Four years of steadily declining home prices have made home ownership more affordable than at any time since the housing boom began in 2003.
The ratio of median home prices to annual household income in 74 major markets declined from 2.3 in late 2005 to 1.6 in the third quarter of last year, according to data compiled by Moody’s Analytics-- the lowest ratio in the 35 years this information has been collected.
“Based on incomes, this is as affordable as it gets,” Mark Zandi, chief economist at Moody’s, told the Wall Street Journal.
That represents the good half of what is a good news-bad news story. The bad news: The price decline that has boosted affordability ratios has left 27 percent of homeowners who have mortgages underwater, with loan balances exceeding the current value of their homes and facing the prospect that prices could decline another 10 percent or more, some analysts believe, before finally hitting bottom next year. Markets that are already seriously undervalued “are going to get even more undervalued,” Zandi warns.
Expectations that the housing recovery will continue to lag have revived concerns that more buyers will “strategically default,” making an economic decision to walk away from homes in which they have no equity and little hope of rebuilding it any time soon. In a recent survey by Housing Predictor, an on line real estate forecasting firm, nearly half the respondents said they would walk away from their homes even though they can still make the payments, if prices continue to fall.
But another study by economists at the Federal Reserve Bank of San Francisco suggests that the concern about strategic defaults may be exaggerated. Borrowers will make a strategic default decision if home values fall too far below their mortgage balance, economists John Krainer and Stephen LeRoy agree. But the tipping point is a lot lower than many analysts assume, they contend in a recently published working paper.
When the home value and mortgage balance are equal, the owner, though in a zero equity position, still has an incentive to remain in the home, Krainer and LeRoy say, because he is in a “heads-I-win, tails-you-lose” position with the lender. If prices decline more, the borrower can walk, increasing the lender’s loss but leaving the borrower no worse off; if prices recover, the borrower benefits. “With both upside potential and downside protection against future losses, the borrower rationally should wait before defaulting,” Krainer and LeRoy argue.
Strategic default predictions based on negative equity alone also fail to recognize the distinction borrower’s make between the “book value” of their equity – a function of the home’s price – and the “market value” which incorporates other variables, including the borrower’s expectation that prices will recover and the costs incurred by walking away, such as moving expenses and a lower credit rating.
“The possibility of price appreciation and the costs of default – [both actual and perceived], move the rational default point well below the underwater mark,” the economists conclude. “One of the key lessons from this area of research is that analysts must be careful in calculating the precise default point on mortgages,” they caution. “We should not expect a discrete jump in default rates once house prices fall to the threshold at which home value equals the remaining book balance on the mortgage.”
OLDER BUT NOT BETTER
Unlike good wine, the results of various foreclosure prevention programs do not seem to be improving with time. In fact, recent statistics suggest that some of the trend lines have turned negative. Servicers modified a total of 36,5000 mortgages through the government’s flagship Home Affordable Mortgage Program and the proprietary programs of individual lenders – down 57 percent from 86,500 modifications reported in April, 2009.
“The combined efforts of HAMP and other loan modification programs have made little more than a dent in the large volume of outstanding distressed loans,” analysts for Fitch Ratings conclude in a recent report.
The performance of loans that have been modified has also been disappointing. A Treasury Department report estimates that 20 percent of the borrowers whose loans were modified under HAMP re-defaulted within 12 months. Separate reports by Moody’s Investors Service and Standard & Poor’s also concluded that modifications are providing only temporary relief, not the foreclosure prevention cure supporters had hoped to create.
Of the 2 million loans in the Moody’s analysis, nearly half (47 percent) of those that were modified re-defaulted within 12 months, compared with only 16 percent of the loans that were not modified re-defaulted. In the S&P study, 80 percent of the loans modified between 2007 and 2010 re-defaulted within 24 months.
“At 24 months following modification, the payment statuses of modified loans showed no significant improvement compared with the month before they were modified,” the S&P report concluded.
Like previous studies, both the Moody’s and S&P reports found that reducing the principal balance of loans improves modification outcomes significantly. And more recent modifications have moved in that direction, but not in large enough numbers to significantly improve the results. As a result, Diane Pendley, managing director at Fitch, predicts: “Based on current and expected inventory, it will take four years to remove the backlog of properties and return the market to balance.”
NEVER MIND
The Federal Reserve Board has decided to take a pass on revising Truth-in-Lending disclosure requirements for residential mortgages.
The Fed issued proposed regulations last year, targeting closed-end mortgage loans, home equity lines of credit, reverse mortgages, and the rescission rights of borrowers. But with the new Consumer Financial Protection Bureau (CFPB) slated to assume rule-making responsibility for both TILA and the Real Estate Settlement Protection Act (RESPA), Fed officials decided that “proceeding with the…proposals would not be in the public interest.”
Mortgage lenders currently give borrowers two sets of disclosures to comply with TILA and RESPA. The Department of Housing and Urban Development (HUD) recently overhauled the RESPA disclosures, over the stringent objections of mortgage industry executives, who continue to complain about the results. Because the Dodd-Frank financial reform legislation directs the CFPB to combine the TILA and RESPA disclosures in a single form, “any new disclosures adopted by the Board would be subject to the CFPB’s further revision in carrying out its mandate to combine the TILA and RESPA disclosures,” the Fed noted in a press release explaining the decision to withdraw its proposed rules. “In addition, a combined TILA-RESPA disclosure rule could well be proposed by the CFPB before any new disclosure requirements issued by the board could be fully implemented,” the Fed release added.
Although the CFPB’s rulemaking would not affect some provisions of the Fed’s proposals, adopting them “in a piecemeal fashion would be of limited benefit, and the issuance of multiple rule with different implementation periods would create compliance difficulties,’ the Fed said.
Elizabeth Warren, appointed as a special advisor to establish the CFPB, has said she wants to replace the “pile of papers” lenders currently produce to comply with the TILA and RESPA disclosure requirements with a one or two-page mortgage disclosure document.
Although simplification proposals have ignited firestorms of opposition in the past, there is little dispute about the need to streamline mortgage disclosures and make them more useful to consumers. Nearly one-third of the respondents to a recent on-line survey by MortggeMatch.com said they found understanding the mortgage process more challenging than actually obtaining a mortgage.
“This survey is a wakeup call,” Sue Stewart, senior vice president at Move Inc., which manages MortgageMatch, said in a press statement. “[The responses] clearly point to the fact that borrowers want a process that is easy to understand and follow. They don’t want surprises and they want to be able to depend on their mortgage lender.”
CONSUMERS SPENDING AGAIN
Consumer debt levels are beginning to rise again, providing either reassurance that the economy is strengthening or cause for concern that consumers are repeating the over-leveraging mistakes of the recent past – and possibly a little of both.
The Federal Reserve reports that consumer borrowing overall increased by 3 percent in December to a seasonally adjusted annual rate of $2.41 trillion – the third consecutive monthly increase. Credit card borrowing alone increased by 3.5 percent, posting the first increase in this category since August of 2008. Even with those gains, consumer borrowing overall is less than 1 percent higher than its three-year low point, reached in September of last year, but analysts are predicting that spending levels will continue to increase this year as the employment picture brightens and lenders relax credit standards. Most analysts don’t expect spending and borrowing to reach boom-period levels, however, at least in part because much of that activity was fueled by an overheated housing market that encouraged homeowners to spend based on the equity in their homes rather than the cash in their bank accounts.
That equity cushion has been deflated, and despite two years of curbing spending and increasing savings, consumers remain heavily burdened by debt. CareOne Services, a debt relief company, reported recently that consumers are still carrying an average debt load of more than $10,000. The report, which ranked states based on average consumer debt loads, found Delaware residents to be the most burdened, with per-person debt loads of $20,233, followed by Rhode Island ($20,130), Maine ($19,454), and Alaska ($19,225). California residents, with the smallest debt burdens, still weighed in at more than $12,000 each.
Borrowers usually accumulate uncomfortable debt levels for one of three reasons, the CareOne report notes: Failing to adjust their standard of living to a change in economic circumstances; using credit cards for emergencies, but then failing to pay off the balance, or “chronic unconscious incompetence,” which the report defines as “a vicious cycle of spending without ever thinking of the consequences.”
“People do just what they’ve always done,” Mike Croxson, president of CareOne, noted. “They spend and they pay, they spend and they pay and they don’t really know what they’re doing.”
MONEY = HAPPINESS AFTER ALL
We all know money can’t buy happiness – but maybe it can. After reviewing 40 years of happiness research spanning hundreds of thousands of people in 155 countries and cross-matched with economic development data, researchers at the Wharton School have concluded that people in more affluent countries are, on the whole, happier than people in less affluent nations.
That conclusion (which seems obvious) actually challenges the widely-accepted view of other behavioral scientists, who have determined that happiness is relative, depending not on how much money individuals have but on how wealthy they feel in relation to others in the same country – a “keeping up-with-the-Joneses” effect.
Based on that theory, someone earning a few dollars more than the average in a poverty-stricken country would be just as happy, in relative terms, as someone earning $200,000 in the United States. The idea that people adjusted to poverty and found happiness even at the lowest economic levels was comforting to people living in more prosperous countries, Justin Wolfers, an associate professor at Wharton and a co-author of the study, told Reuters, because “you didn’t have to feel bad as you drove down the road in your BMW.”
The conventional wisdom assumed that happiness depended on the ability to”keep up with the Joneses,” whatever their income level. But the Wharton study suggests that relative income is only marginally significant in the happiness equation, Wolfers said. “If the Joneses live in a rich country and you also live in a rich country, you’re both happier than you would be if you lived in a poor country,” because in a rich county, “you don’t have to worry as much about your kids dying. You’re rarely in pain. You [probably] don’t have to earn a living through manual labor….In a poor country like Burundi, where you’re worried about your child dying, the little buzz you might get from being richer than the Joneses doesn’t really matter.”
