CHESSNOID

The stock market is up and the economy is still down. Why the discrepancy? I don’t know why  that is, but in college they told us that theoretically the stock market is a 6 month indicator of where the economy is going. That is positive news, but unfortunately it is a theory that has not been true for the last 5 years. I think in a true free economy without government intervention and bailouts that might be true.

I think the Great Recession was caused by the housing market bubble and bust. I here many optimistic economists calling the end of the recession last month, last quarter and last year based on some reports. They may be right, but my guess is they are wrong. Simply because the asset bubble that has grown in the last 2 Bush presidential terms was extremely large. I don’t think it has finished deflating.

This new Fortune article interviews Karen Weaver who understands the numbers.

NEW YORK (Fortune) –

Karen Weaver, global head of Deutsche Bank’s securitization research division — responsible for analyzing credit default swaps, collateralized mortgage obligations, and other exotic Wall Street products — said last week that 48% of U.S. mortgage owners will end up owing more than their home is worth by 2011.

The figure may have left many Americans wondering how this could be possible. But consider that 27% of U.S. homeowners with a mortgage are already “underwater.” And according to Deutsche Bank, home prices may fall another 14% before hitting a bottom.

Fortune spoke with Weaver to understand the implications of her recent forecast, why it will affect regions that missed the housing boom, and why still-falling home prices are hurting even the best borrowers.

How many Americans are underwater?

Currently we estimate that 14 million homeowners have negative equity. However, based on our home price forecast, as prices continue to fall we think that number could reach 25 million, or 48% of all mortgagors.

This fact has many implications on the economy and better explains why it will get worse. The article has an example that demonstrates the truths about a homeowner underwater in his or her mortgage. Forget about contracts and moral obligation, that went out the window when our government committed a moral hazard by bailing out companies with tax money.

At what point of being underwater do homeowners start falling into foreclosure rapidly?

Once you get to the point where negative equity is significant — for example, 25% or more — there have been studies that suggest you get more strategic defaults.

People say, “I bought my house for $500,000, it’s worth $250,000, there are 10 available for sale in my neighborhood. It makes no economic sense to spend the rest of my life trying to pay off a $500,000 debt when there’s no reasonable likelihood to expect this house to go back up to $500,000.”

This might sound extreme, but we have borrowers who bought a $500,000 home in California at the peak of the market on $50,000 of income. So for them to devote their gross income for the next 10 years solely to paying off [their] mortgage doesn’t make any sense.

When this is your reality, sooner or later your common sense will kick in even if you are not a math or finance whiz.  You look at your neighborhood and see 10 houses for sale at 50% of your mortgage balance, you start to see things clearly.  Try calling the bank or mortgage company and asking them to reduce your principal to the current values of the market.  You can see why banks are dragging their feet and not modifying loans.  The corrupt banks that took taxpayer money do not want to recognize or acknowledge any losses on the books.  They are stalling as long as they can.

Does this lead to a new wave of foreclosures?

Well, we don’t think that the wave has stopped in any sense. But the wave is clearly building. That is evident by looking at serious delinquencies. If you look at a chart of how many borrowers have missed more than two payments, a large portion of those people are going to end up being foreclosures.

Well, that rate of serious delinquency has been rising rapidly and continues to rise, pretty much in tandem with unemployment. As long as you have serious delinquencies going up, you know for the next year and a half, a large portion of those are going to turn into foreclosures.

Of subprime and Alt-A (Alternative A-paper) borrowers, about 33% of those borrowers are seriously delinquent. If you look at prime jumbo, the highest quality mortgages, 6.2% are seriously delinquent. That sounds like a low number. But two years ago that number was 1%. It’s a very straight trajectory from September 2007, pretty closely mimicking unemployment.