Impact Of Housing Recession

Nouriel Roubini |

The current housing recession, subprime meltdown and severe credit crunch in financial markets has many worrisome aspects. And while there is always a “crisis de jeur” - one day SIVs, the next day monolines, the next day TOBs or auction-rate securities - one needs to keep some perspective and consider which risks are first-order sources of stress for financial markets and which ones are of second or third-order concern.

I will argue that the most important first-order risk for financial markets derives from the likelihood that 10 million to 15 million households may walk away from their homes if – as likely - home prices fall another 10% in 2008 and further in 2009. When – in the summer of 2006 – this author argued that this would be the worst housing US recession in the last 50 years and that home prices would fall – from their peak value – by 20% such predictions were taken as being nearly lunatic. Too bad that this author ended up being too optimistic, not too pessimistic, about the severity of this housing recession. Indeed, this will end up to likely to be the worst housing recession in US history – not just in the last 50 years – and home prices may likely eventually fall by 30%, not this author’s “optimistic” 20%. By now prices declines of the order of 20% are predicted by Goldman Sachs, Robert Shiller, MarketWatch chief economist Irwin Kellner and others; while Paul Krugman has suggested even a figure of 30%; and, according to Bob Shiller, in some markets home prices may fall by 40 to 50%.

So let us consider the implications for the household sector of price declines of the order of 20 to 30%. The math is simple as I will flesh out in this note: 10 to 15 million households will end up in negative equity territory and will be likely to default on their homes and walk away from them. Then, the losses for the financial system from this massive defaults will be of the order of $1 trillion to $2 trillion, a multiple of the $200 to $400 billion of losses currently estimated for mortgage related securities.