Deutsche Bank figures 48% of all homeowners with mortgages will be underwater before the housing recession ends, which by their reckoning will be the first quarter of 2011. That means the number of underwater homes will grow from 14 million to 25 million. Some of the former-boom areas will see 90% of homeowners underwater (Las Vegas, Modesto, Merced, Ft. Lauderdale). DB anticipates an increase in “Strategic Defaults”.

A strategic default is where the homeowner makes the conscious decision to stop paying the mortgage even If they have the ability to pay; they just decide it makes more sense to default. For example: someone has a mortgage for $300k but the house is worth $150k – they have negative equity of $150k. It will be a long time before that house is worth more than $300k; the borrower is locked into the house and the only way out is to pay the difference between the current market value and the mortgage, or default.

They can go down the street and buy a comparable house (maybe in the wife’s name) for $150k and even get a first time buyer credit of $8k, plus they live in the current house for 6 months rent free while the foreclosure process unfolds. Chicago's Booth School of Business and Northwestern University's Kellogg School of Management found strategic defaulting now accounts for 26% of all mortgage defaults.

What about the moral hazard?  Wait, wait I have to stop laughing. The banks have already set the bar for moral behavior and it is also underwater.

Any other drawbacks to this growing trend? Well, it will hurt your credit report but credit reports can be cleaned up (see bank-o-meter advertiser www.deletederogs.com).

Why not just wait out the housing downturn? Four reasons: 1) Incomes are falling and the old housing prices are unsustainable and people are looking for ways to cut debt, 2) many houses are in the wrong location, 3) a wave of foreclosures and mortgage resets will continue to depress housing; the shadow inventory of foreclosed and pending-foreclosure homes stands at close to 2 million and there are an estimated 18 million vacant homes in the country; the inventory is much, much bigger than you think, and 4) it is not a housing downturn – it is a depression and that means prices will go lower before they stabilize – there will be occasional rebounds that will sucker some fool buyers but asset prices are going lower and won’t get better until they are ridiculously low; the DB estimate of 1Q 2011 is another very optimistic projection – and the bonus reason 5) if you have a choice of excessive debt, postponing retirement, taking care of your family – or paying the bank, well it is an easy call; the bar has been set.

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