One of the central reasons for the recession -- and for the anemic recovery from it so far -- has been the issue of the popping housing bubble. Housing is, for most homeowners, a highly leveraged investment. Even the old conservative rule of a 20% down payment is a far more leveraged position than is allowed when buying stocks, where at least 50% down is required. During the housing bubble, almost no one was putting 20% down anymore, and down payments of under 5% were common.
Even long-time owners were encouraged by the banks to treat their houses as if there was an ATM in the kitchen next to the toaster oven. Cash-out refinancing and homeowners lines of credit were common. In fact, even during the huge run-up in housing prices, the percentage of equity people had in their houses did not rise significantly on average nationwide. People assumed that housing prices would never fall and so it was safe to spend the equity gains that occurred as housing prices rose.
Then, as prices fell, the equity in houses fell even more sharply as a result, wiping out trillions of dollars of wealth. It also resulted in huge numbers of people being "underwater" on their mortgages, owing more than the house is worth.
Being underwater is a necessary condition for a foreclosure to happen. If the homeowner has positive equity in a house, he will always be better off simply selling the house rather than let it slip into foreclosure. It is, of course, not a sufficient condition.
There are lots of people who are underwater on their houses who are still paying the mortgage. The depth of the water matters. There are also non-economic factors to consider -- for most people a house is a home, and they have strong attachments to it and the community it is in. People don't want to have to uproot their families and pull kids out of the schools they are going to.
Letting a house go into foreclosure is not exactly good for your credit rating, either. Thus if a homeowner still has solid cash flow and is only a little bit underwater, the odds are that he or she will keep on paying the mortgage. However, if one or both of the breadwinners in the family become unemployed, the odds of the house going into foreclosure rise significantly. If the house has a mortgage of $250,000 on it, the house is more likely to go back to the bank if it is worth $200,000 than if it is worth $245,000.Still an Enormous Problem
Over the weekend I saw some graphs that were part of a Congressional briefing on the subject by Mark Zandi of Moody's Economics and Robert Schiller, the Yale professor and the co-creator of the Case-Schiller housing price index. The graphs below come by way of http://www.calculatedriskblog.com/2010/07/negative-equity-breakdown.html. They show that while the situation has stabilized recently, we still have an enormous problem on our hands.
The recent small uptick in housing prices is mostly due to the homebuyer tax credit. In a subsidized transaction, and the tax credit is a textbook example of a third party (Uncle Sam) subsidizing a transaction, both the buyer and seller will benefit. The buyer sees it come April 15th, the seller in the form of a higher price for the house.
By arresting the decline of housing prices, the tax credit did prevent more homeowners from slipping below the waves. Of course, after someone actually loses the house to foreclosure, or if he or she can arrange a short sale where the bank agrees to let the homeowner sell the house for less than the amount of the mortgage and not have to show up at closing with a big check, the house is no longer underwater.
The first graph (all the graphs are from this site
) shows the percentage of homes with mortgages that are underwater (solid blue line, left scale). It doesn't matter if the house with the $250,000 mortgage is worth $249,000 or $49,000, as long as it is worth less than the amount of the mortgage it is included.
At one time, it was common for people to have mortgage-burning parties where people celebrated the last payment to the bank on the house.