Thought Theater

Pearls Of Wisdom: The World Is No Longer Our Economic Oyster genre: Econ-Recon

Economists attempt to measure the health of the economy in a variety of ways. I'm of the opinion that two news reports (here and here) shed some ominous light on its status and may well signal the need to sound the alarm bells. For many years real estate, and in particular home ownership, has been the single greatest source of wealth accumulation for the average American. As such, it has served as the foundation for much of our confidence to spend money.

Having the safety and security of growing home equity has given consumers confidence to make purchases they might otherwise forego. It has also been the source of the capital needed to make large ticket purchases that wages may not always enable. The buying, selling, and refinancing of homes has pumped countless dollars into our economy and in recent years it has helped to offset the shifting dynamics of growth.

Following the recessionary period at the beginning of this decade, much of the growth we've experienced hasn't translated to better jobs or higher wages. In fact, for a large majority of Americans, the latest period of economic growth has been accompanied by a decline in the standard of living for those in the top tier of incomes.

Here's where the housing bubble comes into play. In this same period of time, we've seen an unprecedented increase in home values and therefore some means for consumers to offset the lack of measurable benefits from this latest period of economic expansion. Unfortunately, that offset appears headed towards a screeching stop...and likely a virtual reversal of fortune.

Let's first look at the foreclosure picture since the bubble has already burst for these individuals.

WASHINGTON - Home foreclosures soared to an all-time high in the final quarter of last year and are likely to keep on rising, underscoring the suffering of distressed homeowners and the growing danger the housing meltdown poses for the economy.

The Mortgage Bankers Association, in a quarterly snapshot of the mortgage market released Thursday, said the proportion of all mortgages nationwide that fell into foreclosure shot up to a record high of 0.83 percent in the October-to-December quarter. That surpassed the previous high of 0.78 percent set in the prior quarter.

More homeowners -- at the same time -- fell behind on their monthly payments.

The delinquency rate for all mortgages climbed to 5.82 percent in the fourth quarter. That was up from the 5.59 percent in the third quarter and was the highest since 1985. Payments are considered delinquent if they are 30 or more days past due.

The percentage of subprime adjustable-rate mortgages that entered the foreclosure process soared to a record of 5.29 percent in the fourth quarter. That was up from 4.72 percent in the prior quarter, which had marked the previous high. Late payments skyrocketed to a record high of 20.02 percent in the fourth quarter, up from 18.81 percent -- the previous high -- in the third quarter.

Take note of four key numbers. One, we're approaching the point at which one percent of all mortgages are in foreclosure. Two, over five percent of ALL mortgages were considered delinquent. Three, over five percent of all subprime adjustable rate mortgages are in foreclosure. Four, over twenty percent of the remaining subprime loans are delinquent.

It doesn't take a math wizard to realize that we're on the front end of this crisis and it's clearly going to get worse before it gets better. Why? Two reasons. First, the interest rates on more loans are going to adjust upward. Second, home values are going to continue to decline which will mean more borrowers will be unable to refinance. So what does this mean? It means there is currently nothing on the horizon that will blunt the increase in foreclosures...or the increase in borrowers who won't be able to refinance out of unfavorable loans.

Now let's look another key piece of the problem...the decline in homeowner equity.

NEW YORK - Americans' percentage of equity in their homes fell below 50 percent for the first time on record since 1945, the Federal Reserve said Thursday.

Homeowners' portion of equity slipped to downwardly revised 49.6 percent in the second quarter of 2007, the central bank reported in its quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 percent in the fourth quarter -- the third straight quarter it was under 50 percent.

That marks the first time homeowners' debt on their houses exceeds their equity since the Fed started tracking the data in 1945.

The total value of equity also fell for the third straight quarter to $9.65 trillion from a downwardly revised $9.93 trillion in the third quarter.

Home equity, which is equal to the percentage of a home's market value minus mortgage-related debt, has steadily decreased even as home prices jumped earlier this decade due to a surge in cash-out refinances, home equity loans and lines of credit and an increase in 100 percent or more home financing.

Economists expect this figure to drop even further as declining home prices eat into the value of most Americans' single largest asset.

Moody's Economy.com estimates that 8.8 million homeowners, or about 10.3 percent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households, or 15.9 percent, will be "upside down" if prices fall 20 percent from their peak.

The latest Standard & Poor's/Case-Shiller index showed U.S. home prices plunging 8.9 percent in the final quarter of 2007 compared with a year ago, the steepest decline in the 20-year history of the index.

I would argue that this data may be even more troubling than the rising foreclosure and delinquency rates because it undoubtedly predicts more declines in consumer confidence and spending and thus growing recessionary pressure.

Take particular note of the connection between the housing bubble and the latest economic expansion. When home values soared at the beginning of this decade, homeowners borrowed more money. They did so because the economic growth didn't translate into better jobs and higher wages. Hence, more Americans dipped into rising home equity to keep apace with rising costs....and we haven't even touched on rising credit card debt.

What this tells us is that the latest expansionary period was primarily manufactured through the implementation of artificially low interest rates which enabled homeowners to bolster spending through debt. Lower interest rates meant people could afford more expensive homes. Once this rollover process began, it set in motion rising home prices that were unsustainable. Even worse, it gave homeowners and borrowers a false sense of security. People began to believe their home values would continue to rise and they became less averse to pulling out and spending a higher percentage of their paper equity.

While one can fault these individuals for taking greater risk, one must also consider the incompetence of those who enabled this housing bubble...complete with shoddy monetary policy, suspect lending practices, and inadequate oversight. Not since the Savings & Loan scandal of the late 80's have we seen such shortsighted and lax practices...complete with the now infamous non-qualifying assumption loans.

Well, just over twenty years later, we've done it again. I have two favorite examples of the current debacle. First, the 125% loan...a loan that simply allowed homeowners to borrow 25% more than a home was worth. Second, what the industry initially called "stated income" loans (NINA's - no income, no asset verifications), which are now being called "liar loans". Essentially, the borrower was allowed to state an annual income and place a value on assets held without the requirement of any substantiation.

What remains to be seen is how long it will take our government to fully embrace the magnitude of the current crisis. Sadly, the hope that reducing interest rates or rolling out programs like "Project Lifeline" will solve this problem is more of the same. A quick look at the value of the dollar informs us of the consequences that accompany these efforts to avoid the inevitable.

Harsh as this may sound, I find myself in general agreement with the following thoughts of Robert Samuelson from a recent Washington Post column.

Gloom. Doom. Calamity. Home prices are tumbling. We're bombarded by somber reports. But wait. This is actually good news, because lower home prices are the only real solution to the housing collapse. The sooner prices fall, the better. The longer the adjustment takes, the longer the housing slump (weak sales, low construction, high numbers of unsold homes) will last.

Samuelson isn't keen on aggressive measures to assist those who are in foreclosure or upside down; arguing that it only postpones the necessary adjustment. While this may sound heartless, the point he's making is that we must cease our efforts to bolster a weakened and changing economic structure by creating artificial housing prices. The sooner we strip away this facade, the sooner we can begin to address the deficiencies of our underlying economy.

The longer we tinker with the primary means of accumulating wealth (homeownership), the more likely it won't be available to more and more Americans. In this time of job loss to globalization, we can ill-afford to damage one of the last bastions of the American Dream...especially for an increasingly challenged middle class.

We must demand that our politicians implement the measures necessary to insure a sound and sustainable economy without resorting to politically expedient manipulations meant to mask the manifestations of a world economy. While the world used to be our oyster, I suspect our share of the pearls is destined to decline. Knowing this, I would suggest our leaders start by setting a better example with regards to fiscal responsibility. Lest we be buried by the shifting tides, it's time for a sea-change.