Mortgages Matter: What Americans Need To Learn From The Past Recession
Are we safe from another mortgage meltdown? During the first quarter of 2019, ATTOM Data Solutions reports that fewer than 10% of outstanding mortgage loans nationwide are “seriously underwater.” “Seriously underwater” means that the mortgages on the property exceed its value by 25%. While slightly higher than the level at this time last year, this pales in comparison to the first quarter of 2012, when 27.8% of all mortgage loans nationwide were drowning. That said, this quarter represents the first time in eight years that the number has risen year over year. While the number of seriously underwater homes may not appear dangerous, one has to remember that at least as many homes, and probably more, are underwater but just not as deep. How does this happen? Wasn’t Dodd-Frank meant to protect the country from the negative implications of too much mortgaging?
Here in New York City, the co-op apartment system has protected us from the worst excesses of mortgage crises. Since many co-ops only permit 50% financing, and most permit no more than 75%, and since co-ops still outnumber condominiums as the largest segment of owned apartments in Manhattan and Brooklyn, we have always been an equity rich market. All cash deals are not uncommon here, but even when buyers need financing, the amounts are, by national standards, low. Ironically, one of the most expensive markets in the country contains one of the lowest mortgage default rates.
The ongoing question for the banks remains one of balance. If 20% of all mortgage loans are underwater (either seriously or only moderately), does that suggest that bank criteria are still not adequately stringent? Do these loans reflect excessively large loan-to-value ratios in the face of a volatile real estate market which has lost as much as 20% in value in many parts of the country? Perhaps they do.
Real estate tends to be protected from extreme spikes and dips in value by the size and complexity of the transactions (you can’t list, sell, and close on your house in a day or, usually, even a week.) That said, it is a self-referential commodity. Its value cannot be tied to the cost of materials and labor or other easily quantifiable inputs. Only the value of other, similar real estate helps in adjudicating an appropriate value. Appraisal, in the end, consists of educated guessing; it’s intuition dressed up as science. In the end the decision to make the loan depends on the creditworthiness of the buyer and the creditworthiness of the property. Only one of these, the former, can really be quantified.
Banks earn money by loaning money. Even with Dodd-Frank in place, borrowers often receive the benefit of the doubt or, in one of the crazier inversions in modern finance, must pay higher interest rates if their credit is poor. It is understood that these higher rates provide the basis for the bank extending credit at all to these less than perfect borrowers. But doesn’t it seem obvious that if their credit is poor a higher interest rate exponentially INCREASES the likelihood that they will default? But no matter…the question remains: as the recession fades in the rear view mirror, will we as a nation once again ignore signs that too much money on too many properties gets loaned to too many people who cannot afford what they are taking on, especially if the stock market or the real estate market declines? History indicates that as a species we prefer not to remember past problems, and we tend to believe they won’t occur again once they are past. Let’s hope this time will be different.