Collapse in US housing prices now greater than during Great Depression

The UK newspaper, the Independent, had a poignant article yesterday.

The paper notes that the ailing US housing market passed a grim milestone in the first quarter of this year.  Housing in the US has now deteriorated to the point that the collapse in house prices is now greater than that suffered during the Great Depression.

"The brief recovery in prices in 2009, spurred by government aid to first-time buyers, has now been entirely snuffed out, and the average American home now costs 33% less than it did at the peak of the housing bubble in 2007. The peak-to-trough fall in house prices in the 1930s Depression was 31% – and prices took 19 years to recover after that downturn."

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American Graffiti

“The stability we've started to see in U.S. housing was likely a false calm before a bigger storm. There are millions of homeowners under threat of losing their homes in the next two years.”

This is the observation of Derek Holt, vice-president of economics for Scotia Capital.

It seems a record one in seven U.S. mortgages, or four million homeowners, were in foreclosure or at least one payment late in the third quarter.

Even more astonishing is that Americans with solid credit ratings comprised 33% of the quarter's foreclosures.

This is what happens when a huge surge of people default on their mortgages, and the wave of foreclosures causes a big drop in the value of real estate. It puts other homeowners in an 'underwater' position. Throw in the highest jobless rate in 26 years and suddenly its impossible for many homeowners to make their payments in the quarter.

Another Canadian watching the developments closely is Jennifer Lee, an economist at Bank of Montreal. Increased foreclosures among those with good credit is a problem in any recession, said Lee, but this time the increase comes after the subprime crisis forced millions from their homes and pushed prices down as much as 50% in some cities.

Not only are they losing their jobs and falling behind on loan payments, sharply lower prices mean they aren't able to simply sell their homes to pay off their banks.

“We can't say what is typical any more in the housing sector because we've never experienced anything like this,” she said. “People need to start working again, because when they do find work the first thing they do is get back on track with their mortgages. But, that isn't likely to happen soon.”

Most of these have five-year reset rates, and were issued at the height of the market's bubble. They start coming due in January.

Once again Scotiabank's Derek Holt makes a succinct observation. “You didn't have to prove a thing to get [a mortgage],” Mr. Holt said. “They haven't been a problem because they have such long fuses. But those fuses are just about done, and we're heading into entirely uncharted territory.”

It takes a long time for the housing story to play out. For the United States it started in 2006. The full effects won't really start to be seen until next year.

For Canada the writing is on the wall.

It will start with rising interest rates. The first to get caught up will be all those resetting 0/40 mortgages and the huge number of people who "bit off more than they could chew" in the Great Reflation Drive of 2009.

The problem is, too many dismiss the writing on the wall as nothing more than graffiti.

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More US housing/economic news

As we said yesterday, US housing statistics are significant because mortgages are a significant part of the foundation of the U.S. banking system. If they stabalize, it will encourage more lending and, in turn, help get the economy on the mend.

Today RealtyTrac came out with their U.S. Foreclosure Market Report.

A total of 336,173 foreclosure filings — default notices, auction sale notices and bank repossessions — were reported in June 2009, a 5% increase from the previous month and a 33% jump from June of 2008.

The foreclosure filings were the fourth straight monthly total exceeding 300,000 and helped to boost the second quarter total to the highest quarterly total since RealtyTrac began issuing its report in the first quarter of 2005.

Meanwhile another report estimates the percentage of properties “underwater” will rise to 48%, or 25 million homes, as property prices drop through the first quarter of 2011. Deutsche Bank analysts Karen Weaver and Ying Shen note that Deutsche Bank estimates 26% of homeowners are currently underwater. That means this figure will almost double in the coming year.

I guess Deutsche Bank didn't get the memo about house prices finding a bottom.

And where does Deutsche Bank sees the next wave of trouble coming from?

From the formerly secure, blue chip mortgages involving larger valued mortgages for properties from prime mortgage holders (in the US known as Jumbo and Jumbo Prime).

"While subprime and Option ARMs are currently the worst cohorts with underwater borrowers, we project that the next phase of the housing decline will have a far greater impact on prime borrowers (conforming and jumbo) ... By Q1 2011, we estimate that 41% of prime conforming borrowers and 46% of prime jumbo borrowers will be underwater, a significant increase over the percentage of these borrowers in Q1 2009. The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding."

One of the biggest components of the US government plan to help US homeowners is to encourage banks to modify mortgage loans and 'work with' homeowners.

The problem is modification won't help these home, errr... debt-owners. Most modifications just capitalize missed payments and expenses, and either lower the interest rate for a few years or extend the term leaving the homeowner underwater.

In fact so ineffective is the US goverment 'modification' initiative that these modifications have come to be jokingly referred to as 'pretend and extend'.

Pretend and extend. Almost sounds like they're describing this 'supposed' recovery phase we are entering.

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Conflicting US Housing News

Last week the Vancouver Sun carried a story out of New York that proclaimed home prices in major US cities rose in May for the first time in nearly three years.

The closely watched Case-Shiller home-price index, put out by Standard & Poor’s, marked its first increase since July 2006. The index gained 0.5% in May from the previous month.

A small increase, to be sure, but after several months of sharp declines of 2% or more the increase was hearlded as a welcome sign of stability for the U.S. housing market.

This turnaround in housing market statistics is considered significant because it will help stabilize the U.S. banking system and encourage more lending, which would help get the economy on the mend.

But... as always... the news might not be as good as it appears.

This week two analysts for Barclay's (one of the leading providers of personal loans and mortgages) came out and disputed the statistics.

Barclays' analysts Ajay Rajadhyaksha and Glenn Boyd wrote that while the S&P/Case-Shiller index for May showed the first month-over-month price increase since 2006 and a 2 percent seasonally adjusted annualized drop, a more-accurate reading probably would have been an annualized decline of 10 to 15%.

"Seasonally adjusted home-price data has been skewed higher during the spring months of this year and last year by an 'amplified' version of typical patterns, according to the analysts. More homeowners sell their properties during those months, cutting the share of foreclosed homes being offloaded at distressed prices, as new buyers focus on 'desirable neighborhoods' where values hold up better."

"Data reflecting a reversal of the seasonal benefit, as well as a tide of new foreclosure sales' as a moratorium on the seizing of homes put in place by banks subsides, will lead to 'renewed weakness' in the fall," they said.

Rajadhyaksha and Boyd project that U.S. home prices will fall an additional 11% on average before bottoming next year, bringing the total decline to 40% nationally from their peak.

The Barclay's analysts are raining on the parade of some soothsayers who are seeing green shoots that indicate the recession is nearing an end. They cling to the belief that this would mean that even if prices and economic activity don’t shoot back up to boom levels, they would at least stop falling.

But the Barclay's analysts are seeing the same thing that we have been talking about on this blog... another mortgage problem looming on the horizon before this whole situation calms down.

Option ARM's.

The bulk of Option ARM's are going to reset in 2011. These are the ‘pick a payment‘ mortgage products that were marketed as perfect for sophisticated buyers with growing incomes.

The problem was they could quickly get out of hand if the buyer chooses the negative amortization route. In the US about 40% of these loans made in 2006 - 2007 are already delinquent.

New Barclay's Capital research shows that the recasts in the next year or so are expected to be a minor event. But by mid-2011, these borrowers are forecast to see payments that are 50% to 80% higher than what they are grappling with now. (Many of these option ARM's are concentrated in former hot-spot real estate markets, such as California and Florida.)

Loan modification attempts by banks don’t seem to be working with these particularly noxious loans.

In the face rising payments, borrowers don’t have an incentive to keep up with their current payments for homes that are already so horrendously under water, i.e. the loan amount is far above the current value of the property.

Barclay's says that many of the option ARM loans that do get modified turn delinquent soon afters anyway.

They’ve crunched some numbers and forecast that 95% of the loans that are slated for modification will eventually default.

If you think that sounds bad, get this: They say that 80% of the option ARM loans out there that are ok and up-to-date as of right now will eventually default, too.

The message?

There's a heap o' mortgage pain still on the horizon. Pain which is going to wreck havoc on the U.S. banking system, continue to impair lending, and further prevent the world economy from mending.

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