I have been covering the US Real Estate market for decades. I grew up with RE (mom was a RE broker and an investor). I have been a housing bear for about 5 years. I recognized the credit bubble and inevitable bust long before most other analysts/strategists/economists did.

I mention this just to inform readers that it is very rare that I come across any housing analysis that surprises me or adds to my understanding of the real estate landscape in a major way.

Which is why I am so pleased to introduce you to Dhaval Joshi, Chief Strategist at London based hedge fund RAB Capital (and former Societe Generale and J P Morgan Strategist).

Dhaval’s analysis looks a variety of housing data relative to household formation, housing stock, vacancy rates, and inventory is not the typical housing review. It is quite illuminating.

Enjoy:

~~~

Can the US economy really return to “business as usual” when it has 4 million houses surplus to requirement, when 1 out of 4 mortgages are in negative equity, and when by our calculation, it is burdened with $4 trillion of excess mortgage debt, equivalent to 30% of GDP?

For many years, total mortgage debt consistently and reliably equalled 0.4 times the value of the US housing stock. Intuitively, this average of 0.4 makes perfect sense as every property usually has a mortgage ranging from 0 to 0.9 times its value. So in 1990, $6 trillion of housing collateral could support $2.5 trillion of mortgages, and by 2006, $23 trillion of housing collateral could support $10 trillion of mortgages. But since then, the US housing stock’s value has slumped to $16 trillion which means the amount of mortgage lending supportable by the collateral has plunged to $6 trillion. However, actual mortgage debt has remained at $10 trillion – $4 trillion too high.

The fact that mortgage debt has barely declined suggests that relatively few homeowners have defaulted on their mortgages or paid off debt yet. Instead, a quarter of all borrowers are sitting on negative equity. That’s just as well – because were mortgage debt to shrink by even half of $4 trillion, the US economy would slump.

Perhaps homeowners are patiently expecting house prices to rise again. But if so, they may be in for a long wait. Prices are likely to be weighed down by a massive oversupply of homes relative to underlying demographic demand. Whether you look at the houses to population ratio, the houses to household ratio or vacant houses ratio, the conclusion is the same – there is a 3% surplus of properties, equivalent to 4 million homes. And with household formation running at just 0.9 million while the US is still building 0.6 million new homes annually, only 0.3 million of the oversupply will be absorbed per year (see page 5).

Ultra low rates to stay

A recent study by the Federal Reserve (The Depth of Negative Equity and Mortgage Default Decisions by Bhutta, Dokko and Shan) investigated the question: at what point do underwater homeowners “strategically default” on their mortgages? Surprisingly, it found that the average borrower doesn’t walk away from his home until negative equity reaches a very high level, -62%. But the fascinating thing was that there was something that could trigger underwater borrowers to default much, much earlier – and that something was an interest rate rise.

With a quarter of US mortgages underwater, and likely to stay that way for some time, the Fed must follow its own research if it wants to prevent a cascade of defaults. Hence, expect US interest rates to stay ultra low for an ultra long time.

>

>

For many years, total mortgage debt consistently and reliably equalled 0.4 times the value of the US housing stock. Intuitively, this average of 0.4 makes perfect sense as every property usually has a mortgage ranging from 0 to 0.9 times its value. So in 1990, $6 trillion of housing collateral could support $2.5 trillion of mortgages, and by 2006, $23 trillion of housing collateral could support $10 trillion of mortgages. But since then, the US housing stock’s value has slumped to $16 trillion which means the amount of mortgage lending supportable by the collateral has plunged to $6 trillion. However, actual mortgage debt has remained at $10 trillion – $4 trillion too high.

>

Loan to value ratio is 1.5 times too high

>

To put it another way, the loan to value ratio of total mortgages outstanding to housing stock value is currently 1.5 times too high.

>

24% of US mortgages are underwater

>

The fact that mortgage debt has barely declined suggests that relatively few homeowners have defaulted on their mortgages or paid off debt yet. Instead, a quarter of all borrowers are sitting on negative equity.

>

Higher interest rates may trigger cascade of defaults

>

A recent study by the Federal Reserve investigated the central question: at what point do underwater homeowners “strategically default” on their mortgages? Surprisingly, it found that when the decision is based on negative equity alone, the average borrower doesn’t walk away from his home until it is very underwater (negative equity of 62%). But the fascinating thing was that there was something that could trigger underwater borrowers to default much, much earlier – and that something was an interest rate rise. In fact, higher interest rates were even more significant in triggering defaults than higher unemployment.

With a quarter of US mortgages underwater, the Fed must heed the advice of its own research if it wants to prevent a cascade of defaults and the consequent repercussions on the financial system and the economy. Hence, expect US interest rates to stay ultra low until millions of mortgages escape out of negative equity.

>

The US has built far too many houses

>

Perhaps homeowners suffering negative equity are patiently expecting house prices to rise again. But they may be in for a long wait. Prices are likely to be weighed down by a massive oversupply of homes relative to underlying demographic demand.

Between 2002 and 2006, US homebuilders went on a construction binge, building 12 million new homes while the number of households went up by just 7 million. The painful legacy is a massive oversupply of houses relative to the number of households.

>

The oversupply will take years to clear

>

With household formation running at just 0.9 million while the US is still building 0.6 million new homes annually, only 0.3 million of the oversupply will be absorbed per year. As there are currently 4 million too many homes, it may take years to mop up the huge oversupply of houses.

Category: Credit, Economy, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

67 Responses to “The $4 Trillion Dollar Question”

  1. The Curmudgeon says:

    This is a good, graphical quantization of a simple truth: Supply of houses exceeds demand by a long shot, mostly due to the misallocation of capital into the real estate market for virtually a decade.

    The prescription for excess supply in any market? Lower prices. Anything done to prevent price declines in so fantastically imbalanced a market will only exacerbate the problem.

    Thus, practically everything undertaken since 2008 has done nothing but make things worse. As bad as it may seem now, the pain has yet to arrive, and when it finally does, the crash will be far more severe than otherwise if the government had not attempted to artificially support prices.

    Happy thoughts for a Thursday morning.

  2. inessence says:

    American’s largest asset by value, stagnant for years to come. American’s over indebtedness, in the process of mean reversion, again years to return to trend. Wage growth nonexistent. Continued high structural unemployment as far as the eye can see. The 70% portion of U.S. aggregate demand in economic quick sand. Please tell me how this supports current expected equity valuations?

  3. Rikky says:

    the hit to home equity values will decrease the velocity of real estate buy/sell transactions due to people not wanting (or not able to) sell. this will have a cascading effect due to the multiplier of this core trigger. real estate attorneys, title insurers, agents, commissions, home improvements, lenders, etc. etc. are all feeling the pinch of a homeowner trapped in his illiquid asset until ‘something changes’. as inessence points out it doesn’t seem like we’re going to get good changes anytime soon.

  4. This is nice quant data but psychology still reigns when it comes to people and their money. The key takeaway from this article for me is that homeowners care less about negative equity than they do about negative cash flow.

    This explains why most homeowners don’t default unless they are extremely underwater or their mortgage payment rises due to rate reset or rising interest rates. The majority of resets have passed; therefore the big question that remains is when interest rates will rise again; when mortgage payments rise with variable mortgage rates, and home values fall to accommodate higher rates for home buyers.

    Bottom line: The economy is not sinking; it just has nowhere to go without an impetus of change, such as higher wages and lower unemployment.

    The economy is in a state of inertia.

    “An object that is at rest will stay at rest unless an unbalanced force acts upon it.” ~ Sir Isaac Newton

  5. theorioleway says:

    From #1: “The prescription for excess supply in any market? Lower prices. Anything done to prevent price declines in so fantastically imbalanced a market will only exacerbate the problem.”

    Or, more demand. If jobs growth returns (humor me), household formation will rise and the oversupply will be worked through more quickly.

  6. george matkov says:

    With zero interest rates on savings and wage stagnation young people cannot save for a down payment. Furthermore, taking our a loan, mortgage or otherwise, in an environment of wage growth and returns on savings is very different from considering getting a loan when these are nonexistent. When will economists take into account the negative effects of zero interest rates? Don’t zero interest rates also destroy future demand?

  7. inessence says:

    @Kent…your comparison of physics to the current economic malaise is non sequitur. The economy MUST grow to keep from slipping into the deflation spiral and prevent higher unemployment.

  8. louis says:

    Reset every mortgage to current appraised value for all households currently employed. If that is to radical reset every mortgage into a SAM Loan. Let the owner decide how much future appreciation he wants to surrender. Still no go, reset every mortgage to current interest rates without a reduction in principal. They talk about more stimulus and fail to realize the stimulus a re write would bring. You put an extra grand in someone’s wallet every month and they will stimulate an economy. I assume most of the tranches have already been taken care of so what’s the problem here?

  9. Petey Wheatstraw says:

    Some outside the box thinking on RE and the greater economy. This will raise the hackles on many, but only if they are incapable or unwilling to move outside the comfortable framework (?) of our current economic scheme.

    http://www.ft.com/cms/s/0/8f06df9e-8ac1-11df-8e17-00144feab49a.html

  10. NG says:

    Where does he get annual US household formation of 0.9m? I thought it was fairly consistently 1.2-1.25m.

  11. steven says:

    The LTV chart goes back just 20 years, 5 of which represent some type of blowout. So we’ve got 15 years here, to assume as ‘normal’.

    What if the avg LTV was considerably lower in the 70s and 80s ? The ‘excess debt’ would be, perhaps, $10t. And the analysis here would be deemed to be too way out. That’s why it seems it’s back to just 1990.

    Also, since when do prevailing interest rates to mortgagees follow the Fed ? It’s market forces – specifically supply and demand for US currency – that determines this. And with the country’s finances diving, banks becoming hyper-risk-averse and risk profiles increasing on individual and public sector levels, how exactly do interest rates to US mortgagees stay down ? Perhaps by govt decree.

  12. gaddijg says:

    B:
    Oversimplification… Household formation is just a part of demand. What about second homes? What about Real Estate as a “Real” Investment (international buyers). Many people worlwide are scared (out of stocks, Hedge Funds, etc.) and “safe” investment grade bonds yield nothing and still carry a lot of risk if we face a depression.
    Nowadays Real Estate in many cities in Latinamerica is more expensive than in US so there are lots of people looking to invest in US (I guess the same might be happening with Asia). If people dare to invest in Dubai…don’t you think people from all over the world are willing to invest in US?
    Besides, lots of the oversupply refered to in this article, is concentrated in 10 cities/areas.
    The big issue is we are sitting on tons of registered sovereign debt (developed countries) and extra tons of non registered debt (social) which governments will try to honor through asset inlfation (as Greenspan did) -to avoid shot term political costs-. The problem is that this strategy will push intersest rates up…and that will makes thing worse once again. Bumpy road ahead!

    Question: Who is buying 70/90% of Treasury Notes/Bonds?

  13. AHodge says:

    nice
    3 housing points
    1) a lot of that inventory is rowhouses in bombed out Baltimore and the uninhabitable like
    2) the minimum turnover inventory is large takes months on average minimum to sell.
    3) Also if prices move up folks want to hold more inventory self fulfilling.

    No one here will dispute finance remains broken, and housing bringing up the bottom.

    The question is how broken. Can we limp along upward with zero interest rates, 4+% mortgages and blasts of liquidity until new asset price bubbles start blowing and really move us up?

    Are you betting nationwide housing prices reverse and hit new lows? I am the other way, weakly?

  14. NoKidding says:

    Louis,

    How would you feel about those deals if you had put all of your discretionary income into paying off your mortgage early – and just finished this year?

  15. constantnormal says:

    Not surprisingly (as this is the greatest financial crisis to hit the nation in many decades, perhaps since the Great Depression), there have been a lot of pieces on the “housing/mortgage crisis” since things popped in late 2007. This is by far the best I have seen. Thanks.

  16. inessence says:

    @Petey…hackles raised…to much slippery slope of socialism. Although your point brings up the systemic change underway. For more than a half of a century, home ownership was more of an act of utility than speculation. And what fueled that speculation has benn commented on ad infinitum on this blog. Speculative bubbles seem to be an integral part of human evolution over the millennium as the pendulum swings back and forth between central authority intervention and lax regulation.

  17. Petey Wheatstraw says:

    louis:

    So, what’s in it for me, a homeowner with a paid mortgage? What’s in it for someone who rented in order to save or invested elsewhere during the insane inflation of the bubble?

    In the context of our current system, if your ass is underwater, you and everyone similarly situated need to go bankrupt, period. A very high number of bankruptcies would force the hands of the lenders resulting in a necessary marking to reality of THEIR devalued/devaluing assets (the credit to make a deal would magically appear and a bankruptcy on a credit history might even begin to look like a good thing, if the bankrupt party is gainfully employed).

    The only other option, similar to your proposal, would be for the government to pull a W and send every taxpaying household (hell, let’s include every citizen) a huge amount of fiat money (let’s say, $500K — and there’s no need to laugh, it’s fiat, after all), taxable at 50% (anyone with assets or income above $500K would be exempt, on the basis of ‘fuck ‘em — they don’t need it’).

    The trickle up would be phenomenal, and relative worth between the classes would be narrowed considerably.

  18. call me ahab says:

    Reset every mortgage to current appraised value for all households currently employed

    never happen- banks would then have to right down the values of all those loans on their books- it would be a complete bust-

    the USG and Fed didn’t drop trillions to protect the banks from going bust- buying MBS at face value- just to let them crash and burn again

  19. call me ahab says:

    duh! please insert “write down” where “right down” appears on last post

  20. flipspiceland says:

    @inessence

    “….Please tell me how this supports current expected equity valuations?…”

    Goldman Sucks uses Lord Blankfein and Joe Cassano’s Bonus Payment Device to calculate equity valuations.

  21. maxrockbin says:

    HOME OWNERS (unlike business/financial types) SEE THE COST OF A MORTGAGE AS THE AMOUNT OF THE PAYMENT. A very large number do. Maybe they’re neg-aming or maybe they are piling up more and more negative equity. But if the payment stays the same, they will keep paying it if they can.

    That’s just a fact. The whole bubble was based on that fact. Payments were low. House prices were VERY high. The reason people bought houses anyway was because they could afford the payments.

    So, should anyone be surprised that defaults go up when payments (interest rates) go up? A large number of home buyers were indifferent to equity when they bought the house and focused only on the monthlies. Why should they take a sudden interest in equity and be indifferent to cash flow farther down the pike?

  22. b_thunder says:

    I see green shoots! i mean the grass that’s growing through the walls and the foundation of the abandoned and foreclosed homes….

  23. JSchmid says:

    This is great information! I wish our government would have realized the glut of houses a couple of years ago so we could have eased the recession. I hope the FED can keep interest rates low for 2+ years, but I fear they will not be capable of it.

  24. scharfy says:

    Real estate is a spread trade.

    High end BAD.

    Low end GOOD.

    If the millennial’s ever decide to move out of Mom and Dad’s house, we can work off this extra stock… :)

    Or as I’ve said before, offer amnesty and instant citizenship for anyone who buys a house in the US. There’s gotta be 4,000,000 people out there somewhere who wanna come and live in the US?

    Migrant workers, Drug Lords, Arms Dealers, Anyone? Anyone? Bueller?

  25. @inessence:

    We agree. The economy must grow, as you said; but at the moment it is not growing and there is no foreseeable impetus to stimulate growth.

    If the economy is not moving, one can therefore describe it as inert.

  26. NoKidding says:

    Pete W

    “pull a W and send every taxpaying household (hell, let’s include every citizen) a huge amount of fiat money (let’s say, $500K … and relative worth between the classes would be narrowed considerably.”

    In a population of 100 people
    You give the 99 poorest $1000
    And they use half of it to buy from the 1 richest
    The poorest 99 each kept $500
    And the richest 1 kept $49,500.

    “The trickle up would be phenomenal”

    Ya don’t say…

  27. gmherger says:

    Excellent information!

    One observation:

    “Loan to value ratio is 1.5 times too high”

    National aggregate mortgagors’ LTV could be 3.0 times too high because a large percentage (I don’t know, does it approach 50%) of homeowners have no mortgage debt. At least they had none before 2005.

    Possibly this is overaggregation of the data. Outside the hardest hit bubble zones (AZ, CA, FL, NV, MI) the numbers may be not so stark. I’ve seen (my block in western Nassau County, NY) two vacancies sell (what I thought was) surprisingly quickly leading me to believe the sellers pretty much realized asking price.

    Traditional RS loan underwriting set 80% LTV as an upper limit. The chart shows 40% as “equilibrium.” Again, the ratio needs to be tailored to factor in the portion of housing stock that is owner occupied that has 0% LTV, which moves it up to 80% which is a still high aggregate.

    During the RUN-UP, did anyone, anywhere notice that the national percentage of homeownership (compared to renters) rose from 62% to 67%?

    Personal take-away: It’s a buyer’s market, somewhere.

  28. louis says:

    “In the context of our current system, if your ass is underwater, you and everyone similarly situated need to go bankrupt, period.”

    You mean just like the banks that needed a bailout should of been treated in the first place? In the context of our current system if your bank don’t know shit and you take on extreme risk without understanding the securities you created, you and everyone similarly situated need to go bankrupt, period.

  29. [...] Just how big are shadow housing inventories?  (naked capitalism, Big Picture) [...]

  30. formerlawyer says:

    I am curious about the regional housing formation statistics. If, as I would expect, baby-boomers are moving to or buying a second home in the sunshine states (where much of the real estate was being built) in the next 10 years or so the supply may dry-up sooner than expected. I have no information to back this suggestion.

  31. S Brennan says:

    Again,

    >>>JOBS<<<

    This time with feeling,

    Household formation depends on jobs.

    That is, demand drives prices, household formation depends on incomes, income depends on jobs.

    We now have almost 20% of our population out of work, many living with family, friends, "couch surfing", room mating, in cars, homeless…etc…few choose this.

    What the bleep is wrong with the great brains of America's "elite" that they can not understand a simple idea like, demand drives prices upward…and income drives demand and income for the overwhelming majority relies on employment…with decent pay.

  32. allen green says:

    I’m a Loan Officer at one of the big 3 big banks, that has America in its title.

    This bank has virtually stopped funding refinances, and is paying it’s origination staff to originate loans for the sole purpose of cancelling the loans in 120-180 days. It’s amazing that the pay us.

    Most all of my 120 loans in my pipeline are MHA making home affordable loans. We’ve been given scripts, to tell those brw’s waiting for the loan to close, that the Obama administration is responsible for the delay. We acutally has a training class on this.

    Out of 120 loans in the pipeline for 120+ days, 2 funded last month, at least 80 are calling every day begging for a loan.

    Can anyone shed light on why a big bank would pay originators to originate loans that they have no intention of funding? And why make it a corporate policy to blame Obama by name?

    Are any companies actually funding loans?

    AG

  33. randy says:

    Very interesting analysis.

    I agree with maxrockbin, that for most home buyers it is all about the payment. So long as they can make the payment they will continue–no matter what their apparent equity.

    formerlaywer asks about regional distribution. I was thinking the same thing. I have heard that there are large empty communities outside of some cities (Las Vegas, Orlando, etc.) that were built speculatively and have never been occupied. Once a spec house sits empty for a number of years you can no longer consider it available on the market. Those types of local issues need to be accounted for. How many houses are they counting as inventory in Detroit?

    If they adjust the available inventory to remove all of that unsellable inventory then that part of the picture is much less bleak. So, I believe that the housing recovery could come faster than the author indicates.

  34. ashpelham2 says:

    What all of the comments here have summarized to me is that this housing bubble grew so large and so pervasive, that now, with it’s undoing, much of america is also undone. At least American business and household finance. This isn’t a bad thing if done in an orderly way. I will play the Devil’s Advocate here and say that what our government did with TARP and all the other money they shuffled to the banks was to delay and slow down the fall. This extra time might turn out to be what saves us after all.

    The realist in me, the one you all know, tells me that eventually, Americans underwater in their mortgages will have to face an intervention from government or private business. I suggest that a major writedown of all real estate with an attached mortgage be conducted, and that dollar amount be paid back through higher payroll taxes. It’s socialism to the nth degree, but somehow we have to get things back to normal and relinquish our addiction to credit.

  35. lalaland says:

    while it appears everyone has taken the article seriously, I recommend a different font on the graphs…

  36. formerlawyer says:

    To allen green

    I used to act for a collection agency. Their practice was, on a quarterly basis, to make “bad deals” ie. paying $100 a month for a $10,000 debt, in the last few weeks of a quarter. The collectors were bonussed based on having gotten rid of a number of files and the value in a file, again on a quarterly basis. Perhaps you could look at the financial compensation in the bank’s originating business?

    Likewise, as to the President Obama reference you remember the car salesman and the “manager” don’t you? The bank may want to retain some goodwill in casting the blame on Washington for canceling loans they never intended to fund. Often in a mature business environment, market share is the only metric for comparison/compensation. If the bank can tie up the borrowers by an extended approval process they could game the system.

    Outside of that I got bubkes.

  37. Ted Kavadas says:

    Thanks for posting.

    IMHO the residential real estate problems are very complex. The strategic default issue is an important “wildcard.”

  38. bear_in_mind says:

    Love having the macro data mapped out like this. Great get.

    I suspect that Bernanke’s ‘plan’ all along has been to grit his teeth and bide time until late-2012 when most of the adjustable and exotic mortgage variants would have rolled through their re-set periods. With stable housing prices and employment, folks would be able to refi and it would be Morning in America (the indebted). Reality is writing another script, however, and there’s more than a little whiff of desperation leaking out. Each day, the Fed is holding more and more underwater US real estate. And if some exogenous event lights a fire under LIBOR rates, all hell is going to break loose. Subprime issues will look akin to Tiny Tim warming up the crowd for Led Zeppelin.

  39. [...] and the Economy Over on the Barry Rithotz Big Picture blog they have a piece from RAB Capital’s Dhaval Joshi that breaks down the housing overhang and the macro drag [...]

  40. dsawy says:

    What the article doesn’t try to quantify is a point BR made earlier on another thread about underwater mortgages: the decreased economic mobility of people in the US – ie, people who can’t move to take a new job opening outside of commuting distance from their current (underwater) home.

    I believe that this will be a large factor in future employment trends (eg, wage growth) in the US.

  41. Jonathan says:

    I guess around 2020 it’ll be time to buy!

    Until then you can either keep what you already own and watch the price go down, buy something now and watch the price go down, or rent.

  42. formerlawyer says:

    to dsawy:

    Some of that immobility may relate to the reluctance to leave a bad low paying job with medical benefits. How the revision to health care works in detail may see a greater mobility.

  43. Jim67545 says:

    Bear-in-Mind observed that Bernacke’s plan was to keep rates low and get the ARM resets through another cycle. Of course, that plus the temporary good it would do bank’s net interest margin, WAS the intention. Everything done at the time was designed to attenuate the problems so that they could be absorbed/overcome over time hopefully by a strong economic rebound. Some called it kicking the can down the road but, realistically, anyone put into his position would have concluded to do the same thing. To totally cure the problem would have been prohibitively expensive (such as the sort of suggestion above to write down everyone’s mortgage) and politically impossible.

    Ultra low interest rates contributed to the problem in housing. Anything abnormal such as that will continue to cause problems. There are PROBLEMS that begin to arise “down the road” too. One is loss of income by depositors. Another is a downward adjustment in bank’s net interest margins as they are unable to drop deposit rates further but loans’ rates adjust downward squeezing NIM. Bank’s investment portfolios, invested in mortgage backs and various governmental debt, drops as that debt is repaid, or called/refinanced. Faced with decreasing margin while still burdened with high charge offs, lenders will respond by trying to improve the quality of the portfolio, ergo fewer losses. This tends to dry up credit, unless, again, there is more governmental intervention such as through SBA or other governmental guarantee.

    Where there is no governmental intervention as a credit enhancement, available credit constricts. This too is supply and demand. Put another way, if a lender is only getting 5% on a 60 month car loan they will damn well give that loan to someone with a 740 credit score where prospects of collection costs and loss are near zero. Look for rate tiers based on credit score to widen and the “best” rates to drop. This will constrict credit to big ticket consumeables such as autos unless, again, there is more governmental intervention as cash for clunkers.

    This will also increase burden (pay more to get a loan they need) on those with low credit scores and a virtual unavailability of sub-prime credit (such as the 25% of borrowers now with a <600 FICO score – up from 17% in recent years.) I wonder how this will work out for the "walk aways" in the long run?

    And, with rates so low, mortgage backed securities are unappetizing to their traditional investor who is also scalded by subprime defaults unless, again, the government intervenes and buys up and/or guarantees the securities to keep the machine turning. Enter FHA and Fannie/Freddie and exit the non-GSA mortgage packager.

    The moral of the story is that to support the longer term ramifications of ultra low interest rates the government has had to intervene to stimulate other aspects of the marketplace. Since intervention costs the tax payers (or buyers of treasuries) and since there is a growing resistence to this, look for growing difficulties in these areas of secondary and tertiary impact unless, as Mr. Bernacke hoped, the economy recovers quickly and lifts all boats. It may turn out to be a bit like a Shakespearean tragedy. Good intentions turned to tragedy. Hope not.

  44. Spearson says:

    As to this “new” analysis. doctorhousingbubble.com and other blogs have been quantifying the oversupply of homes for months. There isn’t anything new here.

    Independent of the oversupply of homes, how can we pretend that we will ever have a “recovery” per say?? After this housing bubble, we now realize that we are right in the middle of a TRUE global economy (the bubble masked things for years). While we have been spending our bubble money, manufacturing has been exported, planes are landing in China to get serviced, X-rays are being emailed to India, and engineering is being outsourced across the world for 1/5 the cost. Welcome to a global economy!! We have done everything in our power to export our intellectual property for short term gain. If it can be exported it seems it will be exported.

    As a aggregate, we better figure out to get by on less. When someone is willing to do your job at 1/3 to 1/20th of what you would charge, you better have a backup plan. Expect the masses to rationalize taking from the people who have done well. That will then de-motivate the performers. There is a reason why the top 1% have so much and it is because they are motivated and are the reason why America has done so well (past tense). So I expect taxes to rise (or we will go bankrupt) and finish demotivating the performers.

    I don’t see a way out of this. Wages will drop (or unemployment will rise) causing more pressure on housing. Government manipulation cannot solve this core reality. They will tweak the money supply and rates screwing things up even more. Forget the oversupply charts. If I am right, deflation has to happen and it will force the number one expense (housing) to be pushed down further in the long run.

  45. takloo says:

    anybody know of similar analysis on the Canadian housing market? there is a lot of chatter in US about Canada’s housing going bust in the near term…

  46. formerlawyer says:

    to takloo:

    See the Canada Mortgage and Housing Corporation (CMHC) site and in particular:

    https://www03.cmhc-schl.gc.ca/catalog/productDetail.cfm?csid=1&cat=63&itm=1&lang=en&fr=1279288730281

  47. lewiswb says:

    The last chart kind of fascinated me….Theoretically, overbuild and underbuild should balance out over time, indicating that whoever made the chart is fundamentally wrong in whatever assumptions he is using. It would be nice to have taken that chart and adjusted, say the first twenty or twenty five years to where overbuild equaled underbuild, and then use whatever that adjustment turned out to be and applied to everything past then to get a more accurate idea of what it will take to actually get back to equal on the chart. In other words this chart is the statistics in what my wise old pa used to tell me about lies, damn lies and statistics. Other than that, pretty accurate, and now we are digging hard to get out of the hole we are in (yeah, dad said that too_)

  48. bcanuck says:

    Here in Canada the typical mortgage term is five years.
    When the mortgage is up you have to re-qualify
    How could all these underwater people possibly re-qualify?
    Add a whole bunch of unemployed, underwater people trying to re-qualify, how could home prices possibly go up (or stay up) with all these former owners locked out of the market?

  49. teddybearneil says:

    The charts kinda suggest that we have been overbuilding from 1996 through 2006. I am not sure if the attrition rate has been added to the household formation number to arrive at the demand. It would be interesting to see how much of the housing stock in this country is really ‘liveable’ at this time, especially in cities like Detroit, Cleveland etc and a lot of older towns in the new england area. From what I have seen personally a lot of the those decrepit beat up dwellings that a lot of people live in are not liveable at all and need to be torn down and new homes built on those lots. This would be the best solution to the housing crisis i think. Instead of writing down principal of stupid/irresponsible homeowners, we could use that money to get rid of older homes and build new ones in their place. This would not increase the housing stock while at the same time modernising the existing stock.

  50. sidfeinberg says:

    These charts are pure doom and gloom fantasy. My Realtor says it’s never been a better time to buy a house, and I trust her. I recently put down an offer and I’m closing soon. I also bought some Tupperware, Herbalife and ACN phone service from my Realtor.

  51. oc bear says:

    Everything is good as long as you can maintain the current equilibrium. Can Bernanke control interest rates if Foreign buyers are not interested in our debt? Can banks keep REO property on the books and keep postponing foreclosures while their earnings elsewhere erode?

  52. teddybearneil says:

    Mr. sidfeinberg,

    Realtors are always out there to make money out of a Home transaction – either a sale or a purchase. What they say, should not count for us. The boom and the bust came about because a lot of such ‘Realtors’ were advising their clients to buy during the crazy boom years of 2003 – 2006 and at that time, they did not have to sell their stupid clients the Tupperware, Herbalife and ACN phone service!!

  53. Syber Gates says:

    Good work on providing lengthly details and the statistics.

  54. killben says:

    “Surprisingly, it found that when the decision is based on negative equity alone, the average borrower doesn’t walk away from his home until it is very underwater (negative equity of 62%).”

    It just shows that hope and illusion works wonders. People do not want to accept the loss and thus don’t. In fact these are the very things that govt and regulators capitalize on too!

    But the graph also shows that the probability shoots up when you are above 10% underwater and further climbs sharply when 40% underwater ..

    But just because you do not want to see the truth the truth will not go away .. the fact remains that house prices have ways to go south and when it does along with economy going south and unemployment highs …. we will have to see what happens

  55. louis says:

    If you had just paid off your mortgage what would you rather see in your neighborhood, people staying in their homes or people leaving an abandoned property? Nothing is politically impossible anymore. Why not re-write to current interest rates without a reduction in principal? I know a lot of people with income that will vote a certain way if you did just that. If it truly is about the monthly payment what better way to keep people from “strategically defaulting”.

    How do you stop the guy that can pay from walking away? Not the guy’s that can’t where foreclosure helps to drive prices where they need to go. But the guy that decides to cash in his chips and leave the table?

    As Barry pointed out in the book housing must stabilize for the economy to improve.

    “Those people who can afford to stay in their homes with a loan modification or workout are the best targets for legitimate foreclosure avoidance.”

  56. Ray Schmitz says:

    The chart title on the relationship between strategic default probability and interest rates is misleading. Although the explanation says that this is from a Fed study of strategic defaults, the title says probability of default, not probability of strategic default.

    And as the Fed study concludes, the historical relationships may change over time. In fact we should expect it. There is plenty of evidence that homeowners recognize only very slowly that their now home is worth less than they paid for it. Also, distressed borrowers are slow to enter bankruptcy.

    What if strategic defaulters will default at a much higher rate than suggested, but like some distressed borrowers, take that drastic step only after a long lag? Unless home prices begin to appreciate meaningfully – doubtful given the supply overhang – then number of strategic defaults could ultimately be substantially higher than predicted.

  57. [...] Last week, we looked at London based hedge fund RAB Capital Chief Strategist Dhaval Joshi’s The $4 Trillion Dollar Question. [...]

  58. jtuck004 says:

    Are the values in the chart above based on the current rules – marked to the values the banks report, rather than the market? So that the spread isin reality much wider than it looks?

  59. [...] long and detailed look at the oversupply in the national housing market, which of course will lead to a reduction in all [...]

  60. [...] (thanks to Republican policy): The nightmare that is the post-bubble housing market. Hey, Greatest Generation, thanks for the two generations of greedy retards you raised. Good going! [...]

  61. morganwarstler says:

    The logical path is clear:

    1. The a good chunk of 25% of mortgages underwater need to be encouraged to default, and rent.
    2. All foreclosed homes should be auctioned to private investors with 40% down.
    3. Interest rates need to be increased.
    4. Banks that are insolvent need to be dismantled.

    Anything else is madness. Housing prices are going down and staying there, we should want their expectations to match reality.

  62. [...] 20. The Fed began raising interest rates, and the party was over. The entire housing edifice of the 2002-07 era was based on ever rising prices, supported by cheap credit, and a greater number of buyers than there was Household formation. [...]

  63. [...] recent analysis of long-term U.S. real estate data concluded that over time, the nation’s housing equity (collateral) can sustain a mortgage [...]

  64. pownall says:

    correct me if i’m wrong, but don’t you have to take into account that roughly 500k homes must be replaced each year? If this is the case, than the analysis above would lead to lower inventories. So, if we’re building 600k new homes per year, roughly 500k of these are just replacing defunct housing stock, which leaves only 100k for the 900k new households. this implies we’re eating into inventories at roughly 800k per year, not 300k.

    ~~~

    BR: Half a million houses per year? That seems awfully high. Whats the basis of that 500k # ?

  65. pownall says:

    i’ll have to dig around to find some good data source. 500k per a year is less than .5% of the ~130M unit housing stock, so would imply greater than a 200 year average life of a house in the U.S. If someone has a better figure i would love to see it. My main point is simply that, whatever the number is, there is another structural factor in play that should at least make the inventory situation a little better than described above. i’m goign to see if i can find a hard data source.

  66. [...] The $4 Trillion Dollar Question (July 15th, 2010) [...]

  67. [...] From 2001 – 2007, new home building far outstripped new household formation; (we are still saddled with supply in excess of [...]