The Worst Is Yet To Come In Housing

I had planned to write this post on de-leveraging and mortgage debt before I found out that the NBER, the official arbiters of Business Cycle timing, said the "Great" recession ended in June, 2009. Calculated Risk was somewhat taken aback by the decision—

The committee decided that any future downturn of the economy would be a new recession and not a continuation of the recession that began in December 2007. The basis for this decision was the length and strength of the recovery to date.

This is somewhat subjective - and I thought they'd wait longer because the committee usually waits until some of the key indicators have returned to pre-recession levels. This time no indicator has reached the pre-recession level, and some are still very low (like personal income less transfer payments).

Now we can have a double dip—officially! But seriously, I can not think of a better introduction to the balance sheet conundrum in the housing market.

About 75% of household debt in the United States is mortgage debt. See my post The Household Debt Mountain. We have a classic deflationary scenario in which asset values crash, but mortgage debt remains on the books. This is clearly seen in the following two graphs from Eric Janszen's The Committee To Wreck the U.S.A—

Although the value of residential housing and home equity have crashed, household mortgage debt (red line) has only fallen a little below its pre-crash value.

As with household mortgage debt in the first graph, the amount homeowners pay in mortgage interest has again fallen only a few percent below its pre-crash value.

The recession may be over according to the NBER, but the mortgage debt problem is bound to get worse. Calculated Risk summed up the situation in The two key housing problems—

I think there are two key problems for the housing market: 1) the excess supply of existing housing units, and 2) negative equity...

At the end of Q2, CoreLogic reported that "11 million, or 23 percent, of all residential properties with mortgages were in negative equity". And an "additional 2.4 million borrowers had less than five percent equity". With house prices falling, several million more properties will be in a negative equity position later this year and in 2011.

The excess supply is also pushing down house prices (prices are just starting to fall again). Lower prices will eventually help clear the market, however lower prices will push more homeowners into negative equity.

Negative equity frequently leads to distressed sales (short sales or foreclosures), and losses for lenders... The negative equity problem is intractable... It is important to note that falling house prices helps clear the excess supply, although more jobs and more households is the preferred solution. However falling prices makes the negative equity problem worse.

That's clear enough. OK, now look again at the first graph above. The current situation dictates that the value of residential housing (green line) will fall again, and so will home equity (blue line). More and more homeowners will be in negative equity, which means their mortgage debt exceeds the value of their house. But as the housing market searches for a bottom, the residential mortgage debt (red line) will fall only very slowly just as it has up to now.

It's hardly an exaggeration to say that mortgage debt is the single greatest economic threat to America's Middle Class. That is not to say that other types of debt are not a serious problem—they are.

Thus I was disturbed, not to mention really pissed off, to see Defaults Account For Most of Pared Down Debt in the Wall Street Journal—

 
U.S. consumers might not be quite as virtuous as they seem. The sharp decline in U.S. household debt over the past couple years has conjured up images of people across the country tightening their belts in order to pay down their mortgages and credit-card balances. A closer look, though, suggests a different picture: Some are defaulting, while the rest aren’t making much of a dent in their debts at all...

There are two ways, though, that the debts can decline: People can pay off existing loans, or they can renege on the loans, forcing the lender to charge them off. As it happens, the latter accounted for almost all the decline. Our own analysis of data from the Fed and the Federal Deposit Insurance Corp. suggests that over the two years ending June 2010, banks and other lenders charged off a total of about $588 billion in mortgage and consumer loans.

That means consumers managed to shave off only $22 billion in debt through the kind of belt-tightening we typically envision. In other words, in the absence of defaults, they would have achieved an annualized decline of only 0.08%...

To be sure, this analysis holds consumers to a harsh standard. Defaults happen even in normal times, and are typically offset by even stronger growth in new mortgage and consumer loans. By holding their debts steady, consumers are actually being a lot less profligate than usual.

That said, the way U.S. consumers are shedding their debts isn’t encouraging...

Notice how the author Mark Whitehouse—surely this can't really be his name!—blames the victims, whom he refers to as U.S. consumers. Harsh standard, indeed! As I've just explained, in a classic deflationary scenario asset values crash but the debt on those assets (mortgages) remains. How does a family "pare down" the mortgage debt on their house? You can't pay off the existing loan, which usually amounts to tens or hundreds of thousands of dollars. Remember, mortgages make up 75% of the outstanding household debt in the United States.

In many cases Americans are lucky if they can make their mortgage (principal + interest) payments at all, let alone pare down the principal. So how does one get out from under mortgage debt? Default — it's the only way! And here's this asshole Whitehouse chastising households for reneging on their loans instead of paying them off, thus forcing the poor lenders to charge them off. The only mistake these "profligate consumers" made is that they assumed these debts when realtors, bankers and other assorted liars told them house prices would never go down.

As for the other debt, the 25% that consists of credit cards, student loans, car loans, etc., it is a very bad sign that households can not pare down those debts. What the 0.08% deleveraging rate suggests to me, as it should have suggested to Mark Whitehouse or Barry Ritholtz, is that Americans can not allocate money to pay off debt. Not will not allocate money, can not allocate money. It suggests that there's little cash to spare beyond what is spent on necessities (e.g. food, shelter, child care). Alternatively, people are still using credit to buy necessities not covered by their income.

The bottom line is that the worst is yet to come in housing. Until that market reaches the bottom, we are not out of the recession regardless of what the NBER says.

Comments

[Joy]

Cheer up Dave, at least America has defended her core values, the same core values as the Islamic Republic of Iran - virulent homophobia and militant ignorance. My only regret about emigrating from "The Homeland" in 2005 was that I should have done it a decade earlier.

The residential mortgage debt will never go away, and neither will "Don't Ask, Don't Tell". At least there will always be plenty of entrepreneurial opportunities in "The Homeland" in the (tax free) "faith based" hate industry.