Economic Farce Sifting through today's economic madness

Home Prices Climb for Third Consecutive Month

Bloomberg is reporting today that Home Prices in 20 U.S. Cities Climb for Third Consecutive Month

Oct. 27 (Bloomberg) -- Home prices in 20 U.S. cities rose in August for a third consecutive month, bolstering the case that an economic recovery is at hand.

The S&P/Case-Shiller home-price index climbed 1 percent from the prior month on a seasonally adjusted basis after a 1.2 percent increase in July, the group said today in New York. From a year earlier, the gauge was down 11.3 percent, less than forecast.

Rising home sales, due in part to government programs including the first-time buyer credit and efforts to lower borrowing costs, have helped stem the slump in property values that precipitated the worst recession since the 1930s. Sustained gains in household spending, the biggest part of the economy, may be harder to come by as joblessness mounts.

I believe that rising home sales are very much "due in part to government programs including the first-time buyer credit and efforts to lower borrowing costs," but I do not agree that these thintgs have "helped stem the slump in property values." I would say that they have more delayed the inevitable slump, and prolonged the misery of the economy.

But interested readers may want to ask just how big of a role the government programs such as the first-time buyer credit and other market distortions such as Fannie Mae, Freddie Mac, and Ginnie Mae have on the recent rise in house prices.

I came across this article from the Federal Reserve Bank of San Francisco titled Recent Developments in Mortgage Finance. Below is an interesting chart from the article:

This graph shows the market share of different groups of loan originations. We can see that since early 2007, the amount of Bank portfolio loan originations has been declining drastically, to a mere 2% or so of the entire loan origination market. On the other hand, we see that Ginnie Mae has had an incredible rise in loan originations, and Fannie and Freddie have also had substantial rises. In aggregate, the GSE's (Fannie, Freddie, and Ginne) now make up 95% of the U.S. new loan originations. I would argue that the rise in house prices recently has been due to government intervention and policies more than just "in part," in fact it is likely that it is the vast majority of the reason. John Krainer of the San Francisco Fed, and author of the article, seems to agree:

The most noticeable feature of Figure 3 is the abrupt change in financing patterns beginning in the middle of 2007. This period, of course, marks the onset of the financial crisis and the contraction of nonconforming loan originations. Figure 3 shows dramatic declines during this time in both non-agency securitization and originations of loans retained in the lending institution's portfolio. In the present day, when Ginnie Mae's activities are included, the three GSEs are providing unprecedented support to the housing market—owning or guaranteeing almost 95% of the new residential mortgage lending.

....

With the vast majority of current mortgage lending now intermediated in some form by the GSEs, it will be difficult for the housing market to return to normal.

(Emphasis added)

Continuing with the Bloomberg article mentioned first:

“Home prices are coming around,” John Herrmann, president of Herrmann Forecasting in Summit, New Jersey, said before the report. “Demand is picking up. Step by step, the housing recovery will contribute to growth.”

In light of what we have seen above, does it really look like home prices are coming around? Is demand for housing picking up amidst a soaring savings rate and a sinking willingness to take on debt? How many of the millions of unemployed will be looking to buy houses any time soon?

Shadow Housing Inventory

Even with all of the evidence above that shows good evidence for further declines in housing, we have still ignored the elusive shadow housing inventory. For information on this, readers may want to tune into Doctor Housing Bubble, a very interesting blog with lots of good information. He mostly follows California, as that is where he is, but I think a lot of his ideas and conclusions are applicable, and true, across the country. Let's see how he defines shadow inventory:

What is shadow inventory? First, shadow inventory is housing units that are not making it onto the public market for one reason or another. There is speculation surrounding why this is happening. Lenders are overwhelmed and simply do not have the human capital to handle the glut so goes one theory. Others speculate that lenders are simply too incompetent to have a system in place to handle the mess they created.

CalculatedRisk points out several categories of shadow inventory:

There are several categories of shadow inventory:

• REOs. There are bank owned properties that have not been put on the market yet. Several sources have told me the number is growing - no one knows why except possibly for accounting reasons (the banks might have to take an addition write down when they sell the property).
• Foreclosures in process. The delinquency rate has continued to rise, and this will probably lead to many more foreclosures later this year. The number of foreclosures depends somewhat on the success of the modification programs. Last year many delinquent homeowners listed their homes as "short sales" - so those homes were not shadow inventory, however fewer delinquent homeowners are listing their homes now as they try to work with their lenders on a modification. Some percentage of these homes are shadow inventory.
• New high rise condos. These properties are not included in the new home inventory report from the Census Bureau, and do not show up anywhere unless they are listed.
• Homeowners waiting for a better market. This was the group mentioned in the Reuters story (the article also mentioned foreclosures). These are homeowners waiting for better market conditions to sell.

This should be very interesting to anyone interested in the housing market. Many banks are holding houses that have been foreclosed on off of the market for numerous reasons. Many individuals are also waiting for a better market to sell their homes -- a market that may not come for quite some time. As Doctor Housing Bubble shows us below, many banks are waiting up to 6 months befare sending a notice of default on non-paying borrowers:

Timothy Ward who is the deputy director of the Office of Thrift and Supervision even acknowledged the shady practices currently going on at banks:

“(OTS Letter) The following practices are
considered weak and do not appear to be in accordance with GAAP and/or supervisory guidance.

1) Institutions charge-off losses only at foreclosure or when deemed uncollectible. A sound practice is to establish charge-off policies in accordance with the Uniform Retail Credit Classification and Account Management Policy (CEO Memo #128, July 27, 2000). Institutions should assess the current value of the collateral and selling costs when a loan is no more than 180 days past due. Any loan balance in excess of that assessment should be classified Loss.”

180 days past due? You mean 6 months? Well we just found out the foreclosure process is taking 18 months to 2 years (assuming banks even start the process which we now know in many cases they are not). What we need is a heavy crack down but with suspension to mark to market, banks are playing fast and loose with their data.

So banks are allowing borrowers to stop paying their mortgages for potentially up to 6 months before sending a notice of default. This means the actual foreclosure process could take 18 months to 2 years. With all this inventory building up, and default rates still rising, how long will it take to sell all of these homes?

Let us look at another prime location to see some more shadow inventory if you still have some doubts. Many are itching to buy in Culver City so we’ll use that as an example:

Culver City MLS listings: 101

2 listed as a foreclosure and 12 listed as short sales

Now let us look at properties in distress:

How many properties are we looking at above?

170 properties. Keep in mind that only 14 of these are on the MLS. Take out the 2 foreclosed homes and 11 short sales and you have 157 properties not viewable by the public. Given there are only 101 properties on the MLS, there are more properties in the shadows than in the public view. 22 homes sold in Culver City last month. This is the difference between 4.5 months of inventory (low) and 12 months of inventory (high). Big difference and the shadow inventory does exist. I know it was painful to hear as a child that there was no Santa Clause but you can feel comforted that shadow inventory is the real deal.

Here Doctor Housing Bubble is looking at one small area in California, but the numbers are still telling. There are more houses in the shadow inventory than there are actually being sold. The fact that there seems to already be an extra 4.5-12 months of shadow inventory is astonishing.

As defaults and foreclosures continue, these numbers will continually be extended, and the shadow inventory will probably grow. Since the foreclosure process can be seen taking 18 months to 2 years, and defaults are still occuring, I think it is not unreasonable to expect a severely depressed housing market for years to come. And this is considering that no new houses are built! Does anyone think the homebuilders are going to close up shop anytime soon? Maybe they should, but I doubt they will.

In the coming years it seems there will be no shortage of houses to be thrown onto the market, and this is not good for prices.

Where to from here?

So the question that really needs to be asked is where to from here? Can house prices continue to rise with unemployment still increasing by hundreds of thousands per month? How much more of the loan origination market is there for the government to take over? Will this market for loans be expanding or shrinking in the face of a rising savings rate and millions of consumers without jobs? Does the vast decline in loan originations from Bank portfolios tell us something about the inherent risks of lending in the current environment? I think the answer to this last question is obviously a yes. Risk of default is high, and, in fact, defaults are still rising, if not soaring. Anyone should be able to reason that this is bad for house prices in aggregate. How much longer can the government and the FED continue to print money and prop up the illusion that the markets are returning to normal? How long will banks be allowed to suspend mark to market accounting and hold houses on their books while keeping them off of the market?

Time will tell, but as of right now it seems clear that the housing bottom is not in.