The rate of default among home owners with prime mortgages is soaring. These are supposed to be the safest mortgages, the ones that went only to borrowers with the best credit scores, remember.
And that’s a huge problem for a banking system that was almost brought to its knees when subprime mortgages, those that went to borrowers with the worst credit, defaulted by the truck load.
The dollar volume of prime mortgages in delinquency or default rose 13.8% from March to June, according to a new study by Standard & Poor’s.  The study only covered mortgages originated by banks, bundled into securities, and then sold to investors. It omitted what are called “conforming” mortgages, backed by federal-government-backed Fannie Mae (FNM) or Freddie Mac (FRE).
The study comes as some Wall Street analysts have started to question recent numbers suggesting that the housing market has either bottomed or moved into recovery. The widely followed S&P/Case-Shiller index of housing prices showed a gain in prices in May from April. That was the first month-to-month increase since 2006. On an annual basis prices declined a seasonally adjusted 2%, leading investors to argue that the housing market was near a bottom.
The problem, though, is that pesky phrase “seasonally adjusted.” Efforts to revise the raw data to reflect normal seasonal swings in home buying activity–most home buying takes place in the spring and summer–led to over-stating the price recovery, analysts at Barclays Capital and Bank of America have argued. A more accurate estimate, Barclays calculated, would be that housing prices declined at an annual 10% to 15% rate.
In other words, this market hasn’t seen bottom yet.
Coming from different perspectives, it’s striking to me that the studies of prime mortgage defaults and seasonal mid-adjustment both agree that the housing market and home prices aren’t in recovery yet.
The S&P study of default rates found that defaults by the most troubled mortgage borrowers–those holding subprime and Alt-A mortgages–have stabilized. Non-performing balances for Alt-A mortgages, the risk class just above subprime, rose by just 3.2% in the quarter from March to June. The dollar volume of non-performing subprime mortgages fell 4.2% in the quarter.
Why are defaults and deliquencies on risky subprime and Alt-A mortgages falling or leveling off, respectively, when defaults on mortgages to better credit risks are climbing so quickly? The S&P report theorizes that the most troubled borrowers–those who got no-income-verification mortgages, for example, on what turned out to be truly inadequate incomes–have already gone into default. More credit worthy borrowers with prime mortgages have managed to hold on without defaulting but are now finally going under as long-term unemployment devastates family finances.
The analysts at Bank of America are looking for reports this fall to show that housing prices are still falling at double digit rates and that the housing market hasn’t bottomed. “Distressed sales are less seasonal than healthy sales, since distressed borrowers don’t have the luxury to time the sale of their home,” the July 31 report from Bank of America said.
While home sellers who put up for sale signs on their front lawns in the summer–just to see what kind of offer they might get–take those signs down again in September if they haven’t sold, distressed sellers leave them up. That should lead to a higher than normal seasonal supply of houses on the market in the fall and a resumption of declining home prices, the Bank of America report concludes.
Barclays’s analysts calculate that U.S. home prices will fall an additional 11% on average before they hit bottom in 2010.
Henry, what you say is true. The fast money is made by buying before the turn. Of course, if you buy on a false turn, you get slaughtered. I’ve been looking to get some of the gain from being early while cutting the risk by buying some of the corporate bonds of the better capitalized home builders such as D.R. Horton–when the bonds sell for substanial discounts to par. I don’t think you can find bargains in that market now but if we see another housing scare, you should take a look at any of those bonds selling below par and with 8% to 12% yields. Make sure that the company’s cash flow will cover the interest payments, etc.
I’ve been through two other housing busts and in both cases, people who saw the value of their homes plunge walked away and took the credit hit, regardless of their ability to pay. Here in Austin, Tx., our market has remained good for homes below 225K with very little downward pressure and short supply levels. Above 225K, the market has a huge supply along the lines of 23 months and sellers haven’t come to grips with inevitable lower prices.
The bottom isn’t in until people walk away from their mortgage obligations, regardless of their ability to pay.
I still think that recent “recovery” of the housing market was mostly due to the stimulus to the first-time buyers. In most of the areas houses are still overpriced (historically fair, inflation adjusted price is a flat line); however, you can find quite a few bargains if you are willing to wait 5 years and protect your money from a possible wave of inflation.
I was surprised by today’s advancement of AIG. I could understand 20% jump, but 60% is too much, unless someone explain me the math behind this new evaluation of AIG.
I know individuals that have foreclosed on their houses voluntarily. The reasoning is that they are so far underwater on their mortgage that they think it’s a good business decision to walk away….In Phoenix where I live, most homeowners that are prime and bought between 2004 and 2009 are at least 100k underwater.
If you wait until the housing finally bottoms in 2010, Jim, you will have missed a 40% up turn in housing stocks
I know a few families of friends who bought 1M dollar houses in the DC metro area that are now under water and finding it hard to to keep up with mortgages, if 1 person loose their job it would be disastrous for those families.