Dec052012

The failure of loan mods will cause a new wave of foreclosures

I am constantly amazed by the ignorance of the mainstream media when it comes to housing issues. They consistently cheer-lead, take the NAr’s statements at face value, and fail to question their rosy assumptions. This behavior provides people bad information and may cause someone to buy who might otherwise chose to rent if they knew the truth. There are many good reasons to buy today as values are well below historic norms, but people should be given accurate information in order to make an informed decision. That’s not what people get from the mainstream media these days.

Today’s featured article was particularly galling. Not just was it full of shoddy analysis and poor reasoning, it gloated about the correctness of its erroneous contentions. It’s the height of hubris in financial reporting.

Foreclosure Wave Averted as Doomsayers Defied: Mortgages

By John Gittelsohn & Prashant Gopal – Nov 29, 2012 7:50 AM PT

Stockton, California, has the highest U.S. foreclosure rate. It also has a housing shortage.

The number of homes for sale in the city fell 42 percent in October from a year earlier. Listings routinely attract multiple offers. Prices are on the rise.

When banks pulled back on foreclosures two years ago following a government investigation into allegations of faulty practices, market researchers, academics and Wall Street analysts said that a surge of delinquent homes would deluge the U.S. market once lenders resolved the claims and worked through backlog, driving down prices for years to come. RealtyTrac Inc., a seller of property data, warned a year ago of a “new set of incoming foreclosure waves.” Susan Wachter, professor at the University of Pennsylvania’s Wharton School, said in February that a logjam may be “unleashed” and destabilize the market.

In fact, the flood failed to materialize, even after the five biggest U.S. mortgage servicers reached a $25 billion settlement with federal and state regulators in February. Instead, the number of properties for sale shrank to the fewest in a decade, prices appreciated at the fastest pace since 2005, and the gradual healing of the housing market helped boost consumer confidence and the economy.

Here is where a little thoughtful analysis is in order. Why did this occur?

First, banks are in no hurry to process their foreclosures as it requires them to recognize huge losses. It’s far more preferable to them to continue to play the amend-extend-pretend game and try to squeeze a few more pennies out of the living dead. Since the bank’s cost of capital is near zero (have you checked out CD rates lately?), banks can hold these non-performing or poorly-performing notes on their books indefinitely. Also, with the relaxation of mark-to-market accounting, there is no regulatory pressure to liquidate. For these reasons, the banks just don’t foreclose.

Second If a wave of foreclosures were to occur, it doesn’t necessarily mean a wave of MLS for-sale inventory will suddenly appear. These foreclosures can be held by the banks or sold to REO-to-rental hedge funds who keep them as rentals. The banks can meter these properties on to the MLS at the rate the market can absorb them. In fact, that is what they are doing now.

“We don’t have enough homes now to meet the needs of the market,” Paul Jacobson, a Stockton native and real estate broker for 22 years, said as he cruised the city’s northern fringe, where suburbia meets farmland. “People see a foreclosed home for sale in this area and they’re going to jump on it.”

Better hurry up and buy now, right?

‘Wrong’“Many of us, myself included, feared a wave of foreclosures when the settlement came,” Wachter, professor of real estate and finance at Wharton in Philadelphia, said in a telephone interview. “I was wrong.”

Slowing the foreclosure process has allowed banks to avoid booking losses on non-performing loans, said Joshua Rosner, an analyst with Graham Fisher & Co. in New York. …

The goal all along — from the banks, the servicers and the government — was sort of to slow walk the whole thing, bleed it through over time,” Rosner said in a telephone interview.

Someone recognizes what’s really going on. Liquidating shadow inventory requires managing absorption rates.

The strategy may be paying off. Home prices in 20 U.S. cities rose 3 percent in September from a year earlier, the most since 2010, the S&P/Case-Shiller index showed this week.

There is no arguing that the bank’s policies of inflating home prices to harm future buyers for their own benefit is working — for now.

The so-called shadow inventory of pending foreclosures, which may be larger than the visible supply of previously owned homes for sale, is shrinking as new defaults decline and banks work through their backlog of bad loans. Home loans that were more than 90 days late or in the foreclosure process, a proxy for the shadow inventory, fell to 7.03 percent of properties with a mortgage in the third quarter, the lowest share since 2008, the Mortgage Bankers Association said two weeks ago.

If you were a financial reporter, and you were going to make a reassuring statement about banks working through their backlog of bad loans, wouldn’t you do a little research to see if it were really true?

Managed Process

While lenders may bring more distressed properties to market over the next year, it won’t be enough to depress values, said Vishwanath Tirupattur, housing strategist at Morgan Stanley in New York.

I don’t anticipate a flood that will take the market down with it,” he said in a telephone interview. “It will be a much more managed process.”

I agree with him. The banks will manage this process, but how long will it go on? Will they be able to process all their foreclosures and still manage to allow prices to rise?

The shadow inventory — which also includes properties owned by banks but not for sale — fell from an estimated 8.8 million homes in 2010 to 5.36 million as of this month, a faster decline than expected as fewer loan modifications re-defaulted, according to Tirupattur.

The loan modifications were successful in this new wave,” she said. “Transformative steps were being put into place in the loan modification process. I underestimated how transformative those reforms would be.”

Wrong. Wrong. Wrong.

I don’t know what data these people are looking at, but it clearly isn’t the rate of redefault. I reported last week that Loan modification defaults soar 24%, can-kicking fails.

If the reporters had bothered with some simple fact checking, they would have realized that loan modifications, the savior of the housing markets, have been and will continue to be abject failures. The majority of the decline in shadow inventory and the delinquency rate in 2012 is due to expanded can-kicking through loan modifications. The redefault rate on these is very high — nearly 50% fail each year — and these will ultimately end up as foreclosures.

Potential Foreclosures

The inventory of potential foreclosures remains a threat across the U.S. and could result in a new wave of defaults and depress home values, especially if the economy slows, said Robert Shiller, an economics professor at Yale University. Homeowners who owe more than their properties are worth are more likely to default if they lose a job, need to move for employment, or simply decide to walk away, he said.

“I’m still worried about home-price declines,” Shiller, and co-creator of the S&P/Case-Shiller home-price indexes, said in a telephone interview. “It’s funny how people have so much confidence in the recovery. History shows that these markets are hard to predict.”

The reason for confidence is largely due to the chorus of bottom-callers in the mainstream media pounding away in article after article about the housing bottom. Let’s be realistic, the only way this current “recovery” is sustained is based on the managed, slow rate of processing of foreclosures by lenders. Demand hasn’t picked up significantly, particularly among first-time owner occupants, so the chance of a self-fueling rally with escape velocity is near zero.

Delaying the process may also be hindering a faster recovery, said Anthony B. Sanders, an economics professor at George Mason University in Fairfax, Virginia.

The best cure for any market meltdown is to let prices fall to whatever level is needed to clear it,” he said. “Instead, we’re sitting here in 2012 and we’re still not out of the woods yet. The wisdom of delaying foreclosures etc. was more of a political act than an economic act.

Amen. Foreclosures are essential to the economic recovery.

What will lenders do when loan modifications fail?

The can-kicking loan modification programs will fail. Only a very small percentage of loan owners will continue to pay on these until their homes have equity in them again. Most will redefault and many will short sale long before values rise enough to provide any equity. The redefaults are of particular interest because it’s unclear how banks will deal with them going forward.

For the last four years, when people defaulted, they played the squatter’s lottery. Some were randomly foreclosed, a terrorist tactic meant to spook the herd and forestall a wave of strategic default, but most who defaulted were simply allowed to squat. Desperate to squeeze some cash out of the legions of squatters and to avoid political backlash for their foreclosures, banks and politicians hatched loan modification programs to kick the can until a future date when the bank could afford the foreclosure. This policy has been in place nearly four years now, and it shows no sign of changing.

Is this how the housing bust will play out? Will lenders continue the charade of loan modifications, sometimes modifying the same loan multiple times before they finally get around to foreclosing? The squatters are game to play along. Why not? They get periods of cheap housing punctuated by periods of free housing, and they still hold out hope for a massive bailout program that will reward them further for their efforts.

If amend-extend-pretend until foreclosure remains official bank policy, then the housing markets will be burdened with measured liquidations for many years to come. It’s difficult to measure exactly because the numbers of shadow inventory are manipulated by loan modifications. We now have a shadow shadow inventory of doomed loan modifications. I expect to see the delinquency rate remain stubbornly high during 2013 and shadow inventory numbers to flatline as redefaults on loan modifications force the banks to ramp up their foreclosure machinery again. That doesn’t mean any flood of REOs on the MLS, but it does mean the overhang of inventory will persist for much longer than most realize. We may be on the road to recovery, but it will take much longer and be much bumpier than financial reporters lead you to believe.