Housing Packs a Punch

Skyrocketing unemployment.

On average, then, the U.S. economy on solid ground.  That is, if you subscribe to the notion that, on average, a human has one breast and one testicle.

The fact that home prices are still falling, while unemployment claims are still rising is an equation that will yield one result…and it is in no way “average”.  Get ready for a new wave of foreclosures.  And don’t think Obama’s anti-foreclosure plan is going to do anything to stop it.

Just last week, the Mortgage Bankers Association reported that in the first quarter of 2009, about 5.4 million mortgages were delinquent or on the verge of foreclosure.  This staggering figures comes on the heels of the U.S. Government’s unprecedented measures to help stem the tide of home repossessions.

Yes, Obama’s plan is still in its early stages, but the problem is that it’s flawed from the start.  Obama’s home ownership plan is geared towards helping borrowers lower their monthly payments.  Unfortunately, these misguided aims do little to stop the real culprit of home foreclosures:  Negative equity.

Negative equity means that the borrower owes more than what the house is actually worth.  Even if monthly payments on the underlying mortgage are reduced, the borrower still has no cushion in the event the borrower loses a job or suffers some other financial set back.  As a result, if the borrower needs to unload a house to get into something more manageable or to move to another area with better employment opportunities, he is stuck.  The reduction of a monthly payment from $1500 a month to $1200 a month is little solace in the face of a reduction of monthly income from $4000 a month to zero dollars a month.

Currently, the New York Fed estimates there are 15.4 million borrowers who are upside-down in their mortgages.  A voluntary payment reduction plan in midst of historic unemployment rises just is not going to get the job done.  Not all, but a significant number of these people will default and lose their homes…which, of course, only put more pressure on home prices.

Also, it is important to remember that the last 6 months have really just been an intermission of sorts as the subprime meltdown gives way to the Alt-A/Option ARM implosion.  These were loans that suffer an interest rate reset after 3-7 years, unlike subprime loans that reset after 2-3 years.  The fallout from these Alt-A/Option ARM resets is expected to be at least as great as that of the subprime resets.

Finally, and perhaps most disturbingly, is the recent reactions of the U.S. Treasury market.

First, a little background:  Mortgage interest rates are either directly or indirectly influenced by the interest rates of our government’s Treasury Securities.  If Treasuries are in demand, interest rates tend to fall.  The phrase, “Treasuries in demand” is just another way of saying, lots of people are willing to loan our government lots of money.  If a lot of money is available for borrowing, then rates will be lower…because Lender A will have to lower rates in order to be competitive with Lender B.

The astute reader will comment:  “Wait a minute.  If Treasuries are essentially U.S. Government debt… and if the U.S. Government has recently announced that it’s going to buy more Treasuries without raising taxes…then isn’t the government in essence merely printing money to loan itself money in order to keep rates down?  This seems like a shell game.”

BINGO!

And for three months, the credit markets played along.  But now, after these unprecedented maneuvers, interest rates are higher than where we were when the Fed made its epic announcement.

The Fed is in a conundrum.  If the economic news is anything but utterly abysmal, interest rates explode higher, creating even more pressure on house prices and the overall economy.  If the Fed does nothing, however, it risks deflation and economic collapse.

There are no easy answers.

Mortgage Resets

Tags | Alt-A, foreclosure crisis, mortgage rates, mortgage reset, negative equity, option ARM, real estate values, unemployment