Defaults on the Rise, Straining Economy

With mortgage defaults and foreclosures on the rise, U.S. household finances and the overall health of the U.S. economy are seeing substantial strains, according to a new research from Moody's Economy.com, a division of Moody's Analytics.

The highest mortgage default rates, according to Moody’s Economy.com, are in Arizona, California, Florida and Nevada, but they are also high throughout the industrial Midwest and in parts of the Northeast corridor around Washington D.C., Long Island, N.Y., and Rhode Island.

Metropolitan areas with the highest rate of defaults in the second quarter of this year include Miami, Fort Lauderdale, Naples, Orlando and Tampa Bay in Florida, and Sacramento, Fresno, Riverside-San Bernardino and Modesto in California. Only one state, North Dakota, has avoided an increase in defaults over the past year, and only 15 of the 200 metro areas covered by Moody's Economy.com data are not experiencing higher defaults.

While foreclosures in 2006 and 2007 primarily affected speculators and subprime borrowers, a combination of negative equity and a weakening job market is driving a new wave of defaults this year. With national house prices now down 16% from their spring 2006 peak, some 9.6 million U.S. homeowners now have mortgage balances that exceed the market value of their home. This is up from 4.1 million homeowners with negative equity one year ago and 2.7 million two years ago.

Areas where housing markets will continue to unravel the quickest and where economic conditions remain weak will suffer the worst the erosion in household credit quality. By and large, the regions where house price corrections will be largest are also those where house price appreciation was strongest during the housing boom several years ago. Conversely the house price outlook is strongest for counties that missed the boom. These counties are concentrated in the South, outside of Florida, and parts of the West.

Florida and California are home to 43 of the 50 counties that will go through the largest price declines, according to Moody's Economy.com forecasts of S&P/Case-Shiller Home Price Indices. Moody's Economy.com has recently extended its forecast coverage to include county-level house-prices based on Case-Shiller data.

Also, U.S. household credit quality is weakening across all loan types and in nearly every corner of the country. The deterioration is most evident in mortgages. At the end of June there were 2.72 million first mortgage loans in default at an annualized rate.

For all of 2008, defaults could very well hit 3 million, up from approximately 1.5 million in 2007 and 1 million in 2006, according to CreditForecast.com, which provides forecasts of consumer credit quality based on data from credit bureau Equifax and economic projections from Moody's Economy.com.

“Household credit quality is rapidly eroding and overleveraged households are at the heart of the economy's problems,” said Mark Zandi, chief economist for Moody's Economy.com. “The mounting losses on household debt are straining financial institutions and will keep the economy struggling to grow for the remainder of this year and well into 2009.”

Household liabilities that are in delinquency or default totaled $775 billion at the end of June, according to CreditForecast.com data. This is equal to 7.5% of all U.S. household debt, up from 3% just two years ago.

Moody's Economy.com expects household credit conditions to continue weakening through much of the remainder of the decade, with another 5 million homeowners at significant risk of default during this period. This includes about one-half of the current 10.5 million borrowers with subprime (5.25 million), alt-A (4.5 million) or jumbo option ARM mortgages (750,000) that are in significant negative equity positions.