By Ilargi on The Automatic Earth.
I’d like to start off the year with another piece on the US housing situation as it looks to be heading into 2011, and its relation to the overall economy. In an interesting quote I read, economist Patrick Newport at IHS Global Insight says: “The economy has to recover for the housing market to recover, not the other way around.” Thought I’d throw that in there, because it seems to get lost in translation from time to time.
Talking of quotes, I was going through the material I read the past few days, and I couldn’t find a proper way to cut short the quotes and still provide you with the story as I see it, in a way that would be both comprehensive and clarifying. In other words, I think it’s the quotes that tell the story, and without them the story is just not there. So this is going to be a long one, and I think the least I can do is to say as little as possible, and just let you absorb the data. And I sincerely hope that after you’ve gone through them, you’ll see the story I’m talking about.
Many people claim Stoneleigh and I must be crazy, and doomers and all that, for predicting an 80%+ drop in real estate values, but we in turn can’t seem to understand why home prices would fall “only” 20% from here, or why they would fall “just” 40%, as Mish suggested for instance. We think that more than 20% is in the cards just because of the bubble coming back to earth; we think 40% is certain because of the bubble bursting, and we think 80%+ will then happen because the bursting bubble will take the entire financial system down with it. Pretty simple really.
But enough about us. Let’s hear some witnesses:
First off, L. Randall Wray, a Professor of Economics at the University of Missouri-Kansas City, who’s co-operated quite a bit with Bill Black over the past year, throws more oil on the fire of foreclosure fraud, albeit from his own particular angle. Wray’s claim is that Mortgage-Backed Securities are not backed by anything, since the MERS electronic securitization facility carried from its inception a number of plainly illegal concepts. Therefore, he says, most if not all US foreclosures are illegal, and all MBS are unsecured debt that the issuers will have to buy back – to the tune of trillions of dollars. Which entirely dooms the main US banks.
According to L. Randall Wray, lenders may have the right to collect debt on certain loans, if they can prove ownership of the loan, but they can’t foreclose unless and until they have a clear record (chain) of all transactions the loans went through, through their entire existence. And MERS effectively killed that chain.
Caveat: I am not a US lawyer, and neither is Wray. But I have no reason to doubt that he understands his field, if not the fine details. My take-away is that there is much more to come over the next year in legal challenges and political wrangling. Illegal is illegal, no matter how much power Wall Street has in Washington; laws would have to be changed in order to prevent the chain of events Wray talks about from unfolding.
Please read him with care:
I have argued that MERS, a creation of the mortgage banking industry, has effectively destroyed the institution of private property in America. Ironically, MERS was created to facilitate quick and easy and cheap securitization of mortgages — what are called mortgage-backed securities. In fact, what it did was to eliminate any backing of the securities by mortgages. Of the total securitized asset universe, something like $7 trillion are (supposedly) backed by residential mortgages.
However, MERS helped to delink the securities from the mortgages. At best, they are unsecured debt — there is no property backing the securities. What this means is that foreclosure is not permitted. As I have said before, it is likely that most or even all foreclosures occurring in the US are illegal seizures of property — home thefts. We are talking about 100,000 completed home thefts per month, with another 250,000 new foreclosures started to steal homes every month. Projections are that 13 million homes will have been “foreclosed” (read: stolen) by 2012.
Worse, from the perspective of the banks, they’ve got to take back all the fraudulent MBSs, most of which are toxic.[..]
1. A valid “mortgage” requires a (“wet signature”) note and a security instrument; these must be kept together, and any subsequent transfer of lien rights to the security instrument must be recorded at the appropriate public office. The mortgage note must be properly indorsed each time the mortgage is transferred. In the era of securitized mortgages this can be a dozen times or more. If ever presented for foreclosure, endorsements should demonstrate a clear chain of title, from origination through to foreclosure; and this should match the records at the public office.
2. MERS intended to provide an electronic registry of all mortgages. By appointing a “vice president” in every financial firm, it believed that all transfers of lien rights among these firms were “in house”. Hence it operated on the belief that no subsequent public recording was necessary, and no further endorsement of the mortgage note was necessary for in-house transfers of the payment intangible as it kept a record of transfers of the mortgage. It claimed to be a nominee of these firms (purported to hold the mortgage) but also to be the holder of the mortgages including the “Unidentified Indorsees In Blank” — mortgages that were never properly endorsed over to purchasers.
We know, however, that MERS recommended that mortgage servicers retain notes, so MERS’s claim to be the holder rests on its claim that appointed VPs are employees. But these employees are not an agent/employee of the “Unidentified Indorsee In Blank”, nor are they paid by MERS or in any way supervised by MERS.
3. This practice is in violation of numerous laws. Property law requires filing sales in the public record. Notes must be affixed (permanently) to the security instrument — a mortgage without the note has been ruled a “nullity” by the Supreme Court. MERS’s recommended business practice (with the servicer retaining the note) would make the mortgages a “nullity”. A complete chain of title is required to foreclose on property — every sale of a mortgage must be endorsed over to the purchaser, and properly recorded. Without this, it is illegal to foreclose on property — no matter how many payments the homeowner has missed.
4. However, if the notes can be found and if MERS can provide records, it is possible that the mortgages can be made valid (“proved up”) for purposes of collecting upon the indebtedness, but foreclosure would not be possible without a valid continuous perfected mortgage showing a chain of title from origination through to the current party trying to enforce the mortgage note. Any break in the chain of endorsements along with any break in the chain of title renders the Power of Sale clause in the security instrument to be a nullity and therefore no party can foreclose on the real property.
5. If the notes cannot be found and a Lost Note Affidavit can not reestablish the indebtedness, then foreclosure is not possible and collecting of the indebtedness is also not possible. Homeowners still can be sued for collection of owed moneys upon a “proved up” note or lost note affidavit but a current perfected lien is required to foreclose.
6. However since the mortgage-backed securities are governed by PSAs (pooling and service agreements), the practices above make the securities unsecured debt and there is no solution. The securities are no good. (This would be a Representation & Warrant violation as the MBSs stated that a secured indebtedness was to be purchased, but since the Trustees of the securitization would not have the notes, the securities cannot be “secured”.)
What does all this mean? In plain simple language, the banks are royally screwed. They cannot foreclose on the properties. Holders of the “mortgage-backed” securities can turn them back to the banks because they are actually unsecured debt. In previous pieces I have also explained why MERS’s recommended practice also violates US tax code — so back taxes are owed. And we know that the mortgages stuffed into the securities did not meet the “reps” of the PSAs.
So, in short, banks have got to take the whole lot of toxic waste securities back. Trillions of dollars worth. The banks are toast. There is no cooking of the books that will turn this blackened toast back to bread.
Ilargi: Next, Ron Robins at Investing for the Soul argues that credit in the US is vanishing. This is a point that continues to be a hard one for most people. Why would credit disappear? After all, it’s been there all their lives. The reality, however, is that the credit system we’ve known until here has already gone. What’s left is the Treasury and the Federal Reserve lending you your own money, for which you’ll be charged twice: first, through Wall Street, which gets your money at 0.0078% and lends it back to you at some 5% for mortgages and 29-odd% for credit cards, and second, when the government pays back the Federal Reserve for “offering” you your own money this way, with interest.
Can’t win this game, no matter what:
If US consumers believe it difficult to borrow now, just wait! In the next few years credit conditions are likely to go back 70 years when private debt was difficult to obtain. Most Americans intuitively believe there is too much debt at every level of society. But the economic and political vested interests do not want them worried about that. They want to give them credit to infinity to keep this economic mess from imploding. The US Federal Reserve’s new round of quantitative easing (QE2) is clear evidence of that. However, Americans are right about their inordinate debt load, and future economic conditions are likely to create a severe debt scarcity.
The principal reasons for the coming debt scarcity are that ‘debt saturation’—where total income cannot support total debt—has arrived, say some analysts; also, the growing understanding that adding new debt may not increase GDP—it could decrease it; and that the banks and financial system are a train wreck in waiting, eventually being forced to mark their assets to market, thus creating for them massive asset write-downs and strangling their lending ability.
On the subject of consumption, the renowned economist David Rosenberg in The Globe & Mail on August 16 stated that “U.S. household debt-income ratio peaked in the first quarter of 2008 at 136 per cent. The ratio currently sits at 126 per cent, but the pre-2001 norm was 70 per cent. To get down to this normalized ratio again, debt would have to be reduced by about $6-trillion. So far, nearly $600-billion of bad household debt has been destroyed.” This data reaffirms Americans growing aversion to debt, that debt has become too onerous, and is suggestive of debt saturation.
Replacing declining consumer debt is the exponential growth of US government debt. For 2009 and 2010, the combined US government’s fiscal deficits required or require borrowing an extra $2.7 trillion or so. Yet with all that spending—combined with about $2 trillion of ‘money printing’ from the US Federal Reserve (the Fed)—it created only around $1 trillion in increased economic growth! [..]
A further, major reason for the coming debt scarcity will be the tremendously impaired financial condition of the banks. The values assigned to many bank assets are fictional according to numerous experts. QE2 is about many things but one of them is aimed at delaying the potential for implosion of the banking system. In 2009, the Financial Accounting Standards Board (FASB) caved in to government and banking industry lobbyists to allow many bank assets to be ‘marked to fantasy’ and not ‘marked to market.’
This viewpoint is best expressed by highly respected Associate Professor William Black (and formerly a senior regulator who nailed the banks during the savings and loan debacle) and Professor L. Randall Wray, who wrote an article on October 22 in The Huffington Post, entitled, “Foreclose on the Foreclosure Fraudsters, Part 1: Put Bank of America in Receivership.”
They wrote that, “FASB’s new rules allowed the banks (and the Fed, which has taken over a trillion dollars in toxic mortgages as wholly inadequate collateral) to refuse to recognise hundreds of billions of dollars of losses. This accounting scam produces enormous fictional ‘income’ and ‘capital’ at the banks.”
Ilargi: Then, Steven Hansen of Econintersect would like to correct a few numbers and ideas emanating from the National Association of Realtors, which managed to see positive trends recently – as it always seems to do -:
The above graph shows the YoY trend lines between December 2008, December 2009, and Econintersect’s projected 326,000 existing home sales for December. Using this methodology, last month Econintersect had projected November existing home sales at 360,000 – and the actual November existing home sales were 353,000.
In December 2009, existing home sales were 413,000 – and this December 2010 projected home sales of 326,000 represents a decline of 21% YoY.
There is no truth that there is an “improvement” or “gradual recovery” of any kind underway in existing home sales. This absence of buyers will only tend to put downward pressure on home prices. The NAR manipulation of the data is based on no more than wishful thinking.
Ilargi: Let’s move on to Amy Lee for the Huffington Post, who links unemployment, housing (through Case/Shiller) and consumer spending. Important, even though, honestly, everyone should have grasped this by now:
“If home prices continue on this pace down, I think the economy has serious reasons to worry,” Yale economist Robert J. Shiller — and co-creator of the Case-Shiller Index — told the Wall Street Journal in a recent interview. Bad news in the housing market could ripple through to consumer spending, which has recently shown heartening gains this holiday season. Consumer spending makes up about 70 per cent of the economy.
“Our concern on the double-dip is the consumer and the fate of the consumer,” said Allen Sinai, chief economist at Decision Economics, Inc. “I think the lack of stable prices is a negative consumer fundamental for spending.” With unemployment mired at 9.8 per cent, the housing market is hinged upon the job market. “The economy has to recover for the housing market to recover, not the other way around,” said Patrick Newport, an economist with IHS Global Insight.
Homes remain a major part of many Americans’ wealth — households held $6.4 trillion of home equity at the end of the third quarter, according to a Federal Reserve report. “It’s unfortunate because a lot of families have all their wealth in their house, all their savings,” said Sinai. “Household spending in general is hurt. There’s a restraint on consumer spending.”
Ilargi: On to the heavy hitters. Peter Schiff writes in the Wall Street Journal that home prices are likely to break through trendlines on the downside, even as these already spell a 20%+ drop in prices. And he does it well. The only thing I don’t agree with is that the drop would halt there. Really, what is there to stop prices from falling further once we get to that point? Can anyone explain? You need to understand what impact a 20%+ drop in home prices would have on the financial system, the banks, and on society as a whole. The amount of underwater homes would soar, the amount of owner equity would plunge. Take it from there.
Most economists concede that a lasting general recovery is unlikely without a recovery in the housing market. A marked increase in defaults and foreclosures from today’s already elevated levels could produce losses that overwhelm banks and trigger another, deeper financial crisis. Study after study has shown that defaults go up when falling prices put mortgage holders “underwater.” As a result, the trajectory of home prices has tremendous economic significance.
Earlier this year market observers breathed easier when national prices stabilised. But the “robo-signing”-induced slowdown in the foreclosure market, the recent upward spike in home mortgage rates, and third quarter 2010 declines in the Standard & Poor’s Case–Shiller home-price index—including very bad October numbers reported this week—have sparked concerns that a “double dip” in home prices is probable. A longer-term view of home price trends should sharply magnify this fear.
Even those economists worried about renewed price dips would be unlikely to believe that the vicious contractions of 2007 and 2008 (where prices fell about 30% nationally in just two years) could return. But they underestimate how distorted the market had become and how little it has since normalized.
By all accounts, the home price boom that began in January 1998, when the previous 1989 peak was finally surpassed, and topped out in June 2006 was extraordinary. The 173% gain in the Case-Shiller 10-City Index (the only monthly data metric that predates the year 2000) in those nine years averaged an eye-popping 19.2% per year. As we know now, those gains had very little to do with market fundamentals, and everything to do with distortionary government policies that set off a national mania for real-estate wealth and a torrent of temporarily easy credit.
If we assume the bubble was artificial, we can instead imagine that home prices should have followed a more traditional path during that time. In stock-market terms, prices should have followed a trend line. When you do these extrapolations (see lower line in the nearby chart), a sobering picture emerges.
In his book “Irrational Exuberance,” Yale economist Robert Shiller (co-creator of the Case-Shiller indices along with economists Karl Case and Allan Weiss), determined that in the 100 years between 1900 and 2000, home prices in the U.S. increased an average 3.35% per year, just a tad above the average rate of inflation. This period includes the Great Depression when home prices sank significantly, but it also includes the frothy postwar years of the 1950s and ’60s, as well as the strong market of the early-to-mid 1980s, and the surge in the late ’90s.
In January 1998 the 10-City Index was at 82.7. If home prices had followed the 3.35% annual 100 year trend line, then the index would have arrived at 126.7 in October 2010. This week, Case-Shiller announced that figure to be 159.0. This would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line.
How has the market found the strength to stop its descent? No one is making the case that fundamentals have improved. Instead, there is widespread agreement that government intervention stopped the free fall. The home buyer’s tax credit, record low interest rates, government mortgage-assistance programs, and the increased presence of Fannie Mae, Freddie Mac and the Federal Housing Administration in the mortgage-buying business have, for now, put something of a floor under house prices. Without these artificial props, prices would have likely continued to fall.
Where would prices go if these props were removed? Given the current conditions in the real-estate market, with bloated inventories, 9.8% unemployment, a dysfunctional mortgage industry and shattered illusions of real-estate riches, does it makes sense that prices should simply fall back to the trend line? I would argue that they should overshoot on the downside.
With a bleak economic prospect stretching far out into the future, I feel that a 10% dip below the 100-year trend line is a reasonable expectation within the next five years, particularly if mortgage rates rise to more typical levels of 6%. That would put the index at 114.02, or prices 28.3% below where we are now. Even a 5% dip would put us at 120.36, or 24.32% below current prices. If rates stay low, price dips may be less severe, but inflation will be higher.
From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices.
In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognise this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with.
Ilargi: Gary Shilling talks about the same trendlines Peter Schiff addresses, and moreover adds the same notion we at The Automatic Earth have been talking about all along (as does Schiff): When prices come off a huge high, they’ll first fall to their trendline, and then fall below it. Any physicist can tell you how it (i.e. oscillation) works, but in economics that is not that easy, apparently. Forever up, for some reason, is taken seriously.
This huge and growing surplus inventory of houses will probably depress prices considerably from here, perhaps another 20% over the next several years. That would bring the total decline from the first quarter 2006 peak to 42%. This may sound like a lot, but it would return single-family house prices, corrected for general inflation and also for the tendency of houses to increase in size over time, back to the flat trend that has held since 1890.
We are strong believers in reversions to the mean, especially when it has held for over a century and through so many huge changes in the economy in those years—two world wars and the 1930s Depression, the leap in government regulation and involvement in the economy, the economic transformation from an agricultural base to manufacturing and then to services, the post- World War II population shift from cities to suburbs, the western and southern transfer of population and economic strength, the movement from renting to homeownership and the accompanying spreading of mortgage financing, etc.
Furthermore, our forecast of another 20% fall in house prices may be conservative. Prices may well end up back on their long- term trendline, but fall below in the meanwhile. Just as they way overshot the trend on the way up, they may do so on the way down, as is often the case in cycles. Furthermore, another big house price decline will spike delinquencies and foreclosures leading to more REO sales by lenders, which will further depress prices. Our analysis indicates that a further 20% drop in prices will push the number of homeowners who are under water from 23% to 40%, resulting in more strategic defaults, more REO, etc.
At that point, the remaining home equity of those with mortgages would be wiped out on average. That, in turn, would impair already-depressed consumer confidence and their willingness and ability to spend, to say nothing of residential construction. In California, epicentre of the housing boom-bust, construction jobs dropped 43% from June 2006 to June of this year, compared to a 28% decline nationwide, and the unemployment rate in the Golden State jumped to 12.3% in June, far above the 9.5% rate nationally.
Ilargi: And finally, foreclosures are going nowhere but up. Suzanne Kapner in Financial Times has this:
US mortgage foreclosures jumped in the third quarter as fewer borrowers qualified for loan modifications that would have reduced their monthly payments, bank regulators have said. The rise in repossessions and decline in loan modifications are further signs that problems in the US housing market are persisting, in spite of forecasts by some analysts of a recovery before the year-end.
The number of homes entering foreclosure rose 31 per cent compared with the second quarter and 3.7 per cent compared with the year-earlier period, the Office of the Comptroller of the Currency and the Office of Thrift Supervision said. These newly foreclosed homes will add to a growing backlog of 1.2m properties already in some stage of repossession, a 4.5 per cent increase over the second quarter and 10 per cent more than the previous year.
As of the end of the third quarter, 187,000 homes completed the foreclosure process, a 14.7 per cent increase over the second quarter and a 57.5 per cent jump from the same period a year ago. As these properties come on the market, they are expected to depress home prices by between 5 per cent and 10 per cent over the next year, economists said.
Ilargi: So what can I say after all that? How about: are there any questions? Is the picture still not clear?
The entire US housing system, lenders, builders, borrowers, the whole thing, is in grave danger, and that means both the financial system and the economy at large are as well. We’re looking at not just one or two, but a whole series of reinforcing feedback loops. Which neither Obama nor Geithner nor Bernanke have any control over, other than fleetingly and temporarily.
And that will be the story of 2011.
Well, that and, of course, the euro crumbling, Japan deflating, China inflating, cities, counties and states defaulting, violent street protests, millions more Americans sinking into abject poverty, misery and hardship, and so on.
Thing is, you can’t have a 60+% homeownership rate, facing more mayhem after home prices already fell 30%, and then expect your society to keep humming along, or even recover. 2010 has been all about delay of execution. In 2011 we’ll get to choose our last supper.
Have a great year, but please do be careful out there. And if you’re thinking of getting a mortgage loan: don’t. Just don’t.