Sunday, December 23, 2007

More Housing Woes Ahead? Part 1

The Wall Street Journal reports on the spread of homes with negative equity. As of a year ago, estimates were that 7% of mortgages that originated in 2004 through 2006 the amount owed was more than their homes were worth, but housing prices have fallen nearly 5% since then and are predicted to fall further. [In the comment below, Molnar pointed out that my original commentary was in error. Thanks for keeping me honest].

Hagerty, James R. 2007. "Price Indexes Will Map Out Spread of 'Negative Equity." Wall Street Journal (22 December): p. A 2.

http://online.wsj.com/article/SB119829696940946747.html?mod=todays_us_page_one

"Last March, First American CoreLogic, a housing- and mortgage-data supplier in Santa Ana, Calif., calculated that nearly 7% of 32 million U.S. households studied as of December 2006 owed more than their homes were worth, based on computer estimates of the property values. The homes studied had mortgages originated in 2004 through 2006, around the peak in the housing market. Since the end of 2006, U.S. home prices on average have fallen nearly 5%, said Mark Fleming, chief economist at the firm. That suggests that about 11% of the homes studied now would have negative equity. An additional 5% or so probably have equity of less than 5%. That doesn't leave much cushion at a time when prices are still falling and most economists don't expect the market to hit bottom for at least another year."

"Economists at Merrill Lynch say home prices are likely to fall 10% in 2008 after slipping 5% this year. Mark Zandi, chief economist of Moody's Economy.com, a research firm in West Chester, Pa., recently forecast that on average U.S. house prices will decline about 13% by the second quarter of 2009 from a peak in the second quarter of 2006. Declines will be much larger in Florida, California, Arizona and Nevada, as well as in the metropolitan areas of Washington, D.C., and Detroit, he said."

5 comments:

Anonymous said...

But wait, 7% of homes with mortgages that originated between 2004 and 2006 is not the same thing as 7% of homes total.

Michael Perelman said...

Whoops. I will have to change the post Thank you.

Bruce Webb said...

I owed more on my house than it was worth the instant I walked out the signing room. And it is not because I was some idiot buying a McMansion I couldn't afford. I bought a modest condo using a VA loan earned by serving in the military. VA loans allow for a zero/zero option, no dollars down and closing costs rolled into the loan. Due to a last minute glitch I had to go to the bank and get about $140 extra, other things being equal I might have walked away with a check. This didn't make me some hapless victim trapped in an upside down investment, it made me a homeowner who went from a three story walkup apartment in a sixty year old building to a brand new condo unit with in unit appliances. All for a few hundred dollars a month more, offset by some tax advantages. And yes I owed $134,000 on a $128,000 unit. (You drive a new car off the lot and it generally drops in value by 10-20%. You buy ANYTHING new and it immediately has negative resale value, this is a factor of the buyer paying the transaction cost.)

There are plenty of victims out there, but by definition the combination of commissions, other closing costs, and excise taxes will put anyone who gets 100% financing initially in the hole. And in most markets it will take some years before principal repayment even begins to make a dent in that negative equity position.

Is 7% scary? I don't know. My loan would have been in that category initially and I have a 792 FICO score. It certainly didn't bother me at the time, after discounting for rent, tax advantages, and lifestyle improvements I was clearly ahead of the game. Now it was certainly true that if circumstances were such that I had to immediately turn around and sell that I would be down 10% on my 'investment', but at the time I had a secure job and just wanted to change my roof and my VA certificate assisted me in doing that in ways that didn't require heavy out of pocket expense.

This has been the problem with housing reporting from the beginning. Not every upside down loan is going to underperform, many people who financed their houses at 100% LTV and so were technically underwater like I was did so because they had excellent credit and documented income. Not everything is 'stated/stated' not every reset will come as some huge unaffordable shock, oddly enough some home buyers actually planned to plan and did a reasonable job.

Real estate is inherently local. Aggregated national statistics will always distort this to some degree. Statistics that don't account for the fact that certain factors (like being initially upside down in a recently originated mortgage) are features and not bugs, but I don't see enough signs that even the most sophisticated commenters (like Baker, Tanta and CR) are adjusting the aggregates for sanity among the typical homebuyer.

On a slightly different note this is the theoretical gaping hole of orthodox economics. Everybody is a perfectly informed rational economic actor right up until the time the smart people declare market failure. At which time overnight all the actors are immediately transformed into clownish uniformed buffoons who couldn't see the writing on the wall. Well the reality is wedged somewhere in between. There will be victims of this housing turmoil, some witting and others unwitting, but frankly some people are trying to paint a complex portrait with some overly wide brushes.

Everything is simple once you ignore the complexities. Housing is no different.

To return to the case in point. What percentage of all mortgages originated between 2004 and 2006 were financed 100% LTV to people with excellent credit and income? 1%, 3%, 6%? I don't know and the article certainly give me a clue. Reporting '7%' without that context tells me exactly nothing about market risk going forward.

Bruce Webb said...

BTW I still don't see the transmission mechanism that takes a handful of bubble markets resetting and sends that out to markets who remained stable all along. If Bismark S.D didn't experience a run up and there is no material change to employment why should houses go down by double digits?

I understand the usual suspects. Home financing is mostly a national and international phenomenon, lack of access to credit makes for a sticky market everywhere. Okay I get that. A slump in housing starts can send ripples through the entire economy effecting markets in everything from cement to couches. I get that too, if a major part of your local economy derives from cutting down trees or making furniture, then a major downturn anywhere can have an effect. But while current housing inventories in certain markets are up, that is not true everywhere. I just don't see how a collapse in asset prices for a 4 BR house in LA from $800,000 to $600,000 necessarily means a 4BR house in Aberdeen SD automatically resets from $80,000 to $60,000. A lot of really smart people think this makes so much sense as to be obvious, me I don't see it. (And this isn't theoretical to me, I am planning to sell my condo next spring, a lot of things are in the balance depending on whether I get $175,000 or $200,000.)

Michael Perelman said...

There are several transmission mechanisms. Most obviously, people are not as able to withdraw equity from their homes to increase consumption. Just today, the Sacramento Bee had an article about small businesses who are inching toward bankruptcy because they started in anticipation of increased real estate development.

Most important, investment, in general, depends upon a certain degree of confidence -- what Keynes called Animal Spirits. Until something sparks Animal Spirits, the economy will probably be anemic.