Loan owners are $3.7 trillion underwater

The depth of American’s underwater mortgage debts is truly staggering.


That’s not the amount of debt outstanding, that is the amount Americans are underwater. Principal reductions are not going to make America whole again. Nobody, not even the US government can afford to write down amounts that large. The biggest principal reduction programs proposed so far are less than $100 billion. That is less than 1/37th of the problem. In short, principal forgiveness is not going to solve the problem.

Lenders would like to see the problem remedied by having prices go back up. As someone accumulating properties in Las Vegas, that idea has a certain appeal, but the existence of the distressed debt is likely to prevent appreciation from happening because as each loan owner succumbs to the pressure, it adds to the distressed inventory already weighing on market prices.

If principal forgiveness won’t solve the problem, and if appreciation isn’t likely to do it, what other options do policymakers have? I see only two: (1) they can continue to meddle in the markets, delay the recovery, and eventually the problem will work itself out. This is what will probably happen. But there is also another alternative, (2) print money until wage inflation drives house prices up. Unfortunately, this has many downsides as well, not the least of which is rising interest rates which will counteract the increasing incomes and serve to lower loan balances. The solutions to our problems create more problems than doing nothing and taking our medicine.

Negative equity gap nears $4 trillion

By Kerri Panchuk — March 23, 2012 • 3:21pm

The U.S. housing market contains a nearly $4 trillion-dollar negative equity hole, according to Williams Emmons, an economist with the Federal Reserve Bank of St. Louis.

Emmons made that statement while speaking at HousingWire’s 2012 REthink Symposium.

The Fed Bank economist said it would take $3.7 trillion, much more than the $25 billion mortgage servicing settlement and other federal housing initiatives, to get homeowners with mortgage debt back to preferred loan-to-value ratio levels.

The $25B mortgage settlement is 0.67% of the total value of underwater mortgage debt. And most of the settlement money will go toward writing off short-sale losses. The mortgage settlement was clearly a symbolic effort intended to make politicians look like they did something, give lenders protection from future lawsuits, and give loan owners false hope they will get principal reduction. There is no way lenders or the government could scratch the surface on the pool of underwater mortgage debt.

Emmons’ data estimates the average LTV for those with mortgage debt is currently 94.3%.

That compares to preferred LTV levels among mortgage debt holders of 58.4%, which was the average struck among mortgaged homeowners in the period stretching from 1970 to 2005. Emmons told the crowd there is no easy way to fill that gap, and the deep hole is hardly discussed among the media and policymakers.

“We are sort of stuck in this,” he told the crowd. “It’s a sweat box we’re in, and we can’t get out. We are not talking about this very much … it’s just too ugly.”

We are actually talking about this problem a great deal on the political left. The entire principal reduction movement emanates from this problem. What the principal reduction crowd conveniently ignores is the cost of their proposals and who is supposed to pay for it, but that has always been a weakness of the left.

He added, “It is like the debt that is outstanding is crushing the equity that is there.”

In effect he is right. Prices can’t go up as long as so much distressed debt is in the system. The distressed debt translates to distressed sales, and those distresssed sales keep prices down and prevent any meaningful appreciation which would translate to increased equity.

Emmons said the only viable option to narrow the gap is letting home prices fall until they eventually reach levels that entice buyers, bringing private capital back in.

From my earliest writings in 2007 I have made the same case. When prices get low enough that cashflow investors enter the market, they put in a bottom. Every market crash works that way because once prices start falling, appreciation buyers sit on the sidelines. It isn’t until value buyers enter the market that prices eventually bottom.

A home-price boom or a government bailout would help, of course, but both those scenarios are unlikely.

Thank goodness.

At this point, home price appreciation would need to rise 62% to narrow the gap to the ideal LTV level, Emmons said. Significant government intervention also is unlikely given the fact it would take a $3.7 trillion bailout, or 24% of GDP, to narrow the gap, according to Emmons’ data.

He says that amount makes other federal initiatives launched to band-aid the housing market so far look like “peanuts” in comparison.

It’s difficult to grasp the depth of this problem. For years, many of us writing about this issue have lamented the mark-to-fantasy accounting by lenders, but if they were to truly mark these loans to current market value of the homes, our entire banking system would be insolvent three-times over.

With that in mind, the only alternative is that we have “millions of weak homeowners exit, replaced by new private owners with equity to recapitalize the housing sector.”

And that will take time. There is no other viable solution.

Emmons said that option will still be painful since he believes another reduction in home prices is needed to attract new buyers.

“The asset class is not priced attractively yet,” Emmons said. “You need to get the value down to where it looks like a screaming buy.”

In some markets houses are a screaming buy, but not here locally. We are only now reaching a modest state of undervaluation, and above median properties are still not attractively priced (see far right column below).

Emmons in his report said with the assumption that another 20% decline in national home prices is required to bring in new buyers, the amount of mortgage debt that must be eliminated then is $4.97 trillion, or 50% of current face value.

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What a mess.

Nearly a million dollars in HELOC abuse

The former owners of today’s featured property lived there for 24 years. They paid just over $200,000, so with such a small mortgage, it is reasonable to assume they paid the property off. However, these owners where HELOC abusers that managed to pile on over a million dollars in debt.

I have to admit, I’m a bit jealous about this one. These people lived in an ocean view property steps from the beach for 24 years. They got to spend over a million dollars in free money to help them enjoy their property. When times were good, it must have been really good.

Sometimes I wonder if it would have been worth it. Of course, these people now have an enormous sense of entitlement that likely will never be fulfilled again, and the suffering from their unceremonious fall from entitlement must be extreme; however, the years of living irresponsibly had to be fun. Carpe Diem?

  • This property was purchased on 4/26/1988 for $220,000. I don’t have their original loan information, but they likely put 20% down and borrowed $176,000. It that number is correct, they they got over $1,000,000 in HELOC booty.
  • My records go back to 1997. On 5/27/1997 they refinanced with a $242,640 first mortgage and a $30,330 second mortgage. They were already well on their way to being full-blown Ponzis.
  • On 6/25/1998 they refinanced with a $255,000 first mortgage.
  • On 8/2/2000 they refinanced with a $273,500 first mortgage.
  • On 9/18/2001 they refinanced with a $295,000 first mortgage.
  • On 11/27/2001 they refinanced with a $319,500 first mortgage.
  • On 3/19/2002 they obtained a $230 second mortgage.
  • On 6/30/2003 they got a $480,000 HELOC.
  • On 9/7/2004 they refinanced with a $650,000 first mortgage.
  • On 10/4/2005 they refinanced with a $840,000 first mortgage.
  • On 5/24/2006 they refinanced with a $1,000,000 Option ARM with a 1% teaser rate.
  • On 8/15/2007 they obtained a $183,138 HELOC.
  • Total property debt was $1,183,138.
  • Total mortgage equity withdrawal was around $1,000,000.
  • And they got to squat for a year and a half.

It’s people like this that will cause the demise of the high end. The want of this HELOC money motivated many to grossly overpay for property in the beach towns. These markets have historically been supported by people bringing equity from a move-up sale, but that market is dead. Who will replace the HELOC abusers? Who has the cash or the borrowing power to buy these houses? Sure a few will sell, but there are far more houses at these price points than their are people capable of buying them. realtors lament the lack of financing, but financing will not support these markets. There simply aren’t enough borrowers with the income or the savings to absorb these properties. The high end is still going to come down.