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Monday, May 9, 2011

A Bear Housing Market as Justly Deserved?

According to The Wall Street Journal, housing prices had fallen for 57 conseccutive months by May 2011. The Huffington Post reports that even though the recession officially ended in June 2009, the real estate market had yet to hit bottom. Since the housing peak in 2006, home values nationally were down 29.5 percent, according to Zillow.com. Compared to the same time a year before, prices were down 8.2 percent in the U.S. markets. In 2010, according to The Wall Street Journal, house price depreciation slowed or stabilized because of tax credits of up to $8000 that expired during the summer. Accordingly, negative equity became even more prevalent in the first quarter of 2011, according to Huffington, when 28.4 percent of all single-family homes with mortgages were "underwater." 

Monthly declines for February and March were "really staggering," according to Stan Humphries, Zillow's chef economist. The Wall Street Journal further quotes him as saying that the declines reflect "the true underlying demand," which was "being completely overwhelmed by supply." Fannie and Freddie sold more than 94,000 foreclosed houses in the quarter--23% more than in the previous quarter. The increase in supply from the foreclosures is at relatively low prices, hence the impact on the market is particularly depressing.

A declining housing prices translates into lost wealth for extant homeowners. When home values decline, the values of mortgages often do not go down as well. Homeowners lose some of their equity, or the stake they have in their home. When equity becomes negative—that is to say, when the value of a mortgage exceeds the value of the property—homeowners become especially vulnerable to default and foreclosure, according to the Huffington Post. “Falling home prices can create a vicious cycle. When a property falls into foreclosure, it tends to depress the values of properties around it, making those homes more likely to experience a similar fate. [In 2010], nearly 2.9 million homes received a foreclosure filing, and more than 2.8 million homes got one in 2009.” based on the data provider RealtyTrac. More foreclosures further reduce the value of residential mortgage-based securities, which reduces the asset-values and returns of investors in the CDOs (collateralized debt obligations) worldwide.

The Huffington Post also reports that the housing market was “plagued by scandal” in the first quarter of 2011. Homeowners and investors filed “numerous lawsuits alleging that big banks misplaced or even faked crucial mortgage documents.” After it was “revealed that companies that processed foreclosures signed thousands of documents daily without even reading them, potentially violating the law, some of the biggest banks temporarily halted their foreclosure proceedings” in the fall of 2010. I suspect, however, that the failure to read is a red herring; most of the sub-prime residential mortgages required no documents proving income or even a job and many of those mortgage applications contained lies known or even encouraged by the brokers. Yet somehow the borrowers should be expected to have resisted the, “It’s ok, really. Trust me.”

The claim made by some mortgage brokers and Wall Street securitization arrangers that the borrowers should have somehow known better than sign low or no-document subprime mortgages with steep ARM resets of up to double-digit interest rates is more than just disingenuous; the brokers had assured the potential homeowners that the “certain” increase in home equity appreciation from the rising housing market would give them the 20 percent equity stake that is necessary to refinance into a fixed mortgage at a decent rate.

The brokers did not care whether the borrowers enabling the double commissions could make the higher ARM (adjustable rate mortgage) payments. Even if the unheard of would happen and the housing market turn bearish, the mortgage servicers will have sold the mortgages to an investment bank such as Lehman Brothers, which would pass the then-securitized mortgage-based bonds on to investors such as Deutsche Bank and the bank of Iceland. Neither companies such as New Century (or Countrywide), nor investment banks like Lehman, would face any risk unless they happened to be holding mortgages when the merry-go-round stopped. Assuming that the horses would keep spinning around, New Century and Lehman both assumed that they would never get caught with their pants down holding toxic mortgages. They were both wrong—oh so wrong. To be so wrong and yet blame the consumer is, at the very least, bad form.

In conclusion, we ought not to be surprised that the years and years of bull market exploited by mortgage servicer companies and Wall Street banks for a quick buck without virtually any concern for the inherent risk takes more than a few years to return to an equilibrium that is reflective of the real-adjusted demand for the extant supply of houses. Our penchant for quick fixes even in the wake of a near-disaster is perhaps even more astonishing than our propensity to deny (and rely on!) bubbles even as they are rising. Although Clinton’s goal of putting poor people in their own homes was laudable, constructing ARM mortgages with resets that low income people could not afford and relying on a rising market to obviate them was a recipe for years of a bear housing market. So rather than act surprised, we might reflect more on what got us into this market. We might conclude that the "professionals" with a vested interest in a steady housing market deserve more than a few years of economic hardship while the foreclosed poor deserve something better.


Sources:

William Alden, “Home Prices Fall Again in Biggest Drop since 2008,” The Huffington Post, May 9, 2011.

Nick Timiraaos and Dawn Wotapka, "Home Market Takes a Tumble," The Wall Street Journal, May 9, 2011, pp. A1-A2.