There's A World of Pain Ahead

Mike Whitney
April 18, 2010

The brief period of stabilization in housing appears to be over and the next leg-down has begun. Mortgage rates are edging higher, foreclosures are on the rise, and the government programs that supported the sector, are being phased out. The uptick in bank-owned properties (REO) is adding to surplus inventory and pushing down prices. A recently released report from First American CoreLogic shows that �gdistressed sales accounted for 29 per cent of all sales nationwide.�h Nearly one-third of all home sales are distressed REOs. Also, according to a report from Clear Capital, �gHome prices nationally have dropped 3.9 percent quarter to quarter, the first quarterly drop in nine months. (Thanks to Diana Olick, Realty Check, CNBC) Bottom line: More people are being forced from their homes, the banks are facing bigger losses, and the housing market is on the skids.

	If the coming wave of foreclosures is anything close to Bank of America�fs projections, there�fs a world of pain ahead.

The Obama administration�fs Home Affordable Modification Program (HAMP) has largely been a bust. Of the 3 to 4 million potential modifications, only 170,000 homeowners have successfully converted into a new mortgage. Under the new �gprincipal reduction�h plan, borrowers will be able to refinance into a FHA loan if lenders agree to slash the face-value of the mortgage. This puts the government on the hook if the homeowner defaults, which will lead to heftier losses for Uncle Sam. One of the main sticking points with the new program has been second liens, which are the home equity loans that were made using the mortgage as collateral. Falling home prices have made these loans essentially worthless, but the banks have resisted writing them off altogether because hundreds of billions of dollars are at stake. Even so, the four biggest banks have signed on to the new program hoping to stem the surge in foreclosures. Here�fs an excerpt from an article on Housingwire that shows how desperate the banks are to stop the bleeding:

�gTwo major banks are expecting major increases in foreclosures, by the end of 2010.

�gAccording to the Irvine Housing blog, Bank of America, which currently forecloses on 7,500 homes every month will see that number rise to 45,000 by December 2010�c..

�gJPMorgan Chase is forecasting bigger foreclosure numbers in the coming months. According to a presentation at the end of February, JPMorgan expects the amount of real estate owned (REO) properties in its portfolio to reach between 33,000 to 45,000 in Q410. By comparison, in Q409, REO inventories were at 23,100.�h (�gBig Banks Prepare for Major Rise in Foreclosures Ending 2010�� Jon Prior, Housingwire.)

Bank of America�fs 6X increase in projected foreclosures is a real eye-popper. It suggests that housing prices (particularly in California) have quite a bit further to tumble. This will effect everything from private consumption to state revenues. It�fs a disaster.

Worth noting is that subprime defaults are largely over, and that, the new wave of foreclosures is made up of option ARMs, primes and Alt As. Many of these are high-income individuals who are using �gstrategic default�h as a way to cut their losses and walk away from what has turned out to be a bad business deal. In fact, the data show that well-heeled homeowners are almost twice as likely to default than middle or low income people. So much for moral hazard.

Obama�fs revised HAMP program could keep as many as one million homeowners out of foreclosure, but, even so, it�fs just a drop in the bucket. Foreclosures and short sales will soar into 2011 no matter what the government does. In fact, the torrent has already begun as CNBC�fs Diana Olick reports on Tuesday:

�gLender Processing Services just put out its �gMortgage Monitor Report,�h and we have a new record: The nation�fs foreclosure inventories reached record highs. February�fs foreclosure rate of 3.31 per cent represented a 51.1 per cent year-over-year increase. The percentage of new problem loans also remains at a five-year high. The total number of non-current first-lien mortgages and REO properties is now more than 7.9 million loans. Furthermore, the percentage of new problem loans is also at its highest level in five years.�h (CNBC, Diana Olick, Realty Check.)

Whoa. 8 million homeowners are behind on their payments! And, that�fs not all; mortgage applications dropped 9.6 per cent last week while the Refinance Index (refis) fell 9 per cent in the same period. So, mortgage apps are down even though the Firsttime Homebuyer Tax Credit is still in effect (it ends in two weeks) and, even though this is the �gpeak season�h for home sales.

So, why the sudden spike in foreclosures a full four years into the housing crash?

Because the banks have been withholding supply to keep prices artificially high. There may have been an understanding between the banks and the Fed (a quid pro quo?) to keep inventory low so it looked like Bernanke�fs $1.25 trillion Quantitative Easing (QE) program was actually stabilizing the market. But now that the banks are stuffed with reserves, there�fs no need to continue the charade. So the dumping of backlog homes has begun. That will cause inventories to rise and prices to fall. More homeowners will slip into negative equity which will lead to even more foreclosures. It�fs a vicious circle. If the coming wave of foreclosures is anything close to Bank of America�fs projections, there�fs a world of pain ahead.