Loan modifications destroyed the move-up market for a generation

Loan modifications for underwater borrowers preserves the debt so appreciation that ordinarily supports a move-up housing market instead flows to lenders.

bubble-moneyLenders limit financed homebuyers based on borrower income, yet many houses sell at prices prices far above the limits of borrowing power because buyers take profits from a previous sale to increase their down payment and bid up prices far in excess of what most first-time homebuyer can afford.

The move-up market functions when equity accumulates; however, unrestrained mortgage equity withdrawal during the housing bubble plus a large number of peak buyers left many homeowners with little or no equity; millions of homeowners are still underwater. Without this accumulated equity, the the move-up market only finds support from the continued withholding of supply by owners who can’t or won’t sell for a loss — a temporary market manipulation, not fundamental support.

Back in early 2013, I wrote that the move-up market will suffer for another decade. I recently noted the lack of first-time homebuyers is starting to weaken the move up market, just as many more owners of move-up homes list their homes for sale. The overhead supply will be a long-term drag on appreciation, and some believe its a precursor to a crash.

Why the Trade-Up Housing Market Is Gone

August 18, 2014 by Keith Jurow



For four years, I have stood alone in offering compelling evidence that the housing crash is far from over and that the so-called recovery is nothing more than an illusion.

Recently, concerns began to be uttered in the mainstream media that the recovery was showing signs of faltering. After all, new home sales were weak and the Case-Shiller index was showing slower price gains.

(See: Shiller: housing faces “turning point” as seasonally adjusted prices fall in May, and Owner-occupant sales stall while distressed sales plummet)

Did this mean that Wall Street economists finally thought there was something to be worried about? Not at all. Sales of million-dollar homes were stronger than ever. Wall Street is still convinced that a return of the housing collapse is totally out of the question.

For now, I believe Wall Street has good reason to believe a housing collapse is out of the question. The must-sell inventory has been converted to can’t-sell cloud inventory, and housing inventory manipulation overrides all bearish predictions.

With mounting signs that the housing recovery is faltering, let’s take an in-depth look at whether the recovery has any basis in reality.

Soaring Inventory of Homes for Sale

In an article published in early June, I offered evidence that the number of homes for sale has soared in major metros around the country. As I predicted, owners who had held their houses off the market expecting to get a higher price have been pouring onto the market in droves. …

If sales volume was stronger, this huge increase in home listings would not be very troublesome. However,’s latest report for June showed that sales volume was down year-over-year in 21 out of 29 major metros which they track. You don’t need to be a genius to understand what the soaring number of listings combined with weak sales means for home prices.

This is where Keith implies but doesn’t explicitly state his belief that a crash is coming.

I believe reality is more nuanced than Keith’s simple statement implies. The composition of the inventory matters. A small number of must-sell homes has much more destructive power than large numbers of can’t sell cloud inventory homes. Must-sell inventory when combined with weakening demand — a condition we experienced in 2008  — is the recipe for a price crash; however, that isn’t what we have today. Now we have can’t sell cloud inventory combined with weakening demand — a recipe for extremely low sales volumes and stagnant pricing.kick-the-can

The Delinquency Problem Just Will Not Go Away

I have also been writing about the serious delinquency problem for four years. Wall Street continues to disregard the issue.

I recently asked, with flattening house prices how will 300,000 SoCal loanowners get above water? I don’t believe lenders can modify loans and wait for prices to come back in every market. There are many places where prices won’t reach the peak in the working lives of the underwater borrower.

There are two key points which are absolutely crucial for you to understand.

First, the delinquency figures put out by the Mortgage Bankers Association and others are misleading and quite useless. Why? More than 22 million homeowners have had their mortgages modified since 2008. Most of them had been delinquent in their payments. Once the modifications become permanent, the loan is considered current and no longer delinquent. So of course, this pushes the delinquency rate way down. What do you think the delinquency rate would have been without these modifications?

I believe today’s loan modifications are tomorrow’s distressed property sales because these loan modifications will fail; a view Keith and I share.

As I have emphasized in article after article, between 40% and 80% of homeowners with modified mortgages have re-defaulted. Take a look at the latest re-default figures through July 2014 from TCW for mortgages held in private, non-guaranteed mortgage-backed securities (RMBS).

For the first time, TCW now includes the re-default rate for the 2012 and 2013 modifications. Notice how the re-default rate for the 2012 modifications has already surpassed 30% and is clearly heading higher.

The chart above is one of the most important for understanding the future of the housing market. Lenders and the financial media work feverishly to convince potential homebuyers the delinquency and foreclosure problems of 2008 are resolved. I have written extensively that these bad loans are not permanently resolved as lenders are merely can-kicking with loan modifications. The truth of the matter rests on recidivism rates. If borrowers continue to reliably make payments on modified loans up through an equity sale when prices reach the outstanding loan balance, the yarn spun by lenders and the financial media will come true. However, if borrowers redefault in large numbers and fail to reliably make loan modification payments, lenders may be forced to deal with these loans with short sales or foreclosures and endure the painful write-downs.

I believe delinquency and foreclosure rates will remain elevated far above historic norms for many more years than most believe because these loan modifications will continue to go bad, particularly as they reset to higher interest rates and recast to fully amortizing loans. This is also a view Keith and I share.

Where Keith and I differ is on how these will be resolved and what it will do to the market. I believe lenders will stretch this out as long as possible in order to prevent another crash. Their dispositions will keep prices flat, but they won’t push prices lower. Keith believes the resolution of these loans will push prices lower.

Second, the servicing banks continue to avoid foreclosing on these seriously delinquent properties. This has nothing to do with court delays in those states which require judicial foreclosures. Take a good look at this map showing the average length of time that defaulted properties have been delinquent in different states as of June 2014.

Click to View

Source: Black Knight Financial Services

You can see that the average length of delinquency for states which do not mandate a judicial foreclosure has now grown to more than two years. In those states which require court approval of foreclosures, the average delinquency period is almost three years.

For the worst culprit — New York State – the average time in delinquency now approaches four years. I have written about the delinquency problem in this state since 2011. Delinquent borrowers there laugh while they remain in their home for years without either paying a nickel or being forced out through foreclosure. Before you condemn these squatters, ask yourself whether you would be able to resist such a tempting deal. By way of contrast, delinquent renters are normally evicted within six months.

banker_between_rock_and_hard_placeNew York is the extreme of the free ride. In Las Vegas lenders foreclosed on everyone and pounded prices back to the stone ages. This prompted a great deal of strategic default because borrowers were so far underwater it became hopeless. In New York, they didn’t foreclose on anyone, so many people stopped paying their mortgages because they knew there were no repercussions for doing so.

I am now convinced that the servicing banks are simply not interested in pursuing foreclosure. I suspect that most of the lenders are unwilling to take the hit on their earnings that foreclosing would compel them to do.

Many people became convinced of this back in 2009 when lenders began mark-to-fantasy accounting and modifying loans to avoid loss recognition. I knew it was going on but didn’t believe lenders would succeed until October of 2012, about six months after the market bottomed. Keith resisted this idea for a long time, so I’m glad to see him acknowledge what we’ve been seeing in the market for quite a while.

The “too-big-to-fail” banks – which all have large servicing divisions — have no incentive to pursue foreclosure because they own second liens on millions of properties whose first lien they service. There is a clear conflict of interest because foreclosing on the first lien would render their second lien on these underwater properties essentially worthless.

Do the lenders really think that this delaying strategy can solve the problem of seriously delinquent homeowners? My answer: I doubt that they really care about long-term solutions. Their focus is strictly on short-term earnings-per-share. They are inclined to let someone else worry about long-term solutions. …

withheld_inventoryThere are only two solutions to the underwater borrower problem: either house prices must go up, or debt levels must go down. As housing markets across the country reach the limit of bubble reflation efforts, the only alternative is for borrowers to pay down their mortgages.

Fortunately, at very low interest rates, more of the payment goes toward principal than at higher rates, and we’ve had near-record low interest rates for several years. Those borrowers are amortizing their loans quickly, and any of them who are underwater will not be underwater for long. This prompts many to erroneously believe amortization on loans will solve the underwater borrower problem in time because whether or not house prices move up, loan balances are going down. Unfortunately, that is not the case.

Many of those most deeply underwater borrowed too much money at the peak either to buy or to refinance. Most couldn’t afford a fully-amortized payment on the loan, so when they borrowed, they either used interest-only or negative amortization loans. Many of those loans blew up and were foreclosed, but many more were modified. Most private-label modified home loans do not amortize, and of the 7 million modified loans, about 5.5 million are private-label. These loans were designed by lenders to benefit lenders, as I documented in Lenders benefit from loan modifications, homeowners not so much.

Loan amortization will not solve the underwater borrower problem because far too many of these loans don’t amortize. The borrower is making no progress on reducing their loan balance. In my opinion, today’s loan modifications are tomorrow’s distressed property sales.

So when will these distressed sales occur? Will all those underwater borrowers wait for the market to come back? Will some strategically default or demand a short-sale approval? Will lenders ultimately be forced to foreclose?

I believe we will see an increase in foreclosures again as first borrowers and then lenders give up on endless can-kicking. Borrowers will again default, and lenders will be forced to foreclose. Without strongly rising prices to give borrowers hope, there is little reason for them to struggle and keep renting from the bank.Housing_death

As I have argued repeatedly for several years, this trade-up market is dead. You must get used to that idea. Until you accept this as fact, it will be very hard for you to comprehend what is occurring in major metro housing markets and what awaits us down the road. …


Those desperate homeowners opting to rent out their house rather than selling at a loss have no idea what headwinds await them. You do.

With listings soaring and prices now weakening around the country, the number of underwater homeowners will be increasing rather than falling. Here is my advice to you and to your clients in this situation:

  1. Disregard the optimistic pundits and do not assume that your underwater house will regain its equity in the foreseeable future.
  2. If you are thinking of moving try this company, put your house on the market now at a realistic price and take your lumps before the market deteriorates further.

If you have clients with underwater investment properties, my analysis also applies to them. They should seriously consider liquidating their investment real estate holdings while markets are still liquid.

Since Keith believes house prices will do down, his advice is to sell. Since I don’t believe house prices will drop much, I don’t see much urgency to sell — of course, since I don’t believe prices will rise much from here, I don’t see much urgency to buy either.

When prices are stagnant, buying a home for appreciation benefits is off the table. Buyers should focus on buying a property they want, they can afford, and that suits their family. The loan modification can-kicking ruined the move-up market for many years to come, so prices should remain flat while lenders process the loan modification redefaults. Lenders can’t afford another crash, and they know how to limit future declines, so unlike Keith, I don’t see much reason to fear a future drop. But like any other market pundit, I could be wrong.

[listing mls=””]