Notes from Jim Haughey

Apr 12 2007 8:56AM | Permalink | Email this | Comments (1) |
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By Jim Haughey

The fate of the economy, and hence construction, in the next two years depends on the outcome of the individual struggles of millions of families to meet their monthly payments on mortgages taken during the 2004-06 housing boom. This is a bizarre situation. Usually a slowing economy causes a significant boost in delinquencies among older mortgages for homeowners who have suffered a drop in either their income or the value of their home. This rise in delinquencies is negative for economic growth but it is a consequence of weakness elsewhere in the economy and not the cause of the economic slowdown.

This is now happening, as usual, concentrated in the depressed manufacturing cities of the Midwest. But on top of that delinquency rates are soaring among the recent surge of nontraditional mortgages, both to purchase homes and for refinancing. These delinquencies are partly due to the resetting of initially low teaser rates to the market rate or the current sub-prime rate, partly due to poor underwriting that approved credit to borrowers with too little income or too little discipline to pay the mortgage first and partly due to falling home prices that make surrendering the home the cheapest option, especially for speculative buyers that do not live in the home.

A diversion for a primer on mortgage finance terms is necessary here. Delinquency is defined as a mortgage payment 30 days of more overdue. According to creditforecast.com the current delinquency rate is 2.9%, up from 2.0% before the problems with nontraditional mortgages began. Mortgages that remain delinquent for 3-4 months are considered to be in default and a foreclosure notice is issued. The annualized number of foreclosure notices in the first quarter was 1.16 million, nearly 30% higher than the average for 2006. Homeowners have a final opportunity after the foreclosure notice to catch up on overdue payments, negotiate a new payment schedule with the lender or sell the home and pay off the mortgage. Many foreclosure notices do not result in a foreclosure and the eviction of the homeowner.

The number of delinquencies, defaults, foreclosures and evictions and/or distressed move outs will continue to expand to expand for about a year and will remain very high even longer. People struggling to keep their home make fewer trips to the mall and delay replacing cars and other durable goods. Restrained consumer spending quickly becomes restrained business investment, lowering the demand for more building space and facilities. Reduced returns drive real estate investors to other markets. Reduced taxes restrain public building. Reduced home values restrain new home purchases due to uncertainty about the timing and sales price of the current home.

The delinquency rate is expected to approach 3.5% later this year as more teaser rates are reset to the market rate and many currently stressed homeowners exhaust their ability to cut other expenses or borrow. The number of foreclosure notices will increase even faster because of the relatively large number of currently delinquent mortgages and increasing difficulty of selling a home for enough to pay off the mortgage. And the number of foreclosures, evictions, abandonments and distress home sales is likely to rise even faster yet. The future number is unclear because there is no reliable measure of the current number.

No precise forecast is possible of how quickly the mortgage repayment problem will worsen or how bad it will get. The situation is simply too unique. Lenders prefer not to seize homes to avoid monthly carrying cost and a huge capital loss on the sale of the home. But is not yet clear how much they are willing to write off in foregone interest payments to avoid foreclosing. Collectively, mortgage lenders shoot themselves in the foot if they are too aggressive in demanding payments. But each individual lender is best off if he is aggressive and his competitors are not which props up the value of homes when the aggressive lender sells his foreclosed homes.

Such a divergence in the consequences of individual and collective behavior often leads to government intervention to enforce the desired collective behavior. The calls for this have already begun. Both foreclosure moratoriums and subsidies to either distressed homeowners or mortgage lenders have been proposed in Washington and in state capitols. Either type of fix would lessen the impact of the mortgage problem on the economy but inevitably stretch the problem out for a longer period.