Subprime crisis background information

This week’s report that more than 11.3 million homeowners owed more on their house than their house was worth has prompted a fair amount of discussion among the people I talk with.

The big question is what the data point means.

In practical terms, almost 1/3 of homeowners don’t have an ownership interest in their home.  They are tenants to the bank, and at some point have to make a decision whether the cash cost of the mortgage is competitive with the cost of a comparable rental unit.  Most experts agree that consumers executing short sales will get dinged on their credit report — though not as badly as in a foreclosure — and will need two years of credit seasoning before they can buy a new home.

Of course, emotions factor in to the consumer’s decision in the short-term.   They’ll hope that values will recover enough to let them regain some equity.  They’ll decide that they don’t want to leave their Home, with a capital H.  And, they’ll wonder whether the government will find a way to step in and help them regain some value. (The continued paring of price declines in the Case Shiller reports fuels the hope that their home will rebound in value.)

Banks have a vested interest in managing the flow of foreclosures and short sales in the market.  The more distressed properties that come into the market, the more downward pressure on prices, forcing banks to de-value the loans on their books.  In the simplest terms, the banks have an incentive to keep the negative equity loans off the market.

Combine the bank and the consumer incentives and you have a stagnant market.  The foreclosure and short sales inventory hangs over the market, but with little threat of creating another precipitous drop in prices.

Talking about this situation with a colleague, we speculated on what this unnatural market dynamic will mean for real estate this year.  One scenario — which I advanced — was that the volume of home sales could easily stay flat, or decline slightly, in 2010, but that the value of those homes would be up significantly from 2009.  The mix of inventory will shift, as more and more  buyers gain confidence that market has bottomed out and begin to compete for the best inventory in the market.

This kind of activity will be the nature of the slow grind the real estate market, and the economy overall, is going to experience over the next couple of years.  It’s not glamorous…not one bit…but it won’t be as traumatic as the past 24 months.

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