Sizing up The Deutsche Bank Study

Written by: Steve Cook   Sat, August 8, 2009 Beyond Today’s News, Crisis Watch


Two analysts at Deutsche Bank issued a residential market forecast last week that shook the housing industry and cooled the sound bites about “signs of stabilization.”

The lead sentence in the Reuters version especially set teeth on edge.  “The percentage of U.S. homeowners who owe more than their house is worth will nearly double to 48 percent in 2011 from 26 percent at the end of March, portending another blow to the housing market, Deutsche Bank said on Wednesday.”

DB as a reputation for telling it like it is and leaning toward the bearish side, and it followed true to form with this study.  For the bank’s international investment audience, that’s probably a good thing.  For those who follow housing matters, It might be a viable but also worse case scenario.

The study (click on the link above for a copy) emphasizes the role of resetting ARMs on homeowner debt to equity positions yet never discusses whether or not large numbers of ARM holders will refinance, as they have in the past.  The option ARM onslaught, for example, predicted to arrive late last year, has yet to dominate the foreclosure numbers due to the large numbers of borrowers who used low rates and programs like Hope Now, FHA Secure and HARP, the Fannie-Freddie refinancing program that allows even underwater borrowers to refi if the amount they owe on their first lien mortgage does not exceed 125 percent of the current market value of the property.

The researchers rely solely on the Case-Shiller home price index for history and future price levels, which is probably not a good idea and which also might tilt their findings to the conservative side.  Case-Shiller only reflects home price changes in 20 cities, while the National Association of Realtors, NAR, median home price measure and the OFHEO home price measure reflect well over 150 metros across the nation.  Moreover, there are major differences in the magnitude of these home price measures. For example, the Case-Shiller home price index for last November decreased 18.2 percent year over year, while the NAR median home price measure (year-over-year) declined by only 3.2 percent in November. 

Their discussion of prices levels also lacked any analysis of foreclosures, the major depressant on prices today.  Granted, predicting foreclosures right now is about as easy as predicting earthquakes, the study never gets into looking at the factors that may-or may not-cause the further price depreciation necessary to reach the 48 percent underwater prediction that got the attention of homeowners and investors across the country.

A finding that is already coming true is the increased price pressure on mid to upper level properties.  “While subprime and Option ARMs are currently the worst cohorts with underwater borrowers, we project that the next phase of the housing decline will have a far greater impact on prime borrowers (conforming and jumbo) (see Figure 2). By Q1 2011, we estimate that 41% of prime conforming borrowers and 46% of prime jumbo borrowers will be underwater, a significant increase over the percentage of these borrowers in Q1 2009,” they found.

When you couple these findings with those of the recent Chicago study on strategic defaults (Why They Walk Away…), the outlook is even more frightening.  That study found that homeowners start to default at an increasing pace when the value of their homes falls 15 percent or more. In fact, 17 percent of all households would default even if they can afford to pay their mortgage when the equity shortfall reaches 50 percent of the original value of the house.


Karen Weaver and Ying Shen, authors of the DB study, talk about the “kiddie pool” versus the deep end when they discuss negative equity.  The bad news is that they see 28 percent of homeowners in a severe negative equity position by 2011.

 Will severe negative equity become a ranking or leading factor in the default picture within the next two years?

3 Comments For This Post

  1. Lease Purchase Says:

    Please, can you PM me and tell me few more thinks about this, I am really fan of your blog…

  2. konkurrencer Says:

    my God, i thought you were going to chip in with some decisive insght at the end there, not leave it with ?we leave it to you to decide?.

  3. Bivy Says:

    I’ve been always leery of Deutsche Bank. Never was really sure where they were coming from.

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