(This guest post originally appeared at the author’s blog)
One market segment that will not catch fire from anything being done is the mid-to-high end (MTH). This is where the next crisis is building right now. Only significant house price depreciation and sustained low rates can spur sustained sales in this market segment.
Many are counting in large part on the MTH homeowner carrying the housing market, consumer spending, and the broader economy straight into a full-blown economic recovery.
That is a lofty premise if they are talking about the same MTH borrower with whom I worked for years as a West Coast mortgage banker; who are my neighbours, friends, and family, as an MTH CA resident; and whose loan performance I track daily across all originators and servicers through our proprietary data.
Contrary to a growing recent popular opinion that the MTH homeowner is feeling great, it remains my strong opinion that the negative wealth-effect across the MTH homeowners remains powerful, increasing especially over the past few months as end-of-season price dumping and increased short sale activity continued to push prices lower.
The reason why the MTH has not tumbled in the same fashion as the lower price bands is simply because this group of Jumbo Prime, Pay Option and Interest Only borrowers have a) much more leverage-in-finance with loans such as the Pay Option ARM making up a large percentage of the total b) loans that were structured with interest only or neg-am teasers that typically last a minimum of 5-years vs 2-years on a Subprime loan c) more options available to them such as cashing in retirement to keep kicking the can d) more stable employment e) a better chance of qualifying for a mortgage mod.
Bottom Line – the MTH is a slower moving train wreck, which in the macro may be worse than the way Subprime imploded. Subprime borrowers who got wiped out a couple of years after getting their 2/28 are way down the de-levering road — renting a property and living within their means, which is when spending can begin again if they chose. At the end of the day, defaults and foreclosures across the MTH will be in the double digits with a respectable number in front, but stretched out over a longer period of time pressuring this housing and borrower segment for the duration.
The Mid-to-high end collapse will keep its borrowers financially strung out for years, as conscientious home owners sell other assets or cash in retirement to keep making payments while others opt for a pro-bank mortgage mod in which most of their disposable income each month goes to repay their massively underwater monument to stupidity. Some that simply bought at the wrong time with larger down payments, perhaps most of their savings — and who have seen all of their equity evaporate — will opt to earn their way out of it, which is a long process during which spending is restrained. Still, many will choose the route of default and foreclosure because with negative-equity so extreme in the MTH, they are renters anyway, unable to refi, sell or re-buy, and foreclosure is the fastest road to household balance sheet recovery.
Price Dumping & Short Sales Destroy Values Just Like Foreclosures
Make no doubt about it…peak-to-trough the MTH has been devastated in the past year. Millions who purchased, refied, or took out HELOCs on the way up, at the top, or moving back down the other side are in such a serious negative-equity state there is no traditional way out.
The hot period for MTH Real Estate was 2003-2007. During this time 75%-80% of all houses either a) changed hands b) were refinanced (including cash-out, which increasing the loan balance c) were built and purchased for the first time d) or leveraged further through the addition of a second or third mortgage. Yes, the potential at-risk population is the vast majority of MTH owners.
Later in the 2009 season we finally saw more MTH houses turn-over but at sharp discounts or on short sale. Unlike the low end of the market the increased activity was not spurred by a surge in buyer demand, rather due to end-of-season seller panic and increased short sale activity. That being said, there is pent-up demand for this sector at the right price. The problem is that the right price on one sale destroys the net-worth of scores more. This type of increased activity in the earlier innings of the MTH collapse is not a positive market factor because it sets comps and locks-in values for everybody.
Bottom Line – price dumping and short sales destroy neighborhoods just like foreclosures. In fact, they are a leading indicator to house price deflation, defaults and foreclosures. Remember, for every person who gets a ‘great deal’, scores more are thrown into a negative-equity or greater negative equity position exponentially increasing their likelihood of loan default. This sector is a negative-equity time-bomb across all loan types, even 30-year fixed.
A $1 Million House is now the House of a Millionaire
A $1 million house is now the home of a millionaire…someone who can put down $270k and show proof of over $200k per year income for the past few years. Oh, and a 740 credit score is paramount. Unlike the bubble years when a $1 million house could be purchased by a moderate income household — one working as a checker at Safeway and one a mailman (both great jobs with a combined gross income of over $100k) — now the buyers must be rich.
There are far more MTH houses on the MLS — and coming at the market in the foreclosure pipeline — than there are rich buyers who a) do not already own b) who are liquid enough to be able to buy a new house and rent their present house c) or that are in the enviable equity position to be able to sell, pay a Realtor and put a large down payment on their new house.
Mid-to-High End Reminiscent of 2007 Broad Market Conditions
In the mid-to-upper end price bands, the same market dynamics are in play right now as were in the broader housing market in 2007. This market segment has absolutely gone over the top of the mountain and has begun its steep descent down the other side. In fact, there are more Notice-of-Defaults each on Jumbo loans each month in CA then houses sold in the Jumbo price range. The house price compression over the next year or two will be so severe it will undermine any stability found in the low-to-low mid bands especially if stimuli are removed.
In the MTH the foreclosure pipeline has never been as full. But just like with the lower end, the foreclosures have been held back as banks try to retrofit every borrower with a mortgage mod. To date, most MTH foreclosures have only been from a) vacant houses b) those that absolutely do not qualify for a mod c) those that turn down a mod realising they are better off walking away or in foreclosure. This is changing fast.
The Bottom Line is that MTH foreclosures and foreclosure starts have been held down artificially, no doubt. This is because of the national foreclosure prevention programs but also because more Jumbo whole loans are owned by financial insti’s as portfolio loans. This allows the bank the flexibility to do what they want unlike Agency or Subprime loans for example serviced for others, such as an MBS investor. They always fight harder when it’s their own money on the line — think of Jumbo sort of in the same fashion as commercial but to a lesser extent with respect to tampering by the lien holders.
The negative-equity across the MTH is extreme and high-LTV HELOCs are also common with this crowd. In fact, HELOCs behind Jumbo loans attached to MTH properties can be $250k – $1 million, which is even greater motivation for the banks to kick the can as far down the road as possible.
Because of incurable negative-equity, tumbling rents, and overall harsh reality that they have become a renter in a 5000 square foot house, premeditated defaults are a favourite among mid-to-high end homeowners. For those in a serious negative equity position, a pre-mediated loan default, short sale or deed-in-lieu is usually much better than any alternative because a) they can rent the same house down the street for much less than the cost to own b) leaving the house begins the savings, de-leveraging and credit repair clock c) earning their way out of a $500k negative equity hole is simply out of the question for most.
Mid-to-High End Isolated – HOGWASH
Extreme Leverage in this Sector
Most think the MTH homeowner is somehow isolated from the broader housing market collapse – hogwash. They are more impacted because unlike the low-end hand-to-mouthers, these borrowers may have assets to attach or protect and perhaps something called a budget. Right now in cities across America there are married, working couples in MTH houses sitting around the dinner table saying “honey, we make $150k a year. Why can’t we save any money? Where does it all go each month?”
Jumbo Prime, Pay Options, Interest Only etc loans routinely allowed up to a 50% debt-to-income ratio, even on a 30-year fixed. When purchasing a house or pulling cash out through a refi or HELOC, most borrowed what their banker told them they could qualify for, therefore, a large percentage of mid–to-high end owners with a mortgage are highly levered coming out of the gate. Of the 50% DTI, most goes to the mortgage, taxes, insurance and maintenance. And of course, about half got a HELOC after the purchase taking the DTI to 60%. That does not leave a lot for taxes, food, insurance and every other expense not listed on their credit report let alone robust consumer spending.
But in reality the majority of MTH homeowners purchased or refied with a stated income or no doc feature making it impossible to know the true extent of the leverage across the sector. One thing is for sure…it is higher than if it were full-doc or there would have been no reason so many used limited doc loans.
To think the MTH earner will somehow pull through this unscathed, lead high end retail sales this holiday season, etc is verging on laughable. Yes, stocks pulling off the bottom have likely benefited sentiment. But not to the degree that house prices plunging, their HELOC being shut down from further draws and credit card limits being slashed have hurt it. You can’t easily spend and IRA or 401k at the Good Guys for a home theatre system.
Just like most everyone else, a large percentage of MTH homeowners live virtually paycheck to paycheck — they just had more stuff and more debt. Without easy and available credit, this group of homeowners and spenders by and large is as hamstrung as the rest.
What happens to the economy when you knee-cap the MTH earner the same way the low-to-low mid was knee-capped in 2007 when housing first fell off of a cliff? Stay tuned.