Now, this is an economic fact of life. That it was caused in the main by government policies complements of Fannie, Freddie and the Fed, is of no import to the economic remedy. That remedy as in past downturns is economic improvement which can be accelerated by abolishing economic uncertainty caused by over regulation and by reforming the big tax and spend government, cutting spending, and reducing the deficit and its corresponding debt load.

With an improving economy homeowners who can will pay their mortgages; those who can’t will default and as in normal times suffer foreclosure. Banks will resell the foreclosed homes to new buyers who can afford the homes and who believe they have bargain prices.

The economic principle here is that before a market can rebound, it must hit bottom. The psychology here is that new buyers do not want inflated prices; they want bargains.

So, what is our brilliant Obama administration trying to do? At best, it is trying to delay the market from hitting bottom. At worst, it is trying to prevent that bottoming out from happening at all! Obama and crew have tried a number of things to insure this dis-economy:

A while back in 2009 there was the Home Affordable Modification Program, HAMP for short, a forced principal write-down program that was supposed to keep borrowers in the homes that the couldn’t afford in the first place! According to yesterday’s WSJ editorial:  “Instead, the program swamped mortgage servicers as debtors rushed for the goodies, gummed up the foreclosure process and left some borrowers worse off. Special Inspector General for the Troubled Asset Relief Program, Neil Barofsky, said in January that Hamp falls “dramatically short of any meaningful standard of success.” Perhaps the effort should have been more appropriately termed “HEMP,” the kind that is smoked, because the designers certainly must have been “high” to have come up with it!

That didn’t prevent home valuation declines so these geniuses in the Obama administration hit upon several minor glitches in the foreclosure process and along with attorney generals from several states and the ever-present parasitical tort bar sued to bring foreclosures to a standstill. Now, they want to force the defendant banks into a $20 Billion principal write-down as part of a global settlement! Mark my words…a large part of that will go the the parasites!

This has further delayed foreclosures and the rebound likely to follow. It will also in the process further damage bank balance sheets with no relationship to the economic collateral value realizable in foreclosures. And to top it off, $20 Billion would not be a drip in the bucket of the $740 Billion in underwater loans. What are these numskulls thinking?

It’s hard to pick the leading genius in this folly but the Journal hears rumors that Elizabeth Warren, the ex Harvard prof who is now the illegal head of the new Consumer Financial Protection Bureau is the culprit. Recall, she’s the one Obama could not get confirmed so he appointed her as a shadow or titular head to run the bureau. Who said anything about “rule of law?” These leftists continue to ignore economics, misallocate capital, and delay a market rebound. Hopefully, they will wake up soon……but I doubt it!

For a related article see: Foreclosure Silliness Equals More Economic Drag, published back in October.

Here’s some recent foreclosure data for Reno and Las Vegas:

One in sixteen homes in Reno is in foreclosure; and one in nine homes is Las Vegas is in foreclosure, that’s 11%!

The unemployment rate in the state is 14.6%

Yet Reid rejects a Nevada Energy Park plan for nuclear reprocessing and generation which would not only bring thousands of jobs to the state but create a Nevada Permanent Fund, much like Alaska’s, that would pay each family an annual dividend of over $2,000! Harry is sending jobs and money to other states.

Oh, if that’s not enough, Harry now wants to ban prostitution! Yep, kick another industry out! Makes no sense at all. At least these folks work for a living, something Harry who had fed at the public trough for too many years, doesn’t understand!

Maybe Harry just got religion or something. If that’s the case, the gaming industry should start to worry. After all he may next consider gambling a vice!

The public union bosses should apologize to their members for getting this idiot elected. It’s the members who are suffering, not the fat cat bosses.

Intelligent people want the government out of home financing but today there is no other game in town. F&F do virtually all of the current mortgage lending; the capital markets have been burned so badly they have no stomach for it, especially at the subsidized government rates.

Peter Wallison in a WSJ article, Moving Beyond Fannie and Freddie, argues that other developed countries rely on private markets to finance home ownership, and so should we. He suggests that we gradually lower the size of mortgages that F&F are allowed to buy, say in $50,000 increments each six months. Soon they would become a much smaller part of home finance, while direct lending and securitization picked up to fill the void. He also implicitly argues that underwriting standards should be strengthened. Well, sure.

An Atlantic article, How Quickly Can We Rein in Fannie and Freddie?, criticizes Wallison’s faith in the securitization market which has been dead since 2007. It also says his exit time frame is much too ambitious and would kill the nacent recovery as it kills home building. So perhaps the gradual decrease in mortgage size for F&F should be $50,000 each 18 months.

Mark Toomey, our expert in the business, points out that the securitization markets are held back by a number of uncertainties:

• Confidence that housing prices will stabilize; not helped by Dodd-Frank, mortgage deductibility questions, or government interference with foreclosures.
• Transparency of actual performance of mortgage assets on bank balance sheets.
• Dodd-Frank Quantitative Risk Management “hold-back” requirements depending on how applied could force lenders out of the business.

Mark concludes that we are stuck with something like an explicit government guarantee through F&F for three to five years.

If that is the case, (1) there should be strict underwriting requirement including 10-20% down payments, (2) guarantee fees to compensate for the risk of loss and increase the borrowing costs so as to give private markets pricing room to re-enter the market, and (3) a specific, gradual diminution of F&F lending ability, along the lines discussed above.

Above all, there should be no more government interference in home finance whether under the euphemistic guise of “low-income affordability” or the more realistic, vote buying rationale!

Well now we have another mortgage mess, the “robo-signer” brouhaha has brought the foreclosure market to a screeching halt with thousands of would be buyers unable to get title or possession of homes in the foreclosure process. And in this economy, the foreclosure market is a big percentage of overall sales.  NRO rightly asked in today’s editorial, Another Mortgage Mess, “didn’t we just have financial reform?”

Yes, we did. The Dodd-Frank bill was passed this year by the Reid-Pelosi Congress and signed by Obama. It was supposed to reform the financial system. It did not touch Fannie and Freddie who are now involved in the mortgage mess. By the way,  the taxpayer subsidy projected for Fannie and Freddie for the next ten years is $370 Billion!

Note despite Obama’s lies about an inherited deficit, the Democrats including Obama controlled Congress and were creating the so-called “Bush deficits” since 2006. Barney Frank and Chris Dodd were in charge of their respective financial committees and watching Fannie and Freddie go down the drain. They ignored warnings, ignored the facts and failed to take any action reforming the dynamic government duo.

This year’s Dodd-Frank lack of reform was too much for CNBC’s recently Rick Santelli: Democrats still don’t get it, and they refuse to reform Fannie Mae and Freddie Mac, the government mortgage companies that sparked the meltdown by giving high-risk loans to people who couldn’t afford it.   Standing up for American taxpayers, CNBC’s on-air editor, Rick Santelli teed off on Rep. Paul Kanjorski’s (D-PA) claim that Democrats’ couldn’t reform Fannie & Freddie in their financial regulation bill because it was “too complicated,” asking: “It’s too complicated?  You think taxpayers that go to work to pay the money you are subsidizing, it will end up a half a trillion, do you think they think complicated is an excuse?”

The real chutzpah here is that the Democrats that created the mortgage mess are using the foreclosure red herring to bash the evil bank lenders and pander to the ignorant voters! In so doing they further delay or perhaps stop the current weak recovery!

Talk about cutting off your nose to spite your face. Course, no one ever accused them of being smart!

Why? In one of the 23 states requiring judicial foreclosure, a state court lower-level judge thew out a foreclosure action because a clerk failed to read all the foreclosure documents before signing them. In that case there was no question that the borrower had defaulted on the mortgage nor was there any question that the lender was entitled to foreclosure. The lender was being efficient by using a so called “robo-signer” to execute the documents.

The mortgage market works like this: you borrow using your house as security, you sign a promissory note (“I promise to pay”), you pay the monthly loan installments and get to live in your house. If you default and don’t pay, after notice and a grace period, your lender forecloses and tries to sell the house to get back the money you promised to pay but didn’t. What could be simpler? The clerical judge seeking headlines threw out the foreclosure action which has the effect of letting the defaulting borrower live in the house without paying the mortgage, rent, or anything else for that matter! Is this fair?

Let’s look at the consequences of this silliness, immediate and long range:

• Existing home values are in doubt and sales decline. This because of the inventory build up of defaulted mortgages.
• Pricing of comparable houses is in doubt because market clearing prices can’t ber reached absent a public foreclosure sale, an auction on the court house steps.
• The mortgage market will decline because lenders and investors will not feel secure in their loan security.
• Mortgage rates will go up because of the added costs of foreclosure.
• Loan to value ratios will go down and credit standards up because of the weakened security.
• New housing construction will decline because of the existing inventory build up and tougher mortgage requirements.
• Housing occupied by the borrower-turned-squatter will deteriorate causing the ultimate foreclosure value realized to decline and the lender losses to increase.
• Fannie and Freddie will be required to pay more on their guarantees to the market and their losses will increase.
• Taxpayers will be required to fund increased losses of Fannie and Freddie which deal in 90% of the mortgage market.
• Finally, the economy will face slower growth or additional decline since housing as a principal driver will be weakened.

So, the banks may roll over for fear of Obama and the politicians may have an “us and them” field day calling for halts to foreclosures, but in the end this will hurt the middle class that pays its mortgages and funds the government with its taxes. It is much ado about nothing, pure silliness that creates another economic drag to a fragile economy.

The average recovery in new residential construction in the 10 postwar recessions has been 26.3%! In the past year the comparable recovery is 6.3%, not a good omen. And, the authors point out that the market is saturated with foreclosed houses and $771 Billion in negative equity!

Which leads to the next point, the banks’ balances of REO. That’s a pejorative in banking circles, meaning Real Estate Owned. This is something banks avoid, they only own real estate when they foreclose on it. And they are not very good owners. No tender loving care.

Today’s WSJ points out that the banks’ share of distressed sales has fallen from 45% in January of 2009 to around 30% today. Banks are more likely to slash prices and unload REO, a toxic asset as far as capital ratios are concerned. Except–and this is a big caveat–when the government intervenes. This the government did with low mortgage rates, tax credits, low down payment loans, and even mortgage modification programs. Now these programs are wearing off and we have rising supply and falling demand!

So existing homes can be bought for less than the construction costs of comparable new homes. Market clearing prices will eventually be reached and the overhang of supply and the slow growing demand will eventually balance. But  this will be a long slog. The worst thing government policy can do is to delay or moderate it. To do so would be delaying the inevitable, something Japan did which costs that country two “lost decades.” The recent article concludes that, “Banks’ Plans for Foreclosed Homes Will Drive (the) Market.”

Back to the title questions, is anything as important as housing? This is rather basic, it’s low tech, yet it drives so much. But it also foretells something much more important–demand for increases in housing stock means there is an increase in population. Absent government interference, this is an increase in productive population, the most healthy economic driver there is. Even more basic to this is a healthy economy in need of that productive population.

So, my layman’s answer to the second question is emphatically no. No new technology whether it be time travel, bi-location, or merely the latest iSomething from Apple will ever replace the basic human need of housing as an economic driver.

Quod Erat Demonstrandum, we’re in for a long hard economic slog!

The results are several and all bad:

• Potential sales of these assets by economic buyers will be delayed because a market clearing price cannot be reached without foreclosure.
• Potential private market loans using these assets as security will be delayed for the same reason.
• Necessary valuations of these assets whether as security or for tax purposes will be artificial casting doubt on the results of the valuations. Shareholders or lenders have no real idea of the economic value of GM. County governments have no confidence the the assessment value of the underwater home and thus continue to over spend or commit tax revenues.
• Owners of these assets continue contributing to the support of these assets instead of choosing more economic alternatives, for instance renting instead of buying.
• Investment capital is reduced or destroyed by tax increases needed to support the government action.
• The credit of the government is damaged by the debt increases necessary to support the government action.
• And general economic uncertainty is created by the delay in the recognition of real market valuations.

Japan should present a lesson. Its bubble economy of the ’80s in real estate and equities was fostered by cheap money and the close relationship between businesses, banks and government bureaucrats. When the bubble burst in 1990 the valuations continued to be supported by the banks funding one bad loan to repay another. Write downs and write offs were avoided or deferred. Uncertainty prevailed. Business decreased and deflation ensued. All government attempts at rescue were premised on the hope that prices would recover, but they didn’t. Prices decreased with sustained deflation. Savings increased as money was more valuable than goods or services. Consumption obviously decreased. The decade of the ’90s is thus referred to as the lost decade.

So the equation of cheap expansionary monetary policy (Greenspan) and government supported value inflation (Fannie/Freddie subprime lending) created artificial values which government policy now hopes to sustain by avoiding foreclosures and real bankruptcies. Market clearing prices are avoided and economic activity is decreased.

Yesterday’s Democratic umbrage at major companies recognizing GAAP losses resulting from Obamacare betrays their attitude toward proper valuations. These ignorant socialists have put the nation well down the road to serfdom!

The other side of the story is that 11.3 million homeowner mortgages, 24%, of the total are underwater. Nevada has 70% sucking for air, Arizona 51%, Florida 48%, Michigan 39%, and California 35%. (See CNNMoney report.) This will double to 22 million mortgages, 48% of the total by 2011 according to a Reuters report. This means that a lot of people are still paying the monthly payments on the underwater mortgages. Alternatively, it means that the lenders have not filed notices of default and started foreclosures. Is this situation good?

Under most state’s laws, borrowers can walk away from mortgages with no personal liability; hand the keys to the bank, which has no recourse against the borrower, and then go out and rent for less than the mortgage payments. Why aren’t more of the 11.3 million borrowers taking advantage of this?

Kevin Hassett penned an intriguing article in the March 8th edition of National Review, Mortgage Mortality, that attempts to answer that conundrum. He posits two alternatives:

First, in the long range it is uneconomic to default on that underwater mortgage. The default has immediate adverse consequences: the credit rating gets hammered raising the price of future loans, the loss of future equity and potential profit when housing values recover, and the loss of tax deductions on mortgage interest. These adverse consequences outweigh the benefit of default.

Second, there is a branch of economic literature which suggests that “Americans’ morality is driving their default decisions.” A recent survey by Guiso, Sapienza and Zingales of homeowners about their willingness to default found out that 80% said that it would be “morally wrong” to strategically default on their mortgages! But caution, these results reversed if the respondent already knew someone who had defaulted.

So maybe it’s not “morality” that keeps homeowners paying the underwater loans, but social stigma or the lack thereof. Hassett cites Dan Ariely’s tome, Predictably Irrational, to buttress this “social stigma” concept which goes back to Adam Smith. Ariely relates a controlled test taking experiment at MIT, where two groups take the same math test, with one given more of an opportunity to cheat by self-reporting results; however, in the self-reporting group, half had to also list 10 books they had read, and half had to list as many of the Ten Commandments as they could remember. The results: cheating occurred in the self-reporting group and to a greater extent in the non-Ten Commandment half of that group!

So do we have a growing ticking time bomb of underwater mortgages? Are the inflated values of those mortgages on bank and investor balance sheets going to create another financial crisis? Is our government doing all it can to hide the problem and support artificial values on the backs of people who can’t afford their mortgages? Should we forecast several Japan-like lost decades or hope that the bomb explodes?

I have no answers but it appears prudent to be well aware of the problems.

Tom Motherway

To verify the government locked in profit given to these Obama fat cats, I checked with Mark Toomey, our real estate finance expert. Mark’s comment:

“I’ve seen this video at least twenty times this week. Sadly, it’s pretty accurate. The $75,000 note from the consumer may reflect a judgment against the borrower for a non purchase money second and if that’s the case, I highly doubt they’ll ever collect it; more than likely, it will be included in the inevitable BK the consumer is headed toward.”

Worse yet seems to be the regulatory snafu our bureaucrats at Fannie/Freddie, the Fed, and HUD have caused with conflicting regulations the incidental benefit of which will be to keep the trial lawyers in business. Another Democratic constituency!

Mark continues: “Honestly, I think the bigger story is one the media will not pick up on for another two weeks. Residential lending has been virtually shut down in the last week now that the new GFE regulations have been fully enacted. Three dueling regulatory bodies have merged in to the perfect storm. My weekly conference call with the fixed income guys at Blackrock have turned in to a death watch of sorts; the scenario’s I laid out to them in December (ones at which we all laughed) have now come to pass, and we may very well be looking at the last decent funding month for residential mortgages nationwide. The pre-pay speeds have dropped off the table in the last ten days, and it is getting worse. Kiss getting a VA loan good bye.”

(Definitions: “GFE” means good faith estimate typically dealing with all essential and non-essential elements of a real estate closing. “Pre-pay speeds” mean the anticipated rate of pre-payments assumed by secondary market buyers of mortgage pools.)

Mark concluded with his dark Irish humor: “Greece today, New York tomorrow. Guns and gold, Tom, guns and gold.”

When government gets into businesses it shouldn’t be in the opportunities for incompetency and fraud are multiplied exponentially. The favored fat cats of the liberal left, Wall Street, trial lawyers, unions, etc. profit and all from your tax dollars! Truly a wonderful system we have.

Tom Motherway

Fast-forward to the U.S. today. Fannie and Freddie, the efficient government instigators of the subprime residential debt bubble, are government toxic waste dumps. Tim Geithner in a little publicized Christmas Eve surprise, removed the $400 Billion in federal bailout limits from Fannie and Freddie. Currently the government, that’s your tax dollars, are behind everything these toxic twins do, without limit!

Why worry? What do they do? One thing is HAMP, the Home Affordable Modification Program. This is the $75 Billion program to keep people in the over-leveraged, over-priced homes that they can’t afford. It supports the inflated values of mortgage assets on the books of the banks so they won’t be required to write down the value of these assets with the corresponding hit to capital.  As previously reported, including Christmas Eve Time Bomb, the program is a dangerous tilt at windmills! It only postpones the inevitable day of reckoning.

What happens to the Fannie-Freddie mortgages once made? Well, the majority go into the secondary market in packages against which bonds are issued, mortgage backed securities, MBS. Well, you argue, the market should fairly price these instruments. Unfortunately the Fed is the market, at least the great majority of the market, 75-80%. Where does it get the $1.45 Trillion to do this? Well, it prints the money. Yes, the Fed has doubled the monetary base.

Why then don’t we now have runaway inflation? Most of that excess liquidity is sitting on the banks’s balance sheets as bank reserves. The banks have not started lending it into the commercial market. There is little increase in the velocity of money, little economic activity. When the economic recovery gathers steam, inflation will raise its ugly head–on steroids!

To control that inflation the Fed would normally sell assets sitting on its balance sheet, typically government bonds. Problem is that now a lot of the securities sitting on the Fed’s books are the Fannie-Freddie toxic waste. Who’s going to buy that crap? And, at what price?

In an intriguing NRO post today, Fed Hedge, Stephen Spruiell points out that whoever the next Fed chairman is he will fail. He will have no where to turn when the stuff hits the fan. We will face runaway inflation with no exit, no remedy. Defaults, foreclosures, double-digigt interest rates. Borrowing will stop, business will atrophy.

So it really doesn’t matter who the next Fed chairman is. This gives populist bent Senators cover to oppose Bernanke’s confirmation. When the inevitable explosion occurs, they will say “told you so!”

Tom Motherway