The Unresolved Mortgage Bubble

 |  Includes: KBE, KME, KRE
by: John Lounsbury

Michael David White is a mortgage and real estate professional, as well as a Seeking Alpha contributor. In a recent article White posted a number of excellent graphs on the state of the housing market, including the following:

click to enlarge

Click to enlarge

This is a novel way of displaying the data associated with the increasing number of homeowners going underwater on their mortgages. It points out that the total of outstanding mortgage balances is in a bubble with respect to home values.

Banks are looking to resolve this bubble by waiting for mortgage repayment and for house prices to rise. This has been called “extend and pretend”. Some homeowners, on the other hand, are looking to resolve their bubble by strategic default. This refers to the mortgagor walking away from a property rather than continue payments even though they have the cash flow capable of continuing the mortgage payments. This action diminishes the chances of success for the bank strategy.

Of course, the bank strategy is also hindered by economic defaults – foreclosures on properties where the mortgagor is no longer able to meet payments. This problem is aggravated because of lingering high unemployment and under employment, but has a fundamental component arising from the issuance of mortgages not supported by sufficient income to begin with.

White has pointed out the bubble aspect of outstanding mortgage balances compared to house prices. The deflation of the bubble involves returning to the historic relationship where about 50% of home values are mortgaged. At current home values that means outstanding mortgage values would be about $7 trillion, about $5 trillion below the latest level. If this bubble is to be deflated within 2-3 years most of the burden will be born by the mortgagees. Lenders will have to absorb most of the $5 trillion. Of course, the bubble could deflate more slowly, but bubbles usually collapse quite quickly.

Hat tip to a StockTalk by Ricardo and Jesse’s Café Americain.

Disclosure: No positions