Silver Lining from Pandemic, #2: No Housing Armageddon, Probably…

…the key word being “probably” since none of us have any idea how long the current state of affairs will last, how many jobs will be lost, how many companies shut down, and so on.

I did some fun thought experiments on an angle that occurred to me earlier today. That thought?

“How much would home values have to drop for a whole lot of people to be underwater on their mortgages?”

Let’s get into it and I’ll explain why this was important to think about.

2016 Buyers

For the sake of looking at only the most vulnerable, I only took homeowners who bought during the last four years and did some back-of-the-napkin type of math.

Here’s what I came up with:

  • Median home price in 2016: $221,400
  • Average down payment in 2016: 11% or $24,354
  • Average loan amount: $197,046
  • Average mortgage rate in 2016: 3.766%
  • % Share of mortgages that were FHA in Q1/2016: 22.1%
  • Average down payment, FHA loans: 3.5% or $7,749
  • Median home price in March of 2020: $271,100
  • Change in value of home: $49,700

If you’re curious about the source of any of this, just put a comment below and I’ll go post a link. I just didn’t see any reason to link to each one.

If you take the numbers above, then run an amortization schedule, what you get is:

  • Conventional 30-year fixed, payments to principal: $15,647
  • FHA loan, payments to principal: $16,968

Add it all up and you get the average conventional borrower with $89,701 or 33% in equity and the average FHA borrower with $74,417 or 27.5% in equity.

Why This is So Important

In my Triage post, I touched on how various brokers and agents were thinking about business dropping with the COVID-19 and pandemic-induced response. The average came out to be 40% of business lost for 6 months.

But, none of that was about home values. It was about the business to the brokers and agents.

We don’t know what will happen to home values once we come out of the current situation. It’s a fair assumption that values will be down, at least in the short-term, since the drop in demand has to mean a drop in price.

But we also know that until the shutdown orders started coming down, we were seeing some of the strongest numbers for real estate and housing in years. This comes from’s February 2020 housing report:

The median U.S. listing price grew by 3.9 percent, to $310,000  in February, which is a slight acceleration compared to last month, when the median listing price grew by 3.4 percent over the year. In February, listing prices in the largest metros grew by 6.5 percent, on average.

Of the largest 50 metros, 45 saw year-over-year gains in median listing prices. ; and  Philadelphia-Camden-Wilmington, PA-NJ-DE-MD (+17.3 percent); Rochester, NY (+15.0 percent); and Pittsburgh, PA (+14.3 percent) posted the highest year-over-year median list price growth in February. The steepest price declines were seen in Minneapolis-St. Paul-Bloomington, MN-WI (-3.4 percent); Louisville/Jefferson County, KY-IN (-1.9 percent); and Houston-The Woodlands-Sugarland, TX (-1.5 percent). However, Houston and Louisville saw yearly declines decelerate compared to last month.

The big story was the lack of inventory all across the country as the strong economy (unemployment was at the lowest level in decades) and low interest rates boosted buyer demand.

All of that, alas, is in the past. We may bounce back strong, but it won’t be for a while. We don’t know how long the oppressive restrictions will last, and we don’t know what the psychology of the American people will be afterwards.

However, we can expect that home values will drop. The question is how much. Again, we don’t know and have no way of knowing.

Remember the Bubble?

But I was in the industry when the Bubble of the 00’s burst. Many of you were, but many were not. It was a rough time back then, from 2008 to 2013 or so. We thought the industry was going to collapse. So what happened to house values in the worst housing collapse we had ever seen in history?

From the very peak of the Bubble to the very depth of the Collapse, it was roughly 35%.

Even if home prices were unsustainably high in March of 2020, especially in some of the coastal markets, many of the factors that were responsible for the housing bubble of 2000’s were absent. There were no NINJA loans, no predatory lending, no appraisal fraud, etc. If anything, lending standards were perhaps too tight, and lack of inventory was the major issue.

Plus, the economy was fundamentally strong before the pandemic.

So you have to ask, just how likely is it that we’re going to see another drop of 35% in home values in 2020-2021?

It’s possible, of course, because we have no end date for the current lockdown orders. We have no idea just how deep the economic impact is going to be. But as I said in my essay on Triage, I do not believe the American public will choose economic suicide and poverty for themselves and their children in order to save the lives of even 2 million of our own most vulnerable people, even if their parents and grandparents are among that 2 million.

The Problem of Jingle Mail

The nightmare scenario for housing — indeed, for the U.S. economy — is if we have many homeowners who find themselves underwater and decide to just walk away.

These strategic defaults started becoming more widespread towards the end of the Housing Bubble, but in the beginning, they were quite rare. Americans are fundamentally responsible and decent people who try to live up to their promises, including the promise of paying back money they borrowed.

But that was last time. This time, it won’t necessarily be the same.

For one thing, the stigma against default has largely disappeared. So many people walked away, declared bankruptcy, went through foreclosure, etc. that there is no social judgment today for someone who went through that in 2010.

For another, the American public watched the government bail out giant banks and hedge funds with hundreds of billions in taxpayer money. Remember “Too Big to Fail?” A lot of us were adults when that became a phrase etched in our heads. Many of today’s young adults were in school back in 2007-2010, but they watched their parents go through hell, then watched big companies get bailed out. We all watched TARP and other housing programs help people who had simply stop paying their mortgages avoid foreclosure.

Already, there’s talk of government bailouts of airlines, cruises, hotels, and banks. We don’t know what the government will do, but we know they’re debating trillion dollar packages in Congress as I write this.

I do not believe for a second that any borrower this time around would feel even a moment of hesitation about walking away from an underwater mortgage. The moral sanction against breaking one’s promise, at least in the financial arena, is now gone. If there is a second collapse in housing values, I believe the vast majority of underwater borrowers would simply stop paying and dare the banks to foreclose.

If otherwise creditworthy borrowers just default on their mortgages, even if they could pay them, that is the end of the mortgage system in the United States. That might be the end of the entire financial and monetary system we have built. No one would ever lend money again without dramatically outsized security and collateral. Think pawn shops, not banks.

To avoid that fate, homeowners have to have something to lose in a foreclosure. Their loans cannot be underwater. 33% and 27.5% average is sufficient to withstand any scenario short of the Doomsday scenario in the COVID Recession.

Yes, someone who bought a house in 2019 for 3.5% down, made a few payments only to see home values drop by 15% just might walk away. There is no helping that. Hopefully, we have learned some things from the last collapse and we already know how to foreclose quickly, and to sell that house to a new buyer quickly, and move on.

Yes, some of the extreme housing markets might see a bigger drop in value, and therefore more strategic defaults, but those will be regional and hopefully contained/containable as long as the banks are able to withstand the losses from that part of their portfolios.

To have home values drop by more than 33% nationwide, we have to be talking about the kind of existential crisis we faced back in the Great Recession. And we have learned quite a few lessons from then, and have very different economic conditions today. The way I see it, if home values do drop by more than 33%, then we’re going to have a host of much bigger problems in our economy and our society, and we’re not really going to be all that worried about the housing market. We’re going to be more worried about food and water and social unrest and violence in the streets.

That is why this is a ray of hope in these dark times. Things are not great, but the scenarios under which housing drops by 33% or more are… remote. They’re more like dystopian disaster fiction than a reasonable prediction.

I think we can operate under the assumption (although… assumptions make an… nevermind) that we won’t see home values drop enough to trigger enormous waves of strategic defaults. A few here and there, but we can handle that.

There will be a mortgage market when we get through this. There will be a housing market on the other side of the tunnel. The light ahead is not the headlight of a train, but sunshine.

Let’s get there.