Up next in the housing crisis: Strategic default

Thanks to Mark Miller at http://retirementrevised.com

Mark Miller

Syndicated newspaper columnist, blogger atRetirementRevised.com

Posted: January 4, 2010 12:59 PM

In phase one of the foreclosure crisis, policy-makers and news media have focused mainly on homeowners who lose their homes because they can't afford to make mortgage payments.

The next big issue is "strategic default" -- homeowners who can afford their payments but walk away from mortgages and accept foreclosure because they're facing financial stress, and/or their homes are worth less than the loan amounts.

There's an especially large concentration of these underwater mortgages among older Americans. Many pre-retirement baby boomers took on higher mortgage debt in the years running up to the real estate crash; a study this year by the Center for Economic and Policy Research found that 30% of Americans age 45 to 54 are underwater.

That means they'd need to bring cash to a closing in the case of a sale -- say, when it comes time to make a retirement- or health-related move. And mortgages are a key component in retirement planning, since debt reduction is one of the best ways to improve retirement security.

University of Arizona law professor Brent T. White generated a flurry of attention last month when he suggested in a research paper that the rational economic move for some underwater homeowners would be to default on their loans and give their homes back to the bank.

Since then, news media coverage of strategic default has been growing. The Wall Street Journal last month profiled California homeowners who opted to default in order to get out from high mortgage payments, instead renting similar properties in their neighborhoods for a fraction of the monthly cost.

This past weekend, the New York Times wrote that the Obama Administration's Making Home Affordable loan modification program may only be postponing the inevitable day of reckoning for millions of homeowners who will never be able to afford their mortgages and ultimately will face foreclosure.

Economist Mark Zandi argues in a Times piece that underwater loans are a much more important piece of the puzzle than forced foreclosures:

Mr. Zandi argues that the administration needs a new initiative that attacks a primary source of foreclosures: the roughly 15 million American homeowners who are underwater, meaning they owe the bank more than their home is worth.

Increasingly, such borrowers are inclined to walk away and accept foreclosure, rather than continuing to make payments on properties in which they own no equity. A paper by researchers at the Amherst Securities Group suggests that being underwater "is a far more important predictor of defaults than unemployment."

Strategic default poses serious moral and legal issues. Some experts argue that consumers should look at their homes as housing, not an investment and honor the contractual promises made when they took out their loans.

And, despite media coverage of the increasing number of strategic defaults, the percentage of those who do walk away from mortgages is relatively low. White's analysis shows that only 25 percent of mortgage defaults are strategic; the percentage isn't higher, he argues, due to homeowners' perceived shame and guilt of foreclosure, and fear of the consequences.

White further argues that that the emotional constraints are actively cultivated by the government and "social control agents" to encourage homeowners to follow social and moral norms related to the honoring of financial obligations. At same time, homeowners are encouraged to ignore market and legal norms under which strategic default might be viable and the smartest financial decision.

White's definition of "social control agents" include the media and an array of financial counseling services. Although the latter often are non-profit organizations presenting themselves as community-based organizations, many receive funds from government and financial services companies, which have a vested interest in discouraging defaults.

Counseling services that receive HUD certification cannot advise their clients to default. White told me in a recent interview of his conversation with a counselor at one industry-funded agency that counseled 3,000 people in 2008 on how to avoid foreclosure. That agency did an assessment at the end of the year of whether any of these would have been better off with strategic default; the assessment concluded that 53 percent would have been better off due to an unsustainable debt-to-incomer ratio. But, the agency couldn't tell clients that, due to its industry funding.

Credit scores loom large in all of this. White argues that homeowners fear falling scores, yet, most people can recover a good score within two to three years if they stay current on other payments. Walking away from a mortgage frees up cash to do that, he says, and the sky will not fall in during the interim.

White also argues that our current system is set up to remedy the housing crash on the backs of consumers, who are encouraged to keep making payments on real estate where they will never see a return; in the meantime, banks get billions in bailout funds, and are allowed to drag their feet on loan modifications.

All that aside, White took pains during our interview to make clear that he isn't advising homeowners to default. "This is an academic piece that makes the observation that it would be in the best [economic] interest of many consumers to walk away, but that they don' do so due to a double standard -- one for Main Street, the other for lenders and banks. This results in distributional inequality, and propping up market on the backs of the middle class."

White also notes that the wisdom of a strategic default depends heavily on state laws. Some states have non-recourse laws that prevent banks from going after the personal assets of homeowners who default; others don't offer consumers this protection (Click here for more information on non-recourse states).

Other important variables, White says, include how far underwater the loan has become and the prospects for a real estate recovery in a given market. "People need to consult with an attorney and and a financial adviser before making any decision. But I don't believe guilt and shame are good reasons to stay in a house."

The Future of Foreclosures

The Perfect Storm...again?

Greg and I have been speaking publicly for the last few months about a few factors affecting the near future of the housing market. Today, MSNBC picked up an AP story which I linked to below.

Based on our experiences, observations, many anecdotal stories and a recent informal and off-the-record conversation with a Senior Vice President of a major national bank (which received significant TARP funds), we began putting together our vision of what to expect next.

Almost everyone we have spoken to either is in the midst of or knows someone who is trying to get their mortgage modified. We have met only one person who has successfully received a "permanent" loan modification. Of the over half-million modification applications in process at the major mortgage lender mentioned earlier, the bank has "permanently" modified only 98 loans. NINETY EIGHT....nationwide, only 98 loans. Tens of thousands have been granted a "trial period" of between three to six months, but these are not permanent. In order for them to become permanent, the borrower must complete the trial period with all payments made on time, then, at the end of the trial period, RE-APPLY for the modification based on updated and current borrower information. At that point, most applicants cannot qualify. The loan is then immediately declared in default and the foreclosure proceedings begin. Our source at this particular bank admitted to us that the bank has no intention of modifying any more loans than is absolutely necessary in order to keep the Feds off their back and that by using the "Trial Period", the bank can at least get some payments on the account and delay moving the asset into the "bad asset" pile.

We have spoken to hundreds of people who have looked at the current market, the forecasts, what has happened in their neighborhood and the values of the surrounding homes and have made a complete business decision to walk away from the property. Each has cited the same set of factors in their decision: Their lenders unwillingness to modify their loan, the drastic drop in values in their neighborhood, the strictly financial outlook of owing more than double what their neighbor owes and what that will mean for years to come for re-sale and, in many cases, what the lower home prices have done to their neighborhood in terms of appearance and overall enjoyability. These borrowers made a decision that a foreclosure on their credit record and possible bankruptcy, depending upon their circumstances, would be less devastating than staying, even though they could afford the monthly payments. This has recently been dubbed "Strategic Default".

"Shadow Inventory" was a term Greg coined over a year ago and has since been picked up by almost everyone. The term was originally meant to describe the tens or hundreds of thousands of residential properties which had been abandoned or had borrowers who had not made a payment for months or even over a year but were not yet foreclosed upon. Again, we thank our source at that bank mentioned above for validating what we had already assumed: by not foreclosing, or an many cases not even filing a notice default, the bank can keep the number of bad assets "reported" lower than the "real" number should they foreclose on every property meeting the requirements. This artificially inflates the books, artificially lowers the foreclosure rate and allows then bank to boast big gains when, in the real world, they would still be posting record-shattering losses. We can now add the tens of thousands of foreclosed and bank-owned properties which are not yet listed and on the market. Again, this simply keeps available, "for sale" inventory artificially low, competition between their own assets artificially low and keeps the sales numbers artificially high.

Finally, the fantastic government incentives for buyers has helped increase home sales. This worked as it was meant to. First time home buyers have been able to finally get into a home of their own. With exceptionally tight underwriting standards for these loans, these home owners should be in a good position to actually be able to afford the home they just bought.

Now, we can add in a factor that began only a few months ago: higher income borrowers in higher priced homes running out of the savings that has kept them going for the last year or so. These otherwise well-qualified, former grade AA borrowers are making the same business decisions others are making and walking away from their second or vacation homes or sizing down to a smaller home, and, unable to sell their larger and much more expensive home, deciding to walk away from that loan. This has moved the price point of the foreclosures up significantly and is leading to a new round of foreclosures previously not anticipated.

Bottom line: Unwillingness by banks to modify existing loans, strategic default by borrowers, shadow inventory, foreclosures creeping in to higher-income borrowers and the uncertainty of the future of government incentives for home buyers have all factored together for another inevitable perfect storm - another dip, another round of foreclosures, possibly even broader and deeper than what we have already seen.

What does this mean for a potential buyer? Keep your eyes open, stay aware and be ready with as much cash as possible to pounce on the home you want when it finally becomes available.

Look for our next quick article on how to structure your offer on a bank-owned property to make it as attractive as possible to the seller.

Housing may be headed for double dip

MSNBC.com

Data adds to worries industry is mostly propped up by government stimulus

The Associated Press

updated 12:36 p.m. PT, Tues., Jan. 5, 2010

WASHINGTON - The number of people preparing to buy a home in November fell sharply in the latest sign that the housing market, which had been rebounding strongly, may be headed for a "double-dip" downturn over the winter.

Consumers are taking their time following the extension of a tax credit deadline, and that is draining momentum from the summer's recovery, according to data Tuesday from the National Association of Realtors. The figures echoed what homebuilders saw in November and showed how dependent the housing market is on government programs to lower interest rates and lure buyers with tax credits. If those programs expire as planned early this year, the housing market will have to stand on its own.

But outside of housing, there are other signs the economy is climbing out of the recession. Orders to U.S. factories posted a big gain in November, the Commerce Department said Tuesday. That data was the latest evidence of a strong turnaround in manufacturing as industries from China to Europe flash recovery signs.

Taken together, the reports show that, while housing remains vulnerable, makers of steel, computers and chemicals are mounting a surprisingly robust rebound.

"We expect housing to just limp along even as the rest of the economy is growing fairly strongly," said Nomura Securities economist Zach Pandl.

The stock market, meanwhile, zigzagged after the reports gave mixed signals about the economy.

The National Association of Realtors said its seasonally adjusted index of sales agreements fell 16 percent from October to a November reading of 96. It was the first decline following nine straight months of gains and the lowest reading since June.

The drop was far larger than the 2 percent expected from economists surveyed by Thomson Reuters, and analysts were surprised.

"This was bound to happen at some point, although not by this much," wrote a startled Jennifer Lee, senior economist with BMO Capital Markets. "Gulp," she added.

"It will be at least early spring before we see notable gains in sales activity as homebuyers respond to the recently extended and expanded tax credit," Lawrence Yun, the Realtors' chief economist, said in a statement.

Typically there is a one- to two-month lag between a contract and a done deal, so the index is a barometer of future sales. Pending sales were down 26 percent from October in the Northeast and Midwest, 15 percent in the South and 3 percent in the West.

The housing market had been rebounding from the worst downturn in decades, aided by aggressive federal intervention to lower mortgage rates and bring more buyers into the market. Sales of existing homes surged in November to the highest level in nearly three years, but analysts expect December sales to show a big drop.

And concerns remain that the market recovery will stall as the federal programs are phased out.

"This sudden drop risks the stability housing markets have enjoyed in recent months," wrote Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

The nation's factories, however, are faring much better. The Commerce Department orders rose by 1.1 percent in November, more than double the 0.5 percent increase economists had forecast. The increases were widespread with the exception of autos and aircraft, which posted declines.

The Institute of Supply Management had reported Monday that its key gauge of U.S. factory activity showed manufacturing was expanding in December at the fastest pace in more than three years.

Economists are hoping that the fortunes of the manufacturing sector are beginning to rebound as the economy struggles to emerge from the worst recession since the 1930s.

“Shadow Housing Inventory” Put At 1.7 Million in 3Q

“Shadow Housing Inventory” Put At 1.7 Million in 3Q According to First American CoreLogic
Summary:
• As of September 2009, First American CoreLogic estimated there was a 1.7‐million‐unit pending supply of residential housing inventory, up from 1.1 million a year earlier. Pending supply, sometimes referred to as “shadow” inventory, estimates real estate owned (REO) by banks and mortgage companies, as a result of foreclosures and other actions, such as deeds in lieu, as well as real estate that is at least 90 days delinquent. Normally shadow inventory would not be included in the official measures of unsold inventory. At the current sales rate, the pending supply is 3.3 months, up from 2.4 months a year ago. The months’ supply measures how quickly the inventory will run off given the current sales rate.

• The visible supply of unsold inventory was 3.8 million units in September 2009, down from 4.7 million a year earlier. The visible inventory measures the unsold inventory of new and existing homes that are currently on the market. The visible months’ supply fell to 7.8 months in September 2009, down from 10.1 months a year earlier.

• The total unsold inventory (which combines the visible and pending supply) was 5.5 million units in September 2009, down from 5.7 million a year ago. The total months’ supply was 11.1 months, down from 12.7 a year earlier. This indicates that while the visible months’ supply has decreased and is beginning to approach more normal levels, adding in the pending supply reveals there is still quite a bit of inventory that will impact the housing market for the next few years, especially in the context of the current increase in home sales, which is in part due to artificially low interest rates and the homebuyer tax credit.

Number of escrows on rise in Palm Springs Valley

Increase shows 'we're inching in the right direction,' top Realtor says

Erica Solvig
The Desert Sun

Monthly sales may be down, but the number of escrows is slowly rising in the Coachella Valley.

With the exception of a slight dip during traditionally slow December, the upward trend started in September.

Unlike housing sales figures - which show what's been happening month to month - experts use escrow data to indicate what's coming in the market.

The numbers, released this week by the California Desert Association of Realtors, show January's pending sales still lag the escrow figures seen in early 2007.

Still, officials say the increasing number of pending sales means that other market indicators - mainly the closely watched sales tallies - also should start showing an upswing.

"It's going to be a while before these numbers all start to turn positive," said Greg Berkemer, executive vice president of the California Desert Association of Realtors.

"We're inching in the right direction."

January saw 549 pending sales, down about 7 percent from a year ago and up 11.4 percent from December, according to association figures.

February figures have yet to be released.

But if One Brokerage with 400 desert agents are any indication, the upward trend is continuing.

With a few days to go in February, their agents earlier this week reported 206 pending sales - versus the 150 seen in January - said regional vice president Ron Gerlich.

"Normally, around this time of the year, sales do start to increase," he said. "To have this many openings so far in February, this is the best month we've had in six or seven months.

"Its an indication. There are people out here buying."