Many people believe the crash is over because removing the supply stabilized prices. Most people who carefully watch housing markets agree that a cartel of lenders controls the market through its ability to control supply. Since lenders are being permitted to hold non-performing loans on their books -- and allow delinquent borrowers to squat -- they control the flow of properties through the foreclosure process. Also, they control the approval of short sales; therefore, they control the flow of properties through the short sale process. Since distressed sales of foreclosure properties and short sales make up a significant percentage of market sales, lenders control the bulk of the supply on the market.
The speed at which house prices fall over the next few months could depend less on mortgage rates and Americans' appetite for home buying than on how banks decide to manage the huge number of foreclosed homes they own or may take from delinquent borrowers in the near future.
Unlike home owners, banks often are much quicker to slash prices to unload properties quickly.
This has certainly been true in the past, but lenders seem much more willing to emulate homeowner denial this time around. Loan owners are quick to lapse into denial on the false belief that prices will quickly rebound. We explored that phenomenon in Contrarian Investing and the Psychology of Deflation. Lenders are usually pressured by regulators and investors to process their non-performing loans and dispose of their REO. Because this inventory problem is so large, the groups that usually pressure disposition are embracing a hold-and-hope strategy largely doomed to fail.
The upshot is that, the more homes being sold by lenders, the faster prices tend to fall. That pattern was clear over the past two years: Price declines that began four years ago accelerated rapidly in 2008 as banks dumped foreclosed properties at fire-sale prices. By January 2009, the share of distressed sales had soared to 45% of all sales nationally; it was even higher in hard-hit markets such as Phoenix, according to analysts at Barclays Capital.
Even though mortgage defaults kept mounting, housing markets began to stabilize early last year as low prices and government interventions broke the downward spiral. Policy makers spurred demand for homes by holding down mortgage rates, offering tax credits for buyers, and extending low-down-payment loans through the Federal Housing Administration.
This is the squatting problem. We didn't have much squatting prior to 2008 because lenders processed their foreclosures in a timely manner. When they saw what this did to markets like Las Vegas, they stopped processing these foreclosures. Since subprime defaulted first, they were foreclosed on, and since the alt-A and prime mortgages defaulted later, and since those mortgages are much larger, lenders have opted to let those delinquent owners squat.
The government also attacked the supply problem. Regulators relaxed mark-to-market accounting rules, giving banks more flexibility in valuing certain real-estate assets and removing some of the impetus for banks to quickly foreclose.
Meanwhile, the Obama administration put in place an ambitious program to modify mortgages.
The Home Affordable Modification Program has fallen short of its goals. So far, fewer than 500,000 loans have been modified, below the target of three million to four million. Yet the program served as a "closet moratorium" on foreclosures that stanched the flow of bank-owned homes to the market, said Ronald Temple, portfolio manager at Lazard Asset Management.
The result: The share of distressed sales fell by November to 25% of home sales, and prices stabilized. After rising in the winter, the distressed share fell to 22% in June, before bouncing to 30% in July.
The loan modifications programs have all failed, and they will continue to fail. They have provided some political cover for the amend-extend-pretend policy exercised by nearly every bank.
The problem is that these measures are wearing off. Demand plunged this summer after tax credits expired, and unsold homes are piling up. More foreclosures could move onto the market as borrowers fall out of the loan-modification program.
"We see the perfect storm brewing with rising supply and falling demand," said Ivy Zelman, chief executive of research firm Zelman & Associates and one of the first to warn of trouble five years ago. She estimated that distressed sales could account for half of the market by year-end if traditional sales didn't rebound.
Does anyone think the traditional sales market is going to rebound this fall and winter? I don't either. Ivy Zelman is usually correct. Her analysis has been some of the best of the housing bubble.
The market does have some tailwinds: Housing starts are at all-time lows. Banks have hired more staff to manage problem loans and government entities such as Fannie Mae and Freddie Mac that own a growing share of foreclosures are less likely to deluge the market.
The next leg down in prices "isn't going to be the foreclosure-induced freefall where you just had inventory coming out the wazoo, and it was going to be sold one way or the other," said Glenn Kelman, chief executive of Redfin Corp., a real-estate brokerage.
He is probably right that we will not have a mass forced auction that pounds prices back to the stone ages, but we will have significant pricing pressure until this supply is cleared from the market.
Prices also have come down so much already they have less distance to fall. During the housing boom, prices inflated much faster than incomes rose, thanks to speculation and lax lending. The ratio of home prices to annual incomes reached 1.6 at the end of June, which is below the ratio of 1.88 from 1989 to 2003, according to Moody's Analytics.
By those metrics, prices are actually undervalued in markets that have already seen huge declines, such as Las Vegas, Phoenix and Los Angeles. But Moody's data show that prices remain "significantly overvalued" elsewhere, including Boston; New York; Seattle; Orange County, Calif., and Charlotte, N.C. Markets in both camps face supply imbalances that will pressure prices for years.
Moody's is right on. Las Vegas is too low relative to incomes, and Orange County is much too high.
The fastest cure for housing would be job creation because it would boost demand for homes while putting delinquent borrowers back on solid footing.
But if that doesn't materialize, policy makers face a thorny question: whether to intervene if price declines accelerate beyond the 5% to 10% that most economists expect. In recent weeks, the White House has been surveying industry analysts on how to manage the inventory overhang.
Analysts at Barclays Capital estimate that some four million loans are in some stage of foreclosure or are at least 90 days past due, down slightly from a January peak.
While more tax credits aren't likely, policy makers could still attack the supply problem by, for example, taking foreclosed homes off the market and renting them out.
Ultimately, market fundamentals will prevail "and any attempt to get around that will only be short-term," said Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School. But officials should be prepared to intervene anyway, she said, if psychology spurs a downward spiral "where price declines are feeding further price declines."
That leaves few attractive options. Prolonged intervention could backfire by creating uncertainty that keeps buyers on the sidelines. Extending foreclosure timelines also risks inducing more borrowers to default and live rent-free.
Letting the market take its medicine sounds more appealing than it did 18 months ago. But it risks saddling taxpayers and the banking system with billions more in losses and trapping more borrowers in homes on which they owe more than the house is worth.
Write to Nick Timiraos at nick.timiraos@wsj.com
Kudos to Nick Tamiraos for such a lucid description of the problem, and of the problems associated with all the bad solutions that have been implemented to solve the problem to date.
Knife catcher gets sliced
One thing all knife catchers have in common is their belief that they got a good deal when they bought. They are all mistaken.
If we go back two owners, we find a major HELOC abuser:
This property was purchased on 3/4/2005 for $611,000. The owner used a $488,800 first mortgage, a $61,100 second mortgage, and a $61,100 down payment.
On 6/27/2005 he obtained a $102,500 HELOC.
On 1/5/2006 he refinanced with a $742,500 first mortgage.
On 11/14/2006 he refinanced again with a $655,200 Option ARM and a $81,900 stand-alone second.
The total property debt was $737,100 plus negative amortization and missed payments.
The property was sold to the current owner for $820,000 on 3/3/2007. The previous HELOC abuser got away with the abuse plus obtained some extra cash. Not a bad deal for him.
The current owner paid $820,000. The original mortgage data is not in my records. However...
On 5/3/2007 he obtained a $656,000 first mortgage and a $123,000 HELOC.
On 7/31/2007 he increased his HELOC to $160,000. If he maxed it out, he got most of his down payment back.
Total property debt is $816,000.
It's currently listed as a short sale, so we can assume he is no longer making payments.
Home Purchase Price … $820,000 Home Purchase Date .... 3/3/2007
Net Gain (Loss) .......... $(218,400) Percent Change .......... -26.6% Annual Appreciation … -6.6%
Cost of Ownership ------------------------------------------------- $640,000 .......... Asking Price $128,000 .......... 20% Down Conventional 4.34% ............... Mortgage Interest Rate $512,000 .......... 30-Year Mortgage $122,743 .......... Income Requirement
$2,546 .......... Monthly Mortgage Payment
$555 .......... Property Tax $0 .......... Special Taxes and Levies (Mello Roos) $53 .......... Homeowners Insurance $30 .......... Homeowners Association Fees ============================================ $3,184 .......... Monthly Cash Outlays
-$421 .......... Tax Savings (% of Interest and Property Tax) -$694 .......... Equity Hidden in Payment $202 .......... Lost Income to Down Payment (net of taxes) $80 .......... Maintenance and Replacement Reserves ============================================ $2,351 .......... Monthly Cost of Ownership
Cash Acquisition Demands ------------------------------------------------------------------------------ $6,400 .......... Furnishing and Move In @1% $6,400 .......... Closing Costs @1% $5,120 ............ Interest Points @1% of Loan $128,000 .......... Down Payment ============================================ $145,920 .......... Total Cash Costs $36,000 ............ Emergency Cash Reserves ============================================ $181,920 .......... Total Savings Needed
Property Details for 4 STAR THISTLE Irvine, CA 92604 ------------------------------------------------------------------------------ Beds: 4 Baths: 3 baths Home size: 2,474 sq ft ($259 / sq ft) Lot Size: 4,275 sq ft Year Built: 1974 Days on Market: 111 Listing Updated: 40365 MLS Number: P735477 Property Type: Single Family, Residential Community: El Camino Real Tract: Di ------------------------------------------------------------------------------ According to the listing agent, this listing may be a pre-foreclosure or short sale.
Great Schools!!! 4 bedrooms + den. This great house offers thousands in upgrades!! State of the art gourmet kitchen. All bathrooms remodeled. Two bedrooms down three up. Spacious family room. Flat TV and Pool table and bar could be included. Wood floor through out the first floor. Inside laundry room. Built in barbeque. Central air. Close to park.Walking distance to great schools & shopping center, NO Mello roos and low low HOA dues. This home must be seen to be appreciated. Directions Culver & Irvine Center
Great exclamations!!!
Judging by the disheveled appearance, I have to assume this property belongs to a bachelor. You have to admire a guy that has a bar in his bedroom. If he gets his dates drunk, he doesn't have to pursuade them to go far. Those horseshoes are great: Get Lucky!
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.
I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.
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