Declining House Prices Weigh Heavily on Underwater Homeowners

It is still unclear which way the market is going. If only they made it easier for us!

But yesterday, the Dow took a 279-point hit. Oil lost $2, closing at $100. Gold rose $6.

And look at this… The yield on the 10-year note sank below 3%. Go figure. Inflation is at 5%…and people still lend the feds money for ten years at only 3%.

Why? Are they stupid? Are they crazy? Maybe. But interest rates go down in a correction. And we’re in one.

Now, it’s official. Everybody knows. There is no recovery. QE2 is a failure. And housing is in a double-dip. The feedback loops are all turning vicious, and nasty. The Great Correction is beginning to bite harder. The rich don’t feel the pain…and the poor are used to it. But the middle classes suffer; they’ve had it too easy for too long.

Mobs are out on the streets of Barcelona and Athens. Will they soon be out in Atlanta and Baltimore?

Maybe. They’ve got as much reason as anyone. How many Americans lack decent jobs? How many are underwater? How many are on food stamps?

But who will lead the revolution?

Remember those people who were tempted into buying a house with an $8,000 tax credit? Alas, another government program backfires. Many buyers also used the handy services of FHA financing, with just a 3.5% down payment. Housing is now below its 2009 low. So what happened to those new homeowners? They’re underwater!

Thanks a lot, feds!

The best report on the housing market we’ve seen so far comes from the “Campbell Real Estate Timing Letter.” Robert Campbell cites three studies – from Clear Capital, Zillow, and Case-Shiller. The numbers are a little different in each one. But the conclusion is unmistakable and unanimous:

Housing is going down. And with it goes America’s middle class.

First, Mr. Campbell draws our attention to the connection between bank-owned house sales and house prices. In a nutshell, the more houses sold by the banks…the lower prices go. So you have to ask yourself a question: will the number of bank-owned properties on the market go up or down?

He does not make us wait long for the answer. Loan delinquencies are falling. But they are still nearly double the 1995-2005 average. And there are more than 2 million houses in the foreclosure pipeline already – that is, more than 90 days overdue on their mortgage payments. Add those 2 million (most of which will end up as bank-owned sales) to the 2.2 million already in inventory and you have the makings of a glut.

“The data…points to the simple fact that the foreclosure pipeline is bloated…” he says, with as many as 7 million properties hitting the bank re-sale or short sale market in the months ahead.

What will this do to house prices?

They will go down.

Then, what will happen?

Then, the feedback begins to circle around…biting down hard on middle class derrieres.

First, those who are already underwater sink deeper. Many, who have been holding onto to the flotsam and jetsam of the housing disaster, give up. They turn into renters.

Then, as housing prices go down, as many as 4 million more homeowners go under the waves too.

The single factor that influences foreclosures most is negative equity – more even than losing a job. Once submerged, some owners have no choice; they run out of air. Others make a business decision: it is better to let go of the heavy house weight…they reason…and swim for safety.

Interestingly, even many owners who are still ABOVE water will move to higher ground. As prices go down, they will put their houses on the market, trying to rescue the little bit of equity they have left. This – combined with the seizures, foreclosures and ‘walk-aways’ – will greatly increase the inventory of ‘for sale’ properties. You know what happens next. More sales lead to further price declines, provoking more defaults and walk-aways, and generally making the entire middle class writhe in pain and disgust.

Shiller thinks housing will fall back to its 110-year mean. This would require another 5% to 10% drop in prices, which would leave as many as 20 million homeowners underwater.

In Atlanta, 55% of homeowners with mortgages are already underwater, according to Zillow. In Phoenix, the figure is 68%. Imagine how many would be underwater if prices fell another 10%…or more.

But don’t stop there. Use your imagination. If housing overshot on the way up…won’t it overshoot on the way down? Housing prices in Japan dropped 80% – and they’re still near the bottom. So far, in the USA, housing is only down to 2002 levels. It has much further to go – probably another 20% or 30%, at least…taking prices back to levels last seen when Monica Lewinsky was still welcome in the White House.

Here’s a thought. This double dip in housing occurs even while:

1) Interest rates are as low as they’ve been in three generations
2) The Fed is pumping about $100 billion a month into the financial system
3) The federal government is running a deficit of nearly $150 billion a month

How could the financial situation be more favorable? And what will happen when mortgage rates rise?

Oh…now…the teeth are getting sharp.


Bill Bonner
for The Daily Reckoning

The Daily Reckoning