Job creation is the key to economic recovery, FHA loan exposures are becoming problematic, the Strategic Default becomes an American Craze, and Wells Fargo (NYSE:WFC) plays “kick the can”.
Friday morning’s payroll report shows a continued problem with job creation.
Nonfarm Payrolls declined 190,000 with the unemployment rate reaching an historic 10.2%. Most important is that hours worked stayed anemic at just 33.0 hours. The underemployment rate is 17.5%.
Former Fed Chief Alan Greenspan has opined that it would take several months of 100,000 plus job growth before the unemployment rate starts to decline.
Initial Jobless Claims came in at 512,000 last week, which was well above the 350,000 threshold that correlates to a Recession. Congress has extended jobless benefits by another twenty weeks, which should keep jobless claims well above 350,000 for an extended period.
Productivity levels are extremely high because lower business activities are being accomplished by much fewer workers.
FHA Mortgage Exposures Balloon to problematic levels
Even though the Federal Housing Authority (FHA) has tightened credit standards, many mortgages issued in 2007 and 2008 are turning sour. Defaults on loans guaranteed in 2007 are at 24%, loans in the first half of 2008 about 20% sour. At fault is Congress, who encouraged the FHA to save as many homeowners as possible by refinancing loans that should not have been issued in the first place.
Later this month the FHA will disclose that their level of reserves has fallen below the federally mandated level for the first time in its 75-year history. The FHA doesn't make loans but insures lenders against losses if a borrower defaults on mortgages where the borrower has made a down payment of as little as 3.5%. This guarantee includes half of all home-purchase loans made in the country’s hardest-hit housing markets. This policy has added to the potential burden on taxpayers if home-price declines resume.
In addition, delinquencies on refinance loans have been rising faster than those on new loans for the past three years. It seems like the FHA is attempting to restart a housing bubble by taking on riskier loans beginning in 2007 by guaranteeing loans of borrowers with credit scores of less than 600. Sources say that these types of loans were increased by the FHA to 37% in 2007, up from 30% in 2006.
More Americans are walking away from their homes
The trend is known as Strategic Default, where the homeowner loses their job and stops making mortgage payments because they owe more than the home is worth. Such a strategy destroys one’s credit score, but many can stay in the home until the bank comes knocking at the door. Sources say that there were 588,000 Strategic Defaults in 2008, double the total of 2007. This trend should unfortunately continue as the jobless rate moves higher despite a modest bounce in home prices in recent months.
Strategic Defaults will increase foreclosures and short-circuit the fragile housing recovery, increasing bad loans at banks leading to more writedowns and bank failures. The uncertainty of one’s future makes it an easy choice to suspend mortgage payments when a job is lost. Why dip into savings when the asset you own is worth less than you paid for it. Extreme weak reading of Consumer Confidence indicates that this trend could continue for another one to three years.
If banks were able to be more proactive with mortgage holders and offer modifications including reduced loan principal and perhaps a zero percent mortgage during the time a homeowner is unemployed, the strategic default becomes a mute option. But we know banks are under performance pressures of their own as other types of consumer and real estate loans go sour. It’s a vicious cycle that signals that “The Great Credit Crunch” is nowhere near its end.
The Obama Making Homes Affordable program is no help if unpaid mortgages are more than 125% of the home’s market value. Values are being adversely affected by foreclosures and short sales, which pull down appraised values.
Wells Fargo bets House Prices will rise
Wells Fargo holds $107 billion in Alt-A option-adjustable rate mortgages, a loan that allowed borrowers to make smaller monthly payments up front in return for increasing their mortgage balance three to five years from the start of the loan.
To avoid defaults and foreclosures, Wells has decided to off-set increased monthly payments by offering effected homeowners interest-only loans to defer amortization of loans for six to ten years. The bank is betting that home prices will stabilize, and that the economy will improve enough for this bet to pay-off. Only a bank “too big to fail” has a balance sheet big enough to make such a bold move.
Disclosure: I Hold No Positions in the Stocks I Cover.