John Hussman: Mortgages and Unemployment Still Major Concerns

Excerpt from the Hussman Funds' Weekly Market Comment (7/13/09):

With the decline of recent weeks, the market has cleared away the short-term overbought condition it established in June. The percentage of stocks above their respective 50-day averages, for example, has retreated from a disturbingly high 92% to a slightly but not profoundly oversold level of 32% here. Investors have predictably been staring at the “green shoots” and have noticed a conspicuous absence of root formations so far. From our standpoint, the next several weeks look as if they may be critical in either offering evidence that something deeper is taking hold, or pulling those shoots up as weeds.

Because of the enormous second-wave of adjustable mortgage rate resets due to begin in late 2009 and to continue through 2011, as well as the increasing upward pressure that unemployment is putting on delinquencies (e.g. mortgages, credit cards, and home equity loans), I am very concerned about the outlook for the economy in the coming year or two. A wide range of academic studies reach the universal conclusion that two variables account for the majority of fluctuations in mortgage defaults and foreclosures. They are 1) a high “loan-to-value” ratio; that is, the ratio of mortgage loan to the outstanding value of the home, and 2) trigger events - particularly job loss or change in family status. It is also notable that the existence of junior liens, particularly home equity loans, also significantly increases the likelihood of mortgage default when a “trigger event” like unemployment occurs.

It is very important to recognize that the increasing unemployment rate is likely to exert a different dynamic in this economic downturn than it has in prior downturns, because of the high ratio of household debt-to-income, and the high ratio of mortgage loan-to-value at present. In normal downturns, unemployment does trigger a certain amount of loan losses, but the general tendency is for unemployment to behave as a lagging indicator. In the current cycle, high debt-to-income and loan-to-value ratios create a situation where unemployment can easily be the trigger event for further defaults, and could therefore create a tendency for job losses to lead economic weakness (rather than just lagging it). Now I don't think that the feedback will be strong enough to lead to a self-reinforcing collapse, but I do think that it is naïve to expect that the economy will just “shake off the blues” and roar ahead.

Comments

[Sovestor:]

Somewhat insightful but the markets tend to move differently.

Jul 13 02:14 PM

[Living4Divi...:]

Nice snippet. Of course mortgage defaults and unemployment will stifle the recovery.

I agree with your conclusion:
"Now I don't think that the feedback will be strong enough to lead to a self-reinforcing collapse, but I do think that it is naïve to expect that the economy will just “shake off the blues” and roar ahead."

Jul 13 02:45 PM

[Subhankar:]

Logical and sensible viewpoint. Just the kind of opinion that Wall Street hates!

Jul 15 07:52 AM

[sasoros:]

Real common sense stuff. Not enough of it around.

Jul 20 04:31 PM