Some Help in Understanding the Mortgage Meltdown

Friday, October 10, 2008 at 04:45 PM

I talk to a number of registered voters every week as a volunteer for the local Democratic Party. One thing that's pretty clear is that many of them really don't understand the mortgage meltdown or the broader financial meltdown. And in talking to these voters, it became clear to me that I didn't understand it all that well, either.

So I spent a little time trying to understand it better (I think a "thorough" understanding is beyond me, and may well be beyond any single person). This isn't complete, by any means, but here's some information that might help with the basics.

How many mortgages are "bad?"

One figure that I've heard several people mention is that "less than 3% of all mortgages are in foreclosure." I think that comes form an NPR program, Morning Edition, which said:

There are about 51 million first mortgages in the United States right now — but only about 1.4 million of them are either referred for foreclosure or in foreclosure, said Mortgage Bankers Association chief economist Jay Brinkmann. In other words, fewer than 3 percent of American homes with mortgages are in foreclosure.
That makes people wonder how such a small percentage of foreclosures could have precipitated such a big mess. NPR itself offered one answer to that:
The problem is this: Those bad loans are having an outsize impact on the financial world. They are mixed with good loans in securities that are crippling investment banks. No one wants the securities, even though not all of the loans are bad.

"Inside these bundles of mortgages are lots of great mortgages, or at least ones where Joe Smith and wife are going to pay back all the money, they are going to make their payment every month, even if it hurts," said Max Wolff, an economist who teaches at the New School in New York.

That's probably true, but hardly the whole story. For example, the original statistic about less than 3% "of all mortgages" being "in foreclosure" is a pretty wobbly statistic. First, "all mortgages" includes some mortgages that were issued way back in the late 1970s. If you took out a 30-year mortgage in 1979 and haven't prepaid it, that mortgage is still part of the universe of outstanding mortgages. I'd venture that any mortgage taken out 15 or more years ago--and there should still be plenty of those outstanding--is (a) for a relatively small amount of money, (b) has seen the outstanding balance reduced to the point that the homeowners undoubtedly have positive equity unless they've refinanced and taken the equity out, and (c) is a lot less likely to have packaged into these "mortgage backed securities" that have plummeted drastically in value.

The "less than 3 %" statistic also seems to be a snapshot of a single point in time. It doesn't tell you how many mortgages have already been through the entire foreclosure process and, more importantly, it doesn't tell you how many more are likely to go into foreclosure in the pretty near future.

How many are getting very risky?

It's impossible to get a definite answer to how many more are likely to go into foreclosure, but we can get some information that gives us a broad view of the real problem. That's exemplified by the following headline from the Wall Street Journal just yesterday: "Housing Pain Gauge: Nearly 1 in 6 Owners 'Under Water' More Defaults and Foreclosures Are Likely as Borrowers With Greater Debt Than Value in Their Homes Are Put in a Tight Spot."

In other words, if your house is now worth only $175,000 and you owe $200,000 on your mortgage, you just might be looking at a problem mortgage. And there are, indeed, plenty of mortgages "under water," most of which were issued in the last few years at the height of the housing price bubble. Again, according to the WSJ piece:

Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site

Most mortgages in default were issued in 2006 and 2007, when lending standards were loosest and the housing market was peaking. Many who bought then made small down payments or none, so they had little equity in their homes from the start.

These figures get positively frightening in some areas of the country. A sidebar to the WSJ piece lists the % of mortgages under water in various areas, including:
Las Vegas--56%

San Diego--51.3%

Miami/Ft, Lauderdale--44.6%


Home prices in many areas continue to drop, of course, and the more they do, the more mortgages will go under water. In some areas of the country, home prices have already dropped so far that it's surprising more mortgages aren't already in foreclosure. For example, Freddie Mac's web site < a href="">offers a listing of how housing prices fared, state by state, from the 2d quarter of 2007 to the 2d quarter of 2008. Seven states and the District of Columbia saw prices fall 4% or more just in that year:
Calif.........down 17.75%

Nevada......down 15.66%

Florida......down 13.12%

Arizona.....down 9,78%

Rhode Isl...down 5.58%

Maryland...down 4.93%

D. of Col....down 4.71%

Mich..........down 4.71%

Only Wyoming and Oklahoma saw price increases over 4%, 4.12 and 5.03, respectively.

And how will people get the money to pay the mortgages?

The other side of the coin, of course, is how well the homeowners are doing financially. Even if you have negative equity, you have an incentive to avoid default, but you have to have the money to do it/ And as you can tell from last week's jobs report, things aren't going real well in that department, either: 159,000 jobs lost in September, the ninth consecutive month the economy shed jobs. Which is translating into more unemployed, even with the games the government plays with their definition of "unemployed." Although announcing that the national rate was "unchanged" at 6.1% in September, there are, again, some areas of the country where even the officially announced statistics are positively spooky. In fact, for August, 17 states had unemployment rates of 6.5 or higher, with Michigan jumping to 8.9% (why did McCain pull out?), California to 7.7, and Illinois to 7.3.

So.....the risky mortgages tend to be the ones issued in the last two or three years. That time period includes the larger dollar amounts in the mortgage universe, and a very large number of mortgages. Enough homes are now worth less than the amount of the mortgage that foreclosures are pretty much guaranteed to accelerate, especially in the hardest hit areas of the country. Fewer and fewer people have the jobs (not to mention the wages) to keep making payments on mortgages that are "under water." And this large number of large, shaky mortgages are packaged together with other, less risky mortgages into "securities" in a way that makes it near impossible for the holders of the securities to know which mortgages are backing their investments.