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The Economy Sucks Because Banks Are Still Sticking It To Overextended Home Loan Borrowers

Banks aren't budging, and government isn't offering millions of households what they need.

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If the Dow Jones Industral Average is hitting records highs, how come the economy where most Americans live still sucks?

The answer is not just that many people don't own stocks or that cash-rich businesses aren’t hiring, or other oft-cited trends such as stagnant wages or stubborn jobless rates. It’s because a giant slice of the housing market is still frozen, due to millions of underwater mortgages, and that is smothering local economies.

“Each house that is sold creates a number of jobs,” said founder Jon D. Maddux, whose company advises people facing foreclosure. “There is a huge drain on the economy because of this.”

How serious is this economic undercurrent? It depends who you ask, but some affordable housing experts say that it is so big—with 27.5 percent of U.S. mortgage holders owing more than their house was worth as of December—that it helped push the U.S. mobility rate to its lowest level since the Census Bureau started tracking it decades ago. In other words, even though 792,000 people moved last year because lenders foreclosed or were evicted, 13.8 million were stranded with underwater mortgages as of December.

“The underwater homeowners is a serious drag on the economy,” said Brent White, a law professor at University of Arizona and author of Underwater Home: What Should You Do If You Own More On Your Home Than It’s Worth. “When there was a housing boom, there was a lot of spending because homeowners had a lot of positive equity. They were spending because they felt wealthy… now they feel poor. They think their house is not a good investment anymore. There is a negative wealth effect because they feel poor.”

With so many households and communities still held hostage by debt, it is no wonder that news reports of Wall Street's recovery land with a thud on Main Streets across America (see map) where the real estate collapse is still raw. And the prospects for solving this nationwide economic crisis are very slim, because neither the private sector nor government has anything underway that’s intended to help most of these 13.8 million underwater households.

“They’re not offering that,” White said. “That’s the problem. It’s not there.”

Beyond Foreclosures: The Rest Of The Iceberg

The housing bubble was at the heart of the meltdown that caused the Great Recession. People bought homes with easy access to capital. Or they borrowed against rising home values to finance their lifestyles. When those loans could no longer be paid, the market crashed. But the debts did not go away. The most visible part of that collapse was the foreclosure crisis. Today, private investors are buying thousands of foreclosed homes, causing low-end home prices to rise. But they haven’t risen enough to fix underwater mortgages—where the money owed is more than current selling prices.

“The housing market is bifurcated,” said Paul Staley, who buys and sells low-end homes for a Bay Area affordable housing non-profit. “On one hand, what’s happening is prices are strong, but there’s a huge portion of supply where people are not free to trade because they’re still underwater. They’re trying for a loan modification. They want to move, but can’t. Not yet. How do you work that out? This is thousands of local households.”

“There is an artificiality in the housing market now,” he explained, saying that prices are rising in part because a significant supply of affordable homes—those with underwater mortgages—are not available for sale. “Banks slowed down the foreclosure process. But all these other homes are in limbo. The next big question is how do you resolve the debt issues hanging over these homes?”