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Friday, August 31, 2007

Outstanding Mortgage Debt Perspective

Not all of it will be paid back, you know.

Here is where you can get the FRB statistical supplements. Select the year, then the month you want. Then select Mortgage Debt Outstanding under RE (1.54). Please note the following figures are in millions.
end of 2002: 8,245,339

Q1 2007: 13,549,040 (+ 5,303,701 million, or 5.3 trillion)

1-4 Family:
end of 2002: 6,244,957
Q1 2007: 10,426,390 (+ 4,181,433 million, or 4.2 trillion)

Keep in mind that the outstanding federal debt is estimated at about 8.9 trillion.

Guess what - quite a bit of this debt is going to be written off. The income isn't there to service it, and the value isn't there to sell the properties serving as collateral for this to recover all of the principal. The American population doesn't have the income to pay all of the interest and principal back. .Here's a chart of real disposable personal incomes from 2005 to 2007. Needless to say, the recession years from 2001 - 2003 were bad for disposable income.

Here's another. Note that this chart does not begin at zero and that the 2005-2007 curr average change in real disposable personal income was less than $2,000 in real terms. Now the outstanding mortgage debt above is not shown as real. The longer it is held, the more it depreciates in relation to real income. To really get the effect, you have to be able to hold on for 5-10 years in this environment.

Don't forget that this debt was piled up as the largest cohort in the population, the boomers, are moving into their retirement years. They have a lot of it, and they are generally the ones who have the wealth to pay it off. But they don't have it all, and paying it off will reduce their spending.

It is important to understand the unequal distribution of weath. Good free economics papers can be found at Levy Economics Institute of Bard College.

Debt is distributed far more evenly than wealth. See Levy I Working Paper 502, 2007 (pdf, 50 pgs). Try page 12. In 2004, the top 20% of the distribution had 84.7% of the net worth, and 92.5% of the non-household wealth. In 2003, they had about 57% of the income. During the housing boom homeownership reached nearly 70%, with its recent average being around 65%.

In 2004, the bottom 40% had pretty much no wealth and only 10% of the income. Do you catch the discrepancy? Note that there is a group of retirees that own their own homes but have quite low income. Their positions have not largely been improved by the home price inflation, which has primarily either passed their areas by or boosted their property taxes and insurance enough either to eject them from their home or to force them to borrow against it.

Needless to say, burdening much of that bottom 40% with high mortgages will turn out to have been dumb. My guess is that homeownership is due to roll back below the 65% recent average. My point is that the only way you can collect from the bottom 40% is by taking their earnings, and if you do, you produce a depression.

So all the talk about bailouts is irrelevant to the larger picture. There are some homeowners who are only missing by a little because of loans with bad terms. But the solution for a great many will be to exit stage right.

"Please note the following figures are in millions.
All: end of 2002: 8,245,339"

Ok. I stopped reading there.

8,245,339 (in millions) would be

Are you sure about that?

Interesting big picture view. The thinking on mortgages tends to follow their "tranching": prime's fine, jumbo's sort of okay; alt-a is deteriorating; subprime is a disaster. This is a limiting view.

You pose the real question: is there enough income to service total mortgages outstanding? The Fed has commented on this and noted that average debt service ratios are in acceptable ranges. Your answer seems to be to look at income and debt distribution mis-matches. Also, you point out that incomes may fall in a recession.

Still, assuming the "average" debt service ratios are correct, there should be enough income to service the mortgages -- its just a matter of effecting income transfers. Bail-outs, if you will, financed by punitive progressive taxation.

Let's assume away the deadweight losses from income transfers. Is there something else wrong with the "debt service" view of the world? Intuitively it seems there must be.
Anon - please look at the links provided. The figures come from the FRB. If you find them incredible, take it up with them.

They should be pretty accurate.
David - it is the distribution of debt that is the problem. The lower echelon has little or no net worth.

It's the bottom 45% that's the problem. Probably about 10% of that group has taken on an amount of mortgage debt that is wildly disproportionate to their incomes.

Of those in the group that are older (at least a couple of percent), the debt ratios are usually lower in relation to equity, and most of them will basically keep paying from the remaining equity in their homes. Some, of course, will lose their homes.

In the remaining group (these figures don't include consumer debt), they have been subjected to a slow decline in real earning power, and have compensated with more debt. The real reason many participated in the mania is that it worked for a while. Low interest rates boosted home prices so that for many the yearly increase in equity amounted to at least half their other income. That equity was tapped to serve as a security blanket.

With that having been removed, a great many of these mortgages are just unsustainable for years even at relatively low mortgage rates. As soon as they are hit with reverses (job loss, severe illness or injury in the family, divorce), that's it, they must sell. The 2-4 year of additional declining prices yet to come is the fat tail of this event, because most of them will not be able to clear their debt.

The low loss ratios in traditional conforming mortgages come from careful underwriting and downpayments sufficient to keep borrowers from getting underwater. The events above happen to those borrowers at almost identical ratios, but the losses don't occur because they can sell or refinance rather than default.

During this run-up, traditional debt-to-income ratios were absolutely ignored. It used to be that a DTI over 45-50% was almost exclusively seen in predatory lending. Now it is quite normal in the bubble areas.

To get an intuitive feel for the situation, consider that all estimates agree that at least 25-30% of persons are underwater in their CAR.

I cannot stress enough that over the last few years, the normal ratio of 3-4 times gross income for a mortgage became absolutely routinely 6-10. It is not supportable. Basically, about half the persons with less than 15% equity at the end of 2005 are now underwater. Almost everyone who had less than 5% equity is now underwater. (Don't forget the @5% cost of sale).

In this 10/06 post, I provided some figures about the percentages of mortages at the end of 2005 which fit into these brackets. You will find the numbers staggering.

I feel certain that overall home ownership rates will drop below the recent norm of 65%.
No amount of paper shuffling can fix the two problems. Some people havbe debt they cannot service and houses they cannot afford. Every solution to date has involved these people carrying the debt and stay in those houses.
Historically, inflation has been the solution to debt. By dramatically increasing the money supply, mortgages can be paid off with devalued dollars. The mortgage holders could suffer, but that’s what the FED is for -to mitigate their suffering (“to big to fail”).

If mortgages become a major systemic problem, I would predict that the FED will inflate the economy. I base this prediction not on my knowledge of economics; rather my reading of history. There seems to be a notion that inflation is an act of god or a product of normal markets. I say it is a calculated product produced by calculating persons.

Great post MaMa. I use to read many economic blogs. Now, I'm pretty much down to yours. You are more of a political economist than an economist. You draw out the social implications of economic statistics.
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