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Here sits the U.S. economy six years into a housing crisis that never seems to end and a four plus years into a financial crisis related to the housing market meltdown and the excesses of selling junk mortage collateralized securities. Does anything, in the big financial picture, feel or seem any better than it did two or three years ago?

Here are some of the financial realities which I see holding back housing and to a great extent the economy:

  • Housing prices continue to decline - as much as some would wish otherwise. The S&P Case-Shiller home price indexes had home prices posting new lows at the end of 2011, down 4 percent for the year.
  • According to CoreLogic, at the end of last year, 11.1 million, or almost 23 percent of all residential properties with a mortage were upside down on the loans. According to the most recent report, the total negative equity on first mortgages is $717 billion and the average upside down homeower has a loan-to-value greater than 130 percent.
The total loan balance of the mortgages on the upside down homeowners is in the neighborhood of $2.8 trillion. That is a pile of mortgage backed securities not fully backed by home values.

Homeowners who are not underwater with their loans are still affected by the problem. With prices 40 percent below where they were half a decade ago, a homeowner is not going to sell unless there is a very compelling reason. The part of the housing market where buyers sold just to move up to a nicer home is pretty much gone.

The government solution to the problem is to allow deeply underwater homeowners to refinance their loans at lower rates, bringing down the payments. However, at this point a significant number homeowners may be too disgusted with the process to accept a lower payment and then wait a decade or two for their home values to be greater than the money owed to some large financial institution -- especially since those institutions received hundreds of billions of dollars in bailout money to survive the financial crisis.

The point of this discussion is there is still a mortgage bubble -- roughly $2.8 trillion worth or mortgages backed by $2 trillion worth of homes. Some how, some way, someone has to take the haircut on this negative equity. A recovery in home values that would solve this problem seems to be an outcome that is not going to happen.

I see three players at risk to be stuck with this $700 billion dollar bill:

  • Holders of mortgage backed securities. By now the banks and investment houses have dumped most of this paper onto pension funds, mutual funds and the mortgage REITs. These investment pools believe they have a principal guarantee from the federal government by way of Freddie and Fannie.
  • The federal government. The quick solution would be a massive appraisal of every home covered by a Fannie, Freddie or Ginnie Mae insured home and write down the principal to a 95 or 100 percent loan to value. Send money in the amount of the write down to the MBS holders as a repayment of principal. Not a fair or equitable solution, but would get the problem off the books and immediately reignite the housing market.
  • Make the banks which originated all of the problem mortgages cough up the money to clear the negative equity. Goodbye, Bank of America (NYSE:BAC) and Citgroup (NYSE:C). Would we miss these upstanding corporate and financial sector citizens? My guess is that the big banks can negotiate their way out of this possibility and keep the burden in the feds house.
The solutions outlined above will probably never happen unless other financial forces -- re-re-recession or rising interest rates -- push the feds and markets into making a clean slate of the mortgage mess. My guess is the housing market will crawl along at present levels for another decade or so. In 2025 we will be discussing a lost generation of homeowners who never recovered from inflated home prices and fraudulently written mortgages of the early years of the century.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Cleansing Event Necessary To Turn Around Mortgage And Housing Markets