Underwater Mortgages -- Measuring the Unmeasurable

Underwater mortgages are a serious problem affecting the economy, but much of the conventional wisdom about the issue makes no sense.

For instance, no one is quite sure how many mortgages are “underwater”, meaning homes where owners owe more on the homes than they are worth.  Moody’s Analytics estimated there were 14.7 million homes in the second quarter. First American CoreLogic pegs the figure at 10.8 million in the third quarter. In November, Zillow estimated that 21% of US single-family homes had negative equity, another term for “underwater.”  There are roughly 80 million single family homes in the U.S., so Zillow’s  figure, down from 23% in the second quarter, would be about 16.8 million.  Each research firm measures the problem differently and it’s unclear which way is the correct one.

The same confusion goes for the shadow inventory figures, which shows mortgages that are seriously delinquent.  CoreLogic estimates that as of August 2010, shadow inventory reached 2.1 million units, or eight months worth of supply, up from 1.9 million, or a five-months’ supply, from one year earlier.  That sounds very authoritative until you realize that there is no agreed upon definition of the term. Some analysts even add foreclosed home which banks have not put on the market yet as part of shadow inventory.

As the Weakonomics blog  notes:

“Someone might say it only includes homes that have been taken over by the bank.  Another might say it could include any home that is more than 6 months late on a mortgage. … Regardless of what you say shadow inventory is, there’s a lot of it.  Estimates vary between 2 million and 8 million homes in the US.  With sales expected to be 5.5 million this year, that’s a lot of inventory”

Like many bits of economic data taken as gospel by the media, figures about underwater mortgages and shadow inventory are educated guesses derived by economists using sophisticated computer algorithms.   Unlike other bits of housing data such as foreclosure sales, there is no way to know whether any of these estimates are correct. Homes have been appraised by banks for values that are no longer current. And, a home is really only worth what it can be sold for. No amount of research can capture that data. It is actually unknowable.

For one thing, real estate markets are local . Really local.   Many of these statistics are based on macro level real estate sales data for zip codes or even larger geographical areas such as cities.   Mortgage data can be derived from a number of sources such as census data credit information and, of course, through property records.   Since the data is so macro in scope, these economists are unable to point to specific homes that are underwater in a given location to back up their point.

The other problem with underwater mortgages is the notion of strategic default, the idea that people will walk away from homes in which they have no hope of recouping their investments through a sale.  Last year, Moody’s Analytics sounded an ominous tone declaring “Strategic defaults are projected to rise.”  A Harris Interactive Poll released last month found that 48% of respondents would walk away from their homes if they owed more than it was worth.  That was up from 41% from six months earlier.

While it is true that some homeowners are walking away from their underwater mortgages, the exact extent is impossible to know.  For one thing,  it makes little sense for most people to do it, particularly if they have a job and are current on their payments.   If they can’t afford to keep their home, wouldn’t it make more sense for them to try to sell their property and find a smaller property or rent an apartment? Foreclosures remain a black mark on your credit for seven years, at least.

Not all underwater homes are in areas such as Las Vegas, Florida and Stockton, Calif., the epicenters of the real estate crash where prices may take years to recover.  Some markets such as Austin, Tex., Washington, D.C., and Houston; Honolulu; Memphis, Tenn.; Columbus, Ohio; and New York, according to researcher Clear Capital.  The firm, however, predicts that housing prices will fall 3.7% nationwide this year, down from a 4.1% drop in 2010.  Fourteen out of 50 major markets are expected to show gains in the second half of the year.

“Even though many major markets are forecasted to be down again in 2011, definite signs of overall stabilization are evident,” the researcher says.

Moreover,  available statistics fail to account for the fact that some people may actually want to live in their homes.   That means they will be willing to wait out the ups and downs of the real estate market for years, if not decades for their properties to emerge on dry land.

Too be clear, there is a real estate crisis.  Unfortunately, the data used to measure it often can not say if things really are getting better or are getting worse.

Jonathan Berr