The Worst U.S. Housing Market in a Generation Could Mean $1 Trillion in Write-Downs

By , Money Morning •

By Jennifer Yousfi
Managing Editor

Troubling data on the U.S. housing industry released yesterday (Thursday) lends weight to iconic income investor Bill Gross’ theory that global financial firms will eventually see $1 trillion in total write-downs.

Money Morning’s Investment Director Keith Fitz-Gerald agrees. He’s been predicting an eventual $1 trillion total for mortgage-related write-downs since last year.

“I’ve long believed that there’s at least an additional $1 trillion of subprime slime out there - just waiting to rain havoc on investor portfolios,” Fitz-Gerald wrote in a column published in early November 2007.

The global financial industry has already taken $467.9 billion in losses and asset write-downs according to Bloomberg data, but Gross sees that figure doubling before it’s all over, eviscerating the balance sheets of the world’s financial firms.

“The problem with writing off $1 trillion from the finance industry's cumulative balance sheet is that if not matched by capital raising, it necessitates a sale of assets, a reduction in lending or both that in turn begins to affect economic growth,” Gross wrote in a commentary posted on the Pacific Investment Management Co. LLC, better know as PIMCO, website, Bloomberg News reported.

The troubled housing market also is a serious drag on U.S. economic growth.

Sales of existing homes dropped 2.6% in June from May’s level, and sales are down 15.5% from the same period a year prior, according to data from the National Association of Realtors.

“A recent online survey of Realtors shows nearly a quarter of potential homebuyers are waiting on the sidelines,” said Richard F. Gaylord, president of the real estate agents group, Forbes reported.

Housing inventory, already at record levels, ticked up another 0.2% in June, as more first-time homebuyers opted to hold off on purchasing and incomes were squeezed by high food and fuel costs.

“About four in 10 homes are purchased by first-time buyers, which frees existing owners to trade up,” said Lawrence Yun, the Realtors' chief economist.

But with more first-time buyers opting to hold off on making a purchase, the large number of available homes is putting downward pressure on housing prices.

The national median price for existing homes was $215,100 in June, according to NAR data, down 6.1% from $229,000 just one year ago. Yun, the NAR chief economist, said the price of homes is being pushed down due to the rising number of home foreclosures. One-third of homes currently for sale are due to foreclosures, he said.

Lower home prices in turn affect the credit-worthiness of home mortgages. Once a home’s value dips below the balance due on its outstanding loan balance, it becomes much more difficult for a homeowner to refinance or sell. With fewer options for homeowners struggling to grapple with high food and fuel costs and a weakening labor market, foreclosure rates rise.

At the same time, lower median home prices suggest that more properties will fall into the risky subprime asset class that kicked off the credit crisis, causing additional write-downs. Some 25 million U.S. homes are at risk for slipping into negative equity positions on their home loans, Gross said, which could easily lead to higher default rates and more asset write-downs.

The housing market must work through the existing level of home inventory before it can make a true recovery. One method would be for the government to purchase one million new or unoccupied homes, “blow them up, and then start all over again,” Gross wrote, Bloomberg News reported. And while that solution could work to boost housing prices, it’s certainly not feasible, making the proposed housing legislation “the best way to begin the long journey back to normalcy.”

The U.S. House of Representatives passed a bill on Wednesday that includes sweeping provisions to help bolster the U.S. housing market and potentially save struggling mortgage giants Freddie Mac (FRE) and Fannie Mae (FNM), which together secure almost half of the $12 trillion U.S. home mortgage market.
MarketWatch reported that the housing bill includes the following provisions:

  • Allowing the government to insure up to $300 billion in refinanced mortgages.
  • Establishing a tax break of as much as $7,500 for first-time homebuyers
  • And creating a new regulator to oversee government-sponsored enterprises Fannie and Freddie.

The Senate is expected to vote on the bill before the end of this week.

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