Tuesday, December 18, 2007

Walk Away Nation

Suppose, housing price to income ratio fall back to their historic norms. What are the worst consquences of massive declines in home equity.

My fear is that looking at years of being underwater and the likely prospect of having to move for family or job reasons some time in the next 7 years, that potentially hundreds of thousands if not more than a million Alt-A and perhaps even Prime borrowers will walk away from their homes.

We may reach point where walking away is the financially prudent thing for these people to do, not to mention the least painful in the short term. They become subprime borrowers for seven years but they we likely to be forced into selling the house for less than they owed within seven years anyway. Yet, in this case they get to move from what is bone crushing monthly mortgage payment to a much more reasonable monthly rent payment.

There may be some sense of embarrassment for many middle class borrowers to walk away from their homes and become renters but its the type of phenomenon that could become rapidly more popular once the first, most desperate home owners do it with few consquences.

In this case we are looking at a rapidly accelerating rate of foreclosures and perhaps a housing bust that begins to feed on itself and even overshoots the long run equilibrium by a substantial amount. How possible is this scenario? I don't know but it worries me.

23 comments:

Chris said...

You might be interested in this post from Accrued Interest on the home price to income ratio:

http://tinyurl.com/yr87q8

It suggests that it maybe not be so simple to figure out what the historic price to income ratio is...

Karl Smith said...

Good stuff - most of the reports I have been looking at are using the Case-Shiller data which I believe show a more robust deviation from trend.

However, I will have to look at the source for the difference between the two data sets.

Chris said...

Let me know what you find. I'd be interested to know what the difference is.

Chris said...

I was just looking at the comments on the Accrued Interest post and I think someone posted the major difference in the two data sets. See post by "gavin" at 4pm:

"if you want a price index, use a weighted average of case-shiller indices rather than OFHEO. OFHEO only covers 'mortgages have been purchased or securitized by Fannie Mae or Freddie Mac.' - as copy-pasted from their info page. The upper limit on these loans is $417,000.."

Independent George said...

Why would this be a bad thing?

It seems to me that the biggest problem with the current crisis is uncertainty - nobody knows how many loans won't be repaid, for how much, and who has to eat the costs. Walkaways will hurt everyone in the short-term, but if combined with cheap capital from the central banks, would seem to be the best solution long-term. Homeowners stop bleeding money on a mortgage worth more than the property, and can start rebuilding their savings; banks immediately identify just how badly they're screwed, and the markets can react. The sooner you hit bottom, the sooner you can start clawing your way out.

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