[p2p-research] The $4 Trillion Dollar Question

[Ryan]

  Sent to you by Ryan via Google Reader: The $4 Trillion Dollar Question
via The Big Picture by Barry Ritholtz on 7/15/10

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.



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