December 2, 2022

Strategic Defaults – The Difference Between The Rich And “Other People”

Million Dollar Home Owners Falling Off The Cliff

“I think you’ll find the only difference between the rich and other people is that the rich have more money” – Mary Colum

If the difference between the rich and “other people” is money, why are the rich walking away from their mortgages just as fast as anyone else?   This question is examined in a recent New York Times article which cites a serious delinquency rate of 1 in 7 for homeowners with a mortgage over $1 million compared to a delinquency rate of 1 in 12 for smaller mortgages.  The Times’ conclusion is that the biggest defaulters on mortgages are ruthless rich folks with no scruples.

Without citing specific statistical analysis, the Times article seems to draw the conclusion that anyone with a million dollar mortgage would have substantial financial resources that could be tapped to keep the mortgage current.   This may well be the case for some, but drawing from my own experience in the mortgage industry, many homeowners with the million dollar mortgages are financially thin and over leveraged.   For a variety of reasons ranging from ego, poor financial planing or irrational exuberance, many purchasers walk into million dollar homes with empty pockets.

Many of the million dollar homes now in default were purchased when eager buyers believed that home values could only go up and that buying as much home as possible simply meant larger profits down the road.  A ten percent gain on a million dollar home results in a handsome $100,000 gain – ten times the profit from purchasing a $100,000 home.

A few short years ago, at the height of the housing bubble, income was deemed irrelevant when banks granted mortgage approvals.   The proverbial strawberry picker or fast food cashier with average credit could use exotic mortgage programs to buy at any price level chosen, without the bother of a down payment or income verification.    Ever increasing home values then allowed cash extraction from a refinance or second mortgage, once again without the hassles of verifying income.  It should come as no surprise that wannabe millionaires taking the biggest risks now have the highest default rates.

According to the Federal Reserve, “half of the defaults are driven purely by negative equity” when the mortgage debt exceeds 150% of a property’s value.  Since high priced homes have seen large declines in value, it should come as no surprise that many strategic defaults will occur at the high end of the market by homeowners with million dollar mortgages.  The open question is – does having a million dollar mortgage imply a wealthy homeowner?

If a statistical study was done on the net worth of defaulting homeowners who have million dollar mortgages, it would probably reveal that many of these alleged “rich” homeowners have an embarrassingly low or negative net worth.  Consider the findings from one of the most influential studies on the mind set and lifestyles of the wealthy from The Millionaire Next Door: The Surprising Secrets of America’s Wealthy, by Thomas J. Stanley and William D. Danko.

Characteristics of the millionaire next door:

  • Avoids buying status objects or leading a status lifestyle
  • 97% are homeowners with an average home value of $320,000, occupying the same home for over 20 years
  • The average millionaire lives well below his means and spends below his income level

The rich did not get rich by being poor stewards of capital or chasing housing bubbles.  The bulk of those defaulting on million dollar mortgages (strategically or otherwise) are simply poor people, living in big houses they could never afford in the first place.

Living Large

Living Large

Depression In Commercial Real Estate Results In Bargains For Some

Depression Pricing As Empty Hotels Slash Rates

The recent era of easy lending was not confined to residential real estate.  Commercial real estate lending is the next big worry for a banking industry already beset by an avalanche of non performing loans.  The banking industry has $1.8 trillion dollars of commercial real estate loans and many analysts believe that banks have reserved for only a small fraction of current and future losses.  Recent examples of losses on commercial hotel loans  in major travel destinations such as Hawaii and Las Vegas indicate the severity of the problem.

Hawaii Hotel Industry Downturn Worse Than Great Depression

Hawaii Hotels Face Fewer Visitors – For the hotel industry in the continental U.S., this downturn is the worst since the Great Depression. But the Hawaiian resort industry is taking a beating that’s even more severe.

Meanwhile, revenue per available room has fallen nearly 25% in the past two years and now averages $150.75.

Major renovations of existing hotels are common in Hawaii because construction of new resorts has been limited since the 1980s because of steep land prices and local governments’ opposition to expansion. “So the name of the game is to buy, renovate and reposition,” says Joseph Toy, president and CEO of the hotel-consulting company Hospitality Advisors, based in Honolulu. Many of the resorts that changed hands in recent years were built by Japanese owners in the 1980s.

But practitioners of that pricey repositioning strategy now find themselves in a bind due to the recession, the capital crisis and Hawaii’s tourism downturn. “The operating numbers have cratered, the underlying fundamentals aren’t very good, and you have a whole bunch of problem loans,” says David Carey, president and chief executive of Outrigger Enterprises Group, which owns 30 Hawaiian hotels, none in foreclosure.

Las Vegas Hotel Worth 41% Of Construction Cost – Cheaper to Tear Down Than Finish

Doubts Are Cast On Value of Las Vegas’s  Fontainebleau – LAS VEGAS—The Fontainebleau the luxury hotel and casino development at the northern end of the Las Vegas Strip, sits more than half-finished after falling into bankruptcy in June.

But as potential suitors consider rescuing the project, they are facing a grim reality: It may not be worth the money it would cost to complete it. More than $2 billion has already been poured into construction.

“It is going to take $1.2 billion to $2 billion to finish Fontainebleau, and it’s not worth that much,” Penn National Gaming Chief Operating Officer Tim Wilmott said. Penn is currently negotiating to take it over from the project’s creditors.

When the 4,000-room Fontainebleau project was first mapped out four years ago, gambling revenues were soaring and Las Vegas barely had enough hotel rooms to accommodate a flood of visitors.

Now, Las Vegas has a surfeit of luxury rooms. Occupancy rates in August fell to 83% from 94.9% two years earlier, and room rates have fallen sharply.

An outside analysis contracted by some of the Fontainebleau lenders last spring found that Fontainebleau would be worth $1.76 billion if it were completed in May 2010, according to a court filing, far less than its $3 billion total cost.

Depression Pricing For Hotels

Overwhelming supply and weak demand have resulted in hotels slashing room rates to keep the cash flow going.  In many cases, the cost of lodging at major hotels and resorts has dropped as much as 50% from two years ago and vacancy rates still remain high.  For newer resorts that were built during the boom years, the picture is even bleaker, resulting in bargain rates that were previously unimaginable.  On a recent trip to Mexico in September, I had the occasion to visit the newly completed and mostly vacant multi billion dollar resort, La Amada Hotel, Playa Mujeres, Cancun.  The La Amada website describes the property, which opened in May 2009,  as follows:

La Amada Hotel is a 5-star luxury hotel. Here you’ll have a comfortable home base of contemporary luxury. Stylish hotel architecture and decor, generous suites, spotless service, deluxe facilities, and of course, our secluded beachfront setting, all enable you to let your days here happen naturally. Situated just 25 minutes from Cancun International Airport, Playa Mujeres is the newest luxury resort destination in greater Cancun.

This 922-acre (373 hectare) luxury development includes a boutique hotel, upscale residences, a golf, yacht, and beach club, and Cancun’s first marina situated on tranquil Playa Mujeres in the Mexican Caribbean. Envisioned as an exquisitely and carefully developed sustainable community, La Amada is a destination where culture, ecology, history and art are integrated in a stimulating style.

La Amada, located in the Marina section of the Playa Mujeres “master planned’ community, is a 552-unit project of one, two and three bedroom residences, a 110-room five star boutique hotel, and a top of the line spa. In addition, the developers have created a “marina village” with 150,000 square feet of commercial space for restaurants, bars, cafes and shops, creating an ambiance akin to top European resorts such as Puerto Banus and St Tropez. No expense was spared on this spectacular creation; residences can even fly in and land on the properties private helicopter pad.

La Amada is a spectacular luxury resort hotel.  Equally spectacular are the discounts  – luxury suites are being offered at $280 per night, marked down from $700.  Apparently, even at these discounted prices, income stressed consumers are saying no.  During three visits to the property, I saw only one couple on an otherwise deserted beach.  Finished units remain empty with no guests to be seen.   The planned bars, cafes and shops have not opened.   Virtually all of the 176 slips in the Marina remain empty.  La Amada was built during an era of easy money when it was assumed that prosperity, based on eternal asset appreciation, would never end.  There is little doubt that the investors in La Amada have created a truly fabulous resort – far less certain is whether or not they will ever see a return on their investment.

La Amada sign points to empty hotel

La Amada sign points to empty hotel

Deserted La Amada beach

Deserted La Amada beach

Beachfront La Amada

Beachfront La Amada

Empty boat slips at marina

Empty boat slips at marina

La Amada - where are the guests?

La Amada - where are the guests?

Discount prices fail to lure guests

Discount prices fail to lure guests

Can The Unemployed Afford A Mortgage Payment?

Government Determined To Keep Unwilling Homeowners In Homes

The FDIC announced a new initiative to reduce foreclosures on home mortgage loans held by failed banks that were acquired by another institution.   This new FDIC program goes far beyond previous government mortgage assistance programs such as the Home Affordable Refinance Program (HARP) and the Home Affordable Modification Program (HAMP).

Whereas the HARP and HAMP programs require income verification and attempt to lower a monthly mortgage payment to a level that is reasonable in relationship to a homeowner’s income, the new FDIC forbearance plan will attempt to help homeowners who are currently unemployed.

FDIC Encourages Forbearance To Unemployed

As part of its loss-share agreement with acquirers of failed FDIC-insured institutions, the FDIC is encouraging its loss-share partner institutions to consider temporarily reducing mortgage payments for borrowers who are unemployed or underemployed. This program will provide additional foreclosure prevention alternatives to these borrowers through forbearance agreements that will give them an opportunity to regain full employment and avoid an unnecessary foreclosure.

“With more Americans suffering through unemployment or cuts in their paychecks, we believe it is crucial to offer a helping hand to avoid unnecessary and costly foreclosures. This is simply good business since foreclosure rarely benefits lenders and would cost the FDIC more money, not less,” said FDIC Chairman Sheila C. Bair. “This is a win-win for the borrower, who can remain in his or her home while looking for a new job, and the acquiring institution, which continues to receive payments on the loan. Ultimately, by reducing losses under our loss-share agreements, this approach helps reduce losses to the FDIC as well.”

The recommendation to loss-share partners applies where unemployment, or underemployment, is the primary cause for default on a home mortgage. In such cases, the FDIC is urging its loss-share partners to consider the borrower for a temporary forbearance plan, reducing the loan payment to an affordable level for at least six months. The monthly payment during this period should be established based on an affordable payment – given the borrower’s circumstances – and it should allow for reasonable living expenses after payment of mortgage-related expenses.

FDIC Plan Likely To Help Few Homeowners

The objectives of the FDIC’s forbearance plan are well intentioned.  Allowing an out of work homeowner time to find a new job may prevent an unnecessary foreclosure and eliminate the need for a costly foreclosure by the bank.  From a practical standpoint, the FDIC plan may ultimately benefit very few homeowners for the following reasons:

  • The program is only available to those homeowners who have mortgages with failed banks that were acquired by another institution under a loss-share agreement with the FDIC.
  • Under the forbearance agreement, the bank will accept only a portion of the regular mortgage payment.  The FDIC is asking for only a 6 month forbearance.  Given the prospects of a “jobless economic recovery” and the difficulty in finding new employment, the FDIC appears wildly optimistic about a quick change in fortune for an unemployed homeowner.   Banks do not want to foreclose, but very few banks now offer a forbearance plan to the unemployed since they do not expect them to quickly find a new job.
  • The mortgage foreclosure prevention plans currently in effect have had dismal success rates and these programs are limited to candidates who have income.  The HARP program, expected to help millions of homeowners had at the end of July approved only 60,000 refinances.   The government loan modification program (for those not qualified under HARP) has been plagued by very high re default rates ranging from 17% to 45%.
  • The FDIC recommends that the lender establish an “affordable payment” for six months, allowing for reasonable living expenses.  Many homeowners with jobs are struggling to make their mortgage payments.  Many states pay only a fraction of previous earnings in unemployment benefits.   Unless the homeowner has put aside some savings, unemployment compensation will usually cover only basic needs, leaving nothing for a mortgage payment.  It is likely that any payment (other than zero) will be too high for unemployed homeowners.
  • Recent statistics on the “cure rate” for delinquent mortgages show a stunning decline.  The cure rate is the percentage of borrowers who are able to catch up and bring a delinquent mortgage current again.  As of July, the cure rate for prime mortgage loans plummeted to 6.6% from an average of 45% during  2000 to 2006.  Some of the delinquent borrowers had lost their jobs but many were still employed.  This is a sea change in attitudes towards home ownership.   Many of those financially able to catch up apparently saw no benefit in doing so; either the burden of home ownership outweighed the benefits or there was no perceived benefit in continuing to make payments on a home with large negative equity.   Many homeowners may view foreclosure as the best “program” for getting back on their feet since they could potentially enjoy years of “rent free” housing before the bank ultimately forecloses.

Trapped Homeowners Want Out

Heavy Load

Heavy Load

Courtesy: laprogressive

Many Americans are apparently rethinking the “dream” of home ownership and acting accordingly by relieving themselves of the costly burden of mortgage payments, taxes and maintenance on what has become a depreciating asset.

While the government says “yes we can”, impoverished homeowners are saying “no we can’t”.  Perhaps this is why the massive government initiatives to prevent foreclosures are failing.   Trapped homeowners are doing what’s best for them and walking away, while the government vainly attempts to impose home ownership on those who now reject it.

Artificial Mortgage Rates Drop To 4.75%

Fed Manipulation Of Mortgage Rates Continues

Mortgage rates continue their downward trend with the perfect borrower now able to obtain a rate of 4.75% with a two point buy-down on a 30 year fixed rate mortgage.  As expected, with mortgage rates now back in the 4% range, mortgage applications have increased.   The latest stats from the The Mortgage Bankers Association show large increases in mortgage activity, with refinances accounting for almost 60% of total mortgage applications.

The Market Composite Index, a measure of mortgage loan application volume, increased 17.0 percent on a seasonally adjusted basis from one week earlier.  On an unadjusted basis, the Index increased 15.8 percent compared with the previous week and 64.5 percent compared with the same week one year earlier.

While fluctuations in mortgage rates are historically based on many factors, the biggest factor affecting mortgage rates today are the manipulations by the Federal Reserve.   With the mortgage market dominated by the government, it is difficult to determine where rates would be in a free market but indications are that rates would be much higher.  For example, non agency lenders who do not sell mortgage loans to the government agencies but portfolio them instead, are currently quoting 30 year fixed rates at around 6 to 6.5% depending on credit and loan to value (obviously, the non agency lenders are not doing much conforming loan business).

Fed Price Fixing Efforts With Mortgages Will Fail

So what’s the problem with having low mortgage rates?  The  government manipulations in the mortgage market allow homeowners to refinance and buy at low rates.   If mortgage rates drop low enough, perhaps the government will succeed in its objective of re-inflating housing prices.  There just might be a few problems with the government’s manic quest to keep mortgage rates low.

  • How long will investors continue to buy securities backed by mortgages on which payments are guaranteed by the government?  Perhaps forever, but perceptions of the value of a “government guarantee” may diminish as the financial condition of the US Government continues to erode.  At some point, rational buyers will give little credence to the guarantee of a government that needs to borrow 40% of its year outlays while running multi trillion dollar yearly deficits.
  • How long can the Federal Reserve continue to purchase mortgage backed securities and treasury debt with printed money?  It may not seem to be causing a problem in this country (yet) but some of the USA’s largest foreign creditors are getting very nervous – See China Alarmed By US Money Printing.

Banks Load Up On Mortgages

Theoretically, the Federal Reserve can buy every mortgage backed security in existence but at what point does the bond market react with higher rates based on the risk that the Fed is going to monetize debt on a colossal scale?  Fed purchases of mortgage backed securities are fast approaching the announced goal of $1.25 trillion.

Courtesy wsj

Courtesy wsj

As it turns out, the Fed has a willing and able partner in the purchase of mortgage backed securities.  With the banking industry facing massive losses on defaulting mortgages, how is this for irony? – Banks Load Up On Mortgages.

As of June 30, the roughly 8,500 federally insured banks and thrifts were holding $113.5 billion of Ginnie securities, compared with just $41 billion a year earlier, according to a Wall Street Journal analysis of bank financial disclosures. It is the largest amount that banks have reported holding since at least 1994.

Banks, sometimes with the blessing of federal regulators, have been loading up on Ginnie securities for one main reason: They make their balance sheets look healthier. Since the securities are guaranteed by the government, federal banking regulators have deemed them risk-free, meaning that adding them to a bank’s investment portfolio, or replacing assets deemed riskier, lowers the overall risk of the portfolio in the eyes of regulators.

Some banks have used government cash infusions under the Troubled Asset Relief Program to buy Ginnie Mae bonds.

Holding Ginnie bonds help banks look better because federal bank-capital guidelines give the Ginnie securities a “risk weighting” of 0%. That means banks don’t have to hold any cash in reserve to protect against losses.

At the same time that the banks are choking on defaulted mortgages and reluctant to lend, they are purchasing vast quantities of government guaranteed mortgages to shore up their capital ratios, sometimes using TARP funds.

The Great Unwind

The Fed fostered the bubble in the housing market with easy money, leaving us with collapsed housing prices and oceans of defaulted mortgage debt.  The Fed is now inviting a similar disaster in the mortgage market, again with super easy monetary policies.

The massive purchases by the Fed and the banks of mortgage backed securities is artificially inflating the prices of mortgage backed securities, consequently curtailing purchases by private investors.  This leaves the Fed and the banks as the only (irrational) buyers.

At some point mortgage rates will rise regardless of the Fed’s manipulations.  The taxpayers will be stuck with massive losses on the Fed’s mortgage backed securities as yields climb and prices plunge.  Banks, as always, will be heavily invested in the wrong asset at the wrong time.  Due to the magic of FASB accounting rules, the banks won’t have to take losses if they do not sell their mortgage backed securities; but neither will they be able to increase lending with capital frozen in underwater mortgages.

The government’s obsession with housing has resulted in the misallocation of untold trillions of dollars.   Meanwhile, urgent human and infrastructure needs of the country are left unfunded.   With the mortgage markets now completely dominated by the government, we can look forward to a continuation of the same failed policies.

Will Mortgage Rates Soar As Fed Programs Wind Down?

Fed Support No Longer Unlimited

There seems to be near unanimous agreement at all levels of government that a recovery in housing prices is essential for economic stabilization and future growth.   The Federal Reserve has supported this effort by driving short term interest rates to near zero and initiating a program to purchase as much as $1.75 trillion in mortgage debt and treasuries.  As of mid year, the Fed had purchased over a half trillion dollars of mortgage-backed securities and housing agency debt in an attempt to keep mortgage rates low.

How much longer will unlimited Fed support for the housing market continue and will mortgage rates increase when Fed support is withdrawn?  The Federal Reserve has indicated that the credit markets have stabilized.  The Federal Reserve’s balance sheet has been shrinking for weeks and is now below the $2 trillion level reached in March.   With financial Armageddon apparently no longer an immediate threat, the Fed also seems to be responding to political pressure to reduce various emergency lending programs.

In response to pointed warnings from foreign creditors about monetizing US debt,  Chairman Bernanke said:

WSJ – “We absolutely will not monetize the debt,” Mr. Bernanke says, using economist-speak that means he won’t let the Fed become the government’s source of cash for deficits. Fed-fueled deficits would be inflationary. Mr. Bernanke says, “we will not abandon price stability.”

In addition, the Fed faces a full assault on its authority from Ron Paul who is attempting to introduce legislation to audit the Fed.  Many other members of Congress have also been critical of the cost and secrecy of Federal Reserve programs and bailouts.

WSJ – As Mr. Bernanke heads to Capitol Hill today for two days of testimony on the economy, the central bank is fending off attacks on many fronts from critics who want to rein in its power and autonomy.

Rallying one charge is Ron Paul, an iconoclastic Texas Republican who wants to abolish the central bank entirely.

Still, Mr. Paul has persuaded nearly two-thirds of the House to co-sponsor a bill requiring far-reaching congressional audits of the Fed. Audits would show “that it’s the Fed that has caused all the mischief” in the U.S. economy, Mr. Paul says.

Mr. Bernanke will face a tough audience in his semiannual report to Congress Tuesday and Wednesday. The Fed “went too far in bailing out companies and exposing taxpayers” to the costs, says Sen. Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee. “They utterly failed the American people as a bank regulator.”

Outlook For Mortgage Rates

With the credit markets stabilized and the Fed under political pressure to reduce its multi trillion dollar financial  commitments, how will mortgage rates respond as the Fed reduces its programs to keep rates low?  Two top rated bond managers at Pimco and American Beacon Advisors have similar opinions.

July 20 (Bloomberg) — Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., reduced holdings of mortgage debt last month and added to cash and equivalent securities.

Gross cut the $161 billion Total Return Fund’s investment in mortgage bonds to 54 percent of assets, the lowest in almost two years, from 61 percent in May, according to a report on Pimco’s Web site.  Gross trimmed holdings of government-related bonds to 24 percent of assets, the least since February, from 25 percent.

Gross has been selling mortgage-backed securities over the past few months after loading up on them last summer in the midst of the financial crisis, which started with the collapse of the U.S. property market in 2007.

AMERICAN BEACON ADVISORS’ BOND MAVENS, Kirk Brown and Patrick Sporl, have done an admirable job of flying their respective fixed-income funds, AB Treasury Inflation Protected and AB Intermediate Bond, through the credit-market turbulence of the past two years.

He thinks that stagflation — the dreaded combination of a stagnant economy and inflation — is more of a possibility now than at any time since the 1970s.

AB Intermediate Bond, meanwhile, is underweight mortgage-backed securities and overweight corporates.

A reduction of the Fed’s massive intervention in the mortgage market is certain to result in higher mortgage rates, but will not be the disaster that some fear.   The real disaster has already occurred based on the Fed’s past policy of ultra low interest rates to increase lending and inflate housing prices.

Disclosures: No positions

High Risk Mortgage Lending Still Being Promoted By GSEs

Sufficient Income Key To Sound Home Ownership

In an effort to prevent delinquent home owners from losing their homes to foreclosure, the Department of the Treasury recently issued guidelines to lenders.  Under the Making Home Affordable mortgage modification program, the Treasury stated that the mortgage loans for at risk home owners should be modified to result in a front end debt ratio of 31%.   A front end debt ratio is the percentage of gross monthly income that is spent on housing costs, typically principal, interest, taxes and insurance.

Historically, a front end debt ratio of around 31% was considered to be an affordable portion of a borrowers gross income to allocate to housing.   A housing debt ratio in this range allowed the borrower sufficient remaining income to cover other living costs and debt payments.

DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency, Joint Statement of June 23, 2009

On March 4, 2009, Treasury announced guidelines under the Program to promote sustainable loan modifications for homeowners at risk of losing their homes due to foreclosure.

Under the Program, Treasury will partner with lenders and loan servicers to offer at-risk homeowners loan modifications under which the homeowners may obtain more affordable monthly mortgage payments.

The Program guidelines require the lender to first reduce payments on eligible first-lien loans to an amount representing no greater than a 38 percent initial front-end debt-to-income ratio.6 Treasury then will match further reductions in monthly payments with the lender dollar-for-dollar to achieve a 31 percent front-end debt-to-income ratio. Borrowers whose back-end debt-to-income ratio exceeds 55 percent must agree to work with a foreclosure prevention counselor approved by the Department of Housing and Urban Development.

The OCC guidelines corresponded to comments by the Secretary of HUD, Shaun Donovan, who had previously supported lowering the debt ratios of at risk homeowners to 31%.  In response to the question as to why so many home owners re default after having a mortgaged modified, Mr. Donovan stated the obvious – if a mortgage payment was excessive compared to income, default was much more likely.

What it showed was that where there’s actually a reduction in payments, there’s long-term success for those homeowners. People do much better when you lower payments and make them affordable than these other so-called modifications, which actually keep payments the same or increase them.

So I saw it, and in fact, if you look at the report, some of the language in it directly supports the way that we’re setting up our plan to create a standard that is truly affordable for borrowers. 31 percent debt-to-income ratio is the right standard. It’s widely accepted, and if we can get to that level, as we do in our plan, we believe that that sets us up, based on the results of the study, for long-term success for homeowners.

Someone Should Tell The GSEs

The HUD Secretary’s comments make sense and reflect previous sound underwriting guidelines that existing prior to the housing lending mania of the bubble years.  If mortgage lenders had not abandoned traditional income requirements, borrowers would not have been approved at debt ratios that virtually guaranteed future defaults.   The Treasury and HUD are promoting sound lending policies when they recommend a conservative debt ratio.

The problem is that some one forgot to tell Fannie Mae (FNM), Freddie Mac (FRE) and especially the FHA what HUD and the OCC have proposed as a safe debt ratio.  (See Why Does The FHA Approve Loans That Borrowers Cannot Afford.)   We now have the absurdity of lenders being required (at taxpayer expense) to modify mortgages to a 31% debt ratio while it is extremely common to see new mortgages being approved at debt ratios of  50% or higher.   When a borrower is paying out half of pre tax income for housing expenses, there is usually barely enough left for other debt payments, living expenses, home repairs, etc.   A reduction in income, a major unexpected home repair bill or any other unexpected expense can be enough to tip the borrower into default.   Yet, the automated underwriting systems of Fannie, Freddie and the FHA are routinely approving  risky mortgage loans at debt ratios far in excess of 31%.

The government’s obsession with increasing housing sales and refinances has resulted in a bizarro world situation.    Mortgages are being approved with unaffordable payments, the borrower falls behind and then the payments are modified lower under the Making Home Affordable program.  It’s not surprising that the Federal Reserve has had to become the buyer of last resort of mortgage backed securities – who else would want to buy them?

Disclosures: No positions.

The Contradiction Of Empty Homes And Rising Apartment Vacancies

A Housing Surplus

Huge increases in foreclosures have resulted in millions of homes sitting vacant as bank REO managers struggle to sell the empty homes.  Theoretically, people who have been evicted or lost their homes to foreclosures would be new renters.  Consider, however, the increase in apartment vacancies to a 22 year high:

U.S. apartment vacancies rose to their highest in 22 years in the second quarter as job losses cut tenant demand and more units came to market. Vacancies climbed to 7.5 percent from 6.1 percent a year earlier, New York-based real estate research firm Reis Inc. said today. The last time landlords had so much empty space was in 1987,

“Vacancies continued to rise despite what has traditionally been a strong leasing period for apartment properties,” said Victor Calanog, director of research at Reis.

Job losses and falling wages are shrinking the pool of potential renters, defying forecasts that prospective homebuyers would rent rather that purchase as house prices decline. The U.S. unemployment rate rose to a 26-year high in June and U.S. payrolls dropped more than forecast in June, the government said last week.

Rents paid by tenants, also known as effective rents, fell 0.9 percent from the previous quarter to $975, said Reis. Effective rents were 1.9 percent lower than a year earlier.

“New buildings coming online over 2009 and 2010 will face higher initial vacancy levels, and will work to increase the pressure on leasing managers,” Calanog said.

The brutal economic fact is that those losing their homes cannot afford to rent.  In many cases dispossessed adults are now sharing homes with children, friends or relatives.  In addition, USA Today reports  children are moving back into their parents’ homes:

Matthew Costigan is young, single and a recent college graduate.

So what does he do? He gives up his nice pad in the trendy Shadyside neighborhood of Pittsburgh and moves in with mom and dad. To his boyhood home. In the suburbs.

Costigan and many others in the most educated generation of young adults are seeking refuge under their parents’ roofs from skyrocketing housing prices, mounting college debts and a tight job market.

A survey of 2004 college graduates shows that 57% planned to move back in with their parents. MonsterTRAK, an online job site for college students and young alumni that conducted the survey, found that 50% of 2003 graduates are still living at home and 35% are still looking for work.

The Families and Work Institute for the first time asked 3,504 employed adults whether they have grown children living at home. The findings were surprising, says Ellen Galinsky, president of the New York research group. “Fully 25% of employed parents have children from 18 through 29 years of age living at home at least half of the time,” she says.

Forced by economic hardship, children are moving back in with parents and parents are moving in with their children.   Meanwhile, apartments and homes sit vacant, causing bank losses on homes and commercial loans.

Foreclosed empty homes and increasing rental vacancies are just one more sign of an over leveraged, cash poor consumer.  Forecasts predicting an economic recovery based on increased consumer spending are certain to be wrong.  Major job losses and wealth destruction of the past two years are forcing consumer to do what they must to survive.  With job losses increasing and unemployment reaching depression levels, an economic recovery remains a fantasy at this point.

Wells Fargo’s New Zero Down Payment Mortgage Program

Risk Of No Down Payment Mortgages

There is  longstanding and overwhelming statistical proof that zero down payment home buyers default on mortgages at a far higher rate compared to home buyers who make a down payment.   This matter has lately received more attention than in the past due to the large number of foreclosures related to zero down payment purchases during the housing bubble years.  In 2005, for example, nearly half of all home purchasers were made with zero down payment mortgages.

Zero Down Payments = Foreclosures

FHA Delinquency Crisis

Could FHA’s rising delinquency rate be due to FHA incorporating risky practices that have become standard in the mortgage industry? Since industry experts often cite 100% financing as being a major factor in the mortgage meltdown, let’s take a look at borrower down payment sources:

The delinquency rate clearly rises in tandem with the increase in non-profit funded down payments.

In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate.

No Skin In The Game
The analysis indicates that, by far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

Rather, stronger underwriting standards are needed — especially a requirement for relatively high down payments. If substantial down payments had been required, the housing price bubble would certainly have been smaller, if it occurred at all, and the incidence of negative equity would have been much smaller even as home prices fell.

No Down Payment

No Down Payment

Courtesy: WSJ

Wells Fargo Initiates Down Payment Assistance Program

Ignoring the overwhelming evidence of high default rates on zero down payment purchases, Wells Fargo (WFC) this week announced a major nationwide down payment assistance program (DAP) to be used for down payment and/or closing costs on FHA, VA and conforming loans.  Incredibly, the program is being advertised as a means of helping low to moderate income applicants achieve the “American dream” of home ownership.

Based on the historical evidence, Wells Fargo is sowing the seeds for the next major crop of foreclosures.  Incredibly, this is being done even as the current foreclosure crisis grows in intensity.  Approving mortgages that immediately put new homeowners at a high risk of default is financial lunacy and a  disservice not only to the homeowner but to a nation already in financial chaos due to defaulting homeowners.

Down Payment Assistance Programs (DAPs)

Help More Low- and Moderate-Income Borrowers Achieve Home Ownership.

Refer your low- to moderate-income applicants to local housing agency contacts and help them achieve home ownership by using one of these Downpayment Assistance Programs (DAPs) approved for use with a Wells Fargo Wholesale Lending first mortgage. DAPs provide financial assistance for qualified borrowers and, depending on the program, may be used for debt reduction, down payment and/or closing costs on FHA, VA and Conforming Conventional loans.

Disclosures: None

Profile Of A “Making Home Affordable” Homeowner – Everyone Should Do It

Overburdened  Homeowner Subsidized

Home Sweet Home?

Home Sweet Home?

Loan modification programs have been seen as the answer to preventing foreclosures and allowing the housing market to stabilize.  The programs have become progressively more aggressive as foreclosures continue to mount and housing prices continue to slide.  The current government program, Making Home Affordable, has a dual approach whereby a homeowner not eligible for refinancing (at loan to values up to 125%) can then attempt to have the mortgage modified to lower payments.  Eligibility requirements are quite simple – if the borrower has suffered a hardship (such as reduced income), is having trouble making the payment or simply bought more house than he could afford during the exuberance of the housing mania, relief in the form of lower payments may be available.

Here’s an actual example of a borrower granted mortgage concessions under the US Government’s Making Home Affordable program.

Home owner purchase the home in 2005 for $153,000 with a stated income mortgage, 100% financing.

Home owner refinanced a year later and received $30,000 cash with a stated income $190,000 mortgage at 7.125%.   The home is now worth about $165,000.

Home owner works at a grocery chain and earns $43,000 with limited prospects for increased income.  Credit card debt amounts to $22,000 with monthly payments of $315.

Home owner’s current housing expense and other debt payments result in front end and back end debt ratios of 46/55.   A back end debt ratio is calculated by dividing borrower’s total mortgage payment, taxes, insurance and all other minimum monthly debt payments divided by gross income.  After debt payments and payroll taxes, home owner is left with about $950 per month to cover all other expenses.  Home owner is 45 years old, has minimal savings and a negative net worth of around $50,000.

Home owner is not eligible for the Making Home Affordable refinance program since the debt ratios would still be too high even with a rate reduction to the current prevailing mid 5% mortgage rate.

Homeowner therefore applies for a mortgage modification.  The basic requirements are that you are having trouble paying your mortgage and your front end debt ratio exceeds 31%.   The front end debt ratio is the monthly mortgage payment, taxes and insurance divided by gross monthly income.  Homeowner is approved for a mortgage modification that lowers the rate to 2% fixed for two years, with an increase to 3% in year three, 4% in year four and then fixed in year five at the prevailing conforming rate.   No principal reduction of the loan was granted.   The initial rate reduction lower the home owners debt ratios to 31/40, a ratio that should allow debt payments to be handled without undue stress.

Comments – Who Won and Who Lost?

If the homeowner decides to sell the home, $30,000 cash would be required at closing due to negative equity, commissions due, etc.  Since the homeowner has no cash, a sale of the home would have to be a short sale, with the mortgage holder (or taxpayer) taking the loss.

The homeowner in this case received a mortgage rate that is unavailable to the best A+ borrower.  In addition, there were no closing costs to receive the 2% rate.  The average homeowner pays thousands in closing costs on a refinance.

The taxpayer winds up paying, one way or the other,  for the cost of the mortgage subsidy.

The subsidized 31% debt ratio puts the loan modification  homeowner in a vastly better off position than millions of other homeowners with much higher housing debt ratios who are unable to get a loan modification or a refinance.

The homeowner cited would never have been a homeowner if not for the 100% financing, no income verification programs that prevailed during the housing/mortgage bubble years.

Not everyone was victimized by the liar loans and sub prime lenders.  The homeowner in this example has nothing to complain about.   Besides the $30,000 cash received on the refinance and a zero investment in the property, the homeowner also has a super low 2% government subsidized mortgage rate .

As property values continue to decline, expect ever more costly, aggressive and futile  government efforts to reflate the burst Humpty/Dumpty housing bubble.