19 February 2010

Foreclosure Situation Update

The default situation for subprime mortgages got so bad that it has started to get better, but new records for prime mortgage defaults (75% of all mortgages and almost 90% fixed rate) continue.

For the fourth quarter of 2009, about 10% of all prime mortgages were in default and a little more than 3% were in foreclosure. For fixed rate prime mortgages, the default rate is about 7.5% and the foreclosure rate is about 2%. This is a record high. In the 2005-2006 period before the financial crisis, defaults for all prime mortgages hovered at around 2.5% and foreclosures were around 0.2% of all prime mortgages, and was slightly less for fixed rate prime mortgages. This is presumably drive by long term loss of income and by vanishing home equity.

Subprime mortgage defaults peaked in the third quarter of 2009 and are now falling. But, the absolute numbers are still very high. More than 40% of subprime mortgages are in default and more than 15% of subprime mortgages are in foreclosure. Back in 2005, subprime mortgage default rates were under 15% and subprime foreclosre rates were arond 3.5%.

Keep in mind too that new subprime mortgages aren't being created in any significant numbers, while prime mortgages continue to be made as a slow but steady rate. The subprime mortgage concept is well on its way to becoming a historical relic over the next few years.

Overall 14% of all mortgages are in default and about 4.6% are in foreclosure.

New housing construction remains at very low levels by historical standards. Housing vacancy rates are at record highs (about 5.5% for all housing combined) so this situation is likely to persist for a while.

The short term future of commercial real estate is also not bright:

Nationwide, at least $1.4 trillion in commercial real estate debt is expected to roll over during the next three years. . . half of commercial real estate mortgages will be underwater by the beginning of 2011. A fifth of residential mortgages are underwater now. . . . Unlike residential mortgages, which often can be paid over 30 years, commercial real estate mortgages typically must be paid off or refinanced within five years. Commercial properties mortgaged in 2005, 2006 and 2007, at the height of the boom, are reaching their maturity date.


Commercial real estate prices have been falling for thirteen straight months. Hotel occupancy is down 17% from the 2005-2007 peak as a result of a two year long slump, and new hotels planned during the boom and opening now aren't going to help hotels get out of trouble any time soon (commercial mortgage backed security default rates are by type highest for hotel properties). Commercial real estate defaults are expected to continue to rise into 2012.

Underwater commercial real estate that is underwater and comes due has to be either surrendered to the lender or refinanced with money put in by the owner or other new investors. New investors interesting in putting money into commercial real estate that appraises as underwater are likely to be scarce, even if they do have money, why should they put in into a loan that is upside down when they can buy foreclosure properties at firesale prices? Owners have an incentive to put money in, because the alternative is a deficency judgment on top of a foreclosure, but may not have the cash on hand to do so.

About 27% of the nation's industrial capacity is idle.

Core inflation is negative for the first time since 1982.

(Note, mortgages in default as used here, includes mortgages in foreclosure).

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