The U.S. economy may be rebounding in fits and starts, but it isn't likely to emerge from the crisis that started more than four years ago until the real estate market recovers. That won't happen until the economy can rid itself of underwater mortgages, that is, situations in which homeowners owe substantially more than what their now-deflated homes are worth.
The real estate website Zillow has put this problem in perspective. During the first quarter of 2012, nearly one-third of homeowners with mortgages in this country owed more than they could recover by selling their homes, a figure that translates to about 16 million people. In some parts of the country, including Utah, the problem is far worse. For instance, in the 84081 zip code in West Jordan, 51 percent of homeowners are under water, which ranks among the worst 10 percent of zip codes in the country. The 84084 zip code is close behind at 44 percent. Utah County, as a whole, has 39 percent of its mortgage holders under water. Nevada, meanwhile, has a staggering 67 percent rate of underwater mortgages.
Many of these homeowners may not even be aware of their situations. They continue to pay their mortgages on time each month. Still, these mortgages are a drag on the economy.
Since the recession started, many private companies have been able to unwind their debt through layoffs and restructuring. Generally, they have emerged stronger, leaner and more competitive. The same cannot be said for households, banks and governments. The banks that own these underwater mortgages struggle with questionable assets that could haunt them at any moment. Even a faithful customer can die or be forced to move because of a transfer or change in jobs. When that happens, the bank often is left with an asset worth far less than its investment.
Even if the homeowner doesn't move, he or she has less purchasing power, and the bank has less lending power. Governments, meanwhile, continue to collect less in taxes because of depreciating home values. The effect is like a slow leak in a bicycle tire, with these slowly unraveling assets keeping the economy slow and flat.
There are answers to this problem. One we highlighted several months ago remains an attractive proposal. It would require Congress to change the rules to allow for contingent write-downs and equity sharing. Put in simple terms, someone who owes at least 20 percent more than the value of his or her home could agree to let the mortgage holder reduce the principal of that mortgage to market levels. In exchange, the homeowner would agree to share any future equity in that home (say, on a 50-50 basis) with the mortgage holder.
The beauty of this plan, touted by University of Chicago economist Luigi Zingales, Dartmouth's John Vogel and perhaps others, is that it would avoid the dreaded moral hazard of simply writing down mortgages without consequences, something that might encourage irresponsible behavior. People only slightly under water would not qualify.
There may be other viable plans out there, as well. Unfortunately, governments so far have focused on things that don't work, such as credits or other incentives for first-time buyers, or programs that help people refinance. For the most part, these have simply prolonged the slow leak of toxic assets. That leak hurts everyone with an interest in the current ownership of these homes, as well as the overall economy.