From David Wessel's column in today's Wall Street Journal -- Keeping Families Above Water -- come this scary statistic:
Moody's Economy.com estimates that one in roughly 12 American families with mortgages -- four million in all -- already owe more than the current value of their homes. They are said to be "underwater." The firm predicts that by early 2009 nearly one in four, or 12 million, homeowners will be underwater. Most will continue to pay mortgages on time. Many won't, and are at risk of losing their homes.
25% of all mortgages will be underwater!?! That has a whole series of ramifications -- from high levels of foreclosure to evaporated retirement savings (where the home was the major nest egg) to future impacts on the reverse mortgage industry.
Besides being a frightening fact of our economic weakness, this will be a test of economic theory. The fundamental premise of economics is that people act rationally and in their economic self-interest. Economic self-interest would tell those homeowners that they are better off walking away from those mortgages.
Let us hope that economic theory is wrong and that the newly emerged area of behavioral economics may tell us more about what will actually happen.
BTW -- in an interesting side comment, Wessel notes the following:
As the Treasury argued in a recent PowerPoint presentation: "Homeowners who can afford their mortgage but walk away because they are underwater are merely speculators." (It's a bit jarring to hear the Treasury vilifying people who are acting in their economic self-interest.)
Has the Treasury Department converted wholesale to behavioral economics?
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