Summary: Without an economic incentive to foreclose, it would not be in the bank shareholders best interests to pursue foreclosure even though borrowers clearly defaulted & owe money to the lender. In this scenario, even Tyler Durden, whose controversial ZeroHedge site I read and contribute to with a passion, is being too optimistic. Yeah, that’s right! You know things are bad when ZeroHedge is too optimistic! I want all to keep this in mind when pondering the release of reserves by the banks. My JPM quarterly review is still on its way, and I will share a substantial amount with the public.
About a week or so ago, I posed a controversial question, Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two! In that missive I warned that the recovery rate on many of the repossessed properties was not only at a historic low, but actually approaching zero, save a few blips from .gov bubble blowing and shenanigans by banks in the form of kicking cans down the road. I also said that the time may very well come when there may be no economic incentive for banks to foreclose on certain properties, and that pool of properties may grow larger than many could imagine. I know it is difficult for many to come to grips with this, but the math really ain’t that hard.
Even Tyler Durden, whose controversial ZeroHedge site I read and contribute to with a passion, is being too optimistic. Yeah, that’s right! You know things are bad when ZeroHedge is too optimistic! In his post “Quantifying The Full Impact Of Foreclosure Gate: Hundreds Of Billions To Start“, he assumes there WILL be something to foreclose upon. I assert that in increasingly more common instances, there will be no economic interest to foreclose upon. It is starting at the fringes and the margin, but it is moving closer to the center faster than many think. And the longer, and deeper “Fraudclosure” investigations continue, the closer and faster to the center it will get. This is, of course, not even considering the fact that all of this investigating and shining the light in dark corners will reveal the true elephant in the room (and it is not hastily signed affidavits that can be quickly fixed) which is that many, if not most, high LTV mortgage originations were fraudulent to begin with. That means that not only would it not be cost effective to foreclose, but everybody and their momma will be scrambling to put the fraudulent loans back to the originating banks – see The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! for my realistic take on the situation and the expenses that it entails. Yes, the elusive recovery rate is going to be pushed that much lower. Long story short, bank expenses will skyrocket, along with efficiency ratios, which were already increasing to begin with at the same time housing sales economic activity and prices will drop and credit losses will spike. Oh, what fun we have in store.
Here is and excerpt from Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two to refresh your collective memories and then I will run through an example that clearly shows a high LTV property in Nevada that the lender literally has no economic incentive to foreclose upon if there is litigation to be had.
As you can see, the charge-offs on 1-4 family residential housing skyrocketed nearly 1,500% (yes, that is a lot) from the bursting of the bubble in ‘06.
Both recoveries have increased and the charge-offs decrease, giving us an increase in recovery rates over the last two quarters. Now, before we get all giddy about the improvement in the credit situation in residential real estate finance and blow out all of our provisions, let’s take a more careful look at the chart. For one, although the recoveries have increased very slightly, it is the drop in the charge-offs that has served to boost the recovery rate. So, that leads us to ask “What has changed so positively in the market to cause such a drop in charge-offs?” Well, for one the Case Shiller Index has shown a rise in prices. Of course, BoomBustBloggers don’t really go for that, because the Case Shiller Index rise fails to capture many of the elements that are causing aggregate housing values sold to fall on an economic basis. See Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading! then reference this chart below.
I will make the analytical model that created this chart available to all paying subscribers in my next post on this topic, which will drill down on why a lagged, highly filtered price model (no matter how sophisticated, and they did do a good job on it) will often mislead you in regards to the true economic direction of assets as such as housing. You must measure sales activity (which has slowed to a level that nearly approximate 1963 levels) as well as sales prices – and those prices have to capture all aspects of housing. The CS index excludes the most distressed categories, which causes it to have an optimistic skew.
So, if it is not the rising prices of indicated by the Case Shiller index that caused the drop in charge-offs, then what was it? Well, I believe it was something much more old fashioned and mundane. It’s called LYING! See Anecdotal Evidence That Banks Are Hiding Depressed High End Real Estate, as excerpted…
Why are Banks Hiding High End Residential Real Estate? Courtesy of the Real Estate Channel:
- Without the FTB tax credit, the housing market is receiving artificial demand and price support from the FHA loan guarantees and banks sitting on mortgages of homes once valued at $300,000
- Banks in areas that were severely damaged by the downturn in domestic real estate (Cook County, Illinois, Miami-Dade County, Florida, Orange County, California) have significant inventories of homes worth more than $300,000 that they will not put on the market, even after foreclosures lasting more than 2 years
If that doesn’t get you going, reference “They ARE trying to kick the bad mortgages down the road, here’s proof!” and “More on kicking that housing can down the road…“.
Now, taking the above into consideration, let’s run through an example of a high LTV single mortgage home purchased in Nevada.
|Sales price||Loan, expenses||Equity|
|$ 250,000||$ 312,500||$ (62,500)||Starts off with negative equity|
|Current retail value||$ 100,000||$ 300,000||$(200,000)||prices drop|
|Distressed value||$ 64,000||$ 300,000||$(236,000)||distress discounts|
|Carrying costs/maintenance@5 m, taxes/utilities@24 m||$ 12,480||$ 312,480||$(248,480)||can’t hold the property for free!|
|foreclosure costs||$ 6,000||$ 318,480||$(254,480)||cost to foreclose|
|Broker costs@6%||$ 3,840||sales costs|
|Recovery to bank if sold withing 4 months and not drawn into litigation||$ 41,680||net recovery in a perfect world|
|Recovery if marketing period=12M||~35000||recovery if sales continue to slow|
|Recovery if litigated (win or lose?)||$ -||If there is a legal battle (there cropping up all over the place), the bank is better off letting it go.|
This example is not far fetched, and can take place in condos in Florida, California and New York where extra costs can drive down recovery, or the humid coastal regions (ex. Florida) where humidity can drive down recovery over time, or cold weather states, or high crime areas (theft, vandalism), etc.
Methinks it is time to start rethinking the dynamics of distressed real estate, foreclosures, REOs, and recoveries for the economics are definitely starting to morph on the margin and that morphing can quickly spread to the more mainstream.
More Reggie Middleton on residential real estate:
- As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves
- The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!
- The Truth Goes Viral, Pt 1: Housing Prices, Economic Sales and the State of Depression
- Pay Attention to the National Association of Realtors and Their Chief Marketing Agent At Your Own Risk!
- Those Who Blindly Follow Housing Prices Without Taking Other Metrics Into Consideration Are Missing the Housing Depression of the New Millennium.
- Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two!
- Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!
- More Doom and Gloom: Homebuilders Making Better Money as Hedge Funds than Home Builders
- Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…
- Even at Marquis Trump Properties, Your Lyin’ Eyes are Belying the Real Estate is Bottoming Mantra
Disclosure: Short US and European banks