Science & Society

Estimating Nationwide Recessionary Losses from Mortgage Foreclosure

Written by Bruce R. Copeland on January 21, 2009

Tags: consumer spending, economics, foreclosure, home equity, housing bubble, job mobility, mortgage, real estate, recession

At the height of the housing bubble, the nationwide value of residential real estate was commonly estimated to be $20 – $25 trillion. The current national foreclosure rate is about 2% (and climbing). The average DECREASE in property value for foreclosed residential real estate is less than 50%. This yields (0.5)*(0.02)*($25 trillion) = $250 billion as a current estimate of the total loss associated with failed mortgages—probably an overestimate!

This number is lower than other loss estimates originally reported for the mortgage meltdown. Early estimates often reported the dollar value of troubled mortgages. This is highly misleading for three reasons: First, not all troubled mortgages end up in foreclosure. Second the value of a mortgage includes the total principal, whereas the average decrease in home value (the possible loss) is less than 50% of the principal. Third, these estimates include the mortgage interest over the life of the loan—more than double the original principal value. Mortgages get paid off all the time when homeowners sell, and no mortgage holder ever gets to treat 10 or 20 years of missed interest opportunity (over the original life of the mortgage) as a “loss”. The only thing that really matters is whether and how much of the principal (and past due interest) gets paid back.

Some may argue it is also necessary to consider losses in housing value for homeowner’s who are not in mortgage trouble. Certainly such losses are significant. However, except for causing some minor decrease in job mobility and home equity loans, such decreases probably have relatively minimal contribution to a recession. Most individuals do not make decisions about consumer spending based on the changing value of their home.