Bernanke Call too Early, Needs to Focus on Homebuilders

Implications: Some homeowners with the means to pay their mortgage payments are halting those payments, walking away from their homes instead, accepting that they are upside down, and choosing 7 years of bad credit over an unknown period of negative equity.  If Mr. Bernanke is successful in his call to bankers- that is, lower the mortgage debt for those homeowners whose homes are worth less than their outstanding mortgage balance and “struggling” to make payments- fewer owners will likely walk from their homes in 2008.   Our question to Mr. Bernanke is: what about next year?  Prices are still dropping rapidly.

Analysis: Federal Chairman Ben Bernanke’s latest solution to rising foreclosures: persuade banks to write-off a portion of borrowers’ mortgage debt.  Mr. Bernanke appears to have the problem right.  Some homeowners with the means to pay their mortgage payments are halting those payments, walking away from their homes instead, accepting that they are upside down, and choosing 7 years of bad credit over an unknown period of negative equity.   

The most recent foreclosure data and discussions with those being losing their homes support Mr. Bernanke’s thoughts on the problem.  Subprime difficulties and resetting rates are still the biggest challenges, but the percentage of foreclosures involving prime loans is increasing rapidly.  In January, the number of prime borrowers- those borrowers with “good” credit- foreclosed upon was up to 41% from 37% in the fourth quarter (Simon, Wall Street Journal, “Some Borrowers Rescued”, 3/4/08).  Credit counselors are echoing the problem- negative equity.  The reality, it appears, is as Mr. Bernanke suggested earlier in the week (presented in subject article), “’a stressed borrower has less ability…and less financial incentive to try to remain in the home… because of the pervasiveness of negative equity positions’”.  

If Mr. Bernanke is successful in his call to bankers- that is, lower the mortgage debt for those homeowners whose homes are worth less than their outstanding mortgage balance and “struggling” to make payments- fewer owners will likely walk from their homes in 2008.   Our question to Mr. Bernanke is: what about next year?  Prices are still dropping rapidly. 

Belfiore Real Estate Consulting data reflects Phoenix metro area same store new home offering prices fell 16% in 2006, and an additional 14% in 2007.  New home price drops have been most significant during the last 5 months.  Resale prices have only recently begun falling; they stand to fall significantly in 2008, as resellers (including banks) compete with homebuilders to sell off supply.  In many submarket areas, resale home sellers do not stand a chance in competing with homebuilders until the resellers drop prices further.   Dropping mortgage debt to today’s “supposed” market value for homeowners threatening to walk doesn’t make sense today.  In 18 months, aren’t the same homeowners going to threaten to walk after prices have dropped further?  

Mr. Bernanke’s focus is misdirected.  Limited demand and an oversupply of homes (resale and new) is pushing prices downward.  Falling home prices are acting as a disincentive, as he points out in his own words, for owners to work to stay in homes, forcing foreclosure rates upward.  These falling home prices have been predicated upon homebuilders’ belief that lower prices stimulate sales.  Prior to convincing banks to lower mortgage debt, Mr. Bernanke should work on convincing homebuilders that home price decreases fuel skepticism and fear, which feed upon one another, and while the decreases may facilitate a few sales in the short-term, they make home selling more difficult after the initial 45 to 60 days following the price decrease.