to five years after loans are made, said Mark Fleming, the chief economist at First American CoreLogic, a research firm. Not surprisingly, subprime loans from 2005 appear closer to the end of defaults than those made in 2007, for which default rates continue to rise steeply.

This is not encouraging stuff, to say the least. Nor is the following, from the BBC:

  • In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California – with money borrowed from her bank. By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less. So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase.
  • “I thought ‘this is crazy’,” Ms Trainer says. “It just does not make financial sense.” As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded.
  • Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment. Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. “Generally speaking, within 5 years you are about back where you were, so my husband and I decided we’ll take the hit and live with it.”
  • Professor Nouriel Roubini of New York University, one of the first economists to warn of the dangers of the American house price boom, believes the number of people positively choosing to walk away is growing rapidly. “This is becoming a tsunami of voluntary defaults,” Professor Roubini says. “The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion. “You could have most of the US banking system wiped out, so this is a total disaster.”

How does that work?

  • In California and much of the rest of America, there is a powerful incentive for home owners such as Ms Trainer to walk away from their mortgage obligations.
  • Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes.
  • Consequently, by walking away from her apartment, Ms Trainer has also walked away from the loss on her property. Her bank gets stuck with that.

And remember, banks sell these houses fast, in auctions, at bargain basement prices.

The California Association of Realtors® has released its report for March.

  • Home sales increased 17.5 percent in June in California compared with the same period a year ago, while the median price of an existing home fell 37.7 percent, the CALIFORNIA ASSOCIATION OF REALTORS® (C.A.R.) reported today.
  • Sales were driven in part by large shares of deeply discounted distressed sales in many parts of the state,” he said. “With lower prices and favorable interest rates, affordability also has improved significantly in recent months, paving the way for many buyers to purchase their first home.”

However:

  • More than 800,000 vacant homes for sale stand between the housing recession and the bottom of the downturn nationwide. The glut is driving down home prices, slowing sales and turning consumer psychology against the market.
  • New figures out Tuesday showed that home prices fell by a record 15.8 percent in May from a year ago, with none of the 20 cities surveyed registering a price gain. The Standard & Poor’s/Case-Shiller Home Price Index is now down more than 18 percent from its peak in July 2006.

It’s a buyers market, but it doesn’t look like it’s going to turn any time soon..

Tags: The Markets

3 responses so far ↓

  • 1 Rgpapp // Aug 5, 2008 at 7:57 pm

    This is a huge problem for the economy, true. This was brouht on by the sub-prime lenders, true. The really sad part is that society has lost it’s morals. When you sign a mortgage your are making a promise to pay back the note. I just hope there is some way in the future years that the lenders will be able see who made the choice to walk away. Then refuse them financing in the future. People it is not a matter of dollars and cents, it is a about holding up your end of the deal. Home values go up, and down.

  • 2 admin // Aug 5, 2008 at 8:24 pm

    Lost it’s morals, yea, that’s the really sad part, we fully agree with that rgpapp.

  • 3 What to make of the market? // Aug 10, 2008 at 4:17 am

    […] arguing. We agree with his all on the housing situation (we reported on it before, for instance here), but we’re not entirely convinced with his market call, to say the […]