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  Posted on: Thursday, August 20, 2009
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Rising Foreclosures Undermining the Economy

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The current and prospective foreclosure rate on residential mortgages is one of a number of factors threatening to undermine the economy just as various stimulative measures are about to run out.   A report issued by the Mortgage Bankers Association for the second quarter indicated that the share of overdue mortgage loans rose to a record-high 9.24% of all mortgages, from 9.12% in the first quarter and 6.41% a year earlier.  The number of homes already in foreclosure was 4.3% of all loans, the most in three decades of recorded data.  This was up from 3.85% in the prior quarter.  Furthermore the number of loans overdue by 90 days increased to 7.97%, the highest on record.  This is a particularly important statistic since the majority of loans overdue by 90 days usually end up in foreclosure within a short time.  All told, the combined percentage of loans past due and already in foreclosure was another record at 13.16% of all outstanding mortgages.

A key aspect of the report was the increasing problems in prime fixed-rate loans.  The delinquency rate for prime loans climbed to 6.41% from 6.06% while the foreclosure rate increased to 3% from 2.49%.  All in all, prime fixed-rate mortgages accounted for one in three foreclosures, compared to one in five a year earlier.  This was a pronounced shift from earlier periods when the problems were mainly in subprimes, and indicates that mortgages are now being affected by the overall weakness in employment as opposed to earlier in the cycle when the problem was mainly related to structured loans and the issuance of mortgages to people unqualified from the get-go.  In this connection, we note that 5.7million jobs have been lost since January 2008, the largest employment drop since the depression. Employment is still declining, albeit as a reduced rate, and wages are 4.7% below a year ago. Since prime loans account for two-thirds of all mortgages it seems likely that foreclosures will continue rising in the period ahead.

Foreclosures have also continued in the current quarter as well.  Last week RealityTrac reported that July foreclosures were up 7% from June and up 32% from a year earlier.  In addition, as we stated in last week's comment, a study by Deutsche Bank showed that on March 31st, 26% of US homeowners with mortgages owed more on their properties than they were worth, and that this will rise to an estimated 48% by the first quarter of 2011 as home prices drop another 14%.  Such underwater mortgages are another factor that leads to more foreclosures.  As if this weren't enough, another wave of resets on adjustable rate mortgages is due to begin late this year and continue through next year as well.  Throughout the current down cycle in housing, resets have been precursors of more defaults followed by foreclosures.

Together with the poor prospects for a revival of consumer spending (see recent comments) and the coming defaults on commercial loans, the likelihood of a continuing wave of residential mortgage foreclosures is another strong headwind against a robust economic recovery.  More foreclosures mean additional increases in inventories and downward pressure on home prices that further reduces household net worth and the ability and willingness to spend.  Importantly, it also increases the amount of bad loans held by financial companies. Therefore the prospective third quarter increase in GDP will not be sustained, and the most likely outcome is either continued recession or an exceedingly weak recovery that will not validate current stock market expectations.


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