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1 in 6 Home Owners 'Under Water'; Thwarting the "Housing Move Up" Cycle

graphic via WSJ Interactive

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Fascinating WSJ article about "underwater" homeowners:

"The relentless slide in home prices has left nearly one in six U.S. homeowners owing more on a mortgage than the home is worth, raising the possibility of a rise in defaults -- the very misfortune that touched off the credit crisis last year.

The result of homeowners being "under water" is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.

And having more homeowners under water is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home's value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.

About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's Economy.com.

The comparable figures were roughly 4% under water in 2006 and 6% last year . . . Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site Zillow.com."

To me, this data suggests that we should be doing triage on home ownership and mortgages: Identify those people who can afford their homes with a reworked mortgage, and facilitate new financing (think 1930s type HOLC loan work outs).

For those people clearly in over their heads with no hope of reasonably affording their homes, develop a plan to allow them to move forward as quickly as possible.

Its important that the Fed/Treasury stop focusing on prices. If entry level homes remain elevated and unaffordable, the sales move up cycle won't happen. What is missing in the current housing crisis are that buying chain: entry level buyers purchase a "starter home (i.e., 2 bedroom 1 bath, 1/4 acre), from people who buy a larger house to accommodate a growing family (3 bedroom, 2 bath, more yard) from people who up to an even bigger home (4-5 bedrooms, 3 baths, 1 acre), etc.

If the entry level homes are not affordable, the entire chain of transactions won't occur. This is why it is a huge mistake to focus on prices -- they should be allowed to mean revert back to price levels on their own. The Fed and US should instead be working on making mortgage loans available to those who qualify, and reworking those that can feasibly prevent foreclosure in a reasonable manner (i.e., where they won't default again or walk away in 6 months).

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Pending Home Sales Index out today at 10:00am . . .

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Previously:

The Ongoing Impact of the Housing Sector   
Barry Ritholtz
Investor Insight, Aug 27 2007, 11:50 AM
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2007/08/27/the-ongoing-impact-of-the-housing-sector.aspx

Real Estate and the Post-Crash Economy
Barry Ritholtz
Thoughts from the Frontline,December 29,  2006
http://www.2000wave.com/article.asp?id=mwo122906

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Source:
Housing Pain Gauge: Nearly 1 in 6 Owners 'Under Water'
JAMES R. HAGERTY and RUTH SIMON
WSJ, OCTOBER 8, 2008
http://online.wsj.com/article/SB122341352084512611.html

Wednesday, October 08, 2008 | 06:22 AM | Permalink | Comments (37) | TrackBack (1)
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Comments

Here's another part of the problem: From 1991 to 2001, new home construction averaged between 1.0 and 1.7 million new units -- about 1.35 million units on average per year. But from 2002 to the peak in early 2006, the range was 1.6 to 2.2 million new units -- about 1.8 million annual new homes. That 5 year period produced a surplus of about 2 million plus homes. This suggests to me that new home construction will be below par until that excess inventory gets worked off -- about a 4 year period, which we are barely half way through.

Posted by: Barry Ritholtz | Oct 8, 2008 6:51:04 AM

Surprise Fed Cut Joint to UK.

Hope this jacks up the shorts badly.

Posted by: John Borchers | Oct 8, 2008 7:06:32 AM

Yes yes yes yes! Two years ago we rented because it was a dumb time to buy. Now we're still renting because our two-income family still can't afford to buy anything nice enough to want to live in. 10% would do it, 20% would be lovely.

It would be really nice if we as a society could get over the notion that housing is a growth investment, instead of a savings investment...but that's a fat chance, so housing will continue to be a stupid tax, as those that understand boom-bust cycles (and have the stable jobs to make such decisions) only deign to buy low and sell high.

Posted by: DDK | Oct 8, 2008 7:13:17 AM

No worries. McCain promised in the debate last night that he would order the Secretary of the Treasury to buy up all underwater mortgages and then write new mortgages at present value to these "poor" homeowners.

No mention of course as to how he would pay for this largess given all the bailout money the government is already committed to and the fact that McCain says he won't raise taxes. Guess it will all come form that magic money tree in the backyard.

Posted by: Jojo | Oct 8, 2008 7:13:31 AM

As for a plan for "those people clearly in over their heads with no hope of reasonably affording their homes", one already exists: bankruptcy.

No bailouts for anyone.

Posted by: angry taxpayer | Oct 8, 2008 7:14:46 AM

Wow, I am banning asshats and wingnuts by the dozen.

Once again, I remind newbies to the please read our posting policy (here: http://bigpicture.typepad.com/comments/the_big_picture_disclosur.html)

Posted by: Barry Ritholtz | Oct 8, 2008 7:22:05 AM

How does reworking mortgages make entry level homes more affordable? If you rework the mortgage, the people who bid up the price of that house (beyond affordability) can now stay in the house instead of selling it for a reduced price.

Posted by: Renting in Mass | Oct 8, 2008 7:50:30 AM

Barry -- has anybody sent you this yet? It's relevant: XKCD on Youtube comments

Posted by: DDK | Oct 8, 2008 7:55:00 AM

The situation in California is such that there really aren't any "starter homes". The traditional starter home is priced so high, the starters haven't been able to afford them for decades. The California migration is as much high prices as it is high taxes.

Posted by: Ron | Oct 8, 2008 7:58:25 AM

I'm not sure you aren't talking against yourself when you say we need both affordable houses to make a market and we need to do work-outs to keep people in the houses. If the prices don't drop, those people are still underwater.
If by mortgage workout you mean to actually reduce the principle, then you are basically just redistributing the loss... moving it to the bank.
This is not an easy problem. The fact is that the prices agreed to were set too high and now there is no alternative: somebody must take a loss. The only battle is: who?

Posted by: wally | Oct 8, 2008 8:33:19 AM

nothing to worry about, its just a matter of time that all this liquidity pump will eventually cause runaway inflation like we have never seen before and make those underwater well into the black in a big way. tthe dynamic will not be the easy money of the greenspan era but just plain ole vanilla flavored inflation of the 70's. remember anyone?

Posted by: AbeSklaroff | Oct 8, 2008 8:35:19 AM

I propose there're two problems with "starter" homes-- one is, as in the CA comment, the traditional starter home is just too expensive to start with. That solution is in progress. The other, suggested by the "none we'd want to live in" comment (nothing personal, just a convenient blind illustration), is excessive expectations. People seem to want to start where they left off-- their midage parent's home. Stock market bubble capitulation is the easy part. Lifestyle bubble capitulation is going to be the long, slow, ugly part.

Posted by: R.J. Squirrel | Oct 8, 2008 8:36:15 AM

"Lifestyle bubble capitulation is going to be the long, slow, ugly part."

But, but, but we Gen-Xers and Gen-Yers are supposed to have better and easier lives than are parents did... My mommy and daddy told me so.

Posted by: Tyler | Oct 8, 2008 9:01:10 AM

well that didnt work. futures are getting pummeled here in the states.

I thought id speculate at 3:55 and gamble on the cut and teh subsequent boost. I am a loser it looks like on this one. Out of the pool kids if youre stuck in SSO!

Posted by: TheUnrepentantGunner | Oct 8, 2008 9:02:29 AM

R.J. -- you're right about some lifestyle capitulation being needed, but at the moment, the area where I live is asking quite a bit too much for homebuyers.

When I say "nice enough to live in," I mean a basic townhouse or WWII-era cape cod fixer-upper. On a similar family income, I grew up in the same area in a brand new 4-bedroom mcmansion on an 3/4 acre lot with a swimming pool. We'd have to win the lottery to buy that back.

On the other hand, being priced out means we're renting a beautiful apartment in town, walking distance from my job. Buying the equivalent apartment on the same street would cost us more than twice as much per month. That's a wee bit out of whack.

Posted by: DDK | Oct 8, 2008 9:03:23 AM

I'd be interested in seeing this for the UK, and by demographics too. I'm in my late 20s, and off the top of my head I can count 8 couple friends who married in the last 12 months and bought a house. In London.

A few years a go we were young and we could laugh about the "serious" things in the world. Now it's no longer kosher for me to laugh how house prices fell yet again in front of them.

Posted by: Frank Rizzo | Oct 8, 2008 9:06:30 AM

That 5 year period produced a surplus of about 2 million plus homes. This suggests to me that new home construction will be below par until that excess inventory gets worked off -- about a 4 year period, which we are barely half way through.

This embiggens the fallacy that there'll be any sort of home price rises anytime soon, and actually indicates that we'll shoot well past the historical mean home price (2.5-3x income, 100x rent)..

Unless wages rise of course.. LOL :(

Posted by: Dr. Kenneth Noisewater | Oct 8, 2008 9:36:33 AM

BR, why not just pay down mortgage debt directly. according to article, there are 40 million homeowners with debt; just paydown $50k on the primary residence mortgage (no 2nd hoomes, investment properties). Max payment is $2t ($50k * 40m). Some owners owe less than $50k so cost would actually be lower. allow for those that bought property pre-2007 so that recent distress buyers do not benefit doubly.

this would prevent some foreclosures but not all, which indirectly benefits everyone. for foreclosures, it reduces loss severity to the lender. for prudent receipents, this would spur savings or increased consumption, which would be highly stimulative. only indirect benefits to renters and free and clear owners (you get screwed in the paulson-bernanke plan anyway).

how to pay for. rescind Bush tax cuts, that gets you $1.5t over 10 years, get out of iraq, cut spending elsewhere (should be easy if this is so dire).

Posted by: surferdude | Oct 8, 2008 9:45:29 AM

here in oakland, CA the low end of the housing market has completely caved in, making 1st time homeownership a possibility for more people. granted, these are not in the nicest neighborhoods, but i've been looking for six months and have seen plenty of homes that qualify - all at 50% off peak prices and more in line with average low end salaries - especially with local gov't first time home loan programs.

i am waiting for this 'crash' to affect homes in nicer neighborhoods...

Posted by: kingtone | Oct 8, 2008 9:50:05 AM

so far the "deleveraging sink hole" appears to have swallowed up all of the "liquidity pump". The question is how deep is that sink hole - when does it fill up, if at all? Is it $60T deep (derivatives), or just $5T? dmc

Posted by: dmc | Oct 8, 2008 9:58:57 AM

It is really quite simple, and costs virtually nothing the halt the chain reaction of credit destruction. Bank of America has actually done it, with their recently announced arrangement to restructure some 400,000 mortgages so as to prevent the payment increases from pushing the borrowers into default, and contributing to the whole chain of defaults that ensues from the initial mortgage failure.

I have been incessantly yammering at my senators and representative to propose something like this for the past two weeks, but unless accompanied by large contribution checks, or better yet, suitcases full of cash, voter input is simply ignored.

Here's what needs to happen:

Pass a bill that forces ARM, or even ordinary (but failing) fixed rate mortgages to go through a conversion to a reasonable fixed rate mortgage, folding the costs of conversion into the new mortgage. To prevent the lender from unduly suffering from the loss of anticipated interest income, extend the term of the new mortgages to compensate.

By way of a simple example, an ARM borrower who is paying 4% for 5 years followed by a hike to 12% for the remaining 10 years of a 15 year mortgage pays $70,164 interest on a $100,000 loan, with the payments jumping from $739/mo to $1048/mo in year 6. If we fix that mortgage to the 4% rate, but extend the term to allow the same amount of interest to be collected and a payment close to the initial ARM payment, we arrive at a fixed rate 6.25% 20 year mortgage, with a payment of $731/mo.

Interested readers may wish to play around with an amortization spreadsheet, to see how the numbers work. This ain't rocket surgery.

The lender's pain is the loss of the time value of money, the borrower's pain is being stuck with a longer term mortgage in a home that is still under water. They are chained to that house until the mortgage is paid off, or until housing prices improve to the point where they are able to sell it.

Cost to the taxpayer? ZERO.

This undoubtedly explains why this scheme has not captured the attention of anyone in congress. If a plan does not come with a hundred-billion-dollar price tag, it does not even get read.

Why do we even need the congress to enact this plan? Could not all lenders do what BoA has done? Yes, but ... BoA had to work hard to make their deal comply with the state laws in a number of states. Federal legislation could simply roll over the varying state regulations (state's rights are pretty much a fiction these days), and make it happen. You could even extend it to cover homeowners with classic fixed rate mortgages who have been down-sized in their incomes and ability to maintain the payments, courtesy of the ongoing recession.

Posted by: constantnormal | Oct 8, 2008 10:10:36 AM

pardon me for the gibberish that passed my hurried review of the previous comment -- the paragraph that reads:

By way of a simple example, an ARM borrower who is paying 4% for 5 years followed by a hike to 12% for the remaining 10 years of a 15 year mortgage pays $70,164 interest on a $100,000 loan, with the payments jumping from $739/mo to $1048/mo in year 6. If we fix that mortgage to the 4% rate, but extend the term to allow the same amount of interest to be collected and a payment close to the initial ARM payment, we arrive at a fixed rate 6.25% 20 year mortgage, with a payment of $731/mo.

should read:

By way of a simple example, an ARM borrower who is paying 4% for 5 years followed by a hike to 12% for the remaining 10 years of a 15 year mortgage pays $70,164 interest on a $100,000 loan, with the payments jumping from $739/mo to $1048/mo in year 6. If we fix that mortgage, but extend the term to allow the same amount of interest to be collected and a payment close to the initial ARM payment, we arrive at a fixed rate 6.25% 20 year mortgage, with a payment of $731/mo.

Posted by: constantnormal | Oct 8, 2008 10:13:18 AM

> why not just pay down mortgage debt directly

My issue with this is that if the money 'falls out of the sky' to keep home values up, those of us who have to support a mortgage from an income are still left to struggle with the > 2.5-3x income/price ratio that's been created in the last decade. It prices us out of buying.

Posted by: pmorrisonfl | Oct 8, 2008 10:24:31 AM

I think this is quite discriminatory and wrong.

Much better to take that same money plus more and simply give it out equally to each adult American, while also using govt money to take super senior loan positions in the 100 largest banks in order to boost bank capital. The money will make its way to housing.

One neglected factor in the housing bubble has been the way in which the laws have been contorted to so favor home ownership and home owners. The tax deductions (which favor home owners and especially wealthy home owners), the Clinton period capital gains house flipping measure, the "white backlash" tax discrimination of Prop 13 (it came at the same time as the school busing panic)...all of these distort the market.

We need to find a way to go in a different direction.

Posted by: Daniel Kwiat | Oct 8, 2008 10:28:20 AM

You are right on the money. All the housing solutions are being bandied about are solutions so that Wall St. still gets something to trade. Paulson just can't accept the fact that there are no solutions that would enable Wall St to provide a vehicle for people to day trade their homes.

Once Wall St. figured out that management fees and churning commissions for defined contribution pensions (401k's) weren't enough for a Maybach in every Hamptons garage, they went after the largest store of wealth in the US, our homes. Well the piggy bank has been smashed and the money is gone.

Posted by: Thomas Johnson | Oct 8, 2008 10:41:43 AM

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