Everybody knows the math of debt leverage shows that growing, even if only doing so slowly, mortgage debt in combination with several years of only modestly declining home property prices will seem to suddenly collapse highly debt-leveraged home equity.

And we fully expect growth in mortgage debt will decline from its recent 14% year-over-year, seasonally-adjusting peak rate, down to 4%, if not lower, just as it has done several times during the past 50 years after, and thus not considering what happened during, The Great Depression.

But quite counter intuitively -- at least for most homeowners, and even Wall Street bullishly-biased economists -- the chart below illustrates that home equity collapses in highly-leveraged properties even when such home prices only slow their rate of gain to just slightly less faster than the growth in the underlying mortgage debt.

It demonstrates the not-so-obvious point that the huge portion of US home equity that is highly mortgage-leveraged should be expected to virtually collapse even if there was no eventual decline in home prices.

Because mortgage debt has been growing faster than home prices, and will likely continue to do so, the 40+% of American homeowners who currently have less than 10% equity in their property, will be quite shocked as their 90+% mortgage debt leverage (loan-to-value, or LTV) causes them to become upside-down (underwater), where they, quite depressingly, owe more than their property's (re)marketable value.

It is the ever-growing mortgage debt that is the real underlying problem in the so-called "housing bubble" (the associated problem of a MCHVIE* blow-up in financial derivatives is a matter for later discussion), much more so than the unsustainable, and at least partially reversible, price escalation of the 30% or so of American homes without mortgages.

We fully expect such an unavoidable adverse impact on most US homeowner's equity will create an extremely negative wealth effect on household (consumer) spending, which will exacerbate the coming recession, especially because of the negative feedback that creates the vicious downward spiral that predictably leads to reversions to the extreme -- not just to the mean.

© 2005 Bob Bronson
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Bob Bronson
Bronson Capital Markets Research
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