An Apples to Apples look at House Deflation

In the local appraisal business for over five years, Troy Johnson has seen the market reach the heights of the housing bubble.  He has also held a front row seat to its recent rapid decline.  Johnson owns and manages Charlottesville-based Absolute Appraisals.  His team not only valuates properties in Albemarle but in the surrounding counties.

His experience in this market gives a clear picture of what is happening in our area with declining real estate values. 

In that time, he has seen a 15-30% decline in housing values. 

His figures aren’t hard and up to a statistician’s rigor, but they have great illustrative merit.  His approach gives an apples to apples comparison.  Absolute uses the same criteria and methods to assign value to the same property over the same period of time.

“Of all the orders we get,” Johnson says, “20% are reappraisals.”

Seeking more cash out of their homes for one reason or another, many homeowners go back to their loan officer for a new mortgage.   The loan officer contacts Absolute to redo the appraisal for the new mortgage.

Having a lot of repeat customers, Johnson has assessed the same homes over and over, some up to four times in the last two years alone.  “The same people keep coming back until they can’t come back.”

Curiously with all the press of the housing bust, many still believe their houses to be at the peak of their value.  Johnson finds that many, “still think their houses have risen in as much value as they heard about homes going up in Northern Virginia.”

So often, Johnson has to deliver the bad news.  It comes with a shock.  “What do you mean the house is only worth $250,000? That’s impossible.  I owe $270,000.”

Reporting the results back to loan officers who have ordered the appraisals, Johnson gets a now familiar response that sounds like Kubler-Ross’s stages of facing death. 

First is denial.  “How can that possibly be?  They did up grades.”

Then there’s the negotiation stage.  “See what you can do.  I got 55 loan officers in my office.  I’ll pass your name on to them.  You’ll get plenty of business.”

Finally, there’s desperation.  “This old lady is so nice.  She’s going into bankruptcy.  And she lost her son in an auto accident last year.”

Johnson doesn’t doubt the pitiful stories.  Many of these homeowners are desperate.  “But you can’t put that into an appraisal.”

In the present market loan officers know when they get a possible deal that it may not work.  They want him to check comparables before he even goes out to inspect the property.  They tell him, “If the value’s not there, stop immediately.”

He notices the most heavily declining areas are where there is excess supply.  These days, that is in condos and in new construction neighborhoods.  Builders who have gotten in over their heads have been dumping their excess inventory to the detriment of their previous customers.

Older neighborhoods have seen less decline.

Not only has this deflation led to less loan activity, Johnson has also seen it lead to the uglier side of this bubble bust – foreclosures.

“In 2006, not many people in this business [appraisers] knew what REO’s were.”

REO’s, short for Real Estate Owned, are properties that have reverted back to the mortgage lender/bank after a foreclosure sale has failed. 

In late 2007, Johnson started seeing REO business come in the door.  Banks hire his company and others like Absolute to make accurate assessments of how much their repossessed houses are worth in the present market.  The lenders use the numbers so they can wisely consider offers made by potential buyers on the properties.

Does he see a typical pattern in REO’s?  “It’s all across the board, except for the demo that pay cash for their higher-priced homes.”

But if it cuts across all racial and most demographic lines, the middle-class seems to be particularly hard hit.  The homes going into REO’s are mostly in the “$190,000 to $350,000,” range.

Now, between ten to fifteen percent of Absolute Appraisal’s business comes from REO work.  And Johnson sees no slow down in this area. 

The unfortunate fact is that it seems to be accelerating.

The rate rollercoaster

Lately, watching the action in the mortgage backed securities (MBS) markets has been like watching a car full of screaming teenagers hang on through the peaks and valleys of a world class roller coaster. In other words, it's been wild ride.

Just since September, we have seen the 30yr fixed mortgage rate fluctuate nearly 3/4 1 percent - between 5.625% and 6.375% 6.5% (stay up-to-date with our free daily rates email).

In normal markets, one can often get a general sense of the direction. Fundamentals can be followed and trends can be observed. But what we're witnessing in MBS is not the gradual inclines or declines of a functioning market. We're seeing wild swings in prices and reversals that occur in a matter of days.

Yesterday, Bloomberg reported on the difference in yields on MBS vs. US Treasuries. Fannie-Freddie Mortgage Bond Spreads Hit Widest Since March. The recent increased spreads have been driving MBS prices down and rates up.

"Agency mortgage-bond spreads have fluctuated since their record drops on Sept. 8 after the U.S. seized control of Fannie and Freddie. The spreads have widened on days when concern mounted that buyers relying on borrowed money including banks and hedge funds will have less demand for the debt -- including the past five trading sessions. Spreads have tightened when investors heeded a government pledge to support the market."

Predicting the direction of mortgage rates with accuracy in a stable market is a difficult task. But in current conditions it's nearly impossible.

So how does how does this translate for consumers? If you have a purchase contract on a home and plan on closing within the next 60 days, go ahead and lock your rate. Waiting for a particular rate that may or may not come is not worth the risk to your plans or your deposit. And the same goes for those who plan to refinance within the next 6 months - take advantage of the current historically low rates. Keep in mind that the average 30yr fixed rate since 1978 is 9.5% (Freddie Mac)

I'm not trying to "talk up my book" (giving advice or making an argument that bolsters one's position). Just pointing out what I see.

Visual evidence:

FNMA 30yr

We All Could Use Some Good News.

CNNMoney reports that new construction home sales rose in September.   From August, the sales increased 2.7% to an annualized aggregate of 464,000.  

The significance of this number may be diminished by the fact that most of these sales were in process before the bulk of the public front of the financial crisis began.  However, it is good news in that the increase was in new homes – not just existing residences.

The rash of bargains created by foreclosure sales have pumped up other home sales numbers.  And not many people are cheered that there are a lot of foreclosures going on.

We all wait with baited breath to see what October sales look like.

Modifications Coming?

In yesterday's testimony before the Senate Banking Committee, the FDIC Chairman Shelia Blair revealed that her agency is working with the Treasury to mainstream a new program that will supposedly be the help Main Street has been waiting for.

When Indymac collapsed (and no, I’m not obsessed with Indymac), the FDIC took over.  The Feds froze all the bank's foreclosures.  Since, they have offered 15,000 loan modification proposals to borrowers in trouble.  70% of those have responded to the offer.  3,500 of these borrowers have accepted the new terms; thousands more are in process.

The FDIC thinks this is a great model.  As Luke Mullins reports at US News & World Report, Blair testified, “The hope is that our mortgage relief program can be a model and a catalyst to spur loan modifications across the country. It's a process that most loan servicers can use under existing legal arrangements.”

Apparently, Paulson inherited some extra powers in the bailout bill (we’ll probably be hearing about all kinds of extra special powers for years to come.  I think he's going to be the government equivalent of Harry Potter) that could allow him to encourage (strong arm is such an offensive term) banks to offer workouts with troubled loan holders rather than foreclose on their properties.

Questions remain about who would be offered these workouts and under what conditions. 

I, myself, have an ARM that is due to reset in less than a year.  Currently I could pay about $3000 in closing costs to refi this to a higher rate than I presently have.   But now I’m beginning to think I should just wait and see what’s coming.

I’ll be honest.  Working as a mortgage broker means times are tough.  Of late, it’s an effort to scrape up the money to make my monthly housing payment.  Perhaps, if I stop paying my mortgage now, the government will force my bank to modify my mortgage.  I’ll get a great rate and avoid the refi costs. 

And I could use what I would be paying for my mortgage in the intervening months for a great new stereo from Crutchfields. 

Such is life when there is no moral hazard.

Don’t worry.  It’s just a nasty thought, a fleeting temptation to exploit the system.  But I wonder to how many it will be much more than that?

On to Bailout #2 - Is the Hubbard Plan next?

Earlier this month The $700b Bailout was passed into law. Labeled the Emergency Economic Stabilization Act of 2008, it provides Paulson & Co. $700b with which to purchase any type asset from any investor it deems worthy of its favor (among other things).

Not only did it receive a considerable backlash from the general public and quite a few government representatives, but it also drew criticism from a significant number of economists around the country. One of those economists was Jeff Miron of Harvard, who suggested that the banks and investors who purchased all of these risky, non-performing assets bear the responsibility and file for bankruptcy if need be and the American taxpayer should not bail them out.

Another such economist (though not on the list linked above) is Glenn Hubbard, current dean of the Columbia University Graduate School of Business and former chair of the Council of Econimic Advisors. Mr. Hubbard has come up with his own plan which he presented in an editorial in the Wall Street Journal on October 2nd:

First, Let's Stabilize Home Prices

"We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify."

In addition to focusing on the very real problem in the housing market, the plan could be implemented immediately. As a result of the U.S. government's conservatorship of Fannie Mae and Freddie Mac, origination of new mortgages can be financed quickly. Congress would have to raise the overall borrowing limit and approve the new federal purchases of negative equity loans. But it will likely take the Treasury much longer to buy troubled assets than Fannie and Freddie, and it would have to seek the involvement of many additional private actors, as opposed to using vehicles already in place. The decline in housing prices remains the elephant in the room in the discussion of the credit market deterioration. Let's start there."

The Hubbard plan was also covered by NPR:
Bailout Critics Say It Won't Fix Underlying Problem, NPR Morning Edition 10/3

Is this a viable and/or appropriate solution for our ailing economy? Or is Hubbard just trying to score a few points on Bernanke (the guy who took his spot at the Fed)?

Schumer/Indymac 2

I grew up in Louisiana during several terms of Governor Edwin Edwards. Noted for his numerous affairs, gambling junkets and slick demeanor, Edwards was a man best described as colorful.  Everyone knew he was corrupt to the core.  Nevertheless, the people of the Pelican State loved him and kept re-electing him.

This was a man who admittedly kept two million dollars cash in the governor’s mansion for that unexpected emergency or impromptu casino road trip.   It was public knowledge that if you needed a pardon for some state infraction, you hired Edwards’ brother, a lawyer.  For five to ten thousand, depending on the crime, he could get you a pardon from his governor brother.  This arrangement worked until one of the clients, who had been pardoned for a previous murder, upped and killed brother Edwards the lawyer.

Despite numerous trials and impeachment attempts, Edwards remained untouchable.  He goaded prosecutors and press alike.  He used to say that the only way he would lose office is if he was found in bed with a live boy or a dead girl.

Weeks ago, I wrote about Senator Chuck Schumer’s reprehensible behavior involving Indymac Bank.  Quick recap:  last summer, he publicly questioned the bank’s viability which government and financial critics claim caused its collapse.

To the howls of outrage, Chuck claimed that he was merely doing his job as chair of the Senate Banking Subcommittee.  He believed it was his duty to express his “concern” about Indymac’s viability in an open letter to regulators.  Unfortunately, the public understood the “concern” to mean they should get their money now before the bank is shut down.  And they ran the bank.  The Federal Government was left with an eight plus billion tab and a lot of clean up.

Ex-employees who had been “concerned” out of a job pressed the California Attorney General to bring charges against Schumer.  The AG, former Democratic Governor Jerry Brown, declined to pursue a criminal investigation.  The broader defense was that Schumer was just a little naïve, maybe stupid, possibly inept.  But his actions were not illegal.

Now part II.  On Friday, the Wall Street Journal published a disturbing article suggesting that there might be a little more to all this than Chuck just being soft in the head.  At the same time the Senator was performing his patriotic duty in starting a bank run, some of his best friends had a lot to gain.

A group of investors led by Los Angeles-based OakTree Capital Management LP had considered investing in Indymac and thus were given access to the banks books.  Seeing a bank that was not in the best health, they determined they didn’t want to buy the bank.  But they could see a lot of assets worth picking out of the debris should the bank collapse.  They anticipated a lot of great bargains if the bank was taken over by the FDIC and its assets sold.

These OakTree vultures had been major donors to the Democratic Senate campaign committee that Schumer chairs.  They’ve given $700,000 over four years.  And in the culture of D.C., big donors equals big friends.

Despite this warm, close and deep relationship, Schumer and execs at OakTree claim they never talked to one another about Indymac.  And we are asked to take Schumer’s “highly-unusual” behavior in releasing his public “concern” letter as merely coincidental to their perusal of the Indymac books.

To suspicious minds, the question becomes did Schumer cause this panic for OakTree’s benefit.  And that’s going to be really hard to prove beyond a reasonable doubt.

So far, OakTree Capital has not pounced on any of the defunct bank’s assets.  As one exec put it, “there remains a ‘distant possibility’ that OakTree will be interested in buying remnants of IndyMac from the government. Now, though, the rash of institutional failures has presented his firm with a rich smorgasbord of distressed assets.”

To be honest, I don’t see a part three to this.  I’d love to be wrong.  But I doubt there will be any political will from California or the Federal government to pursue a criminal investigation.   

There’s not a dead girl or live boy anywhere to be seen.

More Unintended Consequences

Earlier this week, I wrote about the rising mortgage rates coming after the Fed lowered its Fund rate by 50 basis points.  At that point, I suggested the reason for the increase coming on the decrease may have resulted from investor fears of inflation.  While that may be a part of the case, something else more immediately ominous may be in play.

Bloomberg has an article on Monday’s bond sales reporting a disturbing trend.  Yields on Freddie and Fannie corporate debt rose to record heights against treasuries.  The reason comes from another government attempt to stabilize the mortgage market.

 In a Monday announcement, the Federal Deposit Insurance Corporation (or the FDIC as many of you may have seen engraved on placards hung on your bank walls) put the full faith and guarantee of Uncle Sam on newly issued, unsecured debt from some banks. 

Their good intention was to raise confidence in U.S. banks, calm investor nerves and thus get the lifeblood of credit flowing again.

However, these bank notes are carrying greater yields than those for the GSE’s.  So why should an investor buy troubled Fannie and Freddies’ notes when they’ve got a choice for safe, higher paying bonds backed the FDIC? 

Of course, there’s good will and a general humanitarian spirit.  But in lieu of that, there’s going to be less demand for Fannie and Freddie’s bonds.  And that means to compete the GSE’s will have to offer a higher premium.

CNN Money has a concurring report under the headline, “Mortgage rates spike - biggest jump since '87 

The whole credit crisis started from the collapsing housing market.  Now some of the attempted treatment may have the side effect of worsening the onset illness.

Dance This Mess Around

I still see that stupid, Flash-driven woman dancing on various websites.  She’s still telling me how mortgage rates are even lower, as the Fed cut rates again.  Again, she’s lying to me.

Last week, I wrote about mortgage rates not corresponding to the rates that Fed Chairman Ben Bernanke was cutting.  Well, after the markets for mortgage backed securities market opened, rates for mortgages actually climbed.  I’ll use the rates offered by the company I work at for comparison (Yes, I know they’re so much better than anywhere else.  But they serve well for purposes of illustration ;-).

On Tuesday, last week before the Wednesday rate cut.  You could call us in the morning, and if you and your property would’ve qualified, I could’ve done a conventional 30-year fixed rate mortgage for 5.5% for 1 point (Just so there’s no trouble of anyone considering this an advertisement, I’ll quote the APR in parenthesis.  In this case, it is 5.622).  Friday, the day after Mr. Bernanke and his international pen pals cut their short-term rates, that same mortgage had jumped to 5.75 for 1 point (5.873 APR).

Now this morning, the first full trading day of the week as many banks were closed for Columbus Day, you would’ve gotten the same mortgage for 6% with 1.125 points (6.137 APR).  You can’t even get that rate this afternoon, as we had a price increase during the day.

Why the increases from the decrease?  I think the best answer is fears of inflation.

The significant problem presently choking credit markets remains liquidity.  The U.S. Treasury and world central banks have responded by pumping in hundreds of billions, if not trillions of dollars.

This may get the banks trusting one another and lure investors hoarding cash on the sidelines back into the equity markets.  But what happens once the arteries of commerce start flowing again?

New astronomical amounts of dollars will still be in bank accounts and ledger sheets.  They aren’t going to just disappear.   All these new dollars and their older cousins will be chasing the relatively same amount of goods. 

Equilibrium only returns to the marketplace when all the new dollars are worth significantly less than what they are today.  That’s inflation in a nutshell.

Savvy investors don’t want to see their present money locked in ten-year bonds at lower rates.  Not when that rate might not even keep up with the annual inflation rate.  That's losing money.

The more investors see inflation as a problem, the greater return they’ll demand from mortgage bonds to lock their capital in.  That means mortgage rates will go up, not down like that dancing lady promises.  

C'ville Bubble Blog Interviews The Mortgage Buzz

Charlottesville - Albemarle Real Estate Market
Q: Are Mortgage Still Available? A: Yes!

"With all the blaring headlines about the world-wide credit crisis and financial institutions holding on to their cash, we wondered if the mortgage industry had ground to a halt. So we emailed Jason."

Thanks Real C'ville Bubble Blog for allowing me to opine.

Friday Links - 10/10

The Candidates: Obama v. McCain on Housing
Real C'ville Bubble Blog breaks it down for us.

AIG gets more cash from the Feds on the heels of news that executives recently enjoyed a posh retreat at a luxury hotel. The total cash infusion thus far: $122.8 billion. More to come, I'm sure.

Sheriff in Cook County, Chicago refuses to evict. "These mortgage companies only see pieces of paper, not people, and don't care who's in the building," Sheriff Dart said.

One year later:
DOW down 40% from peak a year ago
Oil Prices Prices Slide to 1-Year Low


This is "old" news (Oct. 6) you may have seen.
Debt clock runs out of space.

Dance the Night Away

There’s one web advertisement that really irritates me.  It’s that small, dancing, flash-driven woman who celebrates the fact that the Fed has cut interest rates to take mortgage rates at an all time low.  It’s a lie.

Yesterday, in a coordinated effort, the central banks of G7 countries announced a 50 basis point reduction in short term interest rates.  The largesse was another attempt to halt the financial meltdown now strangling global financial markets.  The media tells us that the borrowing of money is now cheaper.  Therefore, people assume that mortgage rates will go down, as well.

Before you call your mortgage broker for a refi, be warned.  The rate reduction will not directly affect mortgages.  The prices for fixed rate mortgages will not suddenly drop a half a point. 

No one executive possesses the power to set mortgage rates.  No grand master wakes up in a good mood and says to himself, “I think I’ll be generous today and lower 30 year fixed rates to 4%.  That should make people happy.”

Larger forces work this magic.

Banks and brokers write home loans for thousands of individuals, couples and families.  In turn, they do not for the most part keep them in their own portfolios.  They bundle them together into packages of bond-like instruments called mortgage backed securities (mbs).

Traders peddle these mbs’s back and forth in a wide electronic market.  And what investors are willing to pay for them is what determines their prices.   That’s what sets your rate.

So will yesterday’s rate cuts made by Mr. Bernanke and his international friends affect mortgage rates?  The answer is maybe, probably even.  But not directly.

Their effect will come from how they affect the general financial market mood.  Will lower yields on other bonds now make mbs’s more attractive?  If yes, more investors will want to buy them, driving their price down.  But if investors still think the U.S. housing market remains too risky, they’ll still seek other places to put their money.  Mortgage rates will not decline.

And ironically, rates could even go upwards if investors fear all the new money flooding the globe will spur inflation.  Time and markets will tell.

Mortgage money aplenty, if...

Over the last several weeks we've been hearing in the news that the global credit crunch has been roiling the credit markets and taking it's toll on everything from the hedge fund industry to automobile companies. And we've seen the reports on how borrowers are having more trouble getting car loans and student loans. So it may follow logic to many observers that getting a mortgage loan has become more difficult within the last month.

Yet there is plenty of mortgage money out there. Why, you ask?

It's because over 85% of all US mortgage lending is controlled by the Federal government*. With the recent takeover of Fannie Mae (FNMA) and Freddie Mac (FHLMC), the US Treasury became the "nation's mortgage lender".

And these loan guidelines haven't changed significantly over the last several months (except for the elimination of seller financed DPA for FHA loans). So this means that a vast majority of those who could qualify for a conventional or other government loan before the credit freeze can qualify for a loan now.

What about the 10-15% of the market that isn't federally controlled? Well, this is where we have seen some contraction. Most of this market consists of portfolio products - unique loan programs offered and held by banks and lenders. These types of products provide a very valuable service (such as Jumbo financing) but they are declining in availability as the tough credit market persists. Chevy Chase who just exited the wholesale mortgage business, is an example. So if you need a high balance jumbo loan you may have trouble finding the loan you need at a rate you can afford.

Recommendation: contact your loan officer to discuss your needs and find out what's available before you write off your ability to get a loan.


*Market share as of Q2 2008: GSEs ~75%, FHA ~10%, VA & USDA ?

MONSTROSITY

monstrosity (noun) - a: an object of great and often frightening size, force, or complexity b: an excessively bad or shocking example



Once 3 pages, bailout bill now length of novel