Aug 12, 2007
Bleeding Past Empty
How much pain?
As subprime mortgages crater, here's one of the likely -- and as-yet-undiscussed -- consequences: Deficiency judgments, and perhaps a massive wave of them.
Here's how it works: Buying a $500,000 house, you put $50,000 down and take out an interest-only housing loan for $450,000. Then you can't make your house payments, two or three years later, and the bank forecloses. But the foreclosure is part of an enormous set of regional and national foreclosures, dumping houses on the market while mortgage lenders are cutting back sharply on new home loans. Far fewer buyers are chasing far more homes, so housing prices fall sharply; the bank sells your $500,000 house for $375,000.
You're out of a home -- and you're still carrying $75,000 in interest-bearing debt.
Where have we seen this dynamic before? Here's one noteworthy example:
As subprime mortgages crater, here's one of the likely -- and as-yet-undiscussed -- consequences: Deficiency judgments, and perhaps a massive wave of them.
Here's how it works: Buying a $500,000 house, you put $50,000 down and take out an interest-only housing loan for $450,000. Then you can't make your house payments, two or three years later, and the bank forecloses. But the foreclosure is part of an enormous set of regional and national foreclosures, dumping houses on the market while mortgage lenders are cutting back sharply on new home loans. Far fewer buyers are chasing far more homes, so housing prices fall sharply; the bank sells your $500,000 house for $375,000.
You're out of a home -- and you're still carrying $75,000 in interest-bearing debt.
Where have we seen this dynamic before? Here's one noteworthy example:
In his 1965 book The Cornbelt Rebellion: The Farmer's Holiday Association, the historian John Shover discussed the metastasizing farm foreclosures in Depression-era Iowa, which (among other things) followed the burst of a farm-buying bubble caused by the decline of European grain production during the First World War. American farmers rushed to buy up land on borrowed money so they could expand their production for hungry European markets; fifteen years later, still carrying debt, they found themselves caught in a cycle of sharply declining crop prices. And then the trap closed.
From pages 16-17:
Between 1921 and 1933, 13 percent of Iowa farmland was sold at foreclosure. Yet at the end of 1932, one billion dollars of debt was still outstanding on 45 percent of the land in the state...Land values had declined so greatly (from $140 per acre in the late twenties to $92 per acre in 1932) that proceeds from a forced sale usually did not cover the full amount of the debt. As a result, the debtor was left with a deficiency judgment to cover the balance. In 1921, 26.5 percent of foreclosures in eighteen sampled Iowa counties ended with a bid for less than the amount of the debt; in 1932, 74 percent carried a defiency judgment.This number will be worth watching in the years to come, but here's my guess: A significant number of families who took out subprime housing loans will not only lose their homes, but will be left with a crushing load of debt that will inhibit their recovery and hamper their ability to find new housing.