LyrArc Article Gist
Home Prices have overshot income growth for some years , it would take another drop of 10-12 % in home prices given income growth in coming years to bring them into balance but as prices tend to overshoot in either direction Merrill thinks it would be more like another 20% to 30% decline and Goldman looks at another 15% decline home prices. The Goldman and Merrill estimates which see a strong downside have been borne out so far. For certain states like California, Florida and Arizona where the situation is worse in terms of the gap between incomes and home prices it may be higher. As home prices decline the Loan to Value Ratio rises and as Martin Feldstein fears in his article suggesting Loan Substitution with the Federal Government stepping in with a loan for 20% of the value of a loan, see link, when LTV is at 100% then it makes sense and is the rational thing to do to walk away from a house and default. This expected price decline would thus lead to losses on the mortgage securties and worsen the effect on the economy and on lending.