Thursday, November 13, 2008

Foreclosures spiked 25 percent on year-on-year high

We've got more bad news in the housing market. From MSNBC News:

MIAMI - The number of homeowners caught in the wave of foreclosures in October grew 25 percent nationally over the same month in 2007, data released Thursday showed.

More than 279,500 U.S. homes received at least one foreclosure-related notice in October, an increase of 5 percent over September, according to RealtyTrac Inc. One in every 452 housing units received a foreclosure filing, such as a default notice, auction sale notice or bank repossession.

More than 84,000 properties were repossessed in October, RealtyTrac said.

Foreclosure rates grew 25 percent nationally over the same month of October, year-to-year. From MSNBC News.

A nasty brew of strict lending standards, falling home values and a tough economy is filtering through the housing market. By the end of the year, the company expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.

The MSNBC story does provide some background information on the U.S. Treasury's $700 billion bailout program for Wall Street, even to the point of Treasury Secretary Henry Paulson saying that the $700 billion will not be used to purchase "troubled bank assets." That is just another phrase for saying all those subprime mortgages and mortgage-backed securities the banks are holding, that are currently underwater. But the interesting aspect about this MSNBC story is what is not said. The Wall Street banks have been using this U.S. Treasury bailout money for bolstering their balance sheets, buying other banks, paying big executive bonuses, and basically hoarding the bailout money. Everything else--except for making loans. The banks are facing huge problems in renegotiating loans--especially the subprime mortgage loans. According to this Yahoo News Buzz story:

Voluntary programs don't work. There are already several voluntary efforts to encourage banks and their customers to renegotiate failing mortgages on their own, such as the HOPE NOW program that regulators cite frequently as a stand-in for a real solution. But voluntary efforts are marginal at best. First of all, most banks are free to rework loans without any government urging at all. The reason they don't--big surprise--is that they often lose money. Even if the government tries to strong-arm the banks, that doesn't eliminate the loss, and CEOs still have shareholder money to safeguard. Telling stockholders that "the government said so" doesn't usually justify poor financial performance.

By the most optimistic assessment, the banking industry is reworking about 200,000 troubled mortgages a month, without government compulsion. That might sound like a lot, except there are about 5 million mortgages in foreclosure or at risk of default. So 200,000 workouts amounts to resolving 4 percent of the problem each month, assuming there are no additional foreclosures. But the economy is getting worse, not better, and intensifying layoffs are going to lead to more problem mortgages, not fewer. In recent testimony before Congress, FDIC Chairman Sheila Bair said that "some of the voluntary efforts have helped, but it has clearly not helped enough. We are falling badly behind."

A homeowner bailout would have millions of moving parts. Bailing out banks requires a lot of money and a very careful strategy, but once the Treasury Department has determined which banks to help, the process is straightforward: The government buys preferred shares in the bank, according to standardized rules. Even if the government invests in 1,000 banks, the procedure should be the same in virtually every case.

It's extremely difficult to establish standardized rules for salvaging individual mortgages. Of the 5 million problem mortgages, the majority have been "securitized," which in many cases means the loan has been carved up into various pieces representing repayment of the principal, say, or the interest payments, and then bundled up with pieces of other mortgages and sold as securities to investors worldwide. Some of those have been resold to other investors or pledged as collateral in other deals. It could take as much work to identify all the investors in a single $300,000 mortgage as it does to execute a $3 billion federal investment in a bank with thousands of customers. Now, multiply that effort by 5 million loans. Wanna manage that program? Neither does Bair or Treasury Secretary Henry Paulson.

Homeowner bailouts could worsen the problem. Even when reworking a loan might help save a home and keep the payments coming, there still might be risks to the bank--especially if it's a local bank that issued a lot of mortgages in a concentrated area. "If you suddenly tell borrowers there's a lower amount due, others may see that and stop paying," says economist James Barth of the Milken Institute. So bailing out one guy might persuade his neighbor to stop making payments, even if he can still afford to, and hope for a better deal instead. That makes banks reluctant to renegotiate in the first place, and when they do, they often ask for concessions that the borrowers reject.

One stipulation of a federal program, for example, is that in exchange for a loan guarantee, the government gets a big chunk of any future appreciation in the house, even if you don't sell for 25 years. But sharing your house with Uncle Sam is a strange proposition, and even distressed borrowers are reluctant to go along with that.

The worst loans are the hardest to track. If banks simply issued mortgages and then held onto them, as in the George Bailey days, the problem wouldn't be so complicated. In fact, the FDIC is already reworking at least 40,000 troubled mortgages at IndyMac, the big California bank it took over in July. When the loan is held by the bank that issued it, there are no downstream investors to consult, and the mortgage is usually still intact. At IndyMac, workout efforts are aggressive, because the FDIC doesn't have shareholders to answer to and it wants to fix the bank's balance sheet as fast as possible.

But the riskiest subprime loans--and especially adjustable-rate subprimes, the most "toxic" of all--aren't typically held by banks. Here's the math, according to recent analysis from the Milken Institute:

-- About 50 percent of all foreclosures involve subprime mortgages.

-- About 68 percent of all subprime mortgages are securitized.

-- About half of all securitized subprime loans are held by private institutions, rather than government-controlled entities like Fannie Mae and Freddie Mac.

That means the majority of the bad loans bringing down the housing market are controlled by the private investors whose greed and carelessness fueled the problem in the first place. And there's nothing an individual borrower can do to control who holds his mortgage. The government could help borrowers by buying up all those bad loans, at enormous expense, then essentially refinancing on terms more favorable to the homeowners. But that would amount to an egregious bailout of some of the shadiest players in the business. Even if taxpayers could stomach that, the downstream investors all have different stakes in the mortgage-backed securities they hold, with no motivation to agree to a single bailout plan. And so far, nobody in Washington has figured out a palatable way to help borrowers without also bailing out the downstream investors holding the securities, at a price the government can afford. Anybody who can solve that conundrum should contact Paulson and Bair immediately.

The big problem here is all of the subprime mortgages that are either partially floating, or are going underwater, in the market. These subprime loans have been chopped up and sold off into mortgage-backed securities to the point where no one really knows what the true value of the mortgage-backed securities are. Furthermore, the big Wall Street firms--such as American Income Group--have purchased and sold collateralize debt obligations based on these subprime mortgages, only to see these CDOs go underwater, forcing the Wall Street firms to cough up huge amounts of money to cover their own losses. The Yahoo Buzz story reports that there is around 5 million problem mortgages in the U.S. now. That is a huge number of problem loans that the banks will be forced to renegotiate. The banks are going to renegotiate these problem loans, only as a last resort.

But, with the banks holding on to a million foreclosed properties, representing almost a third of all properties for sale in the U.S. market, I think the banks are now starting to realize that it may be better to renegotiate these subprime loans in order to keep Americans in their homes, rather than having even more foreclosed homes sitting, unsold, on the banks' balance sheets. Banking executives are promising Congress that they will use the government's bailout money "to assist with rewriting residential mortgages" to American families. Citigroup has offered to ease mortgage terms for 130,000 customers, resulting in "workouts of over $20 billion of loans." And it is not just Citigroup that is modifying their loan packages:

Several of the nation’s largest banks have made similar offers to hundreds of thousands of homeowners with plans that may wind up helping a larger pool of troubled borrowers than the government’s plan to partly guarantee home loans. Roughly 1.5 million homes were in foreclosure at the end of June, the last month for which data is available, and economists expect more borrowers to default in the coming months as unemployment rises and home values fall even more.

JPMorgan Chase, which acquired Washington Mutual and its troubled loan portfolio, announced plans in late October to cut monthly payments by lowering interest rates and temporarily reducing loan balances for as many as 400,000 homeowners. Bank of America, which acquired the large mortgage lender Countrywide Financial, announced a similar program aimed at 400,000 borrowers as part of a settlement with state officials a few weeks earlier. And HSBC ramped up its mortgage modification effort in January, and has adjusted 61,000 mortgages so far this year.

The loan modification programs closely resemble one that the Federal Deposit Insurance Corporation put in place at IndyMac after it took over that bank in mid-July. Citi plans to reduce monthly payments by temporarily reducing loan balances and by cutting interest rates to as low as 1 percent for up to 2 years. The F.D.I.C. has said it may be able to help 47,000 delinquent IndyMac borrowers.

I think the banks are starting to realize just how bad this depressed real estate market is hitting their pocketbooks. They are saddled with a huge number of foreclosed homes that they cannot sell to cover their losses, and are watching these foreclosed homes continue to drop in value. In addition, these banks are sitting on even more subprime home mortgages that are threatening to go into default, forcing the banks to foreclose even more homes on their books--homes that they still cannot sell to cover their mortgage losses. So the banks are being forced with unappetizing choice of either renegotiating the subprime loans for those Americans that are threatening to go under, or to continue to get saddled with more undervalued, foreclosed, homes that they cannot sell in a slumping real estate market.

We may be starting to see the slow beginnings of a real estate turn-around. But such a turn-around will still take years, as the shake-out from the subprime mortgage mess continues.

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