The Housing Bear Climbs Over the Mountain

By Kevin Brekke

The bear went over the mountain, the bear went over the mountain

The bear went over the mountain, to see what he could see.

And all that he could see, and all that he could see

Was the other side of the mountain, the other side of the mountain

The other side of the mountain, was all that he could see.

– Children’s Song

I was reminded of this favorite kid’s song, sung to the tune of For He’s a Jolly Good Fellow, while revisiting a chart out of Credit Suisse that made the rounds a few years ago. Many of you will recall this chart that showed the monthly dollar figure of mortgage resets for the years 2007 through 2014.

The original chart was plotted as a column chart. I have converted the figures into a line chart and over-laid it against the Case-Shiller index. There have been several updated versions of the original chart, and they do not all agree exactly on the monthly amounts. In those instances, I have used an average to construct the following chart. The Case-Shiller Index is as of February 2011, which is the latest available data. Here it is:

The steep decline in house prices that commenced in 2007 was interrupted by two speed bumps of reprieve in 2009 and 2010, which were the products of several government intervene-and-rescue schemes.

The $8,000 first-time homebuyer’s tax credit that was rolled out in 2009 (and expired later that year) was revived and expanded in 2010. The brief and shallow recovery in house prices during both years directly correlates to the stimulating effects on demand fostered by these programs.

As you can see, throughout it all, U.S. house prices have had to contend with a multi-year series of spikes in mortgage resets within the context of an overall elevated level of resets, as shown in the next chart.

The $421-billion reset hurdle for housing in 2011 will continue to exert downward pressure on prices. As these mortgages are adjusted to a higher interest rate – and hence a higher monthly mortgage payment – it will likely mean another wave of homeowners unable to make the new payment, ending up in foreclosure or a short sale (the house is sold for less than is owed, contingent on the bank’s acceptance of such terms).

How big might that wave be? If we make a few reasonable assumptions, we can make an initial estimate of the number of mortgages facing reset. Assuming that most of the mortgages are five-year ARMs means they were originated in 2006 when the median price for a house was $242,000. Doing the math ($421 billion divided by $242,000) gives a ballpark figure of 1.74 million mortgages that could potentially adjust this year. But the actual number is almost certainly less, as many of these loans have already defaulted.

Further complicating the picture, and offsetting to an unknown degree the number of loans that defaulted before the reset date, is the amend-pretend-extend consequence of the Home Affordable Modification Program (HAMP) that I discuss here.

This program – and its many derivatives – sought to help homeowners avoid default through modifying the terms of the loan, principal forgiveness, or both. The problem is that over 70% of homeowners who have their mortgages modified are again 60+ days delinquent within 12 months.

HAMP became active in March 2009 and continues still today. Through 2010, 540,000 mortgages have received permanent modifications, which means that the 385,000 of these that will relapse into default did so in 2010, or will do so in 2011, rather than during the prior two years.

Lastly, let’s consider the moratorium on foreclosures that was voluntarily self-imposed by some big U.S. lenders in the final quarter of 2010. Concerns about cutting corners and shoddy paperwork in the foreclosure process reached a fever pitch last October. Bank of America halted all foreclosure proceedings, and JPMorgan and GMAC called a moratorium in many states. The actions were short-lived, though, and succeeded in pushing a large number of foreclosure completions forward into 2011.

Regardless of the actual numbers, the housing market has one more mountain of mortgage resets to climb; it started last month and will continue through late 2012. This will only aggravate the number of foreclosures. With house prices behaving like they intend to resume their trajectory of descent seen in 2008/2009, a bottom in house prices does not look possible until at least 2013.