Underwater mortgages cause defaults - not unemployment

According to the Congressional Oversight Committee (COP), unemployment is presently driving a fifth wave of foreclosures, but analysts at Amherst Securities say that negative equity is far more predictive of home loan defaults than unemployment. The question is critical, because the policy response depends on the answer: if coming defaults are caused by unemployment, then the relevant response would be to subsidize mortgage payments, says Laurie Goodman, head analyst on the team. On the other hand, if negative equity triggers defaults, then principal reduction must receive a higher priority.

Goodman presents two pieces of evidence to make her point. The first is a matter of timing: default transition rates picked up long before unemployment; and the second a matrix of transition rates. The latter led to three conclusions: One, even in the lowest unemployment column, high debt to asset ratios are associated with markedly higher default transition rates. Two, when borrowers have positive equity, unemployment plays a negligible role. Three, unemployment does impact borrowers with substantial negative equity, but far less than does high debt to asset ratios. Carrying the analysis a step further, Amherst broke the data into owner-occupied and non-owner-occupied (investor and second home) categories. The same patterns emerged. Even for owner-occupied houses, unemployment only has a large impact where debt to asset ratios > 120%. For borrowers with very negative equity, unemployment is a catalyst that can kick defaults up, but it's not a cause.

MBA - Demand for loans down

The Mortgage Bankers Association says demand for U.S. home loans slipped last week even as mortgage rates hovered near record lows, but that those figures were distorted by revisions to the prior week's data rise in home purchase requests and a drop in refinancing applications. The MBA revised indexes for the week ended Nov. 13 after one survey participant changed data to show higher application volume and reclassified some loans from purchases to refinances. That lowered the purchase index and increased the refinance index. Borrowing costs stayed low with average 30-year mortgage rates dipping 0.01 percentage point to 4.82 percent last week.

Average home prices rose in September for the fifth straight month but the pace of appreciation slowed. Sales of existing homes shot up by about 10 percent in October as buyers rushed to take advantage of the first-time buyer tax credit that had been slated to expire on Nov. 30. The deadline has since been extended to cover sales contract signed by April 30, with loan closings required by June 30. Housing may be stabilizing but isn't staging much of a recovery. "Consumers are gun-shy at this point," said Cameron Findlay, chief economist at LendingTree.com in Charlotte, North Carolina. He says average home prices will slide as much as 7 percent by June 2010, bringing the total drop from their 2006 peak to 32 percent.

CCI up, but historically down

The Conference Board, a New York-based research group, said its Consumer Confidence Index rose to 49.5 in November from an upwardly revised 48.7 in October, but the overall index remains at historically low levels. A reading above 90 indicates the economy is solid, and 100 or above signals strong growth. Economists were expecting the index to dip to 47.5, according to a Briefing.com consensus survey. The figure, which is based on a survey of 5,000 U.S. households, is closely watched because consumer spending makes up two-thirds of the nation's economic activity.

Consumers' assessment of the job market also continued to deteriorate. The percentage of those claiming that jobs are currently hard to get reached a new high of 49.8%, while the number of consumers claiming that jobs are "plentiful" hit a new low at 3.2%. Employers continued to cut jobs from their payrolls in October, as the unemployment rate rose to 10.2% and hit another 26-year high last month, according to a report from the Labor Department. The percentage of consumers expecting their incomes to increase declined to 10% from 10.7%. Even the "underlying data is abysmal," said Mark Vitner, senior economist at Wells Fargo. "Fewer people think things will get worse, which isn't very comforting. You'd have to be a real pessimist to think things will get worse than they already are," said Vitner, adding that the consumers' assessment of the economy might be "overly bleak."

New Home sales up?

A Reuters survey found that new home sales probably rose by about 2 percent last month to 410,000 units on a seasonally adjusted annual basis from 402,000 in September, but the poll of 70 economists included estimates ranging between a drop to 370,000 and an increase to 430,000. The Commerce Department will report the sales figures today at 1500 GMT. If sales of new homes did turn out to rise, even the most optimistic forecast calls for less of an increase than the record 10.1 percent rise seen for October in sales of existing homes. Since the report reflects signed contracts to buy homes instead of completed sales, new home buyers in October were acting before they knew that the tax credit would be extended and expanded.

Now that the credit will cover contracts signed by April 30, "we'll probably see new home sales trend higher over the next two to three months, perhaps fairly strongly," said Paul Dales, U.S. economist at Capital Economics. In addition to the tax credit, buyers are being attracted by low prices and mortgage rates. The Federal Reserve has kept interest rates in the 5 percent range since the spring, making homeownership more affordable for many buyers. Home prices, as measured by the Standard & Poor's/Case-Shiller index of 20 major cities, rose 0.3 percent in September, in the fourth straight monthly increase, data Tuesday showed, but some experts predict prices will hit a new low next spring, perhaps falling another 5 to 10 percent, as more foreclosures get pushed onto the market.

Credit shrinking

At the same time as huge institutions like Bank of America, Citi and JPMorgan Chase enjoy huge government subsidies, loan balances at commercial banks fell at the fastest rate in at least 25 years in the third quarter, according to the Federal Deposit Insurance Corp. That means banks aren't lending. Outstanding loans have fallen every quarter since last fall, when the collapse of Lehman Brothers and other big financial firms turned the recession into a full-fledged financial crisis. But the Q309 decline was the sharpest yet, leaving banks' balance sheets 7% smaller than they were at this time a year ago. The falloff in bank lending means a taxpayer-financed economic recovery could sputter as borrowers scrounge for credit.

That is a particular concern for small businesses, and they account for much of U.S. job creation. "There are people with legitimate projects out there who cannot get loans, and we can't sustain a real recovery without access to credit," said Brian Olasov, a managing director at law firm McKenna Long & Aldridge who focuses on real estate finance. Bank of America boasted last month that it "extended $183.7 billion in credit during the quarter," but actually ended the quarter with fewer loans than it started with, as loans fell by $28 billion. JPMorgan Chase said in its third-quarter report that it "continues to help consumers and communities in this challenging economy," but its loan book shrank 4% during the quarter and 14% over the past year. That banks are shrinking their balance sheets at a time when the economy is sputtering and consumers are strapped is no surprise, Olasov said. "The choice for the banks is very stark. You can either repair your balance sheet or you can build your loan portfolio, but you can't do both at the same time."

Initial jobless claims down

The Labor Department announced that initial claims for unemployment benefits slid to a seasonally adjusted 466,000 in the week ended Nov. 21, from a revised 501,000 in the prior week. It was the fourth consecutive week of declines in seasonally adjusted claims, and marked a steady march lower from a recent peak of 674,000 in late March, but analysts say claims have to fall below 400,000 to signal payrolls growth. Analysts polled by Reuters had expected a more modest slip to 500,000 claims from the previously reported 505,000. The four-week moving average for new claims fell 16,500 to 496,500 in the latest week, and it's considered a better gauge of underlying trends since it smooths out week-to-week swings. The number of workers still collecting benefits after an initial week of aid fell a greater-than-expected 190,000 to 5.42 million in the week ended Nov. 14, the lowest level since February. Analysts polled by Reuters were expecting so-called insured unemployment to fal l to 5.59 million.
 

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