Housing Crisis Represents the Greatest Threat to the Recovery

Failed home loans are dragging down the economy.


Nearly 3 million homes were repossessed by banks between January 2007 and August 2010, according to RealtyTrac, and many others have been taken over in the months since. The result is a continued dead weight dragging down homeowners, the financial world, and the economy at large, for residential construction and housing have long been the single most important economic engine in the United States.

[See 2010: The Year in Pictures.]

There is little prospect of improvement. Add impending foreclosures to the backlog of 2 million homes for sale and there seems to be ample justification for the expectation that all prices will continue to decline for at least a year, and perhaps two years, before there is a rebound. The estimates are that prices will fall from 10 to 20 percent over the next several years. This would bring the total decline from the peak valuations of the first quarter of 2006 to about 40 percent. But the stabilization of housing prices is impossible given the prevailing amount of inventory, both real and shadow.

All of the above is what shapes the shadow inventory threatening still more downward pressure on home prices. Median resale prices have been declining at an accelerated pace, according to the National Association of Realtors, particularly as mortgage lenders continue to tighten already restrictive standards that have depressed sales and takeovers. As David Rosenberg of Gluskin Sheff put it, "If home prices don't decline at least another 10 percent, then the laws of supply and demand will end up being repealed as far as it pertains to residential real estate." In an atmosphere of dormant demand, declining home-buying intentions, and mortgage applications remaining near decade-low levels, residential real estate markets have not yet found anything like a bottom. Millions more American families remain at risk of losing their biggest asset—their home equity.

[Read more by Mort Zuckerman.]

What is to be done? The options are all bad. A moratorium on foreclosures would reward those who game the system and stay in homes rent-free, and it would be opposed by people struggling to keep paying their mortgages who ask, "Why not us?" As for a repeat of the tax credit given for first-time borrowers, it cost taxpayers about $15 billion, twice the official forecast. Part of it was due to fraud; there were 19,000 tax filers who claimed the credit but didn't buy homes and 74,000 who claimed at least $500 million in tax credits who already owned homes.

Using the government-supported agencies like Fannie Mae and Freddie Mac to mediate housing markets has been a mistake. They have distorted mortgage markets and left taxpayers holding the bag to the tune of at least $150 billion and still rising compared to the $25 billion asserted in Congress when they were taken over by the government. Making profits is no longer the objective of Fannie and Freddie; their objective has become saving the housing sector.

Perhaps the only thing to do is to find a way to reduce the principal of the mortgage to the value of the house. But the cost to the lenders—be they banks or the taxpayer through Fannie and Freddie—would be gigantic: in the range of a trillion dollars. The record of modifying mortgages is poor. Standard & Poor's believes 70 percent of loans already modified will redefault. This would be another huge bill that taxpayers and investors would assume on behalf of those people who purchased homes they couldn't afford, believing that prices would continue to rise.

If mortgages represented roughly 50 percent of the total home value, the 30-plus percent decline in home prices to date has reduced the homeowner's equity by 60 percent. Now we face the possibility of another major down-leg in home equity and its negative consequences for the confidence of consumers and their willingness to spend.

Holiday spending has encouraged hopes of stiffening the fragile recovery. This time our recovery will not be able to depend on a growing U.S. housing market, as was the case in all postwar recessions. It is a recovery that is at risk and the risks are heightened by the distraught conditions in the U.S. housing market.