Banks were still exposed to $1 trillion in unsecured mortgage debt in 2013
Loanowners across the country are deeply underwater, and they have been offered numerous bailouts in the form of loan modifications and assistance programs, refinance opportunities, and interest rate subsidies, plus plenty of lip service from politicians who feel their pain. This has all been a ruse, a diversion from the government’s real efforts to save the banks.
Today’s featured article is about the poor loanowners who are still $1 trillion underwater. Some are so hopelessly underwater that they won’t see equity again in their lifetimes. They are renting from the bank with a feeble hope of equity in some far off future that will never come to pass. This false hope is important as it keeps the sheeple paying rather than strategically defaulting and leaving the lender with another bad loan.
Consider the flipside of a $1 trillion in underwater mortgage holders. Some lender somewhere holds that paper; therefore, lenders have $1 trillion in unsecured mortgage debt not backed by any collateral value. At current prices, if those houses were liquidated, either through foreclosures or short sales, lenders would lose a $1 trillion dollars. The banking system couldn’t absorb losses of that magnitude. Thus we have market supply manipulation, record low interest rates, and endless can-kicking by lenders hoping to avoid recognizing these losses. Lenders don’t have any good options. House prices must go up so they can recover their capital when these bad loans are inevitably processed.
The loan modifications lenders have been completing over the last several years are crazy. They have been refinancing deeply underwater borrowers with terms more volatile than Option ARMs at debt-to-income ratios that make subprime lenders look prudent. They know these loans are going to go bad. Fourteen percent of these modified loans don’t even make three consecutive payments to count as “permanent.” More than 40% redefault every year. The only reason lenders do this is to avoid losing $1 trillion. The insanity makes sense if you see it through that lens.
More people have been lifted out of the shadow of negative equity over the last year, but collectively homeowners still carry $1 trillion in underwater mortgage debt.
And more importantly, banks still carry $1 trillion in exposure to potential losses.
Nearly 2 million homeowners emerged from negative equity last year, according to a new report from Zillow.com. About 13.8 million people were still underwater at the end of the year, compared to 15.7 million at the end of 2011 – a drop of 3.6 percent.
Using price appreciation and depreciation indices, Zillow is forecasting that by the end of this year, the number of homeowners who are underwater will be down another 2 percent, putting a little less than 1 million more homeowners into positive home equity.
With prices rising briskly in some markets, it’s remarkable that only 2% of loanowners will rise above water this year. That’s not good for potential inventory as the number of potential discretionary sellers will not grow significantly. It also points to how far underwater most loanowners really are.
But the level of negative homeowner equity is still extremely high on a historic basis, and these 14 million homeowners have a long way to go to get back above water, even with current levels of home value appreciation. To put this into context, the survey found around 27 percent of homeowners still carry negative equity — that’s one in four homes. That’s still a high percentage considering that the number should hover around zero percent.
“High rates of negative equity were caused by the steep declines in home values during the housing bust,” Zillow senior economist Svenja Gudell said. “In times of home value increases, especially in the years leading up to the peak of the market where we saw extremely high rates of appreciation, negative equity is virtually nonexistent.”
Negative equity is a euphemism that really makes no sense. You can’t have negative equity. You can have excessive debt and a negative net worth, but negative equity is a euphemism designed by the banking industry to foster hope that loanowners will return to positive equity again someday.
In any normal market characterized by substantial down payments and appreciation matching wage growth, people are never underwater. They have equity when they acquire the property, and this equity grows at they pay down their mortgages and house prices slowly appreciate.
What was truly shocking during the housing bubble was that equity actually declined while prices rose at prodigious rates. When homeowner equity should have been setting all-time highs, it was declining due to rampant mortgage equity withdrawal. That’s why we have so much “negative equity” today.
What’s interesting is how the emergence of more homeowners from negative equity could affect the housing market.
According to Zillow, home values rose 5.9 percent year-over-year, largely due to very limited inventory, which could change if more homeowners decide to sell their property. And while having more home sellers in the game is overall a positive trend, that in itself could temporarily push housing prices down again, particularly in economically fragile metropolitan areas.
Given how depleted our inventory is, I don’t see this as a likely scenario. Listings are so far below normal, that a few more discretionary sellers with WTF asking prices necessary to cover their mortgage debt won’t serve to push prices lower. The only thing that will push prices down again would be a large number of REO, but banks are intent on making sure that never happens again.
“Freed from negative equity, homeowners will have more flexibility, and some will likely choose to list their home for sale, helping to ease inventory constraints and moderating sometimes dramatic, demand-driven price increases in some markets,” said Zillow Chief Economist Dr. Stan Humphries in an e-mail.
That’s a nice theory, but in reality, borrowers aren’t emerging from negative equity in large numbers, and their flexibility doesn’t permit them to sell at anything other than a WTF asking price.
While most of the decrease in negative equity can be attributed to increasing home values, some is also due to homeowners who dropped that negative equity through the foreclosure process.
Ultimately, foreclosure is how this problem will ultimately get resolved. If delinquent mortgage squatters won’t sell, the banks will foreclose on them as soon as they get above water again. These borrowers won’t be able to squat their way to an equity check.
And while foreclosures are down nationally, they remain high in states where foreclosures go through the courts, meaning there is a backlog of foreclosures still working their way through the system, particularly in Florida.
“Twelve percent of the mortgages in Florida are in the process of foreclosure, down from a peak of 14.5 percent last year but still an extraordinarily high rate that is impacting the national rate,” said Jay Brinkmann, MBA’s chief economist.
Nevertheless, the Miami area and other areas that saw huge drops in home prices have also seen the greatest number of people emerge from underwater. Of the nation’s 30 largest metro areas, those with the highest number of homeowners freed from negative equity last year were some of the areas hardest hit during the Great Recession. In 2012, Phoenix had 135,099 homeowners freed from negative equity; Los Angeles 72,936; Miami-Fort Lauderdale 70,484; Dallas-Fort Worth 59,461; and Riverside, Calif. saw 58,417 homeowners emerge from underwater.
This is almost entirely due to the infusion of cash from REO-to-rental hedge funds. The most beaten down markets are the ones with the most attractive cashflows, so that’s where these funds have gone in and bid up prices to acquire property. I’ve heard anecdotal reports that rents are off in Phoenix because so many of these rentals hit the market last year.
In a sign that the economy may be reviving slightly, the Mortgage Bankers Association recently reported that fewer homeowners are delinquent on their mortgage payments. The delinquency rate for mortgage loans on residential properties that are 30 days past due fell to a seasonally adjusted rate of 7.09 percent of all loans outstanding at the end of the fourth quarter of 2012, the lowest level since 2008.
A normal level of delinquency is around 2 percent.
Last May, I projected it would take until about 2015 to get to a normal rate, but since lenders embarked on aggressive can-kicking in 2012 to get the housing market to bottom, this timeline has probably been extended a year or two.
Can-Kicking is self preservation
There’s no question that banks are using loan modifications as a way to avoid foreclosure, not because they want to help borrowers stay in houses they can’t afford, but because they must delay foreclosures until collateral values support the loan balance. Lenders don’t have many options. If they foreclose and liquidate, the losses will bankrupt them. If they don’t foreclose, they allow a lot of squatting, and they encourage the worst kinds of moral hazard, but those are problems they can deal with in the future. If they don’t survive today, problems of the future won’t matter much, so the insanity goes on.