It’s apparent that most everyone agrees that underwater mortgages are a problem that begs a solution, and, more often than not, the topic makes its way to the media's front page. Recently I read a Reuters’ article titled “Regulator throws lifeline to underwater homeowners,” pointing out the “government's expansion of a refinancing program in a step that could help up to 1 million borrowers.”
"These are important steps that will help more homeowners refinance at lower rates, save consumers money and help get folks spending again," President Barack Obama told a crowd in Las Vegas, a city hard hit by the foreclosure crisis.
I can appreciate the effort, and on the surface it makes sense, and, for example, if someone can reduce a mortgage rate from 6% to 4% on a 30-year, $150,000 loan, the savings would translate into about $183 per month. Notwithstanding the fact that the added cash would benefit the homeowner and ultimately consumer spending to some degree, there are three sides to this story.
First, the borrower’s condition of having an “underwater” mortgage will not change, for the value of the home is unlikely to increase. Second, the lender’s risk premium is reduced, and if the borrower eventually defaults, the collected risk premiums – or interest – will contribute less to soften the eventual loss that the lender will have to absorb. Although I do feel for those who find themselves in these terrible circumstances, the facts and business risk cannot be overlooked, because the way to hell is sometimes paved with good intentions. Whether the lender is public or private, it is irrelevant from a risk perspective, because somebody will have to pick up the bill.
Thirdly, consumer sentiment may not benefit because despite lower payments, homeowners will still be paying toward a house that is worth less than the mortgage they carry. The big question is whether the economy at large will benefit from the program, and the answer may be less clear that we wish it would be.
A better approach is to mark the mortgages to market – immediate book value loss, but a reflection of the truth – and keep the rates unchanged. And we’re back to the real solution, or debt destruction, which is not very palatable, but is our final destination regardless of how many shortcuts we take between here and there.
But underwater mortgages are not the core problem in my view, and consumer sentiment is being driven by yet another fact that escapes the headlines: Loss of equity. And by that I mean those buyers who bought a house with at least a 10% down payment – or paid cash -- and have seen their equity vanish before their eyes. If one bought a house for $500,000 with a $50,000 down payment, and is now holding onto a home worth $450,000, one is not underwater, yet the individual’s sentiment is hardly upbeat. This scenario covers far more homeowners than the “underwater” market, and is the ongoing contributor to the depressed consumer sentiment readings - and the consumer is ultimately 100% of the economy.
On a broader note, “More than 60% of global consumers downbeat,” as reported by Reuters.
Global consumer confidence remained weak in the third quarter with more than 60% of consumers saying it was not a good time to spend, and one-in-three North Americans saying they have no spare cash, a survey showed on Sunday.
The survey conducted by Nielsen between August 30 and September 18 and “covering 28,000 consumers in 56 countries” indicated that “global consumers facing tighter budgets would cut back on clothing purchases, dining out and buying electronics and appliances before anything else.” I guess Whirlpool (NYSE:WHR) is already feeling it.
What I found interesting in the survey, and makes the “recession” talk laughable to a certain degree, is that consumers are not being guided by official economic data, but rather by their own feelings of where they stand, economically speaking.
“A recessionary mindset is growing among consumers as more than half say they are currently in a recession - up 4 percentage points from last quarter and 7 points from the start of the year.”
And that is what we usually call a “self fulfilling prophecy.”
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.