Housing price declines increase strategic default risk

Home prices are expected to drop another 20% before hitting bottom, according to economists at A. Gary Shilling & Co., raising the risk that 40% of borrowers will walk away from their home in a strategic default. The firm reported in its December Investment Insight that home prices are already 30% below their peak in the first quarter of 2006 and fell 2% between the second and third quarters of 2010. Essentially, the economists wrote, things will get worse before they get better. “Housing normally spurs economic growth early in recoveries as this interest rate-sensitive sector responds to earlier rate cuts by the Fed,” the report said. “This time, it’s been a dud due to the collapse in prices.” According to Pew Research, 36% of Americans said it is acceptable to stop making mortgage payments. Underwater borrowers are more likely to walk away from their mortgage, or strategically default, because they lack incentive to make the payments. Economist Nouriel Roubini, of Roubini Global Economics, echoed the Shilling economists’ sentiment when he told CNBC this week that he believes the housing market is currently experiencing a double dip. “It’s pretty clear the housing market has already double dipped,” Roubini told CNBC, citing the recently released Case-Shiller Index which dropped 0.8% in October. “[E]ven a 5% fall in home prices will push an extra 8 million in negative equity with risk of millions walking away from their home.” The Shilling economists said home prices are dropping because of excess inventory, “the mortal enemy of prices.” According to the report, there is a 1.6 million surplus of housing inventory. There are currently 4.1 million homes on the market, compared to the 2.5 million that is considered the normal working level. “That’s a lot considering the average home construction of 1.5 million annually over time,” the report said. The economists added that a category in the Census Bureau’s U.S. housing inventory data called “vacant units held off the market for other reasons” (such as homeowners pulling their home off the market in hopes of a better price) has grown to 3.6 million from 2.6 million since the housing bubble burst. Roubini attributed the drop in home prices to the expiration of the homebuyer’s tax credit and the ongoing chaos with mortgage documentation. Write to Christine Ricciardi.