By Ramsey Su
Do not get excited. I do not see a light at the end of the tunnel. We have been in the tunnel for so long that I'm just wondering if we will recognize it when the time comes. More importantly, are policy makers aware that the light they are seeing may just be an oncoming train?
At this moment, I'm of the opinion that practically all real estate related data points are noise. The weekly or monthly fluctuations serve no purpose as indicators of the future. Employment is far more important than existing home sales or the Case-Shiller Index. That said, we still have no choice but to at least try to extract some value from the noise.
We need to define what light at the end of the tunnel will consist of. I think it would be a stable real estate market with a somewhat matching number of willing and able buyers and sellers. The market should be supported by a private sector mortgage system with an active secondary market. Prices should then be driven by the economic principle of supply and demand, without government intervention.
Once so defined, it becomes obvious that we are nowhere near to the end of the downturn. In baseball terms, I think we are close to the 9th inning, trailing 20-0 and the season is about to be over.
What we have today is a market with no buyers, in spite of practically free financing in the 4% range. It is unclear what is needed to get it through Bernanke's thick skull that all his QE efforts had been totally ineffective in stimulating loan demand. We also have no sellers. Those who are fortunate enough to have equity only sell if they have an urgent reason to do so.
Many who want to sell have insufficient equity. Depending on which estimates you use, there are somewhere around 10-15 million homeowners whose mortgages exceed the value of their homes. Furthermore, if a homeowner wants to sell, an additional ~8% may be needed for closing costs, moving the barrier even higher for those who want to sell. Institutions that should be selling their inventory to end users cannot do so for one reason or another, mainly due to fear of investor lawsuits and government regulations.
As regards financing, there are 50 States, each with its own rules and it is getting worse. For example, Nevada, just passed some new disclosure requirement.
Some of the Eastern States now have mandatory arbitration. Lenders are supposed to be making loans? A loan in a judicial foreclosure State with rights to deficiency judgment is an entirely different product than a loan in a non-judicial State with no deficiency judgment, unless it is a junior lien or a refinance or a multiple of special circumstances. Then again, what good is deficiency judgment if the state changes the law midstream? The lender cannot even foreclose, not to mention collect on a judgment. How can lenders like BofA or Chase offer a loan that they are willing to carry on their books?
We need a nationwide conforming loan more than ever. We need the Fed, Congress and the White House to step up and standardize lending for the country. There is still no light at the end of that particular tunnel.
What else may be considered good news? Rising employment. Forget about everything else. As conditions continue to deteriorate, there is no chance that housing can lead us out of recession. Once we see employment pick up, then it will be time to look at all the details, such as where the new jobs are. Builders are holding land – and that land cannot be moved. They are all hoping that if jobs ever come back, it will be happening where they have land. Otherwise all they are holding are tumbleweed farms.
What would be the best indicator that things are changing for the better? A rising number of transactions would undoubtedly be the brightest light.
The real estate market can only return to health if buyers and sellers are active again. This would be especially true if the number of REO and short sales were to increase dramatically. Properties would be moving from weak hands to strong hands, building a solid foundation. Unfortunately, I see no light coming from that source either thus far, just never ending darkness.
I am at the Northern Cascades, the tail end of my tour de Cascades. Two weeks of fresh mountain air have done me a lot of good. Unfortunately, thinking things over only confirmed how overly optimistic I have been about housing. When I return home in about a week, it will be time to seriously look at the builders to see which ones might soon go out of business.
(By Pater Tenebrarum):
In the context of Ramsey's continued negative assessment of the residential real estate situation in the US, we decided to take a long overdue look at the recent prices of Markit's structured finance indexes of residential (ABX.HE) and commercial (CMBX) real estate loan pools. Most of the loan originations that form the pools these indexes are based on took place in the crucial years 2006 and 2007, close to or shortly after the top of the residential real estate bubble.
What is remarkable is that in both types of real estate the indexes on the highest rated mortgage pools (i.e., the AAA rated ones) have recently taken the biggest beating. The moves in the lowest rated ones are hardly worth remarking on, since they take place in a tight band close to their lows, but we have included some of those for comparison purposes.
One thing that is immediately clear is that these prices correlate fairly closely with the share prices of major US banks.
First a selection of residential real estate indexes (ABX.HE) in descending order of the underlying ratings (the details such as the components underlying each index and additional charts can be found at markit):
(Click charts to expand)
ABX.HE PENAAA.06-2 – a new low for the move.
ABX.HE AAA.06-1 – same story.
ABX.HE.AA.07-1, an 'Alt A' type index of mortgage pools, moving in a tight range between 5.5 and 6.75 cents on the dollar. Note that all these indexes once traded at par or higher!
ABX.HE.BBB.07-2 – the lowest rated (subprime) type of structured finance index. A few cents on the dollar, which occasionally invites speculative bids or short covering. Yes, these also traded at par once.
Next a selection of AAA and BBB rated CMBX indexes (the underlying collateral consists of commercial real estate loans, the details and more charts can be found here).
CMBX.NA.AAA.4 – a steady downtrend.
CMBX.NA.AAA.5 – also in a steady downtrend.
CMBX.NA.BBB-.3 – subprime commercial real estate loans are also close to worthlessness.
CMBX.NA.BBB-.4 – same story.
In short, the markets seem to agree with Ramsey – there is no light at the end of the tunnel yet.
In the context of the above mentioned deficiency judgments, here is a recent article in the WSJ that may be of interest to our readers: "House is Gone, but the Debt Lives On." Both banks and investors in mortgage backed securities are suing homeowners after foreclosure sales have concluded for the difference owed in the states where this is possible – usually with success. One state where it is possible to obtain deficiency judgments is Florida, one of the places where the real estate and mortgage lending bubble were most pronounced. Since right now the whole exercise is a bit like trying to 'squeeze blood from a stone,' collection efforts are limited. Alas, most deficiency judgments allow lenders to try for up to 20 years to collect the debts, which tend to grow at about 8% annualized. Such judgments trade at values as low as 2 cents on the dollar due to the current distressed financial state of the targets, but obviously the bet is that they will at some point get back on their feet. Sending 'jingle mail' is obviously a more difficult decision in states where deficiency judgments are possible.
Charts by: MarkIt