With housing markets, the elephant in the room is shadow inventory. Much has been written about the subject over the last several years. It’s been portrayed as an apparition among the housing bulls, as if the millions of delinquent mortgages simply don’t exist. Most bulls comfort themselves with fanciful notions of loan modification programs succeeding and some simply denying there is a problem at all. Well, there is a problem. Lenders underwrote trillions of dollars worth of mortgages to people who couldn’t or wouldn’t pay them back. Contrary to the popular myth in the mainstream media, it isn’t a problem of a few unemployed prudent borrowers temporarily unable to keep up with their mortgage payments. The few successes in the loan modification programs served that small group. The problem is the millions of Ponzis who can only pay their bills if a lender gives them more credit. Ponzi borrowing became a lifestyle choice during the bubble, and it’s the Ponzis who are persistently delinquent and won’t survive the amend-extend-pretend dance. Giving Ponzis a reduced payment doesn’t solve their problem. They can’t afford a payment, even a reduced one, without fresh infusions of credit. The shadow inventory problem is an indirect measure of Ponzi behavior. The fact that it has been so persistent shows just how widespread this behavior is.
The real question isn’t whether or not shadow inventory exists.
The question isn’t whether or not loan modifications and short sales will make the problem dissipate.
The question is whether or not the banks can manage the flow of properties to prevent a supply imbalance on the MLS from forcing prices to move lower yet again.
Housing has recovered for two reasons:
1. The Federal government has socialized the mortgage industry, guaranteeing over 90% of all mortgages originated
2. Mortgage lenders have withheld homes off the market to restrict supply, thus driving prices up.
About 15% of the entire mortgaged-home market is held in shadow inventory (about 47 million mortgages, about 7 million in the shadow inventory).
This strategy of artificially restricting supply while socializing mortgages has worked to a point, but housing is vulnerable to any slackening in demand or political pressure to limit the socialization of mortgages. For example, FHA, which has done all the heavy lifting since Fannie Mae was recognized as insolvent, will soon need a taxpayer bailout. Will the public ever tire of subsidizing a manipulated housing market? Stay tuned.
Right now, it’s unlikely anyone will complain about the federal bailout of the FHA or the ongoing market manipulations. Lenders, loanowners, and homeowners are all united in their desire to see higher house prices — at whatever the cost. The government bailout solution is particularly appealing to lenders and loanowners because then they don’t have to bear the full brunt of their foolish decisions. The people who are getting really screwed are renters and future home buyers, but nobody speaks for them.
It’s been a hard year to be a housing bear.
U.S. housing markets finally came alive in 2012, with home sales and housing starts up strongly. And prices are on track to end the year in positive territory for the first time since the downturn began in 2006.
It was a hard year to be a housing bear. There are very few left. Although I am cautious, and I will continue to point out the problems the market faces, I no longer believe prices are going down either. I left the bear camp in September, and as I pointed out in October, The housing bears are right, but prices will go up anyway.
S&P/Case-Shiller home-price data due Wednesday should confirm those gains. The main 20-city, composite index for October is expected to rise by 4.1% from one year ago, according to Zillow Inc.
Skeptics often point to the sizable overhang of properties headed toward foreclosure—the “shadow” inventory—that they say will erode such recent gains. While shadow inventory remains high, there is good reason to think it won’t choke off the nascent recovery in 2013.
He does acknowledge shadow inventory exists. That’s a start.
First, the shadow is shrinking. It has already fallen to 3.4 million units this year from a peak of 4.7 million in 2009, according to John Burns Real Estate Consulting.
One of the big stories of early 2013 will be the “surprising” increase in delinquency rates. Delinquency rates have hovered above 7% since last February. There has been no progress on delinquencies since the settlement with the banks last year. Instead, the banks chose squatting and can-kicking over foreclosure processing to bring down inventories. They sacrificed making progress on delinquencies to accomplish their goal. The mainstream media has been ignoring the fact that the monthly delinquency numbers have flatlined and instead they continue to focus on the year-over-year drops. In early 2013, we will see a year-over-year increase in delinquency rates, and the notion of declining shadow inventory will be dashed.
As well, inventories of new homes for sale are at 50-year lows, while listings of previously owned homes are at an 11-year low. Banks have also become better at approving short sales, where homes sell for less than the mortgage owed.
The danger in focusing so heavily on supply is that skeptics have overlooked demand, which revved up this past year.
There is no danger in focusing on supply. Managing supply is what caused the markets to bottom in 2012, and without continued success in managing supply, prices may turn south again. Demand is up over the dismal levels of last year, but only because we have record low interest rates and increased investor activity. Originations for loans among owner occupants is stuck at 1990s levels.
Sales of existing homes in November were up 14.5% year over year to a three-year high.
Those numbers always look good when compared to a very low base level. In California, demand is still about 5% below the average from 1988 to 2011.
Meanwhile, hearty investor appetites for foreclosed properties have trimmed the backlog and reduced the discount at which foreclosures sell. In September, foreclosures sold for around 7.7% less than traditional home sales, down from a 24% discount three years ago, according to Zillow.
The shadow does pose a threat to some markets. States such as New York, New Jersey, and Florida, where banks have struggled to meet court-administered foreclosure processes, have larger backlogs than the rest of the country. Arizona and California, by contrast, have less restrictive foreclosure processes and have cleared more bad debt.
If banks increase foreclosures, it’s more likely to resemble a tornado than a flood, striking some communities while bypassing others, said Jeffrey Otteau, president of appraisal firm Otteau Valuation Group.
It will be years before housing is back to normal. But as long as demand keeps pace, the market shouldn’t fear its shadow.
It’s not about the demand. The demand for houses will be whatever it is. It’s all about the supply. Can the supply be managed to meet, but not exceed, whatever demand is present? If you had asked me prior to 2012, I would have said no. Cartels are inherently unstable, and it didn’t seem plausible that a collection of lenders who were stupid enough to inflate a massive housing bubble would be intelligent enough to control the supply to prevent its deflation. I was wrong. 2012 proved they could. It took a reduction of inventory of over 35% nationally to do it, but lenders finally managed to find a level of foreclosure and short sale processing that didn’t cause prices to drop. The recent price increases had nothing to do with demand and everything to do with controlling supply.
So can the banks keep control of the supply?
I think the banks can keep control of the supply well enough to prevent another major decline in house prices, assuming interest rates don’t go up. Banks will come under increasing pressure to do something about their 10%+ delinquency rates, if not from regulators, then from rising capital costs. They’ve had six years practice to learn how to dispose of their inventory, and with a great deal of trial and error, they seem to have finally figured it out. I do believe the processing of shadow inventory will cause appreciation to remain below buyer expectations, but I also believe lenders will manage it well enough to keep the 2012 bottom from being taken out.
Ponzis from the start
After looking at thousands of mortgage records, I see patterns in people’s behavior. Many people started Ponzi borrowing tentatively at first, but during the mania, they went for broke and ended up losing their homes. However, some of the people were already well versed in Ponzi borrowing behavior from the first moment they took the keys. Today’s former owners were in the latter category. For them, Ponzi borrowing is just how personal finances are managed. I wonder what they are doing now?
- This property was purchased on3/6/2001 for $229,000. The owners used a $184,000 first mortgage, a $23,000 second mortgage, and a $22,000 down payment.
- On 6/12/2002 they refinanced with a $239,062 first mortgage and obtained a $38,250 stand-alone second.
- On 1/6/2003 they opened a $56,200 HELOC.
- On 7/3/2003 they opened a $80,000 HELOC.
- On 1/5/2004 they refinanced with a $310,500 first mortgage.
- On 9/10/2004 they obtained a $53,000 HELOC.
- On 6/28/2005 they opened a $14,167 HELOC.
- On 10/12/2006 they refinanced with a $488,750 first mortgage.
- On 3/14/2007 they obtained a $28,750 stand-alone second.
- Total property debt was $517,500.
- Total mortgage equity withdrawal was $310,500.
The quit paying in late 2008 and squatted for four years.
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Proprietary OC Housing News home purchase analysis
$399,900 …….. Asking Price
$229,000 ………. Purchase Price
3/6/2001 ………. Purchase Date
$170,900 ………. Gross Gain (Loss)
($31,992) ………… Commissions and Costs at 8%
$138,908 ………. Net Gain (Loss)
74.6% ………. Gross Percent Change
60.7% ………. Net Percent Change
4.7% ………… Annual Appreciation
Cost of Home Ownership
$399,900 …….. Asking Price
$13,997 ………… 3.5% Down FHA Financing
3.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$385,904 …….. Mortgage
$99,178 ………. Income Requirement
$1,714 ………… Monthly Mortgage Payment
$347 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$100 ………… Homeowners Insurance at 0.3%
$402 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,562 ………. Monthly Cash Outlays
($253) ………. Tax Savings
($617) ………. Equity Hidden in Payment
$15 ………….. Lost Income to Down Payment
$120 ………….. Maintenance and Replacement Reserves
$1,827 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$5,499 ………… Furnishing and Move In at 1% + $1,500
$5,499 ………… Closing Costs at 1% + $1,500
$3,859 ………… Interest Points
$13,997 ………… Down Payment
$28,854 ………. Total Cash Costs
$28,000 ………. Emergency Cash Reserves
$56,854 ………. Total Savings Needed