Drowning in Debt - A Look at "Underwater" Homeowners

Karen Weaver & Ying Shen @ Deutsche Bank [288K PDF]:

The U.S. economy has been overwhelmingly a consumer economy. For much of the past decade, U.S. consumers have been greatly enriched by rising home values coupled with "easy credit," enabling them to monetize their home equity early, and often. Some economists estimate that homeowners were extracting 25-30% of every dollar of increase in home equity, primarily for consumption.2 But now, the Joint Center for Housing Studies reports that home equity had fallen 43%1--$5.9 trillion--from 2005 (peak) levels to the end of 2008.

Even if home prices stabilize, it seems unlikely that we will again see the confluence of factors (or one might say mistakes and debacles) that facilitated the millennial wave of consumption. For many, the home has morphed from piggy bank to albatross. The questions now are, how will this wealth destruction drag on consumption and how will outsized mortgage burdens be resolved?

In this paper we look at the issue of "negative equity,"3 the situation where the borrower's total debt obligations exceed the home's current market value. We estimate both the number of borrowers who currently have negative equity, and, using our home price forecast,4 the number of borrowers who we believe will reach a negative equity position before prices stabilize.