Bailout of Housing = Bailout of Banks   (August 5, 2010)

Every bailout shares one central trait: it's always really a bailout of banks advertised as "saving Mom, apple pie and the American Way" or its equivalent.

Here is the only guide you need to understanding any and all bailouts:

Bailout of X (housing, Iceland, Greece, AIG, Harry Potter Theme Park, the ibogaine industry, etc.) is always a bailout of banks. The bailout of X is simply shorthand for the taxpayer bailing out the banks which are insolvent due to their overleveraged, risky lending. The bailout of X (let's say housing) is simply the PR facade, the socially appealing and politically correct pretense to shovel billions of dollars into the banking cartel to save it from the consequences of its faulty risk models, fraud, collusion, embezzlement, misrepresentation and influence-peddling.

Let's take a few examples:

1. Bailout of Greece = bailout of French and German banks which foolishly lent gargantuan sums to Greece.

2. Bailout of AIG ("to save the global financial system we all love and need") = bailout of AIG's counterparties: Goldman Sachs, various European banks (yet again), etc.

3. Bailout of housing (a.k.a. "America's sacred right to home ownership") = bailout of mortgage lenders, institutional owners of defunct mortgage backed securities, Countrywide/Bank of America, etc.

Let's look a little deeper into the ongoing bailout of housing.

Naturally, the bailout is being sold as "helping Americans keep their homes."

Does anyone seriously believe the financial and political Power Elites give a rat's rear-end about the 24% of American homeowners who owe more on their mortgage than their house is worth, i.e. underwater "owners"? Of course they don't. Their only concern is that banks might have to suck up trillions of dollars in losses, and thus eventually be recognized as functionally insolvent.

Knowing as we do that any "aid to housing" is aimed at saving banks from housing-related insolvency, we might ask: just how much pain is potentially out there for banks and institutions holding mortgages and mortgage-backed securities?

Calculated Risk recently published an interesting analysis of negative equity:

As of Q1 2010:

There is almost $2.4 trillion mortgage debt for homes in negative equity.

The total negative equity is $771 billion.

There are 4.1 million homeowners with more than 50% negative equity (they owe 50%+ more than their homes are worth).

Other sources estimate that 24% of mortgage "owners" are underwater.

For context: according to the U.S. Census Bureau, as of 2008, 51 million households have a mortgage and 24 million own homes free and clear (no mortgage), and about 37 million households rent.

Since several million homes have either been foreclosed or are in the foreclosure pipeline (delinquent, defaulted, etc.), the actual number of current mortgages is undoubtedly less than 50 million.

What we do know is that lenders are fearful that many of the 11-12 million homeowners who owe more than their house is worth will walk away from them, especially as the real estate market begins to weaken again. According to this New York Times article, "The so-called strategic defaults have become a matter of intense debate in recent months."

When did "Holy Moly, we're bagholders!" qualify as a debate?

We know that strategic default is the preferred option for the upper class when it finds itself on the wrong side of a speculative investment; the delinquency rate on investment homes where the original mortgage was more than $1 million is now 23 percent. One in seven homes over $1 million are in default.

Lenders have good cause to worry about underwater "owners" walking away. The correlation between being underwater and defaulting is very high, as this chart illustrates.

According to the Fed Flow of Funds, total mortgages total $10.24 trillion and total equity is $16.5 trillion. As I showed in Housing and the Collapse of Upward Mobility (April 16, 2010), since free-and-clear owners hold at least 32% of all $16.5 trillion in home equity ($5.3 trillion), that leaves at best about $1.2 trillion in equity spread amongst the 50 million homes with mortgages.

So roughly 12 million homeowners have negative equity, and about 9 million are underwater by 20% to 50%. While the report published in Calculated Risk pegs negative equity at $771 billion and total mortgage debt on underwater homes at $2.4 trillion--roughly 25% of all outstanding mortgages--the recent decline in sales (post-housing credit) raises the question: how many of the other 37 million mortgages will slip underwater if house prices decline?

One way to estimate how many homeowners are close to being underwater is to look at how many homes have a traditional, conventional 30-year mortgage. As I showed back in 2007, the number of homes with conventional mortgages was modest compared to those encumbered with adjustable-rate mortgages, second mortgages, home equity lines of credit, and so on--in other words, those with low down payments and multiple mortgages on their home.

The large number of low-down FHA loans which have soured suggests that many homeowners have little to no equity, even if they are not yet officially underwater.

If we reckon that the most likely owners to still retain a healthy margin of equity are those 12 million owners with conventional mortgages, that suggests the following:

-- 11-12 million homeowners are already seriously underwater (10%-50%).

-- Of the remaining 37 million mortgages, 25 million are at-risk due to being adjustable, or encumbered with high-interest rate second mortgages or HELOCs (home equity lines of credit).

This suggests that the remaining $1.2 trillion in equity in all homes with a mortgage is concentrated in the 12 million homes which were purchased with a conventional down payment before the housing bubble expanded in earnest around 2002.

If we consider the millions of homeowners who did not re-finance or saddle their properties with additional mortgages, and those who bought in the 1980s or 1990s whose mortgages have already been substantially paid down, then it bolsters the notion that most of this $1.2 trillion in equity resides in about 25% (12 million) homes. Interestingly, $100,000 in equity multiplied by 12 million equals $1.2 trillion.

That suggests fully half (25 million) of homeowners with mortgages have little equity.

Were household income and home values to both decline, many of these 25 million homeowners with minimal equity would be at risk of either being unable to pay their multiple mortgages or of slipping underwater.

Housing: it's worse than you think (by Scott Sambucci, Vice President, Data Analytics, Altos Research)

In other words, the 11-12 million mortgages currently underwater could well be the top of the iceberg if incomes and house values continue stagnating/declining.

No wonder the banks are demanding that housing be bailed out. They could end up holding the bag on a lot more than $770 billion in negative equity.

Housing Basics: Massive Supply, Faltering Demand (July 15, 2010)

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