Tuesday, October 07, 2008

When Will Housing Really Bottom? (Part II)

Yesterday we established the context of the housing market: that the unraveling of global credit bubbles and leverage doom housing to a long decline and stagnation. Today we examine some of the less visible conditions which will exacerbate the decline and stagnation.

Please go to www.oftwominds.com/blog.html to view the charts.

But before we get to that analysis, let's look at this chart of Lehman Brothers (r.i.p.), courtesy of frequent contributor Harun I., and ask if this could presage what is in store not just for banks but for leverage, for credit, for new housing sales and indeed, the global stock markets:

Correspondent Unix Ronin recently sent in a link to the Los Angeles TV station KCET's report on what they term "Foreclosure Alley". While the piece provides nothing new to those of you who have been following the housing bubble's bursting, the comments left by readers included a long, deeply revealing post by a homeowner (signed as Linda Ogden) who successfully renegotiated her first mortgage with the lender.

Here are some excerpts from the post:

"Our mortgage has been modified, we are now able to stay in our home for 4 more years... then we can not afford the payments again, what will happen? Is the lenders help in modification of our loan a help, or just a temporary fix? Our goal is to pray the real estate comes back enough to sell and pay our first and second loans of approximately $566,000. My husband is retired, fortunately from the state of California after 38 years, and he has a pension, and will be able to collect Social Security in November. We are blessed, we are some of the lucky ones with an income.

My husband worries that in four years when we can no longer afford our modified home loan, what is going to happen? Are we going to go through the harrassing phone calls, people knocking on our door, attorneys and private individuals promising us assistance at a cost of course, lenders seem to play good and evil, one person says they understand, the next one who calls yells and threatens.

Our second trust deed of a little over $60,000, was the worst, I can't tell you how we where lied to, threatened, etc. Even when two weeks prior to our foreclosure date the first trust deed (holder) agreed to modify our loan, the second would not, stating that now we should be able to make the interest only payment to them, it is a recourse loan and will follow us to the ends of the earth, or so we have been told. We saw a bankrupcy attorney about claiming bankrupcy, but we have two cars that are paid for, and had paid off the credit cards. We are just house poor! So we were told we would have to buy one of our cars back from the bankruptcy court if we were lucky and were given that option. (We own a 1998 Ford Explorer and a 2004 Chevrolet.)

Now to the important part, we were told by our lender on the first trust deed that the reason we were able to modify our loan, was that we kept in contact with the lender, we did not back down, we did not bury our heads in the sand. No matter how bad and threatening things got, I contacted the lenders every week, yes, every week.

Other Realtors said I was beating a dead horse, I should transfer title to vehicles to friends or relatives, lie about everything under the sun, and play the system. This was not something I or my husband could do. We are honest people and have worked hard, we made a pact that no matter how bad everything got, we were not going to compromise our principles by commiting fraud.

What did our lender finally do? On our first trust deed: two percent interest only for first two years, then three percent interest only for years three and four. Year five it goes to 4.5 percent interest and principal, then year six on at 6.375 percent principal and interest. (emphasis added: CHS)

So you see they did not want another foreclosure property on their hands either.
The lender is also hoping that we will sometime within four years be able to pay the loans off with a sale. They know we can no longer afford this home, so we either lose the house in a little over four years, or the lender will need to work with us again.

About the second trust deed, they were of no help, and said they are in a position of holding firm, of course they say we have commited fraud, taking a loan that we could not pay, although we have been paying on it for years. I have since been able to advise anyone I hear of in foreclosure to not give up, keep in weekly contact with the lenders, leave open ended messages: as our situation has changed...we want to work something out that would be agreeable to all parties, etc. Do not give up, you may end up going to a foreclosure sale, but you will know that you did everything possible to try and keep your home. The lenders do not need nor want another foreclosure. God bless you all and keep thinking positive. "

Here we have the entire rotten-to-the-core world of housing meltdown in one account. Note that Ms. Ogden (admittedly by her own account) appears to be trying to "do the right thing," and no doubt the loan officers who works for the first-mortgage lender also believes he/she is "trying to do the right thing" in keeping a foreclosure off the books and keeping a homeowner in their home.

But if we look between the cracks of this account, what do we see that has deep ramifications for the housing market as whole? Is there any reason to suspect this account is highly unusual or unique? All available evidence suggests it is very typical and reflects widespread lender policies.
1. Even homeowners who were fiscally conservative (paid off cars and credit cards) bought more house than they can afford. Assuming these folks are typical of a certain demographic, it suggests millions of "responsible" households are also hanging on by their fingernails to mortgages and houses they really can't afford.

2. Everyone is depending on a huge rebound in real estate values to save them. Everyone from the homeowners to lenders to Federal Reserve officials is praying for the one thing which would bail everyone out: a sudden re-inflation of the housing bubble which would enable the sale of millions of underwater mortgages to a new generation of marks/suckers.

Too bad there are no more marks or suckers. Loose lending standards and liar loans enabled millions of unqualified people to become homeowners. The gangplank has been pulled up from those no-down, cheap mortgages, so the pool of potential marks/buyers has literally vanished overnight.

So what's Plan B if housing stagnates and does not return to bubble-era valuations in 4-5 years? Foreclosure.

3. Many are counting on their pensions remaining untouched even as a financial firestorm destroys the value of pension funds and as a housing and economic meltdown savages all local and state governments' revenues. Pensions may well take a hit along with everything else, especially if municipalities and agencies find no choice but to declare bankruptcy in the face of unsustainable pension promises.

Could the state of California renege on its promises? Absolutely. As the saying goes, "you can't get blood from a turnip."

4. The mortgage "workout" is a money-losing fig-leaf which masks the lenders' desperation to keep the mortgage out of foreclosure and on the books at "full value," i.e. "marked to maturity." You are already familiar with "marked to maturity," as this fiction is the foundation of the Paulson Bailout Congress just approved: overpay for near-worthless mortgages, and then pray the housing bubble re-inflates and makes everyone whole again.

5. Both borrower and lender are making the tacit assumption that this is merely a holding action: the borrower cannot afford the mortgage under anything but giveaway conditions: super-low interest and no principal payments. The borrower more or less states that she will be unable to pay market-rates on her mortgage.

Thus both borrower and lender are gambling that the market recovers to its bubble-era valuations in 4-5 years. If that doesn't happen, then another wave of foreclosures looms in that time frame.

6. "Responsible" borrowers, i.e. those with recoverable assets and a desire to renegotiate their mortgages, are getting gamed by aggressive lenders. In this case, the second-mortgage lender gamed the situation and saw the benefits of playing hardball: refuse any workout on the theory that the homeowner would reach a deal with the first-mortgage holder, leaving the second mortgage untouched.

The lender's accusation of fraud is a nice little example of chutzpah, i.e. the fellow who murders his parents and then throws himself on the mercy of the courts as a poor orphan.
That game plan only works if the homeowners is trying to keep their home; it's a game of chicken and if the homeowners walk away then the second-mortgage lien holder very likely gets nothing.

Given the incredible recalcitrance of lenders in denial, perhaps the appropriate response for many homeowners is: Choose Foreclosure: The Case For Walking Away (website) and the companion book CHOOSE FORECLOSURE: The Case For Walking Away. I haven't had a chance to read this book yet but but the concept is well worth exploring, and the website has a free excerpt of the book for your review.

7. Other Realtors suggested gaming the system via lying; so the same conditions which fed the bubble--lies, obfuscations, misstatements, omissions, collusion and a lack of verification and transparency--are still the norm. How can anyone accurately price collateral when everyone is still lying or in denial, from the borrower to the ratings agencies to the lenders to the politicos passing bailouts?

Without verified data and full transparency, trust cannot be restored, no matter how much liquidity the Federal Reserve pumps into the corpse of the global "empire of debt and leverage."
8. "The lenders do not need nor want another foreclosure"--true, because if they mark their depreciated mortgage assets to the actual market, they're hopelessly insolvent. This explains why the lenders in this account were so anxious to keep the full (bogus) value of the mortgages on the books, even if payments dropped to a meager 2% interest.

This is precisely what the Japanese banks did for 15 years, propping up zombie loans and borrowers with sweetheart payments and even additional loans to enable the zombies to make token payments on the original debt. And how well did that work out for the Japanese? How about the "Lost Decade" is now "The Lost Two Decades"?

Bottom line: even formerly prudent people bought into the bubble notion that prices could only climb higher. Now the system is attempting to stave off the reality of collapsing values via zombie borrowers and loans. All that this accomplishes is the pain is put off for another 4-5 years.

Lenders are truly on the horns of a dilemma: if they write down their true losses, they are insolvent, so their only choice is to keep as many "zombie" loans on the books at full value as possible, i.e. loans which are uncollectable as they are based on severely depreciated collateral.
The basic premise presented by this homeowner--that we'll all be saved if the housing market goes bubblicious again in 4-5 years--is essentially what Bernanke and Paulson are saying, too: just keep the garbage assets on the books at full value (i.e. "marked to maturity") for a few years until housing recovers, and then the workout will be painless.

But what if housing doesn't shoot back up to bubble-era heights? Then what? Then you get a housing market which stumbles and stagnates for 4-5 years, and then it gets hit with a massive wave of reality as all the zombies slip into their final resting places, i.e the financial graveyard of bankruptcy and insolvency.

And let's not forget that millions of Alt-A and adjustable loans are coming up for re-sets in the years ahead:

These re-sets reach a crescendo in 2011 and then diminish in 2012. So you see what will happen: these re-sets will keep housing declining until 2012, at which point the "workout" jig is up for the zombie borrowers and mortgages who were counting on a re-inflation of the bubble. Thus we can foresee a huge wave of foreclosures hitting in 2011 and 2012, followed by yet another massive wave of zombie borrowers and loans which will finally be exposed to daylight.

By the time that wave recedes, how many buyers will be left? How much trust in the system will there be? How many will still believe the "old-time religion" that real estate only goes up? This is how we come to a conclusion that the housing decline and stagnation might not hit bottom until 2020 or so.

Since I rashly predicted a stock market crash for today back on 9/22/08, Mark Your Calendars: The Crash of October 7, 2008, I will leave you with a comment by Harun regarding the charts I've recently posted:

All of your charts seem to have something in common with the first chart:

Reader Essays:
The Common Chump(Chris Sullins, October 3, 2008)
We are still a ways off on our current timeline leading to a contemporary Marie Antoinette statement about bread and cake. I suspect when that moment arrives in a marbled room on this side of the Atlantic, it will either be tightly controlled or leaked by design. However, we are now at a point where the well-powdered whisper blowing upon the tiny spark of public anger seems to be “If they have two slices of bread, then take their little pat of butter.”

The No Banker Left Behind Bill(Chuck D., September 29, 2008)
I have been mulling over the proposed bailout bill (which I have decided should be called the No Banker Left Behind Bill). I have the feeling that no matter what they do, something big this way is coming. I just don’t know what form it will take.

There Is Ultimately No Gaming the System: When the Micro Crash Reflects the Macro Crash (Zeus Y., September 29, 2008)
The proposed 700 billion dollar bailout cannot really “work” from a system level. I know it’s real intention is to cover the butts of Wall Street investors, but you have the same problem in macro that homeowners have in micro. Nobody knows what homes are worth right now, so buyers are sitting it out. It isn’t about restricted credit (even though that is a factor). It isn’t about being too cash strapped to make a down payment (though that too is a factor). It’s about not wanting to be suckered into buying something that may still be overpriced.

Thank you, James L. ($25), for your much-appreciated generous donation to this site. I am greatly honored by your ongoing support and readership.

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