Does Negative Equity Flood the Market with Defaults?

I hope not to be thought of as similar to 'The Majestic', but with some of this stuff I find it hard to be my usual light-hearted self. Maybe on Fridays we can let one of the earlier commentators follow the desire to force a third topic in there and post top political and financial babes and hunks? I know Alec Baldwin's vote would be for Condi...

Anyway, back to the idea of housing leading he economic downturn and the need to do something about it. A reader, who is a good friend from Nashville, pointed out that I probably have a bit of the "renter's" view. In other words, if home prices go down, I lose nothing and only gain. That's true. I can't really escape it. However, I also cannot escape the point that it does not make sense to try and keep asset prices at an unreasonably high level. It seems to me that any mortgage rate subsidization (hearing 4%) or mortgage backed securities purchases by the government is just an attempt to keep something at an artificial level. How long does it go on for and how does the government get out?

The tax rebate, also mentioned by my friend, for mortgage interest expense is already one nice subsidy for housing. If the Maestro had not lowered interest rates to next to nothing in the first place, we probably would not be in this situation. Let's take our lumps now and get back to a normalized economic growth rate - which unfortunately is probably less than what we've experienced over the past decade.

Another argument is that falling housing prices will just tie people to their homes and the workforce will not be able to move to new jobs elsewhere. Similarly, people will not be able to downsize if they want because they will owe the bank so much. I think the size of this negative feedback loop (selling begets more selling and lower prices still and banks go bankrupt) may be exaggerated. If you bought a house, you likely aim to live there for at least five years. If on paper if you have negative equity, as a result of itemizing your interest expense and fully deducting it, even with typical monthly improvement/upkeep payments, you are probably approximating in monthly payment what a rent payment would be for a similar property.

For example, if you got a $400k no money down, 5% fixed 30 year mortgage, your monthly payment would be $2,563.95 with 1.25% property tax and no PMI. But if you net out your interest expense tax rebate (assume even interest payments over the term of the mortgage) your payment would be about $1,500. So add $300 (arbitrary) a month in "upkeep" to that and you get $1,800. If you put 10% down your monthly payment is approximately $200 less. I am willing to bet that rent from a landlord on a similar property is at least in the neighborhood of $1,800. So if you plan on staying in your home, its probably worth not incurring the costs of moving and makes it unlikely that you will just walk on your property. Hopefully, property values base and negative equity turns positive as more of the principal is paid down (granted unlikely over five years).

If you want to leave town because you have a job elsewhere, but are underwater, in that situation it probably makes sense to just walk. Your credit will take a hit, but you have a job and that should aid in at least finding a place to rent. If you are underwater and need to downsize in order to keep a livable lifestyle, but the bank won't speak w/ you because you have defaulted on a payment, it probably makes sense to try and work some sort of modification of principle out with the bank. There is no need to be ashamed or in denial of the need for this sort of workout. Maybe it takes a couple of missed payments to facilitate this, but probably best not to get to that point and try to deal with bank up front.

I feel bad for people who are underwater and detest the liar loans, bad bankers, brokers, and Realtors who pumped this market up but how does supporting asset values in the context of a market that still has a lot of excess supply makes sense? The money will be spent, but that is no guarantee that confidence will return.

The government should be more focused on unwinding some of these banks, protecting depositors deposits and assets and in a balanced way letting some of these insolvent institutions go. I read an interesting view yesterday that this is what should have happened with Lehman and AIG. The institutions that profited on the upswing should not be bailed out by the government in the downturn. America is a place of change and new faces in the banking industry make sense. Same in the Fed. Didn't Ben Bernanke claim there was no housing issue weeks before taking office?

-2outof4