Is 'Foreclosure-Gate' Masking the Impending 'Strategic Selling' Firestorm?

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 |  Includes: QLD, SSO, UVT
by: Michael James McDonald

Summary

One region’s 11% home price decline for the quarter may signal the beginning of the “walk away” housing collapse leading to another financial crisis. The market can ignore it for awhile, but if it starts in earnest, the market will decline.

The Walk Away Factor

In the article “Is the Housing 'Walk Away' Crisis About to Start?” we wrote:

Since the lapse of the tax credit in June, home prices have generally fallen. We think we are at the critical hour and this must be watched very carefully. I'm sure many underwater homeowners were holding back, hoping that prices would rise and things would get better. If prices reverse and dash those hopes, it could be the deciding factor that triggers many to walk. As prices decline, more negative equity is created, so more walk and the negative feedback process has begun.

We have been watching it “very carefully.” In the Coachella Valley and Palm Springs Area - the region I follow very carefully –– the numbers are just in. They are the three month (quarterly) price changes in home values since losing the tax credit in June. The numbers are foreboding. They show a three month price decline on average of 11% based on 2,000 data points. Anyone with minus 20% home equity in June is now minus 31%.

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I know this small region may not indicate what is happening in broader areas but it is interconnected to a lot of other regions including Los Angeles, Orange County and San Diego. Fifty percent of the buyers come from outside Palm Springs, over 10% from outside the country. We think it acts as a proxy for most of the major distressed cities and states in the country.

Stratgeic Default Forecloures Depend on Price Outcomes

Strategic defaults are the only cause of foreclosures that depend on what happens price wise – if prices decline you get more foreclosures, if they go up, they stop. If “foreclosuregate” has any benefit it’s that it stops more homes coming to market and more price declines for awhile.

Another fact is also helpful; few homeowners know about the price decline. Many might never know. It’s not like they get a statement every months like with stocks. Sometimes "not knowing" is a good thing when it comes to “strategic defaults.”

By the way I hate the word “strategic default” –it’s far too pompous. “Walk Away” is much better. That’s because it better describes what really happens, which goes about like this: Joe: “Honey, I just talked to Bill and he says our homes all lost another 10% last quarter; instead of 20% underwater we’re now 30%. Let’s get out of here.” Harriett: “OK, where should we go?”

Feedback Threat

People often think lower prices bring in buyers. Not here. There are fewer and fewer buyers as more go negative equity. Eventually, sellers simply overwhelm the small, declining pool of buyers. A positive feedback can build on itself and can seem to be able to drive prices to zero (it can’t).

Expansion Means Another Stock Price Decline

With the Obama Administration completely compromised and parties fighting for position instead of for the country, this could easily lead to financial crisis II. The market can ignore this for awhile. At some point if it expands, however, the market won’t be able to and will decline very severely.

Disclosure: Author is long SSO, QLD, UVT and long term SLV call options