Real estate crisis: America underwater

How many homeowners are underwater?

Nearly 29 percent of U.S. homeowners with mortgages owe more on their homes than their properties are worth — the definition of "underwater." That's about 14.7 million borrowers, and they collectively owe $700 billion. The problem is particularly acute in states where the housing bubble sent prices and new construction soaring in the 2000s: In Nevada, 60 percent of mortgaged homeowners are underwater; in Arizona it's 49 percent, and in Florida, 45 percent. After the housing bubble popped in 2008, home prices plummeted, and are down an average of 33 percent from their peak. They continue to fall. "What can we do?" said Charles Mills, who purchased a Las Vegas–area home in 2006 for $308,500 and has watched its value drop to $106,000. "Nobody's going to buy it. Nobody's going to rent it. If we walk away, my credit's shot. We're stuck."

What happens to homeowners like this?

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Some 6 million of them have already lost their homes to foreclosure. Another 3.5 million are in the process, and millions more are one job loss, illness, or other financial shock from joining them. Refinancing is often impossible because they owe too much, so three quarters of underwater homeowners are locked in to "above market" interest rates. Even those who are managing to make payments are a drag on the U.S. economy, because they can't afford to spend much of their income on consumer goods and can't move elsewhere to pursue new jobs. Underwater homeowners are the "most desperate population in the country today," says Barry Bosworth, an economist at the Brookings Institution.

What options do they have?

None of them are good. Underwater homeowners can keep making mortgage payments and hope the housing market eventually improves. They can try to get a rare loan modification. They can attempt a "short sale," in which the house is sold by the bank for less than the mortgage. Or they can walk away from their mortgage, and surrender the home to the bank. Jon Wittenberg still owed $300,000 on a Southern California home that had lost more than half its value when he walked away. "We looked at how much my home was underwater, how much I'd lost thus far, and how much I would continue to lose," he says. The decision wrecked his credit, but in the long-term, "it was a no-brainer."

Why do home prices keep falling?

With millions of homeowners looking to sell, and far fewer people wanting to buy, it's a simple matter of supply and demand. A normal U.S. housing market has an inventory of about six months' worth of unsold homes; the inventory today tops 14 months. With such a glut of properties, few new homes are being built — home construction is down 75 percent from the bubble's peak — but the supply of available houses remains stubbornly high. That's partly because the bad economy prevents new households from forming. Cash-strapped young adults are moving in with their parents or living in group houses and apartments. The housing glut is also caused by banks tightening their mortgage standards; even people who want to buy a house in this market are often denied loans. Still other would-be buyers are staying on the sidelines, even with the benefit of rock-bottom interest rates, out of fear that they'll buy a home whose value will continue to fall.

Is the worst behind us?

It might not be. In October, there was a 31 percent decline in foreclosure notices compared with last year. But that may be because banks are now moving more slowly against delinquent borrowers. In 2010, several major lenders, including Bank of America, JPMorgan Chase, and GMAC Mortgage, temporarily halted foreclosures after it was revealed that they had engaged in what's known as "robo-signing" — mass approvals of foreclosure documents without reviews of individual cases. That scandal led to new checks on the foreclosure process. But there have recently been signs that the banks have adjusted, and are once again picking up the pace.

Can government do anything?

That's debatable. President Obama recently announced the expansion of a program to help underwater homeowners refinance their mortgages, which in theory would free up money for them to spend elsewhere in the economy. But just 1 million homeowners might qualify, a fraction of those who need help. Some housing experts argue that the only way to truly revive the housing market — and the wider economy with it — is to reduce all underwater homeowners' principals, or the amount they owe on mortgages. Banks are understandably reluctant: Forgiving a percentage of mortgage debt across the board, they say, would undermine their balance sheets and create "moral hazard," by undercutting borrowers' obligation to pay back their loans. If nothing is done, however, housing prices are expected to fall another 8 percent by 2013, and prevent a strong recovery from taking hold. "Until that negative equity recedes, the housing market is not going to recover," said Sam Khater, an economist at real estate data firm CoreLogic. "It's a giant anchor that's holding back the economy."

A desert city underwater

Las Vegas was one of the nation's biggest boom towns in the last decade, as tens of thousands moved there for cheap housing and warm weather. That, it turns out, was a bad bet. In some parts of north Las Vegas, where neighborhoods developed so quickly that city services couldn't keep up, four out of five homeowners owe more than their homes are worth. Many of these neighborhood blocks have become ghost towns, hit by a foreclosure epidemic so severe that in some ZIP codes, 80 percent of sales are of foreclosed homes or of homes sold "short.'' As people flee, abandoned homes sit with broken windows, swimming pools filled with fetid water, and overgrown yards with signs that say "For Sale: Bank Owned." Steve and Gay Shoaff, whose $187,980 home is now worth $99,220, have watched their neighborhood empty but can't afford to move. "This house won't be worth what we paid on it until after we die," Gay says.