House Prices, Delinquencies and the Dollar

The much watched Case/Shiller house price index pace of decline is slowing. In Jan, home prices in the 20-large urban centers were 19.01% below year ago levels and today we learned that in April prics were off 18.12% year-over-year. This is the slowest pace of decline since last Oct. Eight of the 20 cities reported an increase in prices in the month of April, the best showing since June 08. Even though the data is not seasonally adjusted, house prices rose 0.6% in San Francisco, the first increase in nearly two years and, as will be appreciated, is one of the areas that experienced a dramatic bubble.

Yale's Shiller acknowledged that "striking improvement in the rate of decline" in house prices. A new ETF was launched today that tracks the cumulative changes in the Case/Shiller Composite Index (for 10 cities)--there is an version of the ETF that can be bought if one expects housing prices in the index to rise and another version of the ETF that can be bought if one expects house prices to continue to fall. Separately, the US government reported today that the delinquency rate on prime mortgages doubled in Q1 09 from Q108. The delinquency rate, where payments are 60-days or more overdue, rose to 2.9% in Q1 from 1.1% in Q1 08. Prime loans account for roughly 2/3 of US mortgages. Some 662,000 prime mortgages are seriously delinquent. Serious delinquencies of course are a leading indicator of foreclosures.

Overall, in 2007 and 2008 roughly 3 mln mortgages were foreclosed. There was a "voluntary" moratorium of foreclosures by the end of last year that carried into the first part of the year. Foreclosures are likely to rise this year, even as the financial markets and economy stabilize.

Nevertheless, ultimately the financial crisis, the trillions of dollars of lost wealth and the magnitude of the bailouts is not simply a function, as it is often portrayed, of savvy US consumers taking advantage of the banks to get loans that they could not pay back. Banks appeared to lend money not based so much on the credit worthiness of the borrower, but on the value of the collateral--the house. At the end of the day, it was not American households that thought house prices could only rise, but the banks themselves.

The numbers to attribute the crisis to the American households are just not there. The average mortgage in the US is for roughly $210k. Typically in a foreclosure, a bank can recoup 75% of the mortgage. Say this is a worse than average crisis and rather than recouping 75%, say that a bank only manages to claw back 40%. On the 3 mln foreclosures in 07 and 08 combined costs the banks $378 bln--a lot of money to be sure, but not the trillions.

The missing ingredient to get from the almost $400 bln to the trillions of dollar in losses is leverage. Bank and other financial institutions were leveraged to the gills. Moreover, leveraging seems to know no national frontier or regulatory regime. It was nearly universal. And US excesses, whether the increase in house prices or leverage of financial institutions, were not the most extreme among the major industrialized countries.

The economic downturn in the US (and the UK) appear more shallow than Continental Europe or Japan. Yet the US government (broadly understood to include the Fed and Treasury and Federal government) is doing more to address the crisis. Our medium term constructive outlook for the dollar is predicated on the idea that the US is 3-6 months at least ahead of most of the other industrialized countries and that while it is premature to think about Fed tightening, we suspect it will materialize long before the ECB will be able to hike rates. That said, it is difficult to envisage much more than stabilization of the residential real estate market this year.