Incredible Shrinking Home Equity

Among other horrors, the Federal Reserve reported today, first quarter homeowners' equity is down to 41.4% of home value.

As we have stated repeatedly, about one-third of homeowners own their houses free-and-clear. This means that the 58.6% of aggregate house value that covers all mortgages falls to the two-thirds with mortgages. Running through a bit of algebra, we get to the point that homeowners with mortgages only have 12% equity.

In a world of crashing real-estate 12% is not a lot to fall further from the end of March. Given that prices are falling in something like a 20% annual pace, 12% is just a matter of months.

So, we hereby predict, by the end of 2009 - give or take a few months - homeowners with mortgages will be, in the aggregate, underwater - owing more than their houses are worth. Naturally, because of regional variations and the amount of mortgage debt people carry, many homeowners will be very, very underwater, though some won't be at all.

We further predict that most of the homeowners who are very, very underwater will default one way or another, as will quite a few of those who are merely very underwater. Among the many consequences of this will be the holders of the mortgages will lose most of their investment. This will be very bad for banks, especially the government-owned behemoths, Fannie Mae and Freddie Mac.

Bank losses will begin to mushroom to the tune of hundreds of billions, if not trillions. Another stock market crash will likely be part of the picture as the reality of this situation sinks in to the investing public. This all beginning in months, if we have our sums right.