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Is the Housing Market Over-leveraged?

housingWhile some economists are starting to predict another housing crisis, opining on when and how it will happen, the New York Fed seeks to answer the question, “Are we prepared for another housing crisis—or even just a slump in home prices?”

The answer, according to New York Fed: “The household sector is still vulnerable to severe house-price declines, although it has become steadily less risky in recent years.”

This is the opinion of New York Fed researchers Andreas Fuster, Benedict Guttman-Kenney, and Andrew Haughwout in their report, “Tracking and Stress-Testing U.S. Household Leverage.”

The researchers track household leverage, the ratio of housing debt to home values, noting that there is a “strong correlation between a borrower’s leverage and their propensity to become seriously delinquent.”

In fact, the researchers assert, “High household debt is widely considered one of the main causes of the Great Recession and the slow recovery that followed.”

As of the first quarter of 2017, 3 percent of borrowers are underwater and 78 percent have a combined loan-to-value ratio lower than 80 percent. (The combined LTV rate takes second liens into account in addition to first mortgage loans.)

If national home prices slip to their levels of just two years ago, the underwater ratio rises to 9 percent. If prices fall to their level recorded four years ago, the tide rises, resulting in a 21 percent negative equity rate.

In a more dramatic “stress test,” the New York Fed predicts a 38 percent negative equity rate in the case of a “peak-to-trough house price drop” mimicking that of the Great Recession. At this point, just 38 percent of homeowners would have a combined LTV rate below 80.

“Unsurprisingly, this outcome would be worse than at the height of the bust, since, in many areas of the country, house prices have not yet recovered to the same peaks from which they previously fell,” the New York Fed study stated.

The “sand states” that fared poorly during the last housing crisis would again flounder. The rate of underwater homeowners in Nevada would be near 50 percent. In Florida, the rate would be 35 percent; in Arizona, 31 percent; and in California, 23 percent.

The New York Fed conducted similar “stress tests” to determine the seriously delinquency rates in cases of pricing downturns.

Were housing prices to remain steady, the researchers predict a 4.2 percent serious delinquency rate over the following 24 months, starting with the first quarter of 2017.

If housing prices drop to their levels of two years ago, that rate would rise by just one percentage point.

If prices fall to their four-year-ago levels, the serious delinquency rate would be 67 percent above the base, reaching 7.0 percent.

In a crisis “peak-to-trough” scenario, serious delinquencies would rise to a substantial 9.9 percent of all outstanding mortgages.

Again, the most severe rates would be seen in the “sand states.”

The New York Fed also compared leveraging among types of loans, saying, “Unsurprisingly, since the GSE and portfolio loans are the least levered, they have the lowest projected delinquency rates across scenarios.”

In fact, projected serious delinquency rates in a crisis similar to the last would be twice as high for government loans as for GSE and portfolio loans.

The New York Fed conducted its stress test at the county level to reveal the varying impact on different markets. As can be expected, “The scenario proves to be especially harsh for regions where house prices have not recovered from their troughs.”

About Author: Krista Franks Brock

Krista Franks Brock is a professional writer and editor who has covered the mortgage banking and default servicing sectors since 2011. Previously, she served as managing editor of DS News and Southern Distinction, a regional lifestyle publication. Her work has appeared in a variety of print and online publications, including Consumers Digest, Dallas Style and Design, DS News and DSNews.com, MReport and theMReport.com. She holds degrees in journalism and art from the University of Georgia.
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