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Spokesmen for the Obama Administration and the Wall Street
establishment refer to the slight up tic in lower-priced housing prices and
existing home sales as a positive sign that we're close to a bottom. Why is
it, then, that housing prices in the mid to high-end range are still
crashing? Indeed, if you close your eyes and listen to the happy talk, you
could be swayed into believing that the massive credit losses from housing
are coming to an end and economic recovery is finally here. But before
singing the chorus to "happy days are here again", you'll need to
open your eyes and take a look at some facts and their relationship to
mortgage defaults.
The first wave of the mortgage credit tsunami (which actually
began around 2005 when loan underwriting started to unravel) was caused by
hundreds of billions of sub-prime mortgages that defaulted. These loans were
made to unqualified borrowers who couldn't really afford the monthly
payments, even if they had a job at the time the loan was made. Because there
was so little warning of the approaching tsunami, it took a few more years
for the storm to develop but when it did, it bankrupted Bear Stearns and
Lehman Brothers and caused the nationalization of Fannie Mae, Freddie Mac, GM
and Chrysler. Moreover, the fall in housing prices and the end of consumer
refinancing kicked the legs out from under consumer spending, fueling
unemployment and a now grim job market. Unfortunately for all, the sub-prime
disaster was not the end of the credit crisis in home mortgages, but just the
first wave.
The next tidal wave of losses on home mortgages is testament to
a failed housing experiment designed by the Federal Reserve under the false
pretense of home ownership. In past years, mortgages were issued to
responsible homeowners who took pride in home ownership and paid their
mortgage on time. But when so many risky mortgage products, such as option
ARMS, interest-only loans, cash out REFI's, no money down, etc., became
available to practically anyone looking to buy a house, regardless of income,
these products became the rage (a 20 percent down payment to bind an owner to
a property was so yesterday) and home equity literally vanished.
The assumption that people will continue paying a mortgage
without an equity stake in a property worth less than they paid was a false
hope. Mortgage losses from sub-prime loans have now spread to Alt-A, Option
ARM, and standard prime mortgages. Practically every town, city, and state
has been affected in some way by the 16 million homeowners living in homes
with negative equity (a home worth less than the mortgage). Buyers of
property who experimented and gambled with other people's money have been
caught up in an American Dream that has now become their worst nightmare.
Analysts at Deutsch Bank have forecasted that the 30 percent of
underwater mortgages today could rise to 48 percent by 2011, so you won't
have to look too far to see what will happen to foreclosures and mortgage
losses when the number rises to 20 million people. A study done on $1.7
trillion mortgages by Fitch Ratings lays out the cold facts in black and
white on how people treat their mortgages:
From 2000 through 2006 when homeowners actually had
equity in their homes, and prices were rising, mortgages were paid on time. In
this time frame, the mortgage "cure rate" was 19.4 percent on
sub-prime loans, 30.2 percent on Alt-A loans, and 45 percent on standard
prime loans.
In 2009, when housing prices had crashed and home
mortgages were under water, the "cure rate" for prime loans is a
pathetic 6.6 percent (barely above the "cure rates of sub-prime at 5.3
percent, and Alt-A at 4.3 percent). No wonder over 50 percent of foreclosures
are now on prime mortgages!
The plan by Fannie Mae & and Freddie Mac to refinance loans
up to 125 percent LTV is a failure. Very few underwater homeowners are
falling for the loan modification government scheme. Even the FHA, which is
now making 25 percent or more of all new home loans and will take as little
as 3.5 percent as a down payment, has seen late and foreclosed loans jump
from about 5 percent last year, to 8 percent today. FHA borrowers generally
have lower credit scores, wages, and job skills. Since initial unemployment
claims are still averaging 550,000 a week, many of these FHA borrowers will
lose their jobs, causing an FHA loan default rate of well over 10 percent.
In today's world, homeowners motivated by cold hard economics
and common sense are not stupid. When you don't have any real equity in your
house or are underwater and out of work, it's time to mail the house keys
back to the government or the bank! Foreclosures are picking up not only
because mortgage holders are walking away, but when many people stop paying
their mortgage, they also stop paying their property taxes. Local governments
everywhere are strapped for cash and are willing to quickly sell tax liens on
properties with delinquent taxes due. The buyer of a tax lien has rights to
the property that come before that of the mortgage holder so if the mortgage
holder doesn't pay the tax lien, they could be wiped out when the holder of
the tax lien files to get clear title of the property.
So how big is the next wave in the housing mortgage disaster? Currently,
one out of eight mortgages is in foreclosure or paying late, and with
unemployment averaging over 9 percent for 2009 and 2010 and peaking in 2011,
it's likely one in five mortgages could ultimately default. Moreover, we have
seen that less than 7 percent of those mortgages that are late will get cured
and stay out of foreclosure. Over the last six months, notices of home
foreclosures have been running about 350,000 a month, which is over 4 million a year. A lot of homes are headed to the auction block with
their mortgages headed for the shredder.
For
mortgage losses we should recognize that prime mortgages on average are
significantly larger than sub-prime, and it only stands to reason that the
larger the house and mortgage, the bigger the loss. With over 50 percent of
mortgages failing coming from prime loans, bigger loan losses lie ahead. The
total losses to come is anyone's guess, but the $11 trillion in outstanding
home mortgages could easily produce over $2 trillion in defaulted mortgages,
and another $600 billion of credit losses! So, until this wave has crashed on
the shore, I would recommend staying away from the water!
Richard Benson
SfGroup.org
Richard Benson is the
founder of The Specialty Finance Group ("SFG") was founded in 1989
as a financial broker to private finance companies, introducing them to major
financial institutions that would provide them with equity, subordinated
debt, and senior credit facilities using the Capital Market.
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