What If Millions Of More Mortgages Go Underwater

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Alan Greenspan’s mastery of  discovering the obvious is never more on display than when he examines a problem and says he has brought light to a dark corner which is already well-illuminated. Housing prices, he claims, are critical to the direction of the economy. He said on NBC’s “Meet The Press” that “If home prices stay stable, then I think we will skirt the worst of the housing problem. But right under this current price level, mainly 5, 7 or 8 percent below, is a very large block of mortgages, which are under water, so to speak, or could be under water. And that would induce a major increase in foreclosures, foreclosures would feed on the weakness in prices, and it would create a problem.”

The one issue in Greenspan’s comments that offers a kernel for thought is how many American mortgages are actually within a hair of going underwater, and what will people who own those homes do?

No one in the government or the private sector has set up a simple chart that shows how many mortgages will worth more than the houses that they cover if the market for real estate continues to fall.  Do one million mortgages fall into this category if home prices drop 2%? Does the number move to two million if prices go down 4%? There are not enough accurate data on what houses are appraised for by city, but town, or by neighborhood. There is not enough information from the hundreds of banks that have provided mortgages to offer a clear picture from the lender’s side.

What is obvious is that the 11 million or so mortgages that are underwater now could rise sharply in just a matter of months. Greenspan’s assessment of that is accurate, but his theory about the effect of a rise in underwater home loans is not.

RealtyTrac has reported that there are over 300,000 mortgage defaults and foreclosures a month now. The number is likely to top three million for the first time in history in 2010. Does that mean the a quarter of people with underwater mortgages default? It is probably not a bad guess if the 11 million number is right. Homes that still have substantial equity get sold by financially needy owners which can take some amount away from the transaction, however modest. The balance of home owners are trapped.

The comparison of underwater mortgages to foreclosures indicates that a weakening real estate market could move monthly defaults and foreclosures above the 400,000 level. That would be a catastrophe on top of a catastrophe and one that would take a desperate home market and shred any confidence that home sellers have left.

The Greenspan math may hold up and so may his concerns that housing could be a greater and greater drag on the economy.

What has not been suggested by Greenspan and most of his peers is what a solution might be. One way to build a modest foundation under home prices would be to revamp the HAMP program which is funded with $75 billion, by most measures, to help three to four million Americans who face foreclosures. It is not news that the program has been a failure. Only a few hundreds thousand home loans have been permanently modified and many people who receive modifications still default. Those defaults may have to do with underlying credit problems that some home owners have beyond their mortgages. It may have to do with job loss. Or, some people who own homes may simply despair of the fact that their houses will never be worth more than what is owed on them

HAMP is meant to modify the monthly payments that homeowners make. It does not deal with adjusting principal valuations. Until its does so quickly, there is no telling how far prices will drop. Bank bureaucracy and paperwork problems with HAMP have hampered it. A slow solution to the housing problem is not a solution at all. Prices and the inventory of unsold homes are getting worse too quickly

The other option the government has is what some observers call the “nuclear” one. That is to withdraw all support from the housing system and allow it to fall apart rapidly. This would, some analysts argue, bring down the cost of houses enough so that buyers would not be able to resist the temptation to rush into the market. Mortgage rates, which are at all-time lows, would tempt even more people to enter the real estate market. If the government would bring back the tax credit for homebuyers that lapsed at the end of table, the crush of buyers would be even larger.

Congress and the Administration cannot cut the baby in half. They have to either allow the housing markets be destroyed and help buyers move into the market to pick up the wreckage, or they can make a heroic financial effort to lower the balances on existing mortgages. The problem is, as with almost all federal problems, that the system is not able to react quickly to any problem, because it is too large and complex.

The problem with housing, now in its third year, will probably not improve for another two or three years, and that is if employment and access to credit improve substantially over the short-term.

Not likely

Douglas A. McIntyre