One area of the economy that has been receiving a great deal of scrutiny is the mortgage market, because frankly, housing drives the economy. The Federal takeover of Fannie Mae and Freddie Mac has the mortgage market convinced that it is back to business as usual. Despite this, things are more than likely going to get worse before the housing market truly rebounds.
Foreclosures are at a record high, and the percentage of homes in foreclosure continues to climb with each passing month, although we see a plateau on foreclosures in early 2010. The real question is WHY Americans are defaulting on their loans. The answer is: they bought their house with rented money. At the heart of the issue are Adjustable or Graduated Rate Mortgages and Interest Only Mortgages. The way these mortgages function is the borrower pays off their loan at a low rate for a set number of years. At the end of this period the balance is due and the terms are reset. That is renting money. When you take a 30 year note that is paid in full with the last payment, you are buying the money. When you rent money – the rent goes up. When this happens, it becomes more difficult, and sometimes impossible, for a borrower to meet these increases, and the home slips into foreclosure.
In 2008, roughly $40 billion in loans experienced their first reset. In the same year, the loan delinquency rate increased nearly 2 points to 7% and the foreclosure rate increased from 2% to 3.3%. By the end of 2009, the amount of loans receiving their first reset skyrocketed to $360 billion. This is what fueled the hike in foreclosure rates in that year, and it is not likely to stop. According to Credit Suisse, another $400 billion dollars in loans will be reset in both 2010 and 2011. If their estimates are accurate, and the correlation between home defaults and loan resets persists, we will have seen the worst of the resets by late 2011.
The implications that the mortgage resets have in the housing market are astounding. In some areas, for every house that goes into foreclosure, the surrounding prices lose as much as 9%. However, this is not the end of the story. The drop in housing prices creates a spiral effect; as housing prices fall, more houses will be forced into foreclosure, due to the value of the mortgages exceeding the value of the home. Overall, home prices nationwide have plummeted 20%.
The secondary mortgage market has been completely socialized by the federal government. Moreover, investments in the mortgage market by the banking system have caused nationwide bank failures, further damaging the economy. Without long term stabilization of the mortgage market there will be increased bank failures, as well as further intervention by the federal government. The Obama Administration has already begun to take action to try to keep the effects of the mortgage market collapse to a minimum, through TARP Plan initiatives.
The Home Affordable Modification Program helps homeowners in risk of foreclosure renegotiate their mortgages at the new, lower, rates. Programs have also been established to aid in the refinancing of mortgages. To accomplish this, the Federal government is offering special incentives to the banks, lenders and investors to the tune of $1,500 per mortgage. Beyond that, the government is also aiding in the reduction of monthly payments, by providing cash, so that the modified mortgages will account for no more then 31% of the individual’s monthly income. The primary issue with these initiatives is that the Government is simply throwing money at the problem. While this will help the individual homeowners who receive the aid, it is bad for the country as a whole. In order to finance this, the government will have to increase the money supply, causing inflation and the devaluation of the dollar. Furthermore, the government will most likely be forced to further increase taxes and issue more debt to cover immediate obligations.