Keeping things in perspective

Posted by: Dean Foust on August 10, 2007

bowyer.jpgAmid all the hand-wringing over the sub-prime meltdown, and the stock market volatility, seems like this is a good time for a reality check. And it comes courtesy of Jerry Bowyer, an economic advisor to Blue Vase Capital Management. On the National Review Online website, Bowyer makes these observations regarding subprime:

Currently there are about 44 million mortgages in the U.S., and less than 14 percent of them are sub-prime. And only about 13 percent of those are late on payments, with the majority of late payers working through their problems with the banks.

So, all in all, when you work through the details and get down to the number that really matters, only about 0.6 percent of U.S. mortgages are currently in foreclosure. That’s up a hair from roughly 0.5 percent last year. That’s it.

Actually, that’s not it. Things are actually better than the numbers suggest, since sub-prime-mortgage homes are less expensive than prime-mortgage homes.

This makes sense. Wealthier people, generally, can afford costlier homes than less-wealthy people. The recent sub-prime surge brought large numbers of moderate-income families into the home-ownership market, and their houses are less expensive than most. Therefore, the dollar impact of the sub-prime default is smaller than if it were a prime default.

With approximately 254,000 mortgages in foreclosure at the moment — up from roughly 219,000 last year — the sub-prime meltdown has given us an increase of 35,000 mortgage foreclosures over the last quarter. Since the average sub-prime mortgage clocks in at almost exactly $200,000, we’re looking at an approximate $7 billion increase in foreclosed value in the first quarter of this year.

How big is household net worth in the U.S.? … About $53 trillion. In other words, the recent increase in sub-prime foreclosures amounts to 0.01 percent of net U.S. household wealth.

Feel better?

Granted, these calculations don’t include troubles among prime loans, nor the possibility that homeowners who bought at the peak in bubble-driven markets like Southern California and south Florida – and who are now $200,000 underwater versus what they paid – opt to just mail in the keys and walk away.

And they don't include the “reverse wealth effect” – that homeowners whose houses are worth a lot less than before – simply “feel” poorer and don’t vacation or splurge on that new kitchen renovation (although economists tell me that the cutbacks from the “reverse wealth effect” isn’t as dramatic as the spending gains during boom times. And maybe more than anything, they don't include the problem that hedge funds that invested in subprime leveraged up 10 to 1, so their losses are outsized, but that's a financial problem not a mortgage problem.

But you get the point. Seemed like a good afternoon for a reality check. And here's the chart Bowyer included to illustrate his point.


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Reader Comments

Angel Armendariz

August 10, 2007 7:37 PM

Thanks for putting things in perspective Dean. Having worked in the Mortgage Industry a while back, I know the general landscape of things. Right, now there is a lot of pania, media is doing a good job,lol. Nonetheless I thought it would be beneficial to give some insight to actual homeowners, so that they can make some sense as to were they stand regarding the "housing bust." My partner and I made a quick guide for homeowners that gives resources they can use to understand what they can do to protect themselves, and what to be cautious about. I now work in the consulting/sales training industry; but I saw the need in our communities for some simple reference guide...to keep the right perspective and be prepared.

David Porter

August 10, 2007 8:17 PM

Dean,

Nice job on this article. I hope it spreads across the net like wildfire to bring some perspective.

rich

August 11, 2007 7:05 AM

Dean,

Events of the past few weeks have assured that the U.S. economy will enter recession soon, and that the recession will not end quickly. Decimation of mortgage market means an even greater slowdown in housing sales and new construction. Homebuilders start to go under, led by Beazer as soon as next week. The largest mortgage lenders, including Countrywide and Wamu, go into deep distress mode. Corporate commercial paper comes under stress as real estate companies falter. The next big domino, already starting to tip, is commercial real estate. Auto sales topple. Then, by Christmas, serious pain in retail sales.

Go ahead and publish pretty stories.

Brandon W

August 11, 2007 10:36 AM

I think there are two different issues here that are related, but are being confused with one another. The two issues are a real estate bubble, and a credit crunch. The real estate bubble has come into being due to easily available money from the credit system and spiraling speculation. This has driven home prices in most markets outside affordability for the median household (much less anyone below median). Thus, the downward adjustment of housing prices is catching a lot of people in negative equity, forcing them to stay in ARMs that are adjusting upward without the ability to refinance. Also, the equity loss is eliminating the so-called Housing ATM, which has been increasing consumer spending and partially explains the negative savings rate in the U.S. Difficulties for the real estate and homebuilding industries are hangover from the bubble. But this is all specific to the real estate bubble.

The second issue is the credit crunch. Certainly, the defaults on loans have set off this "crisis", and since we're only at the beginning of resets from the huge increase in ARM originations, it is likely to worsen as a driver of the credit crunch. However, it's not really the whole picture. The whole picture is that the Federal Reserve created a situation where excess liquidity allowed for too-easy access to credit both in and outside the real estate markets. Risk on most of this debt has been badly underpriced, and now the banks hold a substantial sum of risky debt on which they aren't making reasonable returns. This has spooked the banks and credit markets, and caused an overall tightening of credit which retards the entire economy. The risk also exists that enough of this debt could default to cause a tipping point (nod to Gladwell) and spiral downward into a full blown fiscal crisis on the Great Depression level. The real estate bubble mortgages have been one of the credit issues pushing toward this tipping point, but not the only one.

So let's be more clear about what the issues are, and no confuse the two. The foreclosures may not seem dramatic, but they don't need to be. They are, however, pushing the entire fiscal system towards that tipping point.

Sarasota real estate

August 11, 2007 10:06 PM

Thanks for the mortgage stats. It is good to put things in perspective. Perhaps we will see more foreclosures as the adjustable mortgages start adjusting.

I am a Realtor in Sarasota, Florida and the coming foreclosure have not hit yet. They will increase our inventories which generally lead to lower prices. However, our market is 25-30% off the 2005 highs. I am starting to get calls from buyers who have been sitting on the sidelines waiting for lower prices. They are starting to sense blood in the streets and may finally jump in the pool.

The press will make the morgage situation sound worse than it is because it sells newspapers and tv commercials. This could be the bottom.

Contrarian investors - they seek opportunities to profit from situations when the crowd mentality leads to unreasonable valuations for assets, either on the upside or the downside.

Nemoudeis

August 13, 2007 4:50 AM

And if a bee stings you, what's the problem? The wound the stinger makes can't make up any more than .001% of your skin area, right?

Yet, somehow, it still manages to hurt like hell. And if you're the wrong kind of person, it can even kill ya.

Maintaining proper perspective is important; panic is a self-reinforcing cycle, after all. But Bowyer should also consider the corollary to that function, which is this: "HOPE IS NOT A PLAN."

What's happening in the mortgage markets is very real. And it is happening to people ... real-live, breathing, humans. Their houses aren't selling. Their condos are sitting fallow for months -- even years.

Foreclosures are rising, too. And while the number of properties currently IN foreclosure may not look like much at any given moment, this doesn't change the fact that the REO market that feeds on it is growing at a mind-boggling clip.

When worldwide markets tumble whole percentage points in unison, jerk up a notch, then tumble a few percentage points more, that is not a media-contrived event. When the Fed and ECB start tossing blank IOU's around like confetti at an astronaut's parade, that's not just because Lou Dobbs or Jim Cramer burst a blood vessel the night before. When Morgan Stanley takes Cerberus for a long walk on a short pier, that's not to spite a particularly twitchy Nouriel Roubini post or Paul Krugman article. And just because the media tells you something is happening, that doesn't mean that it's happening just because the media tells you about it.

Jerry Bowyer can go ahead, shut his eyes, grab an elephant's tail, and tell everybody that the gigantic animal everyone's talking about is really just a harmless little snake. And as long as that elephant doesn't have any unfortunate gastrointestinal episodes, Bowyer can keep reporting that back to his fans. Or maybe it IS just a snake Bowyer's got in his hand, and the rest of us must just be so high on bubble juice that we've reduced ourselves to leaning on streetlamps, ranting about seeing pink elephants for as far as the eye can see.

I'm sure Bowyer will keep all of us apprised either way.

rich

August 13, 2007 8:47 AM

The point that almost everybody is missing in the mainstream media, and among mainstream economists also, is how fragile U.S. household balance sheets are in relating to current lifestyles and income needs. The reason for waves of foreclosures isn't just bad mortgage decisions. It's lack of personal financial flexibility and liquidity.

Look...California has just reported that its July sales tax revenues ell off the table. California is the leading financial edge of the U.S.

Look...in today's NY Times, many people who must buy their own health insurance have to pay $4,000 or more per month.

Look...oil is at over $70 per barrel and not trending lower.

LOOK AROUND YOU AND WAKE UP!

P.S. What is propping up the American economy right now is easy credit card debt, which keeps exploding. And guess where that's heading?

Keith

August 13, 2007 11:51 AM

What is it about some people who really want things to go to hell (though they will never admit it). I knew several people during the year 2000 change that were conviced it was the end of civilization, and any facts to the contrary just made them mad. Then they were disappointed when the end did not come (but they would not admit it, but you could tell). Maybe the next Great Depression is at our doorstep, however, all facts need to be considered.

rich

August 13, 2007 12:46 PM

You know, Keith, there is one big thing that has changed just since the last bear market. If you believe hard times are coming, you can take steps to protect yourself. It's easier now than ever before due to changes in financial markets that allow investors to invest outside the U.S., to participate in commodities and go short via ETFs, futures, options, to buy foreign currencies, etc.

I assure you that the hot-money financial institutions and hedge funds will be protecting themselves with these tools. They already are, and it's making financial markets more volatile. There was not nearly this much hot money around in 2000, you know.

A huge PR industry is out there yelling in your ear everyday, telling you to keep spending money, keep buying stocks, and everything will be okay. This industry hires flacks and dresses them up as analysts, economists and journalists. But the people who pay the PR bills are already starting to jump ship. Do you want ordinary consumers and investors to be the bag-holders again?

You also can take protective steps like saving more money and not taking on too much debt. Knowledge is power. Thank god for blogs so people can communicate real knowledge, not just hear the PR spin.

Lord

August 13, 2007 1:43 PM

I don't doubt it is not that bad yet, but housing is a momentum game, and the momentum is negative and is not abating, and once it has built up, it will take much to stem.

Brandon W

August 13, 2007 1:43 PM

I'm about to launch a business. The last thing I want is another Great Depression. Obviously, I'm optimistic about the future or I wouldn't be starting a business, right? But I'm also realistic about what COULD happen if things don't get under control. I say what I say as a counterbalance to the cheerleading and to argue against this idea that a relatively small factor is unimportant to the big picture. I don't intend to sound like a doomsayer, but we also can not fix a problem if we're denying its existence or turning a blind eye to key factors.

rich

August 13, 2007 3:53 PM

The U.S. has had the most phenomenal 25-year economic growth run of any nation, or any civilization, in history. It has just been breathtaking from any perspective. But part of it has been achieved by borrowing from the future and speculating in the present.

This 25-year period has made many people, and especially journalists and economists, feel that the U.S. economy is invincible. What they miss is -- economic cycles get exhausted over time, and the U.S. economy has finally run out of gas. It will take up to a decade to work out the problems. It doesn't mean an entrepreneurial person can't be successful here. Just stay focused on what lies ahead, not behind.

Jim D

August 14, 2007 10:11 AM

I read this blog entry days ago, and it's been bothering me ever since.

If you want to get worried, or even if you don't, let me just ask one question: what about leverage?

Subprime a small problem? What about leverage? Contained and not spreading to Alt-A (already proven false), what about leverage?

These bad loans (and we've only seen the tip of the iceberg for defaults) were leveraged and re-leveraged by hedgefunds 6x, 10x. That means that as the values of the underlying securities evaporate, margins need to be adjusted, causing massive selloffs of existing performing securities, since the underperforming securities aren't actually liquid. Once the fantasy of mark-to-model really ends for these funds, and we start having real mark-to-market prices, we're going to see a huge unwinding to the downside for every asset class - and it's already underway.

And of course that doesn't even begin to touch what happens to home values when 20% (or more) of the market gets taken away because suddenly lenders discover that they shouldn't make loans to anyone with a pulse and a falsified income statement. And the inevitable hit the economy will take when the MEW train stops running.

Really guys, I expect better from you. This is probably the biggest business story of our lives. Look a little deeper.

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About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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