Housing is bad enough, but wait–it'll get worse

If you think the housing slump can't get much worse, Martin Feldstein thinks that both home prices and the broader economy can–and very likely will–get a whole lot worse. The Harvard University professor and former chief economic adviser to Ronald Reagan isn't part of the crowd that continually forecasts doom. For two decades, he's headed the National Bureau of Economic Research, which officially determines when U.S. recessions begin and end. So when he spoke on Monday night at the annual dinner of the National Economists Club, a gathering of like-minded wonks, Feldstein's grim calculations were noteworthy. "There are now 12 million homes in the United States with a loan-to-value ratio greater than 100 percent. That's one mortgage in four. The aggregate amount of that is some $2 trillion," said Feldstein. "If you look at the median (midpoint) loan-to-value ratio in that 12 million group of underwater mortgages–mortgages with negative equity–the median loan-to-value ratio is 120 percent." That means about 25 percent of all U.S. mortgages are exceed the value of the homes the mortgages are financing. In the case of half the homes that are underwater, homeowners are paying a mortgage that's now 20 percent higher than the value of the home. That's bad–but it's likely to get worse. A recent report by First American Core Logic, a real-estate data firm in Santa Ana, Calif., estimated that as of Sept. 30, 7.5 million mortgages, or 18 percent of all properties with a mortgage, had negative equity. The group thinks there are another 2.1 million mortgages that are within 5 percent of going underwater. Together, these two categories account for 23 percent of all properties with a mortgage. Nevada led all states with 48 percent of homes with negative equity. Florida and Arizona each had 29 percent of homes with underwater mortgages, while 27 percent of mortgages in California were upside-down, the group said. If home prices fall another 10 to 15 percent, as measured by the Case/Shiller Home Price Index, then four out of every 10 mortgages in the U.S. could be underwater, Feldstein said. "At those levels, it's hard to see how many people are going to be willing to keep up with their mortgages," Feldstein said. The implications for many homeowners are staggering. Before the recent housing boom of 2000 to 2006, homes increased in value at a historical annual rate of about 2.3 percent when adjusted for inflation. That means that for homeowners who owe 35 percent more than their homes' value, it would take, at historical averages, about 15 years just to break even on their home investment. They won't build equity. It would be a huge incentive for millions to hand the keys back to the lender and seek cheaper housing. Not all real estate experts buy Feldstein's stark numbers. "That's the highest percentage I've heard from anybody, by quite a bit," said Rick Sharga, senior vice president for Realtytrac, an Irvine, Calif., company that publishes foreclosure data. More conservative forecasts, though still dismal, point to a smaller drop in home prices of 5 percent to 7 percent, he said. Added Jay Brinkmann, chief economist for the Mortgage Bankers Association in the nation's capital, "If you generalize the numbers too far, I think it leads to some incorrect conclusions." The Case/Shiller Index is driven by home sales that have taken place. It doesn't reflect the stability in older, established neighborhoods, Brinkmann said. The vacant and for-sale rates nationwide for homes built before 2000–that is, pre-boom–is just 2 percent. The delinquency and foreclosure problems are concentrated mostly in a handful of states, such as California, Florida, Arizona and Nevada, which had overbuilding and weak lending standards. "Those states have about 25 percent of the mortgages and 50 percent of the foreclosure starts" in the latest association survey, Brinkmann said. Nationwide, 6.4 percent of all mortgages were delinquent through June, but the number of delinquencies and foreclosure starts are breaking records every quarter, the most recent MBA survey said. Brinkmann's own rough guess is that somewhere between 6 million and 8 million mortgages are underwater, still a very high number. He doesn't see the national outlook getting better any time soon, framing his estimate of when that happens in the form of a question: "When does the influence of these massive declines in California and Florida go away?" Realtytrac's forecast isn't any brighter. "The best-case scenario in terms of the real estate market is we probably bottom out between mid-year and the end of 2009. And that's the best case from where we're sitting," Sharga said. "The only reason it could happen that soon is because of how rapidly and how severe the downturn has been in the housing market." A lot would have to go right to reach that best-case scenario. Government and industry efforts would have to step up efforts to forgive or make up the difference between the value of the mortgage and the value of the home. The final batch of subprime mortgages scheduled to reset to a higher interest rate will have done so by the end of the first quarter of 2009. In a rare bit of relief for one segment of the housing market, the interest rates that determine the monthly payments for some adjustable-rate mortgages are falling. Sharga said, however, that the next problem is the $60 billion of adjustable-rate Alt-A mortgages, which fall between subprime and prime loans. Millions of these loans are scheduled to reset next year to higher interest rates. That could bring monthly mortgage payment increases of $1,000 or more if the loans aren't modified or refinanced. All this is happening amid what now clearly is a deepening recession, with the highest job losses and deepest drops in consumer spending in decades. The Labor Department reported on Thursday that weekly jobless claims jumped to 542,000, a 16-year high, last week. That suggests a fast-deepening recession. The White House Thursday acknowledged for the first time that it now supports efforts in Congress to extend unemployment benefits for longer periods to the millions of Americans who can't find work in the downturn. Consumer spending drives about two-thirds of U.S. economic activity, and as unemployment mounts and consumers retrench, that leads to even more unemployment, mortgage delinquencies and foreclosures. "The problem now is what will be happening with jobs," Brinkmann said.