Home-Account.com

The Obama Administration, only days old, is already in a terrible bind.  For all the talk of fiscal stimulus, there is a very good chance that spending a quick $1 trillion or so on public works, tax reductions, and buying back bad loans simply isn’t going to do enough to foreshorten what is already a nasty recession.  Some economists like Paul Krugman of the New York Times and Princeton University say the answer is simply to spend more money.  If $1 trillion won’t do it, then try $2 trillion.

But there is another solution starting to bubble-up from the mortgage industry, itself.  It’s a bit of lateral thinking that wouldn’t generally come to the mind of an academic like Fed Chairman Ben Bernanke, but just might offer a cheaper and easier way out of this mess – a way inspired by the Japanese.  The Japanese of 1600 that is.

The problem faced by the Obama Administration is that this is, at heart, a housing crisis, yet most of the solutions tried so far have little direct effect on housing.  We can use tax dollars to recapitalize the banks, but that doesn’t seem to result in more mortgages being issued, for example.  There are simply too many houses available in the U.S. and WAY too many of those are worth less than their owners paid to either buy or build them.  At least 10 million U.S. homeowners are effectively under water and therefore unable to refinance.  Their options are to pay outrageous mortgage payments as their adjustable rate loans get more and more expensive, or to simply walk away from their homes, taking with them their problems yet leaving their empty houses as a further drag on the U.S. economy.

The White House has no new ideas for handling this crisis, or appears not to.  Congress is equally stymied.  The Treasury Department and Federal Reserve have used all the tools at their disposal and invented a few more, too, with little effect.  What we need is a miracle.

So did Japan just before 1600.  The country was in turmoil and had been for more than 100 years thanks to the introduction of western firearms in 1477.  The B-movie culture of Samurai swordsmen had given way to armies of peasant soldiers with guns doing as they were told to do by officers who generally came from what was left of the Samurai class.  Japan had lost culture, identity, power in the world, and had especially lost a hell of a lot of Samurai as they found it far more efficient to blow each other up in groups than to die one at a time in sword battles.

All the traditional Japanese feudal classes were threatened.  Something had to be done.  So Japan gave up firearms.  After more than 120 years of shooting-off body parts, Japan under the rule of daimo Toyotomi Hideoshi after 1600 successfully repudiated firearms and went back to the old way of Samurai swords-for-hire hacking each other to bits in service of their feudal lords.

This idea of deliberately turning away from technology is foreign to western thinking, yet we seem poised to do something very similar to end the mortgage crisis – repudiating a specific technology that stands in the way of a quick and soft landing for the economy.  Suddenly there is talk in mortgage circles of selectively giving up under certain highly specific conditions that stalwart weapon of home financing, the real estate appraisal.

There are millions of homes in the United States that are worth less than is owed on them.  The Fed and Treasury are thinking-up ever more expensive ways of dealing with this problem – everything from buying-up sub-prime mortgages and holding them to maturity to buying up sub-prime homes, paying-off their mortgages, then simply tearing them down to reduce supply and help prices to firm.  And the bogeyman most directly faced by politicians attempting to address the housing crisis is  that houses under water can’t, by definition, be refinanced.  The problem is lack of equity in light of  FHA, Fannie Mae, and Freddie Mac rules that require a down payment that varies from five to 20 percent for replacement mortgages and refis.

And yet, in the bad old days of just over a year or so ago there were mortgage brokers selling all day long no-doc loans that required no money down to borrow up to 125 percent of a home’s value.  Why can’t we do that today?

We can’t because the rules have changed – tightened – and it is harder to qualify for a loan.  Yet to hear the Administration talk about it, this is just the time when it would help a lot if more people – not less – could qualify for a mortgage.  People would buy houses, which means other people could sell houses and eventually prices would stabilize and even start to rise, leading the banks out of their current wilderness in the process.

The solution to this problem is simple and actually doesn’t require more money or even an act of Congress:  just stop requiring an appraisal for FHA, Fannie Mae, or Freddie Mac qualifying refinance loans.  Let the actual value of the house or property float.

For new loans on new property, yes, an appraisal would still be required.  But for refinance loans on existing owner-occupied properties with no cash out, appraisals would not be required.  Rather than assign a home value lenders would simply use the previous loan balance.  The new loans could be fixed-rate, rather than adjustable, and at current interest rates payments would be lower.  If they weren’t enough lower, the lenders could still use painless (to them) mortgage management tools like 40-year terms and zero-interest introductory periods.  Few houses would be lost to foreclosure, less capital would be needed by the banks, and because bad loans were being replaced with better ones, the associated toxic derivative securities would be pulled from circulation.

This solution separates – as Wall Street has already done in effect through the use of derivative securities – the house from the loan.  It isn’t the house that is toxic, it is the loan.  Interest rates are down and millions of homeowners – and society as a whole – would be well served if these loans could be refinanced to reflect those lower rates, making the houses in turn more affordable.  The method for doing this is to forgo appraisals and simply refinance the mortgage, not the house.

It’s don’t ask, don’t tell — a convenient ruse that lets us fix what needs to be fixed without too much introspection or analysis.

This isn’t such a radical suggestion.  Many mortgages are already granted without appraisals for properties where large down payments and historical pricing precedents make appraisals just an added expense that lenders sometimes prefer to give up.

Not requiring an appraisal effectively raises the limits on how little equity a homeowner can retain in the property while still claiming to own it – in this case probably allowing financing of up to 109 percent of the market value by recent estimates.  But we won’t officially know that because there is no appraisal.

By simply changing the rules in this manner millions of foreclosures can be avoided, families can avoid disruption, the economy can start to heal quicker, billions can be saved, and nobody has to know better.

It’s the Samurai way.

cringely Blog appraisals, Blog, down payment, mortgage, refinance, Samurai

A couple weeks ago I wrote a post about using Case-Schiller Home Price Index futures to predict when the housing market would hit bottom.   Part of the Case-Schiller Index of course shows how prices have changed over time but the futures are a good guess about where they are headed in the months and years ahead.  The news was bad in that it predicted a market bottom around 2011 but good in that the bottom had a few months before been pegged as coming as late as 2013.  This shortening can happen because Case-Schiller futures are not just a prediction of where prices are going but a BET, and such bets can change over time.  Still what makes it so compelling is that very betting aspect, since these aren’t the prognostications of some analyst who says, “Jesus, it’s Monday and I’d better predict where the housing market is headed:” they are the results of trading volume involving real money and are only secondarily an estimate of future behavior. 

A lot of words lately have been written about when this market is going to turn and why.  Take a look back at that column and study the chart then tell me the people who say the market is bottoming RIGHT NOW have a clue at all.  They are either full of beans or are trying to PREDICT housing out of a slump, which won’t work.  You can’t fool professional traders when their money is at stake and real data is readily available to show that we are nationally FAR from that market bottom. 

To be clear, the data don’t show a precipitous decline from here but rather a bumpy bottom that won’t start to rise again until sometime after 2011.  This could change further over time as lower mortgage rates and – hopefully – banks actually funding loans help to firm prices.  But we’re not there yet.  And to explain why, let’s move a bit further down the Case-Schiller data food chain. 

It’s all a matter of supply and demand. 

Here are three charts thanks to a very helpful reader who has spent 25 years as a futures trader.  You don’t survive 25 years in futures without understanding markets and this one is clear. 

The first two charts show the inventories of U.S. new and existing homes over a period of several years as well as the months of available supply in each case.  This latter figure is also used in tracking car sales and is a useful statistic for gauging the health of any retail market for physical goods.  The third chart is just the Case-Schiller historical prices for the same period with break-outs for certain major markets.

House inventories respond to both demand for new homes and to economic conditions that may stimulate re-sales of existing homes.  In the case of new homes, developers always have to guess because they can’t know exactly whether the market will still be as eager to buy that new house when they pull the trigger on construction months before the property is available for sale.  They have to guess what demand will be. 

As you can see, historical inventories amount to about four months for both new and existing homes while the figure for both now stands at about 11 months.  This is not good news for people trying to sell these houses.  Builders have carrying costs on their unsold houses, which were generally built with borrowed money.  Even if they weren’t built with borrowed money there are still opportunity costs because that money could have been better used for something else.  With money going out every month to keep and market those houses, the potential profit from their sale naturally drops over time.  And remember that new houses are still being built, though at a much lower rate than before.  So if a house is finished this week built at a cost of $300,000 and the builder is financing it with an interest-only loan at seven percent, the cost of simply holding the house until it is likely to sell in the current market (if unchanged) is about $20,000 or about $12,000 more than it would have been with historic turnover rates.

That $12,000, then, is the discount any rational builder would give off the selling price TODAY just to get the house off his hands.  While a $12,000 discount may not seem like much for a house that cost $300,000 to build, it is more than half the builder’s historic profit margin for such a house.  So it isn’t a great deal already for the developer and that’s his absolutely best case given the market.  What if things get worse?  In many ways they already have.  Builders have drastically cut back new construction for good reason, but this spreads their overhead across a smaller number of units cutting further into the profit margin of each new house IF it can be sold.  At this point most U.S. builders would be happy to get rid of their current inventory AT COST.  

Comparing all three charts you can see that as supply began to rise in 2006 prices stopped rising.  Those supply increases started as bad decisions in 2004.  The subprime mortgage crisis didn’t come to a head until 2008.  There is cause and effect in these numbers and in every case a lag that probably can’t be removed.  Just as we learned in high school economics, increasing supply leads to softening prices.  Lax lending policies, overzealous mortgage marketing and regulators who were, at best, asleep at the wheel, allowed this system to spiral out of control. UNDER THE BEST POSSIBLE CONDITIONS this suggests that the housing market has two more years of hurt ahead of it (that two year lag again).  

But these aren’t the best possible conditions, are they?  So absent some really extreme actions on the part of someone, maybe the Fed (who knows?) we probably have more than two years before the situation starts to improve and house prices recover.  It’s pretty easy to see a bottom in 2011 and an eventual recovery after 2013 IF WE ARE LUCKY.  Remember it took Japan a decade to even start such a recovery under a similar circumstance, so four years is actually optimistic.

That’s the future based on current forces at work.  There are ways it could be made worse and some that could make it better.  Concentrating on the optimistic side, though, there are only a few actions that could make the downturn shorter, which is to say increase U.S. housing demand thus firming prices.  Here is the list which would seem to me comprises possible actions by the Obama Administration.  I’m not condoning or condemning any of these possible moves, by the way, just listing them for discussion purposes.   

To stimulate housing demand and firm prices the U.S. could:

–  Throw open the doors and allow unlimited immigration.

–  Buy houses and tear them down, thus permanently reducing inventory, possibly aligned with energy policy (similar to junking gas guzzlers).

–  Take over mortgages, foreclose, then turn excess housing inventory into rentals with Uncle Sam as the landlord, to be resold years from now after the market recovers.

The most contentious item here is immigration, but it is also the only one of the three that doesn’t cost tax dollars.  So look for the immigration debates of two years ago to be rejoined but with new priorities and possibly new outcomes.

Remember you read it here first.

cringely Blog Blog, housing prices, mortgage, policy, real estate economics

Michael Lewis (Liar’s Poker), has decided to write a quickie book on the global financial crisis from the sound of two Op-Ed pieces published last weekend in the New York Times.  You can read them here and here.  I say it’s a quickie book because I can’t imagine he’s taken a co-author (David Einhorn) for any other reason.  This Einhorn guy has the goods and Lewis has the glib, I’m sure.

It is clear from these essays that Lewis plans to make Treasury Secretary Hank Paulson into the Devil, which may be the right thing to do, since Paulson’s policies to this point have been mainly about cronyism and barely about solving a global financial crisis. 

Lewis is a very good writer.  This is going to be an important work that will have at least a superficial effect on Obama policy.  It isn’t clear whether Lewis can actually shape the ensuing debate, but he’s pretty darned good at what he does.

The reason I bring this up is because he’s proposing a homeowner bailout of sorts.  It’s always dangerous when writers come to think of themselves as pundits.  I should know.

Here’s his proposal, excerpted by me:

“If we are going to spend trillions of dollars of taxpayer money, it makes more sense to focus less on the failed institutions at the top of the financial system and more on the individuals at the bottom. Instead of buying dodgy assets and guaranteeing deals that should never have been made in the first place, we should use our money to A) repair the social safety net, now badly rent in ways that cause perfectly rational people to be terrified; and B) transform the bailout of the banks into a rescue of homeowners..

…. Congress might grant qualifying homeowners the ability to get new government loans based on the current appraised values without requiring their bank’s consent. When a corporation gets into trouble, its lenders often accept a partial payment in return for some share in any future recovery. Similarly, homeowners should be permitted to satisfy current first mortgages with a combination of the proceeds of the new government loan and a share in any future recovery from the future sale or refinancing of their homes. Lenders who issued second mortgages should be forced to release their claims on property. The important point is that homeowners, not lenders, be granted the right to obtain new government loans. To work, the program needs to be universal and should not require homeowners to file for bankruptcy.”

This idea may get a lot of play in coming weeks.  It’s a clever idea but it probably won’t be allowed to work.  Here’s why

Some of these tactics Lewis proposes are already in use with the Farmers Home Administration.  Farmers Home will subsidize an equity position and loan amount that allows the would-be homeowner to buy a property in designated area in order to attract growth, (This is rarely done anymore, by the way.)

When the homeowner attempts to Sell or Refinance property under this program they must pay Recapture, (pay back to the FHA the amount of the loan subsidy). The big problem with the Lewis proposal is that release of claim by the holders of second mortgages: the banks won’t do it

This proposed second mortgage release of lien will cause problems due to the amount of write downs the banks will be facing.  This will leave them unsecured on junior liens they currently service making that paper default at a much higher rate and therefore the value of the asset will drop considerably.

Let me explain this a little differently.  By decoupling the second mortgage from its collateral (the house) the lender can no longer foreclose (take the house for non-payment) and therefore loses influence with the debtor (the homeowner).  Less influence automatically translates into higher default rates on those second mortgages.  Why pay the second if not paying doesn’t hurt you much?  But the result of non-payment is that the value of the house automatically goes down, owner equity decreases, and our financial death spiral steepens.

While laudable as a good try, Lewis’s proposal not only won’t work, it will make things worse.

I’ll be writing a lot about these issues in the next few days.  It is becoming very clear to me that the U.S. government is in a bad spot when it comes to effectively helping homeowners keep their homes.  The government doesn’t know what it is doing for one thing.  And for another, the lenders simply can’t be trusted to do the right thing

Toward the end of its life Pan American World Airways began to sell-off parts of its global route system to keep the rest of the company afloat.  United Airlines bought Pan Am’s Asian routes along with staff, crews, and as I recall about 25 aging 747s.  Before they handed over the big Boeings to United, Pan Am installed on those planes all their oldest engines, keeping the newer ones for their remaining fleet.  At $1 million per engine it was a $100 million rip-off of United, which eventually had to trash every engine it got from Pan Am.  If something like Lewis’s proposal makes it through we should expect similar behavior from the big banks, offering up first for government refinancing their worst loans, the ones most likely never to be repaid.

cringely Blog bailout, Blog, financial crisis, Michael Lewis, New York Times

With apologies to Charles Dickens, which is this, the best or worst time to buy a house or refinance your mortgage? Those are two completely different questions, but the short answer is that it’s a lousy time to buy and not all that good a time to refi, either, despite record low mortgage rates.

Home prices are down nationally and you’d think that would make this a good time to buy but it isn’t. That’s because values are STILL DROPPING. The time to buy an asset is when it is just starting to appreciate. I’m not demanding here that every potential home buyer try to time the market but it is simple logic that it makes little sense to buy something today if you can buy it cheaper tomorrow. Home prices are dropping and it looks like they will continue to drop at least through 2010 and maybe even to 2012 according to the S&P/Case-Shiller Housing Futures Index traded on the Chicago Mercantile Exchange. The Case-Shiller is the best indication we have of where housing prices are headed. And though the index has shortened a bit in recent months from predicting a 2013 housing market bottom, renting still looks smarter than buying until at least 2011.

If you are selling, not buying, it doesn’t look all that good, either. Yes, sell now if you can’t wait for 2013 or later when some price recovery will have finally taken place, but there aren’t that many buyers out there specifically because the smart money is still waiting for the market to hit bottom. Houses will always sell at the right price but these days the right price sucks.

What about refinancing your mortgage, then, and hanging onto your house? The perception in the news is that rates are down and refinancing is hot, hot, hot, except not that many people are actually getting loans. Fannie Mae and Freddie Mac lending guidelines have just tightened-up. Banks are demanding bigger down payments, more reserves, and dramatically higher credit scores than in the past. Today the rate you could get a year ago with a 660 credit score requires a 740 number. Ouch!

And all those properties that are under water with their owners having no equity at all and owing more than the house is worth – those properties are IMPOSSIBLE to refinance under current circumstances.

What we’ll see then in the coming months is a small bump in refi business but not at all the resurgence one might expect. Defaults and foreclosures will continue to rise for at least another year or more no matter what the Obama Administration does.

So this would be a great time for someone to come up with a new approach to home finance, please, because things are going to get a lot worse before they’ll get better.

Sorry.

cringely Blog Blog, Case-Shiller, futures market, housing prices

It’s getting ugly out there. No matter where you live in the United States mortgage defaults are up, as are foreclosures. Though everyone looks to the incoming Obama Administration to do something miraculous for homeowners, the stats don’t look good. In many markets falling home valuations have erased owner equity completely. People owe more than their house is presently worth and are paying more to live in that depreciating hovel than it would cost to rent something perfectly comparable down the street.

No wonder foreclosures are up.

But the truth is that your bank or mortgage company would actually far rather NOT foreclose, because foreclosure is a losing game for the bank.

The entire point of down payments on mortgages is enabling foreclosures. It always has been. But that doesn’t mean foreclosures are in the general interest of the lender. The ideal for lenders, remember, is to keep us owing as much as possible on our homes for as long as possible, so down payments just cut into their action. In an ideal environment the lenders would rather lend 100 percent of the house value. And as long as home values were consistently rising faster than inflation the banks could get away with that, because they actually MADE MONEY on foreclosures.

Here’s how foreclosures used to work. It takes a year and several thousand dollars worth of legal work to actually foreclose on a home, during which time the bank or lender is also deprived of revenue from the mortgage because we aren’t making payments, remember. But as long as home values were going up AND THE BANK COULD ACTUALLY SELL FOR THAT HIGHER AMOUNT it didn’t really matter. That’s because the increase in home value during the foreclosure time frame usually more than made up for the legal costs and lost revenue, even for houses originally bought with no money down.

This is yet another reason why the housing bubble got so big, because the lenders saw themselves as having literally no risk. THEY WANTED US TO DEFAULT. That is until housing prices started going south.

The current situation is far worse, however. The point of having a traditional 20 percent down payment was that the difference between the principle on the loan and the actual home value (that difference being the down payment) was supposed to more than cover the expenses of any foreclosure, even in a non-boom market. So traditionally while the lender didn’t WANT to foreclose, they also weren’t afraid to do so, because the down payment covered their inherent risk.

But no more. We’re in a housing Depression. With our houses leveraged as much as possible and selling prices down by 30+ percent in many markets, there is no longer that equity cushion to protect the bank. Where banks used to easily get 80 cents on the dollar or more through foreclosures, their current yield is closer to 50 cents on the dollar. Banks have a lot less incentive to foreclose than they did a year or more ago. Foreclosures are a losing business for banks and banks HATE to lose money.

The preferred alternative to foreclosure these days is loan modification. Surprisingly, banks tend to LOVE loan modifications. This is for two reasons; 1) they aren’t losing money on a foreclosure, and; 2) loan modifications as they are presently being done are actually profit centers for most lenders. Though we homeowners appear to pay less for our homes under modification plans, the banks actually tend to make MORE profit on the revised deals.

The point of loan modifications is to get your monthly payment down to something you can actually pay. The point quite specifically ISN’T to help you actually own your home. So the typical loan restructuring spreads out repayment, converting your 30-year mortgage into a 40-year mortgage, making the next 10 years of that loan interest-only. Your payment drops by a few hundred dollars per month and you feel some relief. But if you calculate the extra interest you’ll be paying over the life of the loan that savings is very expensive, benefiting only the bank.

Still, we tend to accept the modified terms because the payments are lower and it is only until we can refinance, right? Wrong. Underwater loans CAN’T be refinanced unless we come up with a big down payment we don’t have. So instead of being stuck with this loan for 2-3 years, we could be stuck with it for 40, or more likely the average 10 years we’ll own the house.

Extending the shelf life of the average mortgage from the current three years to 10 is a huge boon to the banks because they don’t have to spend three times as much marketing money to support the same level of homeowner debt over that time frame. They don’t have to sell the loan three times over, instead simply allowing us to stay in the house we couldn’t afford in the first place and really still can’t afford.

Lucky us.

cringely Blog banks, Blog, financial crisis, foreclosure, mortgage, mortgage default