Where is the floor for house prices?

In this new column for National Journal, I discuss the Fed's latest maneuvers:

If banks are too scared to lend and consumers too scared to borrow regardless of interest rates, even the most aggressive easing of monetary policy might fail to push the economy out of recession. That is why, separately from the push to lower interest rates, the Fed is struggling so hard to maintain structural confidence in the financial system -- by keeping Bear Stearns in business and by promising to give banks (and now, for the first time, many nonbanks) the assurance of access to short-term loans they are no longer willing to extend to each other.

Where does it all end? If the Fed could be granted one wish, it would be that house prices start to bottom out. That would begin to put a floor under losses on mortgage-backed securities, and help to restore banks' confidence in one another. Its biggest fear, conversely, is that house prices fall further and faster. A particular risk in that case is that many more borrowers would find they owed more than their house is worth, so that it would make sense for them to default on their mortgage. (Most mortgages are nonrecourse loans, meaning that in case of default the lender gets the house and has no further claim.) If mortgage defaults catch on in a big way, causing a flood of foreclosures and forced sales, it is hard to say where the floor for house prices might be -- and the losses for lenders could dwarf current estimates.

You can read the whole column here (the link expires at the end of the week).

Comments

(Most mortgages are nonrecourse loans....)

You might want to check that fact as I believe you have been misinformed.

Posted by David Sucher | March 23, 2008 11:35 PM

The floor is probably somewhere around three times the average annual salary of the area in question. Check out some of the lowest-cost housing markets in the country, and compare those to the average incomes. Especially in the area around the Great Lakes, where both housing prices and wages have been pretty stagnant for years, a house costs about three times the average annual salary (around $100k to around $33k). I'm fairly sure the ratio doesn't get much lower than that. But if you take a place like Northern Virginia, where a household is pulling in about $75k average (old numbers, 2003 or so), but the average housing prices are around $430k. That's more like five or six to one, not three to one. Some of that is probably that the housing around DC is actually more valuable. People want to be in DC more than they want to be in Cleveland, so the prices reflect that. But the right ratio is probably a lot closer to 3:1 than 6:1.

Posted by Tel | March 24, 2008 9:43 AM

I think David Sucher is right that in most cases, mortgage borrowers are legally responsible for any shortfall between the recovery on the collateral (their house) and the amount they owe on the mortgage. As a practical matter, lenders typically have not sued defaulting homeowners for the shortfall, because a default means the borrower is probably broke, and it's not worth the attorneys' fees to chase him down.

But you know what? We live in interesting times, and all that may change. With millions of mortgages expected to go "underwater," with the loan amount exceeding the home value, there will be many more homeowners who do have other assets and choose to default just because their mortgage isn't a good deal anymore. I think you'll see much more aggressive collection activities in response.

Posted by jbd | March 24, 2008 1:57 PM