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Housing’s Next Leg Down And QE3

by John Rubino on July 26, 2011 · 23 comments

That US home prices are once again trending down is no secret. But just how bad things are likely to get is not yet well understood. Consider this from the Atlantic’s Daniel Indiviglio:

Chart of the Day: The Housing Market Is Worse Than You Think
Has the state of the housing market gotten better or worse since the first quarter of 2009? To answer this, you have to define what you mean by the state of the housing market. If you mean sales alone, then the state of the market hasn’t changed much: existing home sales are up a little from that time, while new home sales are down a bit. But assessing the inventory of defaulted, unsold homes in the market probably provides a better measure of health.

The following chart created by Laurie Goodman, a housing market expert at Amherst Securities, shows the ominous rise of shadow foreclosure inventory. It was part of a slide in a presentation she recently gave at an event last week at the American Enterprise Institute on how the Dodd-Frank financial regulation bill is stifling mortgage credit.

This chart answers the question: what’s happening to the homes of all those defaulted borrowers that we hear about? Many of those properties are a part of so-called shadow inventory. This is the sort of limbo between when a home’s loan defaults and when the property is put on the market for purchase.

The increase shown above is staggering. The shaded area shows mortgages more than 12 months delinquent or in foreclosure (darker blue) and those seized by the bank (lighter blue). The sum has risen from just below 2 million in early 2009 to 3.35 million in April 2011. That’s an increase of more than 67.5% over this period of about two years.

Also interesting: despite accumulating more defaulted properties, banks are very careful not to increase the number of loans sold very much. Loans sold has been very steady from 80,000 to 95,000 over this period. So recently prices have begun declining again even though the inventory for homes available for sale is being kept relatively low compared to the number that should actually be available to buyers.

`According to Goodman’s presentation, even though homes sold are only about 90,000 per month, inventory is growing by around 60,000 per month. So the homes sold each month would have to increase by two-thirds just to keep up with the growing inventory — not to begin to cut the 3.35 million homes in the shadows. To conjure up enough demand to meet 150,000 sales instead of just 90,000, home prices would almost certainly have to fall faster.

Wow. Housing is heading back into a depression even though banks are keeping millions of foreclosed houses off the market. Bank auditors won’t let them hold these depreciating assets indefinitely, so in the coming year the trend will reverse, as banks are forced to clear out their real estate. That’s a ton of new listings at a time when even current listings aren’t selling. So unless something radical happens (a government subsidy aimed directly at housing, for instance), the next leg down in prices should be epic.

This will cause consumers to spend less as their main investment turns out to be an even bigger loser than they currently fear. So a housing crash becomes a broader recession.

To my knowledge no one has tried to calculate what kinds of losses banks are sitting on. So let’s speculate that the average foreclosed house is worth $20,000 less than its mortgage (a conservative guess since most California houses are underwater by way more than that). 3.5 million times $20,000 blows a $70 billion hole in bank balance sheets that will have to come to light sometime soon.

Since the government’s reason for existing these days is to feed the banks, losses of this magnitude will pretty much guarantee a response. If QE3 hasn’t already happened, this will bring it on.

  • John Phillips

    Hi John
    What affect will Freddie and Fannie have in the US on the mortgage industry and how banks, etc. will handle their surplus of housing in the coming year since they (Freddie and Fannie) own most of the mortgages? Does that fact act as a buffer on availability and thus a bottoming affect on home prices…. since you and I (USA) are on the hook. Does the government or Fed Reserve buy up more mortgages with paper money produced out of thin air?

    • Mitch Bupp

      HI, My name is Mitch and I work on foreclosures. The banks have FHA loan garuntee which is why Freddie and Fannie exsit. When a bank forecloses on a property that property is auctioned off. However, the auction starts at what principal is owed because of the FHA loan garuntee.. The prices at which most of these homes were sold at is far above market value because the bank has a loan garuntee/insurance on the property via Freddie and Frannie. This sets an artifical bottom price in the foreclosure market andeliminates any risk or loss to the banks who sold the loans. And don’t forget to take into count that housing was oversold and the market for new customers was eliminated as people bought while the loans were easy to get reducing the future supply of people looking to buy.

  • Ken

    On my side of it I see a horrible rental market, with prices falling in areas that are rural, housing is ridiculously affordable due to bank owned properties, real property owners can’t sell but at a loss so prices are tumbling. QE3 hahah…

  • Bruce C.

    “…even though homes sold are only about 90,000 per month, inventory is growing by around 60,000 per month. So the homes sold each month would have to increase by two-thirds just to keep up with the growing inventory — not to begin to cut the 3.35 million homes in the shadows. To conjure up enough demand to meet 150,000 sales instead of just 90,000, home prices would almost certainly have to fall faster.”

    I don’t understand the arithmetic implied here. Presumably, “homes sold” includes both new (construction) ones and existing/foreclosed/”distressed” ones. The latter type are increasing by 60,000 per month which is less than the total number being sold (90,000). Is Goodman implying that every single home sold is a new or non-distressed one? That is the only way to conclude that total home sales must increase to AT LEAST 150,000 to absorb the shadow inventory. As I understand things, there is relatively little new home construction and most home sales are for older homes – both distressed and non-distressed, so I don’t understand the article’s last paragraph.

    Nevertheless, I do agree with the basic conclusion that home prices are heading lower, but from a more subjective stance. I am actually involved with someone who is having to buy a new house because of a divorce and I – personally – think that prices are still too high. As a home builder and remodeler I witnessed first hand the bubble years in real estate and I still wouldn’t pay anything near the asking prices of the houses I’ve seen. I consider them over-priced by about 100%. Four and five hundred dollar houses should (and I think will) be more like two to three. Despite all the money printing,etc. money is becoming scarcer and business more competitive. The Fed is going to have to create A LOT more FRNs to counteract the all-pervasive deflationary forces going on.

    • paper is poverty

      The way I read it, everything in that chart was essentially bank-owned, either foreclosures or properties that ought to be in foreclosure (12+ months delinquent). There would be no non-distressed homes anywhere in the calculations; everything discussed belongs to the banks.

      Perhaps it would’ve been helpful to order it differently: there are 150,000 distressed homes landing in the banks’ laps every month, but they’re only able to clear 90,000 per month off their books.

      • Bruce C.

        I think you’re right. She’s talking about “bank owned” properties only. Thanks.

        But still, (and this is a general comment, not to you personally) “the banker’s” mentality is still bizarre. One reason prices (for distressed properties) continue to decline is that the properties themselves are declining. I’ve seen them first-hand. If they were to allow all possessed properties to go to market immediately they would get their best returns both short-term and long-term. Yes, it would lower RE prices GENERALLY but that would lower the down-side exposure to the new mortgages being written on ALL properties. I also know that home builders are not about to count on the banks continuing to act disfunctionally. To invest in home manufacturing today based upon a price structure governed by current banking policy is both cynical and risky. It’s another example of how market interference always yields less than optimal results.

        • Brad Thrasher

          Hey Guys,

          A recent, maybe 2-3 days old, CNBC RE report said that 75% of residential transactions were cash sales.

          Many of these cash buyers are paying 20-40% or put another way getting a 60-80% discount from what your typical 3-20% down buyer is paying. There is a cash price and a credit price that is no different from what is found on used car lots.

          The banks are between a rock and a hard place. They can’t move the shadow inventory faster than their ability to afford the offsetting write downs.

          QE3? Bernanke has already said that the FRB is prepared to re-enter the market at any moment. He didn’t say what would trigger such an intervention.

  • paper is poverty

    I know the $20,000 per foreclosure figure was meant to be quite conservative, and it does seem very conservative… this (http://bit.ly/cEiLCA) is an old 2008 article that cites a Congressional committee and the S&P pegging the cost to the lender at around $50,000 per foreclosure. Who knows what the figure really is, but I’d imagine the bank losses could run well into the hundreds of billions, especially if housing is heading south again. And just when Bank of America has been cannibalizing their loss reserves to boost their earnings… I’d laugh, except that we all know who’s gonna bail them out.

  • John G.

    Banks: burn, baby, burn!

  • Johnny

    I’m buying a townhouse for 90K which has a realistic rental income of 1300 a month… Its hard to lose with some of these deals, the rent will pay my mortgage, tax, hoa and still cut me a fat check each month for over 400!

    • Jason Emery

      Hi Johnny. If the job market is so good that $1300/mo tenants are plentiful, then why aren’t those people bidding up the price of townhouses? I hope it works out well for you, but it seems strange.

      These people will reliably pay you $1300 each and every month, and get no mortgage interest deduction, but they don’t want to buy and pay $900/month ($1300 – your $400 profit), plus get a mortgage interest deduction? Either they are horrible credit risks or they are scared to death about keeping their jobs, otherwise they would be buying. There aren’t too many free lunches out there waiting to be eaten, lol.

      • Johnny

        Hi Jason, because they are all too afraid to buy like everyone on this board; it pays to be the contrarian!

      • http://www.google.com/ Deon

        You can always tell an expert! Thanks for conrtiubtnig.

  • Jason Emery

    Any attempt to move that shadow inventory would destroy home prices, so I don’t think it will happen. If they are going to hand out more money to banks, the logical thing to do would be to negotiate a massive block of short sales and hand the properties over to some group like Habitat for Humanity. But Congress appears to be going down the path of spending cuts, not increases, so that probably won’t fly either.

    The chart above showing 3.35 million homes in foreclosure or already bank owned, although scary, it represents only about half of the problem. There are another 2 or 3 million seriously past due mortgages (90+ days behind) that aren’t even in the above figures. So the real number is 6 million properties that need to be sold.

    There is no way out of this mess except to hyper-inflate the dollar into toilet paper, and that isn’t exactly a great solution from the perspective of savers, except those that chose to save in something a little yellower than paper, grin……….

  • Jehapafet

    This data dovetails nicely into the rapidly emerging ‘Bi-furcated’ economy scenario posed by many over the past ~2 years. Regional employment and the attendant housing values being the primary drivers. Take for example here in Willow Glen area of San Jose, Ca. Many homes on the market in this area are actually selling at or near 2006/2007 valuations. Why? Money and employment. Certain industries (if you can actually call things like ‘social networking’ companies ‘Industries’, but I digress…) are doing quite fine, and many of their employees are ‘fat’ with savings and shares. Of course, the realtors convince them that top-shelf neighborhoods will Never go down in value – hence, they should ‘buy now’…

    We’re going to see a lot of this going forward – Scattered industry and employment, with a stark black & white contrast between those who have gainful employment and wherewithal, juxtaposed with those only a few miles away living on the edge of abject poverty. It’s real now, and is set to become front-row-center spotlight reality going forward. And it has very little to do with ‘education’ or ‘high-tech’ skills for an ‘advanced economy’. It has to do primarily with the fact that we no longer have large-scale domestic, goods-producing manufacturing capability that employs large swaths of the population. Of course, all of the salient arguments apply; Too much government regulation, quarterly earnings priorities as opposed to steady, long-term growth, etc. We all know the reasons. Unfortunately, economic and societal disaster seems to be our path instead, before we learn that to have a solid economy, you must push actual products, not paper.

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  • Mike Sanders

    I have been following this whole financial problem in the United States in relation to Bible prophecy. I read several articles that point to the US not being involved in the End Time events. One article refers to the upcoming events that will happen in the next year: http://howlongolord.com/?p=36

    Out of all the prophecies in the Bible, all have been precise and happened exactly as foretold.

    From Forbes Magazine:

    Muslim Prophecy

    forbes magazine link

    “Is Barack Obama the ‘promised warrior’ coming to help the Hidden Imam of Shiite Muslims conquer the world?” asked columnist Amir Taheri in Forbes. “The question has made the rounds in Iran since last month, when a pro-government website published a Hadith (or tradition) from a Shiite text of the 17th century. The tradition comes from Bahar al-Anvar (meaning Oceans of Light) by Mullah Majlisi, a magnum opus in 132 volumes and the basis of modern Shiite Islam.

    “According to the tradition, Imam Ali Ibn Abi-Talib (the prophet’s cousin and son-in-law) prophesied that at the End of Times and just before the return of the Mahdi, the Ultimate Saviour, a ‘tall black man will assume the reins of government in the West.’ Commanding ‘the strongest army on earth,’ the new ruler in the West will carry ‘a clear sign’ from the third imam, whose name was Hussein Ibn Ali. The tradition concludes: ‘Shiites should have no doubt that he is with us.’”

    The Khomeinist establishment in Iran sees Obama’s rise as another sign of the West’s decline and the triumph of Islam and the return of the Mahdi.

    • Brad Thrasher

      I certainly admire every churches business model. Scare the beejeebers out of people until they offer/donate their assets in this life on the promise of realizing a return in the next. Starting a church has always been my personal Plan B.

      • agneaux

        Prophecy is bunk.

      • Johnny

        Brad – sounds a lot like Peter Schiff’s business model too, doesn’t it? Except in this context they are donating there assets so he can “save” them.

  • Frank

    John Philips, the “bottoming effect” will come when you can’t find any food to eat, capish? You’re living in dreamland, the USA.

  • Sabby

    What most people don’t understand is that most of this shadow inventory is not just put on the market like normal homes. Most of these homes are sold by the bank in bulk quantities to investors. The investors have their contractors fix them up real nice, and then they go back on the market slowly. What people also don’t understand is that there are micro-markets in the hot urban areas where housing is doing quite well. This all plays into the ever-widening gap between the rich and poor, of course. So yes, in the end, the incredible shrinking middle class will lead to more declines in housing. You should expect a long gradual decline though, not a Mad Max scenario.

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