One Major Reason the Economy Will Not Recover Anytime Soon

Many Americans have their wealth tied to their real estate holdings. More Americans than ever bought homes and many of those who made their purchases during the real estate boom did so on easy credit with little regard for their capacity to repay. The ensuing real estate market correction and the credit market collapse should have brought the government policy of trying to expand homeownership into greater scrutiny since it was government programs and policy that sought to expand homeownership and demanded lenders extend mortgages to those who lacked the wherewithal to repay.

Now, we get word that nearly 50% of homeowners will be underwater on their real estate holdings by 2011.

The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday.

Home price declines will have their biggest impact on prime "conforming" loans that meet underwriting and size guidelines of Fannie Mae and Freddie Mac, the bank said in a report. Prime conforming loans make up two-thirds of mortgages, and are typically less risky because of stringent requirements.

"We project the next phase of the housing decline will have a far greater impact on prime borrowers," Deutsche analysts Karen Weaver and Ying Shen said in the report.

Of prime conforming loans, 41 percent will be "underwater" by the first quarter of 2011, up from 16 percent at the end of the first quarter 2009, it said. Forty-six percent of prime jumbo loans will be larger than their properties' value, up from 29 percent, it said.

That is a direct symptom of the easy credit years. It is also a symptom of the adjustable rate mortgage years, where buyers could get homes with no or little money down, and adjustable rate mortgages that looked great on paper for the first year or first few years, but which jumped up tremendously once the initial teaser rates ended.

Now, coupled with the real estate collapse, many of those who bought homes now face a situation where their homes aren't worth as much as the mortgages. That makes selling those homes ever more difficult creating short sale situations. That means that the home sales going forward are going to remain depressed for some time to come as sellers realize they aren't going to get the money they need to clear their mortgages and buyers find that they can't buy easily since the short sale transactions are more time consuming and difficult since the banks have to sign off on the deals.

There are no easy answers to this mess, but only time will allow the markets to rebound naturally. Government programs to improve homeownership will only result in exacerbating the situation and extending the difficulties.

This too will have a ripple effect across the economy, as homeowners will find that they can't obtain home equity lines of credit to carry out repairs or other improvements, since the property values can't sustain the additional credit hit to the property. It means that demand for capital items will remain below normal, and that means that industries reliant on home sales will suffer (think furniture companies, home improvement companies, home builders, etc.)