The strain of increased debt and falling home prices is pushing the U.S. economy to a breaking point, setting up consumers and investors for a nasty fall later this year, according to new research published Wednesday by Moody’s Economy.com. Credit quality is weakening across all loan types and in nearly every corner of the country, the Moody’s report found — but 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; and 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. HW readers know that we have been projecting that the number of defaults in 2008 would double 2007’s high totals since the year began. The rest of the economic press is now catching onto the theme. “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. That’s equal to 7.5 percent of all U.S. household debt, up from 3 percent just two years ago. Where the pain is Not surprisingly, it’s the former boom states that are paying the highest price for the correction in the nation’s housing markets. The highest mortgage default rates are in Arizona, California, Florida and Nevada — but they are also very high throughout the industrial Midwest, and in parts of the Northeast corridor around Washington D.C., Long Island, NY, and Rhode Island, Moody’s noted. 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 percent from their spring 2006 peak, some 9.6 million U.S. homeowners now have mortgage balances that exceed the market value of their home, Zandi estimated. While some are projecting a quick turnaround out of the current doldrums, Moody’s is clearly not nearly as sanguine on the prospects for either housing or the economy. The company said it 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 — a total that includes about one-half of the current 10.5 million borrowers with subprime, Alt-A or jumbo option ARM mortgages that are in significant negative equity positions. In other words: strap yourself in. It could be a very long ride. For more information, visit http://www.economy.com.

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