"The most valuable truths are the ones most people don't believe. They're like undervalued stocks. If you start with them, you'll have the whole field to yourself. So when you find an idea you know is good but most people disagree with, you should not merely ignore their objections, but push aggressively in that direction." Paul Graham
He makes a lot of assumptions in this analysis, but if he’s right about the increasing number of foreclosures and the slim number of non-REO sales taking place, the California housing market will continue to be a scary place for quite some time.
Take a look at the debate going on at his Web site if you want to see other people’s perspectives on his video.
We are now undergoing a self-reinforcing cycle of default, foreclosure, home price declines, and mortgage credit contraction, the likes of which we have not experienced since the 1930s. The annual number of U.S. foreclosures nearly doubled between 2005 and 2007 to more than 1.5 million, and some private forecasts project 2 million foreclosures or more during 2008 if action is not taken now. Beyond their immediate costs, which include hundreds of thousands of displaced families and tens of billions of dollars in financial losses, these defaults and foreclosures are now resulting in wider problems for our communities and our economy.
When this happened in the early 1990s, the FDIC helped shut down banks and liquidate their assets. Now it says we’re facing a crisis that’s even worse. If bank failures begin again in earnest, the FDIC will have a lot of work on its hands.
Home prices in ten large U.S. cities fell on average by 13.6 percent in the year ending in February, and home price declines of more than 15 percent were registered in major metropolitan areas of California, Nevada, Arizona, Florida, and Michigan. A large inventory of unsold homes points to a protracted oversupply of homes. Of the net 6.6 million homes added to the U.S. housing stock since 2004, more than half are currently vacant. The problem is made worse by the difficulty of securitizing mortgage debt outside of the government-sponsored enterprises. The data show that private MBS issuance in the fourth quarter of 2007 was down 80 percent from the same quarter the year before, and originations of nonconforming loans financed by private mortgage backed securities (MBS) declined by similar amounts.
More than half of the unsold homes are vacant. That’s 3.3 million empty houses. Empty houses are eventually attacked by weather, vandals, and squatters. What will happen to property values then?
Because of the high costs associated with foreclosure (which can range up to 40 percent of the value of the property), it is in the interest of both borrowers and lenders to avoid this remedy whenever possible. But the progress of loan modifications to date has been too slow. A recent study indicates that seven out of ten seriously delinquent borrowers are not yet in any loss mitigation process, and that new loans are becoming delinquent faster than the servicers can modify them on their own.
Loan modifications are going to be an important part of bringing the housing market to a recovery point. I don’t think it’s the government’s job to make sure that these modifications take place. Rather, lenders have every reason to preserve themselves financially by increasing the efficiency of their loss mitigation efforts and by selling their problem loans to investors who are skilled at dealing with delinquent loans.
Subsidizing lenders who are unable to do this simply subsidizes their irresponsible lending choices and business practices. Subsidizing homeowners who put nothing down and are now in distress has the effect of penalizing homeowners who used substantial down payments to buy their properties but have lost most or all of their equity. (See Richard Martens’ post on homeowner bailouts.)
Investors are already responding to lenders’ needs by doing short sales, buying REOs, and purchasing pools of unwanted mortgage paper. Profits exist where lenders need help, and the strength of that need is going to increase through the coming recession.
Delinquencies for Alt-A mortgages rated between 2005 and 2007 are climbing, with total delinquencies rising as high as 17 percent in some cases, more than 6 percentage points higher than previous estimates, the ratings agency said in a report.
Alt-A mortgages are considered higher-quality than subprime ones because Alt-A borrowers have high credit scores, often better than 700. However, most of these loans were made with little or no documentation of the borrowers’ income. Now the market is beginning to show what a risk these loans really are.
Lower-quality subprime mortgage delinquencies soared as high as 37 percent for mortgages originated in 2006, 4 percentage points higher than previous estimates, S&P said.
Subprime mortgages originated in 2007 saw delinquencies climb to almost 26 percent, 6 percentage points higher.
That’s a staggering delinquency rate. Banks’ loss mitigation departments are overwhelmed and understaffed.
“The 2007 issuance year continues to be the worst-performing vintage in terms of cumulative losses,” S&P said, regarding subprime mortgages. “Serious delinquencies” of payments 90 days late or more and foreclosures also are rising, S&P said.
Things may be bad now, but the Alt-A crisis hasn’t even fully begun. The housing market is going down before it comes back up.
Investors who are prepared for this will profit. Everyone else will get slaughtered.
Can a Florida real estate brokerage still make money? Ed Bonkowski, a Fort Myers-based broker, says “yes”, but he’s waiting for certain market conditions.
One recent attendee [of foreclosure auctions] was Kim Hardin, a real estate agent with Century 21 Sunbelt Realty # 1.
She didn’t bid on any properties but was interested in buying foreclosed houses from the regulars.
Hardin said she’s looking to buy in bulk for clients interested in holding houses and leasing them out.
But that could be difficult, Carney said. “We can’t get the houses” in large numbers from the banks.
Ed Bonkowski, a Fort Myers-based real estate broker, did a lot of business in foreclosed properties in the early ’90s in the last major downturn but said he hasn’t lately because good deals are “few and far between.”
He expects that will change eventually, as foreclosure sales accelerate and bank-owned homes pile up.
“Our decision to buy’s going to be when the banks are ready to bulk sale a bunch of them, then it’d make some sense,” Bonkowski said.
But prices will have to drop steeply for that to happen, he said.
“At 15 cents on the dollar, all those properties will be gobbled up, investors will come out of the woodwork and buy them and everybody will go back to work,” Bonkowski said.
Rentals are worth buying, even in Florida, but only if the prices are right.
People who buy right are not scared of this market. They’re excited. That’s worth remembering.
One of the members of our team ran across this article from the Bank Wage-Hour and Personnel Report (No. 7, Vol. LVIII). My emphases are in bold.
The FDIC is warning banks to prepare for the increased workload that will come as more and more loans default. It’s advising banks to bring on the staff necessary to work these problems out with the borrowers.
The banking crisis is not going away. Don’t be caught off guard.
Shore Up Loan Workout Staff, FDIC Advises
April 15, 2008
The Federal Deposit Insurance Corporation (FDIC) is urging insured financial institutions with significant commercial real estate (CRE) concentrations, including concentrations of construction and development (C&D) loans, to immediately undertake a number of risk management actions. Such actions include bolstering the institution’s loan workout infrastructure and staffing to handle the increased workload associated with problem loans….
According to the FDIC, institutions with CRE and/or C&D concentrations should ensure that they have sufficient staff with the appropriate skill sets to properly manage an increase in problem loans and workouts.
Staffing decisions may involve hiring, making internal staffing changes, and training. Human resources strategists may also entail entering into arrangements with third-party experts on a temporary outsourcing basis. The FDIC suggests that management should develop a ready network of legal, appraisal, real estate brokerage, and property management professionals to handle additional prospective workouts.
If your institution’s management is currently adopting risk management strategies to contain the damage from subprime loan losses and the associated financial repercussions, you should insist on a place at the planning table. No risk management strategy can be successful without adequate staff who are appropriately trained to handle the potential wave of problem loans.
Thanks for posting that, Cory. I ran into the same video from another source. It seems that many of the experienced investors are talking about how bad Alt-A is going to be, but this sort of thing never seems to hit popular media until after it becomes a big problem.
Alt-A [and option ARM] resets will peak in 2011. Things will remain bad for quite a while. Bad for everyone else, that is, and good for those who help bring liquidity to the markets through short sales, REO purchases, and note purchases.
Addition: It typically takes about six months after an adjustable-rate mortgage resets for the bank to repossesses the property. It may then take another six months for the property to sell and six more months before the property is no longer used as a comp to lower the values of the houses around it.
There’s a year and a half between an ARM re-set and the time when the house is no longer used as a comp. The fallout from the mortgage crisis is going to be around for a couple of years.
The Fed currently isn’t doing much to “save” the markets. The swaps for T-bills aren’t inflationary (yet), since the assets have to be swapped back every 28 days. I think swaps will become inflationary when the paper stops performing while it’s being held by the Fed.
I think Bernanke is more concerned about the value of the dollar than he is with bailing out the markets. I’ve written about this before:
