The New York Times’ Joe Nocera has spoken to FT Alphaville favourite Laurie Goodman of Amherst Securities Group and is now convinced of the need for principal reductions to clean-up the US mortgage mess.
Nocera’s column on Monday contains some startling statistics from Goodman:
Her [Goodman's] truth begins with a shocking calculation: of the 55 million mortgages in America, more than 10 million are reasonably likely to default. That is a staggering number — and it is, in large part, because so many homes are worth so much less than the mortgage the homeowners are holding. That is, they’re underwater.
Her second calculation is that the supply of housing is going to drastically outstrip demand for the foreseeable future; she estimates that the glut of unneeded homes could get as high as 6.2 million over the next six years. The primary reason for this, she says, is that household formation has been very low in recent years, presumably because of the grim economy. (Young adults are living with their parents instead of moving into their own homes, etc.) What’s more, nearly 20 percent of current homeowners no longer qualify for a mortgage, as lending standards have tightened.
Nocera argues that we’re close to a “housing death spiral”: house prices fall –> more borrowers become underwater –> more defaults and foreclosures –> house prices fall further.
This leads Nocera, like Goodman, to advocate for principal reduction. Harp II, with its lack of ambition, may help a little but interest rate modification doesn’t solve the fundamental problem — underwater homeowners, says Nocera.
For more on this line of reasoning and the data behind it (“more than 10 million are reasonably likely to default”), check out Goodman’s September testimony to the House Subcommittee on Housing, Transportation and Community Development, which Nocera embeds in his column. It’s an excellent analytical short summary of the US housing market and comes highly recommended.
Goodman starts from the basis that of the 80m homes in the US, 55m have mortgages. She thus divides the mortgage market as follows:
– 4.5m non-performing loans
– 3.9m re-performing loans (RPLs, i.e. those were previously 60+ days delinquent but are now being paid)
– 2.6m always performing loans with LTVs greater than 120 per cent
– 5.4m always performing loans with LTVs between 100 and 120 per cent
– 38.6m always performing loans with LTVs less than 100 per cent
Goodman then estimates likely default rates for each of these categories. Her methodology is exhaustively detailed in the appendix.
Her inclusion of RPLs is especially important — too often our focus is just on NPLs, such as those on second mortgages. But, in essence, Goodman argues that most RPLs are NPLs, they just don’t know it yet. In the appendix she notes that “over the past 3 months, 47.2 per cent of the re-performers (on an annualized basis) have again transitioned to delinquent status” and 44.6 per cent of RPLs are either delinquent or in default after two years.
Tallying all this up provides this useful table and the headline stats Nocera refers to in his column (click to expand):
Our results indicate if no changes in policy are made, 10.4 million additional borrowers are likely to default under our base “reasonable” case, and 8.3 million borrowers will default under our lower bound numbers. Since there are 55 million homes carrying mortgages, 10.4 million borrowers roughly equates to 1 borrower out of every 5. This includes 4.1 million of the 4.5 million borrowers who are already non-performing; the remainder of defaults will come from borrowers current on their loans, but who are likely to eventually default. Many in this group (2.5 million) represent re-performing loans that history suggests are very prone to another default.
Goodman says she has made conservative assumptions. Let’s, for example, look at what she assumes for NPLs and RPLs, which together comprise two-thirds of future defaults, according to Goodman. Current experience would suggest default rates of over 99 per cent and 94.7 per cent on NPLs and RPLs, respectively. However, Goodman’s “reasonable estimate” is 90 per cent for NPLs and 65 per cent for RPLs. The RPL estimate could be contested but it’s definitely not outside the bounds of possibility. The more serious problem with the assumptions is, as Goodman implies, the time scale — she assumes an “arbitrary” six year window but given the current pace of events it could easily have take even longer to get through the inventories of delinquent and defaulted homes.
What to do, then, with those 10m underwater borrowers?
On the supply side, there’s principal reduction, which in spite of the moral hazard risk, might just be the least worst idea around right now.
But we need a demand side solution as well, says Goodman. Thus, she proposes regulatory changes to encourage more large scale private sector home purchases, which can then be rented out. She makes a strong case but we’re not sufficiently smart sighted to understand the full ramifications.
Other than to note it echoes Morgan Stanley’s call that “The beginning of the rentership society is upon us,” as the FT reports in an analysis piece on the state of the US housing market.
The end of the home ownership dream, redux.
Related links:
Streets behind – FT
To Fix Housing, See the Data – NYT