Homeowners With Negative Equity
Submitted by
CalculatedRisk on Tue, 12/04/2007 - 8:45am (147 comments)
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Excellent as always!
The selling price is usually stated from the buyers point of view, ie what the buyer pays. But if were taking home equity, we should use prices from the sellers point of view, ie subtract realtor fees, expenses to fix defects and any other selling expenses.
There is a big social problem arising. What percentage of, let's say between 12-20 million, would foreclose? Let's hope employment keeps strong.
Good stuff. Even if the government freezes rates, most of these no/negative equity owners will likely walk away anyway. It won't help the homebuilders at all.
Three bank failures spur concern
Three bank failures spur concerns | HeraldTribune.com | Sarasota Florida | Southwest Florida's Information Leader
There are at least 3 interesting ways to use the data:
1) How many homeowners will "feel stressed"? This is the graph as currently presented.
2) How many homeowners will not be able to sell? These are the numbers adjusted for selling costs - move everything 6-8% and then look at this measure.
3) How many homeowners will not be able to refinance/ take money out? This is the number adjusted for required haircut (20%).
Isn't it likely that the same recent buyers who are underwater on their mortgages are more likely to face job losses and other significant events? Add a few more risks to the list that the folks with "layered risk" loans face and the picture gets even uglier.
If they are young they may be the least senior people at their jobs. If they work in real estate or lending they may already be out of a job. Or they may want to start a family and move out of that 800 square foot condo.
Prices are set on the margin, and the margins in this case are very marginal.
Great analysis -- if I understand it, it must be good!
Depressing though. I need a laugh: Anybody want to declare that housing has reached a bottom?
"Isn't it likely that the same recent buyers who are underwater on their mortgages are more likely to face job losses and other significant events?"
Not necessarily.
Will all those who are upside down walk away? Not if the house is useful and no more expensive than renting. I understand that this does not describe much of CA, FL, AZ, or NV but it certainly may be the case in NE. I can imagine chaos on the coasts and peace in the Dakotas.
The ATM isn't open just because you have some equity. Just like the primary lender wants you to have 10% or 20%, the HELOC is no longer will let you drive your equity to 0%. The ATM shuts down 2 to 4 columns to the right of 0% equity.
"Just like the primary lender wants you to have 10% or 20%, the HELOC is no longer will let you drive your equity to 0%."
Is this really the case - are the terms currently being offered have a limit that is less that 100% LTV? (I've never looked at the paperwork for a HELOC - very un-American of me, I know.)
Very OT:
The Bank of Canada may have overstepped its legal powers by accepting CP and other "non-standard" securities in order to alleviate the summer credit crunch.
Bank of Canada may have overstepped powers: study
| Reuters
The bank stepped into "questionable legal territory" when it began accepting commercial paper, foreign bonds and corporate bonds in addition to the usual government securities, bills of exchange and promissory notes...
The law governing the Bank of Canada says that only government-issued and guaranteed securities may be used as collateral for central bank operations designed to influence the overnight lending rate. These include the Special Purchase and Resale Agreements, whereby it buys securities with the agreement to sell them back the next business day.
It will be interesting if the Bank of Canada is forced to sell any CP on its balance sheet.
Q307 saw 450,000 properties foreclosed/NoD'ed. Presumably the thing this is most closely tied to is negative equity at the end of '06 (assuming about 9 months to go through the whole process from going underwater to struggling to actual foreclosure.) That suggests about 10% of those with negative equity get foreclosed per quarter, after a lag of 3 quarters. (That, in turn, implies a "mean lifetime" with negative equity of about 3 years before foreclosure, which seems not wholly implausible.)
At the bottom, off 20%, that implies something in the niehgborhood of 1.5 M foreclosures per quarter. (Though a more detailed model might well put it at a little less, as some of those will already have been taken out by foreclosure in earlier years.) I don't even like to look at 30%...
So we better hope that the foreclosures are NOT proportional to the number of people with negative equity, or that right now those with negative equity are going into foreclosure at a faster rate than they will in the future. Because 6M American households going into foreclosure a year for a couple of years will generate the kinds of political forces that make economic prediction worthless.
If Krugman's estimate is right then 1 out of every 5 households in the U.S. (20m/100m) will be underwater on their mortgage. This can't be good.
--
"this raises the question if the HUD projections of "two million foreclosures by 2008 or 2009" are too low."
When was the last time that negative projections by bureaucrats were not too low?
Only crooks and liars get to have positions of power in America.
Jas
Greg,
Excellent point, I was thinking along the same lines for the home ATM. Additionally, the folks at the other end who have buckets 'o equity seem unlikely to HELOC for consumption, that's whyy they ended up with buckets!
Florida Accepts BlackRock Plan to Split Local Government Fund -Isolating more than $1.5 billion of downgraded and defaulted holdings as it seeks to reopen the pool for limited withdrawals
Florida Investment Chief Quits; Fund Rescue Approved (Update4) - Bloomberg.com
Andrew,
That's if the rate stays constant - I imagine there will be feedback effects in the larger decline scenarios that may increase the walk away factor.
Great exhibit 16, great article and comments so far. How confident can we be in the numbers underlying exhibit 16? Does CoreLogic this on a regular basis?
Elvis -
Most with negative equity do not, in fact, 'walk away' for that reason alone. Think of when you buy a car, you have negative equity in it the moment you drive it off the lot. Does that mean you drive it straight to the repo man's garage? Heck, no. Because that car also provides you with utility.
Same goes for a house. It still provides shelter, regardless of equity level. So, although you may have done a crappy job of timing the market, you will gain positive equity over time. In that respect, a house is so much better than an auto.
A far more important factor is whether or not a consumer would default on a loan and volunarily surrender collateral is whether or not they can afford the payment. If rates are frozen, it would aid affordability of payments in a general sort of way. Whether or not freezing rates is good policy, that is another matter.
Excellent overlay. It would be interesting to further estimate the social impact by drilling down into age-related cohorts within the equity percentages.
Younger homeowners generally have longer career and earnings spans than do boomers/retirees. This complicates the social impact considerably.
aren't upside down homeowners the least likely to sell? it seems they would just put plans on hold, tighten up their belts and ride it out, no?
Two thoughts,
First, given that historically, 10-20% down payments were commonplace.....and home prices have generally speaking continued to rise for decades....has negative equity on a mass scale ever been seen? contemplated? Do we have any recent historical precedent of millions with neg equity?
Second, I agree with schapster in that people are used to negative equity. Every new car buyer has experienced it. I am not sure that it follows that neg equity on a loan you can afford means you walk away. There are currently entire neighborhoods upside down in many so cal areas. I suspect those who walk are faced with monthly payments they can't afford and it has little to do with the perceived value of the home (unless of course they are dependant upon the value to be able to refi into a better loan.)
Shnapster, your comment does not take into account the recent Boston Fed study. It's not just a question of whether your equity is currently negative, but whether it's heading down due to falling prices.
Homeowners who can technically keep up with their high payments just don't see the point once the value of their house starts falling.
energyecon--
or, rates could go down because we've been shaking out the flippers and speculators, and soon we'll reach a "hard core" of primary residence homeowners.
Or rates could go up, as the economy worsens and more people experience "events".
I don't know. I just know that over a wide range (2x either way) of assumptions, the numbers look absolutely horrific.
Schnapster--the point is, I think, what CR pointed out. You go underwater. For a while, you're fine. But if anything happens, you're just plain out of luck. If you've got equity, and something happens, there are options. Some are expensive, but at least you keep the house. If you're underwater, your options are very limited.
Also, I imagine ability to make the payments, and amount of equity in the house, are strongly correlated. I wouldn't hold out a lot of hope that those who have nothing in their homes, are precisely those sitting on large, secure funding streams to keep making their mortgage payments.
Anonymous, yes, I thought about adding another 5% or so, but I was being conservative.
Not everyone will walk away, so people shouldn't think there will be 20 million foreclosures if prices fall 30%. But 2 million will be far too low.
Shnapster, I believe you are correct for someone that is only upside down a few percent; their ability to make their payment is key.
However, there is more and more research that shows an excellent indicator of default is the amount of equity (or negative equity) - not the ability to make the payment (or resets). If someone owes 600K on a house that sells for $400K, they will seriously consider walking - even if they can make the payment.
The most recent Boston Fed report stated:
"... house price appreciation plays a dominant role in generating foreclosures. In fact, we attribute most of the dramatic rise in Massachusetts foreclosures during 2006 and 2007 to the decline in house prices that began in the summer of 2005."
In general, it's not the payment, it's the value of the house.
Best to all.
CR - The graphs show the number of homeowners in positive and negative equity, but has no information on the size of the corresponding mortgages.
Is it a fair assumption to state that the loan sizes on the left-hand side of the graph are generally larger than the RHS?
I am reminded of the research you did a while back:
Calculated Risk: How Much Cash is Left in the Home ATM?
that found that the value of homes with no mortgage (~31.8% of all homes) is less than the average value of homes with mortgages. In my opinion, homes on the very RHS of the graph would have characteristics of fully-paid-off homes.
The last fools to buy in at the top bought the high-priced crap and thus are crowded to the left.
"Will all those who are upside down walk away? Not if the house is useful and no more expensive than renting. I understand that this does not describe much of CA, FL, AZ, or NV but it certainly may be the case in NE. I can imagine chaos on the coasts and peace in the Dakotas."
I live in Central California, on the coast; one of the local paper's real estate columnists -- a guy who's normally really rah-rah on home ownership -- did an analysis on monthly cost of home ownership (mortage, taxes, etc.) locally versus renting and found that it cost $4500 a month to "own" a house that you could rent for $2500. He concluded that it would take a minimum 20 percent drop in the price of housing to make it even vaguely competitive with renting (figuring in mortgate deductions, etc.) And remember, this guy's normally Mr. Optimism.
Given even a 20 percent drop and a nontoxic loan, I think most recent buyers would suck it up and stay in place. But when you factor in all the possibles -- how many newer buyers are still on teaser rates, how tightly stretched household budgets are in "prime" territory, and rising unemployment in the face of a recession -- a panic is possible.
I mean, suppose you're a Silicon Valley guy (we're right next door) and there's a recession and your job is eliminated, but you somehow manage to find another one with Intel out in Arizona. And you're underwater on your house. The economists' "rational man' (I hate that term) would walk away from the overpriced house to the new job in Arizona -- where he could probably find something to buy at 1/4 the price, and somebody to write him another loan.
Prices will fall back to somewhere in 1996-1999 levels. Just basic math tells us to expect 40%-50% price drops, unless everyone starts getting big pay raises. In Japan they suffered, in some cases, 80% price drops. The clear and simple way to assess the coming price deflation is to look at people's ability to pay the base price of the asset. Base Asset Price exceeding -- often by many multiples -- the Income necessary to afford the asset, and not what kind of loan or what interest rate that they got, is why people are in so much trouble now. US earners, excluding the top 10%, have been suffering negative income growth since 2001.
OT but not:
Florida Accepts BlackRock Plan to Split Local Government Fund
By David Evans
Dec. 4 (Bloomberg) -- Florida officials led by Governor Charlie Crist approved a plan by BlackRock Inc. to split in two a $14 billion investment fund for local governments, isolating more than $1.5 billion of downgraded and defaulted holdings, as it sought to reopen the pool for limited withdrawals.
Officials also voted at a cabinet meeting today in Tallahassee to make BlackRock the interim manager of the fund, taking over from the State Board of Administration for up to 90 days. They will seek an outside firm to run the pool. Coleman Stipanovich, executive director of the state board, announced his resignation at the meeting.
[snip]
Citigroup SIV's Junior Sedna Debt Cut to CCC by Fitch - Citi's Sedna Finance Corp had $867 million of junior ranking debt downgraded 12 levels to CCC...
Citigroup SIV's Junior Sedna Debt Cut to CCC by Fitch (Update3) - Bloomberg.com
CR,
I think the Boston article was saying that when people get in trouble the reason that they end in forclosure is the drop in value. It doesn't say that a drop in value results in forclosure...it says that due to the price drop....problems that used to end in a refi or a sale now result in forclosure.
So people are walking due to price drops....people are walking because price drops mean the other common solution aren't available.
Should say...people aren't walking due to price drops"
FFDIC,
Thanks - twelve notch downgrade - ouch!
ReadingNLearning I agree..over next 3-4 yrs the new water cooler, cocktail hr., and online chat will invariably include HOW MUCH DID YOUR HOME DEPRECIATE ?
Markel - a link would be nice.
Whether it's heading down? That, would be a matter of speculation. I'm not saying consumer sentiment isn't important.
At some point, I agree that if negative equity were to become severe enough, and rents are cheap enough, a decision to abandon becomes an economic one. i.e. what value does one place on having a decent credit score? I would love to hear some anecdotals of someone who could afford her payments, but decided to nuke her FICO instead due to a drastic negative equity position.
Shanpster, CR provided the link to the Fed study above. An important read.
Love those graphs and charts, depressing as they are. I also was wondering if we have ever seen this drastic a drop in prices (assuming they continue to fall as it appears they will). Is this unprecedented in US history or does it compare with the 1930's?
Most with negative equity do not, in fact, 'walk away' for that reason alone.
Quite true. But every year a significant fraction of the populace has no choice but to move, due to factors such as divorce and job loss. And it seems pretty safe to predict that divorce and job loss are going to get a lot more common as this rolls on. It's a safe bet there's a lot of couples out there where one spouse steamrollered the other's objections to buying an overly expensive home, and they're going to split over the consequences -- and that even when both agreed to the purchase, the stress from the consequences will split them. And there will be a lot of jobs lost.
And this will be regenerative downwards.
It's often said by cheerleader economists that the nation is less prone to recessions because better business control of inventories prevents the inventory-correction recessions we used to have. But they're wrong, because the current glut of housing is probably the most enormous inventory surplus the nation has ever seen, many, many times larger than any surplus manufacturers or retailers ever built up.
Kumbaya moment:
This kind of analysis and high quality of commentary is why I have a BAD CR habit!
Interesting info
Some great comments including OT!
Is there any foreclosure analysis out there that estimates based on the various variables?
Is there any subjective info out there describing homeowner behavior? Negative equity, occupancy, income, and available substitutes seem to be key variables.
If a California homeowner is underwater over $100K and can rent a similar house for less than the mortgage, there's some incentive there. I presume a growing number of underwater speculators are considering walking even if they can make the payment.
CR said: "From the linked Fed paper, this figure compares the foreclosure rate in Massachusetts with changes in house prices. As prices rise, the foreclosure rate falls, since homeowners in trouble can either sell or refinance their homes. As prices fall, there is no way out - except foreclosure - for homeowners facing difficulties."
This supports schnapster. It's "problems" that cause a need to refi, sell, or forclose.
When values drop...these "problems" affording the loan mean that more of them will result in Forclosure.
It doens't say (I didn't see it anyway) that otherwise performing loans go bad once the perceived value of the house drops below the loan balance.
A lot of folks are not going to walk away from their homes simply because of negative equity. For starters, it costs 10% - 15% of the cost of a home in selling and moving costs. Also, they are not going to want to ruin their credit.
The first chart tells me that there is plenty of room for MEW to continue should interest rates fall low enough to entice refinancing of outstanding mortgages. It looks like a number of homeowners have more than enough equity to cover say a 20% drop in home prices.
My comments are not intended to diminish the fallout from subprimes or the credit freeze. Just to observe some countervailing forces that may come into play.
"I can imagine chaos on the coasts and peace in the Dakotas."
I don't know much about the Dakotas. Maybe Congress will goose wheat subsidies to make ethanol or something moronic like that.
I do know a little bit about the rust belt. If folks on the coast can't get a HELOC to buy whatever the folks in the rust belt are selling, many folks in the rust belt will be unemployed. If constant teaser refinancing is not available, many WalMart workers in Podunk will not be able to afford their $100,000 mortgages any more than former mortgage brokers in Orange County can afford their $800,000 mortgages. And I think there are a lot of marginally employed folks in custom-built 3,000 square foot cardboard boxes on outlots all over the townships who are already not feeling all that peaceful.
Much of flyover country is just as overextended as the coasts, just in a different way.
newer buyers are still on teaser rates, how tightly stretched household budgets are in "prime" territory, and rising unemployment in the face of a recession -- a panic is possible.
I would also add that the "new" home owner probably did not understand 1% of a very large number is a large number. For some reason the property tax escrow account started getting dropped, so the first tax bill was a shock. I'm guessing the second one is a death knell for many. I wonder how the property tax receipts are doing?
Shnapster:
My anecdote goes back to the last housing crash in OC in the '90s. My mom purchased a condo in 1989 or 1990, right around the top of the market, for $180K. By the mid '90s, her condo had depreciated to $120K (based on sales of similar condos in her complex). She isn't rich (was a teacher, now a principal at an elementary school), and $60K in the '90s was a lot money for her. She seriously considered walking away. Probably the only thing that stopped her was that she actually really liked the condo.
Fast forward to today, and if we see declines like these (which we are already seeing in some places, just not a lot of places - yet), then the numbers are not going to be $180K down to $120K, but $900K down to $600K, or $600K down to $400K. Being underwated by $200K or $300K in today's environment is pretty tough on the psyche. I believe that a number of folks in such a situation will walk away, as their FICO score just isn't worth that much money. JMHO.
Not to nit-pick, but a couple of considerations may moderate the numbers somewhat. First, people will be paying off their mortgages, so given no HELOC withdrawals and no new entrants, the number of people underwater will trend down. Now, of course, in recent years we saw a lot of MEW, but at least right now that has slowed considerably, so even over the next year mortgage paydowns may outpace mortgage equity withdrawals.
Second, new entrants will also skew the numbers. In recent years new entrants had little to no equity, but the current lending situation being what it is, that has reversed and new entrants are likely increasing the net equity position of homeowners.
I don't know how much of an effect those will have, but they can be approximated using a thirty-year mortgage, so somewhere on the scale of 3%, maybe a little more. In any case, those are two factors that will improve the situation going forward.
is this really the case - are the terms currently being offered have a limit that is less that 100% LTV? (I've never looked at the paperwork for a HELOC - very un-American of me, I know.)
I've seen examples on this site where people were able to take out 100% equity via HELOC but I know my HELOC was capped based on a few variables (I wasn't too happy about that and tried to convince them I deserved more). I think the problem was my bank actually had some lending standards. Based on their appraisal I was only able to get access to 60% of my equity via HELOC.
Sure, not all folks will walk away, but what negative or low equity will do is basically freeze these people in place. They won't be trying to move up the housing chain like they would normally do in a traditionally appricating market.
Its another big chunk taken out of the historic levels of housing demand-and another reason why I think things will NOT be "normal" again in 3-5 years.
sdfts,
With HPA negative and transaction volume cratering...ummm property taxes will...wait a minute, wait a minute!
At the same time, there are bubble zones that are already showing YoY declines in sales taxes. State and municipal governments are going to get squeezed HARD.
Which, as an aside, is part of why Mr. Freeze's proposal for state and muni bond's to bail out the banks (er, refinance homeowners) sounded particularly batsh!t...
"Think of when you buy a car, you have negative equity in it the moment you drive it off the lot. Does that mean you drive it straight to the repo man's garage? Heck, no. Because that car also provides you with utility."
What if you drive the car off of the lot and a few months later you see that you can get the same car for half the payment? Many people might just drop off the first car they bought and tell the car salesman "You screwed me!"
That was me 1:41
WaitinginOC,
Your anectode supports Schapster's point in that it is difficult to simply walk away from your home and demolish your credit simply to save money. You still have to pay rent, and you lose your tax deduction, and owning rather than renting is worth some subjective amount each month. So deciding exactly when your are upsdidedown enough to make it worth it would be a difficult call for anyone. Throw in the belief that someday prices will come back means that I think prices would have to really drop big and stay low long for any meaningful amount of people to simply walk away from their home loan they can afford because they can rent alot cheaper.
Second, new entrants will also skew the numbers. In recent years new entrants had little to no equity
And let's not forget the REO sales will swipe out negative equity and produce positive equity, percentage-wise.
I imagine the first consideration of paying down equity is mostly at the starting minimal rate, easily outpaced by price declines.
"Florida Accepts BlackRock Plan to Split Local Government Fund"
FL pays some investment bank huge fees to set up this ultra-safe money market fund over the years. Now they pay BlackRock huge fees to advise them on how to stop the bleeding. WS picked the pockets of these poor bastards coming and going.
How many other state and county funds are in similar peril?
A lot of good points on this blog. Yes, the country has never experienced widespread negative equity. Yes, I think that an expectation that home prices will continue to go down would be deadly for homeowners in distress. I read the popular financial magazines, like Money, Smart Money and Kipplingers. These are now saying that home prices are declining and will go down 5% in the next year. They are also saying that a very slow recovery should begin in mid 2008. Such a prognosis in the popular press is probably enough to give home owners in distress some hope--"we only need to hold on for less than another year." If and when some of the more pessimistic views come to the fore and when the fed and treasury are shown to be ineffective, the situation could deteriorate sharply. For example, if the economy does go into a recession, distressed home owners will probably give up quickly. Afterall, it seems that the housing situation is now much worse than at the end of previous recessions in the 80's and 90's.
I dunno but up here in the border states we're lovin' the Loonie. Busloads of Canadians at the malls every weekend.
Joe - Not only does one lose their tax deduction, but speaking of tax implications, in all likelihood they get a big, fat 1099 for the shortage.
All I'm saying, folks, is that it better be a lot of negative equity to cause a walkaway for that reason alone.
BTW, the Boston Fed Paper was limited to subprime only. Just sayin'.
An additional factor, whose magnitude is very difficult to imagine, let alone predict, is that a significant fraction of the baby boom generation has been looking forward to funding their retirement by cashing out from big, they-stretched-to-buy-em homes in suburbs with high tax rates and downsizing to a less expensive area.
Soon, they will be faced with a situation in which they'll not only get nothing from the home when they downsize, with the high payments and taxes consuming most of their income. Some will realize that the only way to free disposable income and accumulate the savings they'll need for retirement will be to hand the keys back to the bank and become renters.
Where is Tanta to remind me that 'we are all subprime' now?
Nobody today has mentioned the effect on people who are near retirement. Many of these people were planning on using their equity to move somewhere cheaper and to live on. Especially for the self-employed. How many people thought they did not have to save because they were making 10% a year on their house?
Average Joe:
I agree that it is difficult for people to walk away for the reasons you describe. But, I believe that more people will walk away this time than in previous busts because this time many people had no (or very little) skin in the game. In prior busts, the people walking away had made significant down payments. That is not the case this time around for many people. Additionally, in prior busts, most people had fixed rate mortgages. Again, that is different this time, as many people have I/O, ARMs, or even Option ARMs.
However, the real point to my anecdote was that when people are significantly underwater, they will consider walking away even if they can afford the payment. As you mentioned, they may not because they believe prices will come back in the long run, and there are costs associated with walking away. But that doesn't mean that they won't at least consider their options, including walking away. Because some of the recent buyers have so little skin in the game and their payments may not be affordable (due to rising mortgage payments), I think that a larger percentage will walk away this time than in prior busts. Again, this is JMHO.
jm, I was reading your mind.
The Fed paper addressed subprime in detail, but certainly the higher level data about foreclosures was not confined to subprimers.
The banks are severly tightening up their lending criteria on HELOCs and 2nds. As they do so the effective line on Goldmans graph in which a person can respond to economic hardship without losing the home is diminished.
Citi, National City, Wells, Etrade are all having issues with the HELOCs and 2nds in this enviroment.
The homeowners with equity facing economic stress (or just wanting to change jobs) will have to sell into an illiquid market.
Let's not forget that many of these homes in AZ, FL, CA, and all the coastal areas were flips or investments?
In any case, underwater 2-300K, maybe more....no way...they walk in my opinion.
Remember,...this I believe is the real issue, Affordability. Housing prices disconnected from fundamentals. I mean in some cases only 10% of the local population could afford a medium priced home. Yet people, the stupids, continued to purchae them regardless of their ability to pay. And....had no NO skin in the game, no down payment!
In my opinion, Tough shitsville for the investors and lendors! you win some and you LOSE some! You gambled on these losers and you lost! No Bailout!
Is there any data on small business loans? How much issued by quarter? How much is currently outstanding? Especially, for California.
We're sync'd, w.
Consider this: as real estate prices continue to drop, those homeowners who are struggling to handle payments on a severely Over-Priced housing asset ALSO face an increasing cost of living in almost all significant areas (education, health care, base commodities, insurance, taxes, government fees, entertainments costs, many food items, most services, gas, gasoline, and oil, electricity, cars and transportation, etc) AND a decreasing real income level due to Global Employment Arbitrage, consolidation, and all other forms of DOWNSIZING.
At the same time, all around them, they will witness falling housing asset prices and falling rents. They will witness other people buying the same, or better, housing, in their own neighborhoods, or similar / better -- FOR FAR LESS BASE PRICE. At some point there will be a severe Soul Searching whether to continue to suffer trying to pay off an Inflated Bubble Asset, or to simply walk away, rent cheap a few years, and then start again. While some people will have a difficult time, emotionally, deciding to say "screw it" to a debt obligation in favor of acting in their OWN BEST INTERESTS, most will have little hesitation. This "revelation" will be the THIRD REO WAVE.
I know this will happen -- I saw this kind of decision making first hand in the 1990s. Many people who were financially capable of making their mortgage payments NEVERTHELESS, walked away from Too-High-Prices because it was in their Best Interest to do so.
Average Joe, on your original question, "Do we have any recent historical precedent of millions with neg equity?" -- It's not what you'd call recent, but I think the Great Depression qualified for that. The average real estate prices dropped like a rock as incomes dried up.
My family has some cousins who's grandfather lost the family farm in the 30's, then bought it back from the bank for less than he originally paid for it in the 40's (and he got them to fix it up and paint the buildings before he would buy).
However, I think you have a valid point. Things still have to get pretty bad financially on a personal level for folks and people will need to become absolutely convinced that prices aren't coming back up in our lifetimes before you'll see en-mass walk aways happening. Houses are homes, that makes them sticky.
Yeah, I knew we were going to be in trouble when friends started telling me they had to buy a big home "for their retirement investment". I think that point as far back as seven years ago was when I realized things were going to get crazy.
Americans need to learn once again to create value in our lives -- and quit just inflating assets. It's going to be a tough lesson to learn.
The Bank of Canada may have overstepped its legal powers by accepting CP and other "non-standard" securities in order to alleviate the summer credit crunch.
[...]
It will be interesting if the Bank of Canada is forced to sell any CP on its balance sheet.
Will T | 12.04.07 - 1:06 pm | #
Will - remember Canada doesn't have a constitution like ours nor a gov't like ours - theirs is parliamentary with 'separation of powers' but FAR more strength in their legislative branch (parliament) than in either the 'executive' (which is for all practical purposes the majority party in parliament - so is it really separate?) and their judiciary.
And if I understand the Canadian version of parliamentary gov't it unlike the UK is also a CONFEDERACY with provinces wielding far more power than our states.
Combine all that and I believe that what Parliament says is constitutional IS constitutional vis-a-vis the Bank of Canada (which is Ottawa's responsibility alone)... but "the gov't" might have to push specific changes to the charter through the HOC first.
That would be interesting for a conservative gov't relying on support from places like Saskatchewan & Alberta (if Canada were US - that would be 'Ron Paul' country).
I'd love to hear a real Canuck chime in & correct me - I just live in a border state & do biz with them so might have some of that bass ackwards.
Regardless, it might be a preview of what we'll experience.
Totally with you RNL. The only question is, how rational are people with their finances? Clearly, many people didnt get it that the investments they were making were crap, and that's how you end up $200k under water, for just one example. But once you are staring into that abyss, you have to wonder who does the right cost benefit analysis. Why stay that deep in the hole? Id walk, but first, Id have to think hard about the costs. So, what are they? Do they even come close over the next few years of bad credit, to approximate a $200k hit? There is no rational way you ever make that back on the house in anything but the very very long term, since there isnt going to be another bubble like this. So, at first, maybe people wont get it, but soon, it will be the neighbors saying : "why they hell havent you dumped that house back to the lender???" When that mentality sets in (and I think it will), we'll eventually get to a true bottom. The problem is, this will be happening in the midst of a major consumer recession, so the bottom will likely be an overshoot for some period. I see that period as around 2014.
OT - MOM's got an interesting post on her site on the Credit Manager's Index falling.
MaxedOutMama: Oh, AGGH
"'The seasonally adjusted Credit Managers Index (CMI) fell for the third consecutive month in November, losing 0.7% as both service and manufacturing sector indexes declined. Although the drop was relatively small, all six unfavorable factors components fell, leaving five below the 50 level, indicating economic contraction. 'This is the first time that there has ever been more than four components indicating contraction since the inception of the CMI in 2002, and it could well be a harbinger of things to come,' said Daniel North, chief economist with credit insurer Euler Hermes ACI.'
Because NACM CMI basically measures interbusiness credit, it is a good indicator of how much damage the "real economy" is taking."
Paul Krugman's Blog also points to Jim Hamilton (Econobrowser) on the once again increasing TED/LIBOR spread being a harbinger of ongoing bank liquidity troubles.
TED spread - Paul Krugman Blog - NYTimes.com
Econbrowser: Risk premia creeping higher
"TED spread
Ah heres a good chart of the spread between 3-month Libor and 3-month Treasury bills what I was referring to in my last column. This spread is normally very small, but it has gaped wide as banks lose trust in each other. Notice the pattern: crisis of confidence in August, seeming recovery in Sept/Oct, but now were in big trouble again.
Plus, as Jim Hamilton points out, risk spreads that werent so bad in August, like the premium on lower-grade corporate bonds, have now widened a lot.
Why is this so scary? The crisis of August resembled the 1998 LTCM crisis, which was terrifying but over quickly. This time, however, the crisis took a vacation but came back. Its not at all clear what the Fed does next."
"Some will realize that the only way to free disposable income and accumulate the savings they'll need for retirement will be to hand the keys back to the bank and become renters."
One of the biggest factors in my decision. I am sure that many of us are thinking about all the factors mentioned here, the tax implications, how much a good FICO is worth...
CR,
I'm slightly confuzled by that first chart. Is it saying that only 1.2% of the homeowners are totally at the 100% equity level ? (iow, have no outstanding debt against the property). If so, that is much less than I would have expected.
OT--just because we could all use a laugh:
Goldman's Cohen Sees S&P 500 Rising 14% by 2008's End (Update5)
By Eric Martin and Alexis Xydias
Dec. 4 (Bloomberg) -- Abby Joseph Cohen, the Goldman Sachs Group Inc. strategist whose call for a year-end rally in U.S. stocks hasn't come true, predicted the Standard & Poor's 500 Index will rise 14 percent by the end of next year
.....
Cohen kept her 2007 estimate, which calls for the steepest year-end rally since 1971, even after U.S. stocks posted the biggest monthly loss in five years. That forecast implies an 8 percent advance in December, which would be the steepest monthly gain since April 2003.
....
Cohen said in October 2000 that technology shares would be a good investment in 2001. The S&P 500 Information Technology Index tumbled 26 percent that year.
Goldman's Cohen Sees S&P 500 Rising 14% by 2008's End (Update6) - Bloomberg.com
I think even 50% declines are blindly optimistic.
From 1970-1979, 30 yr fixed mortgage rates averaged between 7-9 percent.
From 1979-1983, 30 yr fixed mortgage rates averaged between 12-18 percent.
We are still very close to historical lows for mortgage rates.
One of two things are guaranteed to happen over the next 5 years.
1) Interest rates must rise across the board, think volker.
2) Capital flight, dollar crisis(end of dollar?).
Either of the scenarios implicate significant job losses in the US.
Where is the demand going to come from to put a bottom in this market when there is negative equity across the board, extreme doubt about ones future employment prospects, and extreme doubt about housing as an investment.
Agree with most (all?) that this was an insightful (if "conservative") analysis, CR.
Following Cal's remark above:
The homeowners with equity facing economic stress (or just wanting to change jobs) will have to sell into an illiquid market.
suggests that the changes so far have been mild/moderate and that it might be a mistake to think that the "stickiness" of house prices will remain more or less linear.
The first inclination about forecasting some unkown event is to think that tomorrow will be pretty much like today...ie, not a lot of thinking and mostly just inclining.
I'm way over due on hearing from Kasriel, you?
I'm slightly confuzled by that first chart. Is it saying that only 1.2% of the homeowners are totally at the 100% equity level ? (iow, have no outstanding debt against the property). If so, that is much less than I would have expected.
Ray - That's because that chart represents properties with mortgages only.
The right hand side of the chart has folks approaching zero monthly mortgage costs, and lower than average property taxes in places like California. It also has folks who may have (re)financed into a 30 year fixed rate when rates hit all time lows, and who may in fact pay less per month than
any equivalent rental might offer today.
So while there is upside-down vicious cycle pressure pushing the dashed line to the right, there is also back pressure as the dashed line moves right, because it's running against an increasing number of financially sane people who have managed to drive down their montly costs, and are likely to stay put because their costs are ALWAYS lower than what's currently available on the market, and doubly so if they really like their location.
Think of the dashed line as the "speculator vs prudent long term home owner" dividing line. It's going to
separate speculators from their home investments, and take some late arrivals with them, but then it will dampen out.
Considering that cash flow was king in getting many of the purchasers into houses in the last five years, it seems reasonable to think that cash flow will be king in getting them out.
"Look dear, we can rent next door and have $2k more a month! Pack the bags; I'm mailing in the keys!"
They planned to flip the house for huge profit anyway. That $2k is just like sweet passive income.
We're going to need to extend the left side of chart 2 (back to around 1976, or so).
I hope I'm exaggerating.
"Where is Tanta to remind me that 'we are all subprime' now?"
Shnapster | Homepage | 12.04.07 - 1:50 pm |
2012 version: "We're all Section 8 now"
.
OT:
Went to In-N-Out burger today and saw that prices went up 3%. The 2nd price rise this year.
What inflation?
RayOnTheFarm, this excludes the 31% or so of homeowners that have no debt. This is for households with mortgages only.
Best Wishes.
"For some reason the property tax escrow account started getting dropped, so the first tax bill was a shock."
Even 15 years ago, I didn't have to have a mortgage escrow or insurance escrow account (just proof of insurance). But I was told what the annual tax bill would be. Do the banks and brokers not even do that anymore?
WaitingInOC
I agree 100% that we will see more people walking away for all the reasons you describe. I also think, a few people will walk away from a home loan they can afford simply for financial reasons, i.e. to repurchase a like house much cheaper, or to rent and save the difference. However, the savings would have to be very large and long to ruin your FICO for any "meaningful" number of people to do this.
I was only supporting the premise that while forclosure and neg equity go hand n hand.....I don't think that neg equity causes forclosure. It's the usual difficulties such as the need to move, inability to afford payments, divorce, job loss, resets etc that will mean a solution is sought. Neg equity just means that the typical solution to the problem won't be selling, or refinancing, but simply walking away.
It may be a difference without a distinction and not worth the words so far spent.
In any case neg equity can't be good.
ReadingNLearning gets first prize on this thread.
"Prices will fall back to somewhere in 1996-1999 levels. Just basic math tells us to expect 40%-50% price drops, unless everyone starts getting big pay raises."
Everyone should read your posts over and over until they get it. I have been saying the same thing for over 3, only 40%-60% in bubble areas such as Phoenix, Las Vegas, South Florida and most of California.
"I saw this kind of decision making first hand in the 1990s"
I saw it in the 80's and 90's. It was more painful in the 80's in Phoenix than the 90's. California was especially hard-hit in the early 90's from what I can remember.
GOOD NEWS!!
A guest on CNBC just said that the banks are fully liquid and ready to make loans but that borrowers are being confused by the negative stories in the media (at least he didn't say Liberal media). According to him, this is NOT a financial crisis but a confidence crisis. When borrowers regain confidence, this will all pass. This is not the first time I have heard this argument.
Now don't you feel better?
Guys - a homeowner will not stretch to make a home payment when they are 10-15% down and heading further down. They won't. They'll stop making the payments, or they will buy a much cheaper house, move in, and default on the first while declaring bankruptcy.
What distinguished this last round of lending is that the DTIs were way too high. Huge numbers of people were stretching to get into a house because they believed they would get paid back in a year or two. They find themselves charging any extra expenses to CCs, and after a few years it's just not doable.
CR is right. In this round, getting significantly underwater is going to be an extremely strong contributor to default. The lax lending is causative both of getting underwater and not being able to carry the payment long term. In previous downturns, we just haven't had these types of loans to deal with. When we do, they do go back to the bank.
Primary homeowners don't necessarily default when they go underwater if they can handle their payments. So if the loans had been underwritten properly, you wouldn't see such high levels of defaults. But when even FHA is writing 41% DTIs, the sky's the limit in foreclosures.
Home values went down significantly in the Great Depression, but most homeowners going into the Great Depression had much more room than they do today.
In my opinion, Tough shitsville for the investors and lendors! you win some and you LOSE some! You gambled on these losers and you lost! No Bailout!
The branch manager at a locally owned bank is also the neighbor of my mother. Mom and I were down there doing some business last week. I asked him how the REO situation was. He said they had taken back 2 properties thus far, were being very proactive in talking to the borrowers, and ... had never written any loans higher than 65% LTV. Basically they sat out the mad rush of the past few years and did business with the locals as they always have. That happens to be the only bank (state regional or national) in my area with a "1" rating.
All, many good points. Tough to handicap this when the homeowner has a local job and family. However, I remember reading that 40% of home purchases in 2004/2005 were for second/investment homes. No doubt, these will be much easier to walk away from. Just think of having a negative $3000/mo payment 1000 miles away in Miami or Vegas. Underwater and cash flow negative. NO THANK YOU. Mr. Market is never kind to foolish lending.
"Fundamentals, not liquidity conditions, are behind MBS crash" « naked capitalism
At root, CreditSights calculate a severity loss ratio for lenders on individual defaulting subprime mortgages based on mortgage market data collected over the past few weeks. The survey results indicate that such loss severity rates on mortgages are painfully high. They range from 24 per cent to 55 per cent - with a weighted average at 35 per cent. And theyre expected to rise. For second-lien mortgages - that is, second mortgages on a property, the loss severity rates average 94 per cent.
So how do those figures translate into the capital structure of structured mortgage-backed debt? Foreclosure rates are rising higher and higher - which means the number of occasions when the above loss severity ratios have to be applied are increasing.
And it doesnt look like the blame can be pinned on any particular vintages of MBS. Heres a graph of foreclosures on vintages since 2004:
"Considering that cash flow was king in getting many of the purchasers into houses in the last five years, it seems reasonable to think that cash flow will be king in getting them out."
The buyers, at the end of the bubble, with zero down and teaser loans got in because they bought the meme that prices always go up in RE. Those same buyers will get it the moment they realize their premise was horribly wrong.
It was "easy" to get in, a "no brainer", at the end. I suspect that the "easy" thing to do is exactly the choice these same buyers will make when they realize they're upside down. They probably had a poor FICO before and wrecking it more won't amount to a whole heck of a lot now, will it?
The only question is how many people to which this applies. So far, it sounds like an awful lot.
"Home values went down significantly in the Great Depression, but most homeowners going into the Great Depression had much more room than they do today."
Can you explain? What do you mean by much more room?
So, although you may have done a crappy job of timing the market, you will gain positive equity over time
Tell that to the Japanese. Imagine a world where maintenance and taxes rise faster than equity!
20% of all mortgages underwater. That's awesome. There's some growth opportunities in the foreclosure business. Not in BUYING the properties but in processing the paperwork!
Matt is right. The RE bubble started in the early 1990s and not in 2000, as many believe. A graph of the bubble is out there somewhere that illustrates it very well. Home prices need to fall 50% from the peak in order to fall back to sustainable levels, and it's likely that it will overcompensate - 60% before bobbing back up to the mean.
Do the banks and brokers not even do that anymore?
Who can say what was said to the latest crop of borrowers? And who knows what they retained? From all the stories it sounds like people were just signing away, carefree and trusting.
"Guys - a homeowner will not stretch to make a home payment when they are 10-15% down and heading further down. They won't. They'll stop making the payments, or they will buy a much cheaper house, move in, and default on the first while declaring bankruptcy."
MOM, hate disagree, but while I think forclosures will be sky high...I don't think we'll get much contribution from people just walking away from a house they can afford because it's cheaper elsewhere, especially at the cost of their FICO.
This is where the "new car" purchase example comes in. People are used to being upsidedown.
If people were so economically inclined then even people who owe nothing on their houses now would be selling in droves simply to rent, reninvest the proceeds and buy cheaper later.
The fact is that neg equity alone is not a driver of default, but it's other things in a neg equity enviroment that will make up 90%+ of the coming forclosures.
There's just something disturbing about reading advice from an "Average Joe".
Couldn't you be "Awesome Joe" or "Alabama Joe"?
"Home values went down significantly in the Great Depression, but most homeowners going into the Great Depression had much more room than they do today."
As I recall, most home loans in those days were very short-term: five years or so. I would take that to imply that a much larger percentage of homeowners were debt-free than now -- although there probably weren't near as many homeowners as a percentage of the population, at least in urban areas.
Avg Joe. Afraid you can't make the comparison of being underwater on a small loan for a car where you EXPECT to be underwater, vs a house where most people would have never expected it. First, there is the amount of being underwater. Then, there is the known trend of going under water big up front on a car, and slowly after. Thats fine, it's an expense, and it's rational to do that, AND , there isnt another economic alternative that makes more sense, since leasing is hardly different in terms of net worth. A used car makes sense, but it's not directly comparable for many reasons.
For a home, once you break the routine of being above the surface, you have no idea how under water you are going to go. But as it appears that you are likely to sink more and more, this further breaks the analogy to car loans.
Correction:
MOM, I now noticed you said "stretched" to afford....this implies resets. With this I don't disagree.
My point was that those who are easily comfortable now in their home loan and don't face resets or job losses or divorces etc, are unlikely to walk away from their house soley because the house is worth less than they owe.
We can't count on these people to add greatly to the forclosure numbers.
I am not sure you disagree.
For "debt free" above, substitute "paid off on their mortgages." They may well have had other consumer debt, bought stocks on margins, etc. And of course family farms borrowed a lot.
The last window of "affordibility" in California was 1994-1996. If prices
reach that point again, I'll consider
buying a second home to rent.
Prices in California were clearly
untethered from median wages
by 2000.
Therefore, I'll go out on a limb and
predict that California home prices
will see pre-2000 levels, but probably
not pre-1995 levels, and maybe not
even pre-1997 levels given non-governmental measures of inflation.
The above is my bet for the home price bottom....pick your spots before the pool fills up.
Can you explain? What do you mean by much more room?
thinking of walking away | 12.04.07 - 2:29 pm | #
The proportion of equity was in general much greater.
This is where the "new car" purchase example comes in. People are used to being upsidedown.
It is one thing to be 3-4k$ underwater on a new car. It is another to be 30-40k$ underwater on a house.
They probably had a poor FICO before and wrecking it more won't amount to a whole heck of a lot now, will it?
That is why I diverge from CR on this one: taking the conclusions of the Boston Fed study (which was limited to subprime) and projecting them out to the broader market.
MoM - I will share with you all a quick anedocte. I have a brother who recently built a new home. Previously, he owned for years and is quite outfitted for/accustommed to homeownership. Knowing my SIL, I'm sure they put at least 20% down, probably more. He is not trying to game the market, the new place was their goal for a long time, they weren't trying to time/game the market.
If they found out tomorrow that the home was built on a sacred Indian burial mound, and was now worth zero since they could never sell it to another soul -- guess what? He'd still pay for it, because it is worth the X dollars he paid TO HIM. I am certain that he would stay there, make payments as promised, and live with the godawful cabinets he picked out.
Even if the market tanked and he could move his family into an apartment and half the cost, I still doubt he would. Becasue he values the house for what it actaully provides. He finds utility in having a yard for his kids to play in and all that crap.
My point is, not everyone out there is gaming the system and weighing the merits of destroying their credit.
At the margins, sure. The subprimer who bought with nothing down and will have see his FICO go from 575 to 550, yeah - small wonder he'd hit the bricks.
But for the majority of working AMERICANS (read: not Japanese), walking away from 10% negative equity is not a normal thing to do.
I am on the right side of that curve and can't imagine walking away from my house, even if I were expecting the value to fall. I don't know much about California, but in many places there is a very slim selection of single-family homes available for rent and prices are not better than owning. Remember that $100,000 mnortgage in Dakota if it is a 6 % fixed only costs $ 600/month or so. Even in Dakota, that doesn't rent you a palace.
thinking of walking away, in the 1920s, a 50% downpayment was required - and obviously there were no HELOCs and owners didn't treat their homes as ATMs!
The entire financing package was different: 50% LTV, IO (no amortiziation), 10 year balloon payment was a common loan.
BTW, this is common in China now (50% down). I spoke with a builder in China, and he doesn't break ground on condos until EVERY unit is sold with a 50% downpayment! No wonder China has a high savings rate - it's the only way to buy.
Hey, a whole new market for New Century, Option One, etc.
Best to all.
Shnapster,
I agree with what you say about your brother, and would guess that at least half the US population is like him, and wouldn't walk from a home whose payments they could afford just because they were upside down.
But I'll also guess that about half the population isn't like him, because while they may be able technically to afford their home payments, they took them on expecting their home to be a great investment as well as a place to live. And in many cases they are so close to retirement, with little or no other savings, that they will really need to genuinely save money by living well within their means -- and their current mortgage and interest payments are not well within their means.
Dryfly: I am a Canuck. Canada does have a Constitution-it's called the British North America Act and dates to 1867 when the original 4 provinces united. There is also a Charter of Individual Rights and Freedoms. The Bank of Canada is constituted pretty similarly to the Fed. The Prime Minister appoints governors and you have many hold-overs from previous governments. Regarding the issue of their owning paper they shouldn't own, I'm not sure what Parliament could do post facto. I guess the government could sue in court (I'm not a lawyer) but I don't know how that would go. The Prime Minister could threaten not to re-appoint Governors, but I'm not really sure the PM is even opposed to their doing this.
Not sure that helps.
I'd guess foreclosures will spike in 2008, far beyond mere analysts' abilities to measure them. (so far)
As the economy slows down, a couple of interesting things happen that are kind of hard to account for.
One, velocity of money slows down. People spend less, and all purchases become 'considered' purchases. At its worst, that's when inflationary policy has no effect on consumption. Liquidity trap.
Second, the displaced people move in with relatives, etc.. Household formation declines in recessions, although I can't remember by how much (help on the number, please). That's when a 10 month housing supply 'problem' becomes sci-fi horrific.
Should that happen, people will start quoting James Kunstler who called suburbia, 'The greatest waste of resources in the history of mankind.'
Or, things will be just fine, and the Dow will hit 20k. You choose.
This number is important because homeowners with little or no equity are very vulnerable to negative events
beware the "Four Ds"...
Such an interesting contrast CR: the China banking system --the one Paulson & Group was so interested in "modernizing"...requiring 50% down on those house mortgages.
New Century to the rescue indeed.
I like the "half" and "half" analysis jm...now if only those streams of income paying for those mortgage payments keep coming...despite growing foreclosures and bankruptcies that are masked by buoyant UE stats from entry level service jobs...that don't even pay the rent.
Shnapster,
The problem with your theory is that the people that won't walk away are the ones that either don't have a mortgage or can easily afford their mortgage and are not likely to be in the hole. They didn't buy to make money, they likely didn't overpay, and they certainly didn't MEW it all out. These people never walk.
The rest will walk -- you might as well count'em as gone now.
p.s.: The car analogy was not applicable in the least. The expectations aren't the same (as cited above) and the numbers are on an entirely different scale.
The calculation until 2005 was, how do I keep up, can I afford not to buy?
The calcualation now will be, how do I keep up, retirement is around the corner and I have to do something, how can I afford not to walk ?
I believe the housing market is putting in what is known as a "rolling bottom", it's just that it's still rolling downhill.
tj That's me. Not walking
The #1 impact of this will be the utter devastation of the trade up market. The high prices of bubble markets even prior to the boom were due to decades of equity rollover. That equity will very shortly be gone, so all housing must revert to median prices that reflect a rational multiple (3x) of median incomes, period.
One of my friends walked away from a home in Northern CA in 2002, because he lost his job & was under water $50K (from the 2000 peak - which of course got eclipsed by the later peak). He could have held on because his wife had a good job, but didn't.
It was a purely "financial" transaction for him - he checked with a lawyer to make sure they won't come after his other assets (he had savings). He just didn't want to be "wasting" his savings paying mortgage on a depreciating asset (in 2002 things did look bleak around here).
Wouldn't the line tend to move to the right in a high-inflation environment?
When you folks are quoting/predicting drops in housing prices, and then looking back at prior years to see where it intersects, are you talking nominal or real prices?
Also, don't forget that you can live payment-free for 4-5 months, easy, in your soon-to-be-foreclosed-upon house. Factor that into the decision process for marginal walk-aways.
Great blog, great comments.
CR, you wrote:
The first doesn't quite follow from the second - in the second, the change of equity is mentioned (with increasing equity giving hope) while you refer to the absolute amount.
I think that more is wrong with the Boston Fed report, not actual falseness but misleading words. From the data is clear: More house price appreciation means less foreclosures, and vice versa. But what are the reasons? One obvious reason is that people who can't pay the mortgage anymore can sell the house for enough money in an appreciating environment. They would have lost their houses no matter what, but the outcome became a foreclosure due to the depreciating environment. That is nearly trivial and wouldn't have anything to do with a conscientous decision of the homedebtor, as you seem to indicate. Another reason for correlation has been pointed out by piggington.com: With more foreclosures we have more must-sell inventory that will surpress prices (a causation the other way around).
You seem to see most homeowners as the rational beings of economic theory who cooly calculate possible win and loss and act accordingly. I would expect that most people will just act like people around them: First sacrificing to save the house (even 401k extraction has been foolishly proposed) and then mailing in the keys after seeing sufficiently many other people doing so.
TJ - I'm not quite sure you understand my theory, partly coz my typing sucks today...but let me clarify something:
The very notion of WALKING AWAY is rather exclusive to those who are, in fact, upside down. Anyone who could simply sell, payoff their ourstanding mortgage debt, and walk away with cash, would do so.
In other words, for those you mention (don't have a mortgage, etc) walking away is not really applicable to begin with.
So, I am saying, those who become upside-down on their primary residence thanks to falling home prices, and have decent credit scores aren't as likely to walk as subprimers who bought with zero out-of-pocket cost and are in the same situation.
I appreciate the fact that many buyers recognize the 'investment' component in their home. But even given this - have you dumped every stock you've ever owned the minute its value dipped below your basis?
Peter T, I believe you are hitting on a key element to the "walk away" scenario; it has to be socially acceptable.
Right now everyone in trouble is labeled "subprime" - even though that isn't true. But if a large enough group of otherwise middle class / normal credit history homeowners start to walk - it will be a flood.
BTW, I'm not relying on the Fed report. Research has shown that house prices and foreclosure activity correlate inversely very well. Why? There are probably a number of reasons - from the 4 D's (Death, Divorce, Disability and corporate Downsizing) to ARM resets, to anger at owing more than your property is worth. I've seen them all.
Best Wishes.
Excellent post since it highlights why this deflating Housing Bubble is acting like a neutron bomb - with housing still standing but destruction wrought more subtly on the owners bank statements.
When making estimates as to where homeowners are to classified in terms of current equity in their respective houses, we should perhaps run the same charts and tables for two different modifications:
After all, 85% is not much of a buffer after all: account for 10% drop (likely), add 6% commission, and also 5% for inflated house appraisal and voila - we are done to 79.9% (100 minus 10 minus 5 equals 85. 85 minus 6% equals 79.9%. Throw in a safety margin 5% (just 5%) und we are done to 75% LTV.
Banks doing 85% LTV are still drinking the Kool-aid as much as their borrowers.
For how many additional homeowners would the ATM be closed with a LTV of 85% becoming the norm in 2008,, with 80% in 2009 and 75% in 2010 (all accomponied by nominally falling house prices along the way)?
As a legal immigrant from Germany my astonishment about the unfolding of events continues. This country will look very different in 2010 than today with a large former middle class with no savings and its population will be open to a lot of different ideas. Ownership Society will not be among them.
One more thought about the decline of the dollar: Each time the dollar drops one cent, thousands of additional Asian and European parents can suddenly afford sending their children to US colleges. American colleges will be forced to chose between suspending tuition growth rates from 7% annually or keeping increasing tuition rates at that pace and increasing the share of foreign students to 35-40% (as Harvard has already done).
It does not pay to spend childhood in a suburban subdivision basement between age 14 and 17 to prepare properly for tertiary education.
What this all means is a possible revival of currently "uncool" states such as Wisconsin, Indiana and other states around the Great Lakes and the North West where arable land
Tj: But what about non-bubble markets? In "mid-range" markets, median home price is around $ 200K and median family income is around $ 50K. If we say median income for homebuyers is a bit higher than non-buyers (which will include vast majority of the poor) , then say income is closer to $ 60K. So with a 10 % downpayment, that house is not really over-priced. But you guys are too interested in the sounds of your own voices and your California dreamin' to listen...
Similar to traditional German mortgages: the senior mortgage covered up to only 60%, but had good rates. If you needed, you could get a second, junior mortgage for up to 20%, with high rates. Now, due to universal finance, 100% mortgages have been introduced in Germany by American and Dutch banks.
Were HELOCs not illegal in many places, because the home should not be put on the line? I think Texas allowed HELOCs only in the 1990s, because before people had tried so many ways around the prohibition, like high cash-out financing.
Hallo Kottan, welcome, I'm a legal immigrant from Germany, too. I agree with you when you write:
If I could buy a stock of "socialist ideas" I would do it, but I haven't found any yet
Another New Deal in the cards?
Personally, I would prefer to live in an "ownership society" rather than in a socialist society: spending less than you make, saving and investing the rest, in stocks, bonds, commodities, even in real estate. America doesn't look like an ownership society to me now.
Hallo Peter T,
Being from the Rhineland in West Germany I grew up alsmost as far away from East Germany as possibly within Germany. I agree, America does not look like a true Ownership Society now with all the underfunding of the four minimum four pillars for an adult life in the Industrualized World: Housing, Pension, Health, Education. Yes, I do believe that there will be longing for a Great Deal or an equivalent and for a much better ideas of meaningful risk-sharing as Western European societies, incl. Germany, have done.
The current housing crisis will serve as a catalyst for this discussion and it is perhaps no accident that Mike Huckabee is rising so fast now in the polls (A Republican with a human face and record of public good accomplishments in Arkansas)
Risk-sharing is, however, no substitute for responsibility and here America still has a strong hand by placing so much trust in the hands of its own citizen to meaningfully navigate their own lives and to be fair: I have benefited greatly from this trust since I arrived here in 1998.
The housing crisis is a reminder that a large share of the population is overwhelmed by this task (incl. by refusing to remain a renter and instead capitulating to peer-pressure, a behaviour unbecoming a member of a proud republic such as the US).
The housing crisis is therefore also a reminder in the limits of what can be reasonably expected from its own citizenry and hence very sad in this regard as well (even more so than just the vanished equity in residential houses).
Owning a house is counted in economic terms as "consumption". Excessive home ownership would therefore be "overconsumption". Perhaps the German homeownership rate of 45% is too low, but equally perhaps the 68% (down from 69% in 2004) in the US is too high.
Aiming for a higher share of affluent renters (without any stigma) that would indeed save in stocks and other investments to achieve capital accumulation in productive enterprises would therefore perhaps benefit the US much more that promote the American Dream which is for too many just that.
Kottan,
Please continue -- HaloScan will cut you off after a certain number of characters, but you can continue in a new comment immediately after.
Average Joe My point was that those who are easily comfortable now in their home loan and don't face resets or job losses or divorces etc, are unlikely to walk away from their house soley because the house is worth less than they owe.
No, I think you are right there. For people in this category, it would only be trouble that disrupts their comfort zone which would produce a default. How many recent FTHB are in that category?
But consider two things, Average Joe: First, the easy credit has extended to far more than homes, so if someone got underwater on the car/boat/vacation bonanza, they will still likely go BK. If they are well under in the home, they will not try to exclude it from the BK. I have stories I could tell you about bank customers.... It's really frightening.
Second, far too few of FTHB in the last few years have been granted loans that are easily affordable. This is all over the country, flyover included. Last week Cal posted a link to Blownmortgage describing what a great borrower looks like nowadays.
Forget the subprime. Fannie and the rest have been handing out Alt-As and even prime loans with delusional DTIs. In the first 5 years you own a home, a whole lot of things can come down the pike when you have little equity. That's in normal times. The old idea was that back end DTIs should be 36% or so, but now no one has a problem with 45%, and many go higher without blinking. These loans would normally run into trouble for a relatively high percentage of borrowers. What will be different is that far fewer will be able to sell now.
The rate of serious adverse events is about 1% a year, of intermediate adverse events 3-5% a year depending on economy. Over a few years it adds up. That's why mods are such a common thing. You are not gonna dump a good payer just because they lost their job or got in a car accident. When people have no margin for anything but basic living expenses, can't save, and have one of these, they never do catch up.
Hallo Kottan, I'm from Gladbeck, legally also part of the Rhineland but culturally part of the Pott.
Rightly so, just as my rent payments. Investment is only a small part of the costs of homeowning - it seemed only so big in the last years, because leverage increased the gains, - now leverage increases the losses.
If I consider an indivual or an individual household, buying too much house is overconsumption (remember: Buy as much as you can afford!) and is rightfully punished, just as renting too much house. I don't consider switching between renting and owning (= renting money) a form of overconsumption per se, it is just a choice with many input parameters.
Generally, a low homeownership rate can give flexibility, but German workers are not known for easy relocation either. I don't see any advantage with high homeownership rates. I do see an advantage with widespread property though, and homes have been traditionally a property even for the many.
Exactly. One way to improve things would be giving renters a better standing in society, not only now when we have obviously made the better choice but in all things. I consider the "American Dream" just a sales slogan from politicians and real estate agents that want what is in your wallet. The real "American Dream" is to make it, by yourself, and hopefully big.
Is it too paranoid to believe that future innovation in debt collection will squeeze blood from the runaway mortgager? Even now, out-of-statute debt is worth money 'Zombie' debt is hard to kill - MSN Money.
Shnapster,
I'm thinking you don't quite get my point, either, which is this...
Most of the people that would walk away are those that are underwater -- they self-selected, so to speak. Therefore, you can expect that a vast majority of those in trouble will in fact walk.
Biotech Guru,
It doesn't matter if the "buyers" have higher than median incomes, because the historical ratios still apply. If the nation as a whole averages prices that are 2.5xMHI, then that's the ratio. Because people historically have stretched for places like SoCal (where I live), you could probably see 3x, but the premiums associated with equity trade-ups are history.
Nothing to add.
Excellent post, keep up the good work.
4runner says
It is one thing to be 3-4k$ underwater on a new car. It is another to be 30-40k$ underwater on a house.
Some of these poor bastards are going to be 3 or 4 hundred thousand dollars upside down in their house.
They'll take a look and say to themselves, "you know, I've been saving for retirement for 20 years, and I don't have 400K saved, yet."
I saw it happen here in Texas in the mid-80s. Friends that walked away from
an 80K house in Austin that they'd put 30K down on 3 years before, because they couldn't get anyone to buy it at even 40K, and the only job he could find after looking for 6 months was in Dallas.
I appreciate the fact that many buyers recognize the 'investment' component in their home. But even given this - have you dumped every stock you've ever owned the minute its value dipped below your basis?
No. But comparing this situation to, say, something convenient and not too far out of mind - the Nasdaq, circa 2000 - when did the vast majority of retail, umm, "investors" dump their holdings in those high-flying Internet companies?
Not at the first sign of losses, or a 10% or 20% breakpoint, but when one of two things happened:
(1) They got margin calls that they couldn't meet.
(2) They gave up and dumped them. Not, mind you, while they held out hope that they'd make their money back in three months ... err, six months ... ok, three years ... but only when they became convinced that "these things are all going to zero".
Substitute "ARM resets" or "a realization that my credit rating isn't worth $300K" for "margin calls" in point (1) above and voila, everything old is new again. Your subprime / Alt-A / option ARM homeowners are group (1); your speculators and flippers are group (2). And the reality of the situation hasn't dawned on either group yet ... which is to say, to risk stretching a parallel, that we're still only at about July, 2000 in the popping of this bubble.
It's gonna get ugly.
Look at Houston during the early 1980's. That will give you a pretty good idea of what will happen. Also remember these people almost always put 20% down and they walked in droves.
Thank you CR and Tanta for your fantastic blog!
IMHO, homeowners will not begin to act rationally. As the bubble inflated, I noticed that home buyers' identities were too closely linked to their purchase. They were their home. People took great pride in the home choice that they made, and for many it represented their position in their culture, their values, their class and their taste. Renters were losers. I think that people will walk away more for psychological and social reasons than for purely financial ones. If the house becomes psychologically associated with a poor choice, with "loserness", then I see people walking away. This may be more true in large urban areas where communities are fractured, social contacts are fluid, and where status is primarily defined by consumption. People whose identity is based on personal responsibility will probably spend the next several years fuming about all the bailouts and policy changes which ensue from this mess, while remaining in their homes. People do not like to believe that they make emotional decisions, but fMRIs have helped to demonstrate that that is indeed what is happening.
On an ironic note, I see housing anxiety manifesting as fat fascism. It may be acceptable to walk away from your mortgage, but a couple extra pounds around the midsection will mark you as a wanton overconsumer.
There is strong reason in my opinion to believe that OFHEO is more accurate than Case-Shiller nationwide; relatedly, a 30% decline in Case-Shiller is much more likely than a 30% decline in OFHEO.
Case-Shiller systematically oversamples wealthier areas, especially coastal areas. OFHEO does a broader survey. The areas undersampled by Case-Shiller were those that missed out on the initial price rises as well. If it was a bubble (as I think most agree), then the areas not sampled by Case-Shiller are also less likely to decline.
The various more limited Case-Shiller numbers, that focus on only the largest markets, showed a steeper rise during the bubble and a steeper decline now, in accordance with this hypothesis.
Who is famed economist A?
Abby Cohen still has a job?
I have a problem like this 2006 I paid 600,000 for my new house I put down 135,000 cash. due to forclousers in my area same houe sold for 335,000. Do I stay and pay 3000. amonth payment for maybe 3yrs to reach what I owe. Or do I rent the same house for 1500mo.and put the rest of the money in my pocket not to talk about 7200.year in property tax for three yrs. In 3yrs. @ 1500 month plus property tax I could have back what I lost.