Q-Burn: Unhinged Economics

Arthur Lee & LOVE ~ A House is not a Motel

At my house I've got no shackles
You can come and look if you want to
In the halls you'll see the mantles
Where the light shines dim all around you
And the streets are paved with gold
If Someone asks you, you can call my name

So, whoTF is Q-Burn and why should anyone what I have to say about the economic meltdown? After all, I'm a college dropout who never owned a stock portfolio, let alone managed one. But the roots of the stock market meltdown and all the related economic ills lie in the real estate market, and that I do know about.

These observations are based on experience gained as a realtor in South Florida from 1984-91, encompassing some boom years and bust years. I won sales awards in both commercial and residential property. My clients ranged from cashiers and mechanics to members of the Palm Beach and Jupiter Island elite.

I dealt with all kinds of lenders and got some people out of impending foreclosure with a few bucks in their pockets. I've had to sit down at a kitchen table and explain to a transferred family that they had no hope of selling their house because they were "underwater"- owing more than the house was worth. Might as well just hand over the keys to the lender.
That's the situation an unprecedented number of Americans are in today.

Excerpts from a recent forum of economists:

MORT ZUCKERMAN: Let me go to another point, which is what's happening to home prices. There are an estimated 10 million homes where the mortgages exceed the value of the homes. If you have another 15 percent drop in prices, that number may go up to between 15 (million) and 20 million homes. Now, some of those homes, a much larger proportion of those homes than we have ever imagined, are going to be foreclosed and thrown on the market. That will change the supply and demand by, in effect, accelerating or supercharging the decline.Do you foresee anything like that happening?

NOURIEL ROUBINI: Well, I think you pointed out rightly the most crucial thing with homes falling about 30 (percent), 35 percent, about 40 percent of households that have a mortgage, or about 21 million out of the 51 million, their mortgages are going to be underwater with negative equity in their homes, essentially, where the value of their home is below the value of their mortgages.

And as you know, in the United States, mortgages are effectively non-recourse loans. So if you decide to walk away from your home, you're underwater--what people refer to as jingle mail--you know, you put the keys in an envelope, you send it to the bankers and you say goodbye -- then the creditor cannot go after you for the differences in the value of the home, in the value of the mortgage.

By the way, there are entire websites, like walkaway.com, where they teach you how to walk away from your home, minimizing the legal risk. Well, this has become a big issue. And it's actually a bigger issue not just for subprime, because, you know, if you're a subprime borrower, you eventually might be kicked out because, you know, you cannot pay and they're going to evict you. But actually, think about all the people who were essentially buying second homes, vacation homes, the condo flippers, the speculative homes. They were putting zero down, so they're starting with no equity. Now they're deeply into negative equity. Why would they want to service it? So it's Alt A, the near prime, the jumbo loans, the other stuff.

How many of those "underwater" will find a way to stay in their homes and how many will end up foreclosed? Until that question is answered, the real estate market cannot find a bottom and there can be no overall economic recovery. That's because these are the very mortgages that have been sliced, diced and spun into the complex mortgage-based derivatives that are the toxic heart of the meltdown. And yet, some of the "solutions" coming out of Washington will only drag that process out and may even make things worse.

To understand why, let's look at Subprime Acres, a hard-hit California subdivision. The median home price peaked at $600,000 here in 2006 before the bubble burst, values crashed and the market ground to a halt. Two years later, the good news is that sales are starting to pick up and bargain hunters are coming back into the market.

The bad news is, most all of the sales are bank foreclosures and the average price is $300,000. Since these are the only "comps" or comparable sales, the "foreclosure price" has now become the new value for all the other homes in the neighborhood. So now a whole lot more people are "underwater".

Bobby Bailout bought his Subprime Acres palace in 2005 for $500,000, taking out a no-documentation subprime mortgage with a three year adjustable teaser rate. In one year the value of the house went up 20%, and Bobby decided to get a home equity loan so he could put in a pool and buy a new Hummer. Good times! Now the three years are up, he can no longer make his payments, neither can he sell or refinance.

But wait.. if he can only hang on a few months. Who's that riding to the rescue? Is it Hopalong Obama? Or maybe Maverick McCain? Both candidates are promising relief for distressed homeowners like Bailout Bob. While Obama's a little vague on the details, McCain wants to buy that bad debt at face value and give Bob a nice new $300,000 fixed rate mortgage that he can afford, with taxpayers eating the difference. The mortgage holder is made whole, and the foreign investors who bought the exotic derivative this mortgage is part of can sleep at night. Bob even gets to keep the Hummer and the pool. The housing market is stabilized and happy days are here again!

But Bobby's neighbor Prudent Pat wasn't all that happy when he heard about Bobby's great deal. He bought a couple years earlier than Bob and paid a lower price. He also got a normal 30 year fixed rate mortgage. He has good credit, a good job and never missed a payment. But guess what? Due to the reckless actions of those less prudent than he, Pat is also underwater, owing $380,000 on his $300,000 home. Not only is he feeling like a sucker, he starts to think.. "how can I get some of this bailout action? Maybe if I missed a couple payments...."

Bottom line- whatever happens to the stock market, millions more foreclosures are in the pipeline. Absent some kind of freeze on foreclosures, the downward spiral in housing prices will continue. No amount of buying up toxic debt or bailing out miscreants is going to change that... it might make matters worse, by interfering with the market's ability to find a natural bottom. And lenders currently have no incentive to take a hit and negotiate with underwater homeowners, not if the Feds are riding to the rescue to pay top dollar for their toxic loans.
It's worth pointing out the regional aspect of all this. The vast majority of subprime loans were written in the priciest coastal areas, those of us in flyover country have seen little if any price depreciation... yet.

Yes this is all speculation, who knows how it's all going to play out? But the scariest words in the English language remain... "We're from the Federal government and we're here to help."
~ Q-Burn

As of August 2008, the national median home price had fallen 9.5 percent in the preceding 12 months, to $203,100 due to rising foreclosures, increasing inventory, and decreased availability of consumer credit. The median price represents the price that is the midpoint - half of all home sales prices were above the median and half were below. The median generally provides a clearer picture of home prices than the average or mean would.

By region, the median price decreased across the board. The West lead the way, as hefty foreclosure rates created an extremely competitive market, forcing sellers to drastically lower their prices. The median price in the West sank 23.9 percent since August 2007 to $251,600, knocking it out of the priciest region slot. The Northeast now takes that title, where the median home price is $271,000, although it still reflects a 3.8 yearly decline. The median price fell 5.6 percent in the Midwest to $168,000 and the median price in the South dropped 3.4 percent to $176,500.

~ Data Source: National Association of Realtors