The WSJ had a good article yesterday reporting that almost one in six homeowners is underwater. This may actually be overly optimistic. David Rosnick and I did an analysis of data from the Federal Reserve Board's Survey of Consumer Finance and concluded that 21.6 percent of late baby boomers (people aged 45-54) would need to bring cash to their closing next year. This is a somewhat different question. We assumed that closing costs are 6 percent of the sale price (the standard realtor's fee). We also projected a real price decline of 10 percent from the March 2008 level to the middle of 2009. (Most of this drop has already occurred.) On the other side, the late boomers should rank high in home equity, having been in the work force for more than 20 years and near their peak wealth level. There are two important implications of this analysis. One is that many current homeowners will be like first-time homebuyers in that they will lack money for a down payment. The second implication is that bank losses on mortgages will continue for a long time. There will be millions of short sales (the median period of home ownership is 5 years, so many of these houses will be sold soon) where a seller get $50,000 or $100,000 less than the value of the outstanding mortgage. Very few of these people have any significant savings that can be tapped to make up the difference. This means that the banks will have to eat big losses on these sales. The losses on this unprecedented wave of short sales has yet been recognized. If we assume 5 million short sales for an average of 10 percent of the sale price that gets us another $125 billion of losses ($25,000 per house). Make it 10 million short sales at 20 percent ($50,000 per house) and you get $500 billion in losses. In other words, the fun is just beginning.
--Dean Baker