Denying short sales restricts inventory, reduces sales, inflates prices
When lenders deny short sales, it removes MLS inventory from the market and contributes to low sales volumes and inflated house prices.
I’ve mentioned many times that the housing market bottomed in early 2012 because lenders changed their policies toward delinquency and foreclosure, not because fundamentals of the housing market improved. Rather than foreclosing on delinquent borrowers, lenders began offering generous loan modification terms to cure the delinquency — at least in the short term — thus can-kicking became official bank policy.
Another policy lenders implemented had less fanfare but was equally as important as loan modification in drying up the MLS inventory: lenders stopped approving short sales.
When a seller can’t obtain enough money to repay the loan at a property sale, the seller must agree to the “short sale,” aptly titled because the seller is “short” the cash necessary to repay. Since many borrowers didn’t have any other assets, and since lenders recovered more in short sales than foreclosure, lenders approved many of these deals from 2008-2011; however, sometime in 2011, lenders stopped approving these deals, particularly if the borrower had other assets the borrower could liquidate for cash.
Denying short sales became standard policy at the banks, and in order to take the pressure off borrowers, many of these troubled loans were modified. The effect of denying short sales, coupled with the expiration of the tax break on forgiven debt, caused many potential sellers to keep their homes off the market. Lenders discovered that manipulating MLS inventory could reverse the problems of the housing bust.
The fact is low housing inventory is an indicator of residual mortgage distress. I’ve been writing about this fact for over two years, but the financial media has largely ignored this fact in favor of less plausible explanations of the lack of inventory.
While existing home sales are up nearly 5 percent from last year, economists say activity would likely be more brisk if it weren’t for the negative equity overhang that has lately worsened in many markets.
Completed sales on existing homes rose 4.7 percent in February compared with a year ago, reaching an annual rate of 4.88 million, according to the National Association of Realtors, a 1.2 percent increase over January. But Mark Fleming, the chief economist at First American Financial Corporation, a national provider of title insurance and settlement services, says his research tells him that home sales ought to be even higher. The labor market has improved considerably. And home prices are higher, which, though it may sound counterintuitive, have historically correlated with rising home sales, he said.
This is a noted economist who clearly does not understand that the new mortgage rules changed how housing markets work. Higher home prices used to correlate with rising home sales largely because affordability products and kool-aid intoxication came together to stoke financial manias. This is no longer possible, and housing markets now act like most other markets were higher prices reduce sales volumes because the product gets too expensive.
“Rising prices only crimp affordability for the first-time buyer who doesn’t yet own the asset,” Mr. Fleming said.
And that’s one reason first-time homebuyer participation remains near record lows.
“But the vast majority of home sales are to existing homeowners. And for existing homeowners, what changes affordability is their own income and the price of money.”
And the price of money (mortgage rates) has dropped from 6.5% in 2006 to 3.5% in 2012, and recently drifted back down near record lows. It’s only this dramatic reduction in the price of money that stopped a deeper decline during the housing bust.
Negative equity — owing more on your mortgage than your home is worth — is obviously a “huge impediment” for homeowners looking to move.
To characterize this as an impediment implies it’s an obstacle that can be overcome. If reality, unless the borrower strategically defaults and leaves, the home is a debtor’s prison — comfortable perhaps, but a prison none the less.
Mr. Fleming said that levels of equity below 20 percent also act as a disincentive to sell because homeowners have to be able to cover costs associated with the transaction. Stan Humphries, the chief economist at Zillow, the real estate listing and information site, estimated that around 35 percent of homeowners nationwide are essentially locked out of the housing market because of either negative equity or equity below 20 percent.
The share of homeowners underwater has, in fact, declined dramatically from the 2011 peak of 31 percent. As of the fourth quarter of 2014, the national rate was closer to 17 percent, according to Mr. Humphries.
“A big part of that is because of robust home value appreciation in the last three-plus years,” Mr. Humphries said.
As I’ve also pointed out many times over the last several years, every penny of the improvement in real estate prices has accrued as a benefit to the banker who otherwise would have lost that money in a short sale or a foreclosure. It’s generally portrayed as a benefit to the homeowner, but it’s really a boon for the banks.
But he emphasized that the decline in underwater homeowners is “now slowing as the housing cycle matures. As price gains moderate, the pace at which we work out negative equity slows down.” By the end of 2015, the share of homes with negative equity will likely still be above 15 percent, he said.
Reflating the housing bubble
The intentional side effect of restricted inventory caused by denying short sales was to reflate the old housing bubble. Lenders correctly reasoned that even the tepid demand of a post-bubble economy could be overcome by restricting for-sale inventory. When lenders stopped approving short sales, MLS inventory evaporated, and the few existing buyers competed with each other, reflating the housing bubble.
Low inventory is the new normal
Back during the housing bubble, the fear was that if you didn’t buy, you would be priced out forever. realtors liked to make that bogus claim to create a false sense of urgency to generate commissions. With the conspiracy to reflate the bubble, limited inventory is now the problem. Since it will take many years to reflate the housing bubble, and since so many need peak prices to sell without a loss, low inventory will be with us for a very long time. Low housing inventory is the new normal.