Tuesday, July 14, 2009

Housing Bubble - The Sequel

It is strange that it is July 14th and I still have to wear a jacket out to the car in the morning because it is so cool out. Come on hot weather, I miss you!

Goldman Sachs Earnings
This morning confirmed what everyone knew yesterday, Goldman Sachs (GS) had a monster quarter and beat expectations by a mile. I will not recount all the details, but a few notes on the GS news:
-I never really looked at a GS earnings report. These guys do not disclose anything. There is no way to really know how and where the money is being made.
-To make the killing GS did, they had to be positioned heavy on the long side of the ledger to capture the market rally. One could ask how they were so sure the market would take off, but that question answers itself, yes? What would be VERY interesting is if say 100 points gets knocked off the S&P 500 by next quarter. If GS is still making a killing I would call bullsh#t. Nobody is that right all the time. Nobody.
-GS commercial real estate holdings are taking a beating. And that is while they are still gamed as mark to fantasy.

Overall about what you would expect. Still sits very poorly that the bank is making huge cake while all the risk is shouldered by the US government, but what do you want.

Housing Bubble - The Sequel
The big story of the day to me was the floating of an idea that would permanently destroy economic freedom as we know it. While the assault has been harsh over the past year, this new plan would accomplish what the bankers have wanted since time began; Total control over private property.

So what is the plan? Here is the Reuters story from this morning:
U.S. mulling mortgage aid for unemployed
NEW YORK/WASHINGTON (Reuters) - President Barack Obama is mulling new ways to delay foreclosure for jobless homeowners who are unable to keep up with monthly payments, an administration official said on Monday.

The official told Reuters it was reasonable for policymakers to consider options for loan forbearance -- allowing borrowers to delay, defer or skip payments -- that are more effective than those currently available in the private sector.

The number of failing home loans has been climbing for three years as risky borrowers have defaulted on their easy-to-get loans, property values have sunk and the unemployment rate has climbed.

But the official said the idea, which is still evolving, was difficult from a policy perspective and carries potential hazards. It could help more people struggling with economic difficulty, but it also could create perverse incentives that distort the housing market, said the official, who did not want to speak on the record about internal administration debates.

So right from the start we can argue about the morality of this plan. Help for jobless homeowners? Why not help for all homeowners? How about jobless renters? Why the double standard? Writing checks to pay the banks that hold the mortgages does nothing to help the jobless owner, but it does help the banks! The same theme continues unabated.

While the moral hazard of the proposal is heavy indeed, It was in a later article that I saw the true purpose of this scheme. I have to say, I was appalled and amazed at the sheer boldness and morbidity involved here. From Clusterstock:
Obama Considers New Mortgage Solution: Own-To-Rent
Is The Atlantic now the most influential magazine in America?

The most recent issue is pretentiously self-styled as “The Ideas Issue: How To Fix The World.” It contains a brief piece by Felix Salmon making the clever argument that the mortgage defaulters should be turned into renters. The idea does have an attractive symmetry: if one of our problems is that too many people who should be renters wound up taking out mortgages they couldn’t afford to become ersatz homeowners, why not just make them renters?

It's a brilliant reversal of the old idea of rent-to-own homes. But just because it's brilliant doesn't mean it would work.

Now Reuters reports that U.S. government officials are weighing a plan to do just that. The plan would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes. They’d give up all their equity—if they have any—and future claims on the equity, in exchange for getting to keep their homes.
There are lots of problems with this idea, including havoc it would create in securitized mortgages, that it would make the housing market even more illiquid than it is, and that it would create a huge incentive on the part of even more borrowers to default. Think about it: now you don’t even have to walk away.

Reuters also reports that officials are creating a “housing stipend” that would attach to unemployment, hoping to reduce the role in job losses in driving mortgage defaults. This would be either hugely costly or ineffective. (And it would really anger unemployed renters.)

Did you catch the real target of this idea?

Once more:
The plan would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes. They’d give up all their equity—if they have any—and future claims on the equity, in exchange for getting to keep their homes

So what is the single biggest issue banks are facing right now? Falling home prices are causing many "owners" to give up as the up side of ownership has vanished. This has created enormous pressure on mortgage products across the spectrum. Unable to turn the economy around through monetary policy and stimulus, the government is at a loss for options.

Instead of taking a step back and seeing the big picture, this new proposal gives the banks total control over the real estate market. If you think Level III accounting is fantasy, wait for "Real Estate Equity Upside Targeting" by the banks.

Let me explain.

Home owner Joe bought his home for $250,000 in 2005. He has now become "troubled" (by job loss or whatever) and cannot afford the old $1500 a month mortgage (@6% rate). Added to this the home is now appraised at $150,000 so Joe is pretty much out of luck. And time.

Enter the "Equity Surrender Plan". Bank X offers Joe a new rental option at about $720 a month (equates to a $120,000 note at 6%) as long as Joe surrenders his ownership and any claim on future upside in the home price. Joe can afford the new rent, and he is less likely to burn the place down after being foreclosed on. Everyone is happy, right?

Well certainly the banks will be.

Think of the magnitude of foreclosures right now. Add in all the shadow inventory that the banks have been sitting on (seemingly to hide loss marks, but now maybe in hopes of this plan). The equates to a not tiny percentage of the housing market today (I have no idea what that number is by the way).

Now the banks, of which there are far fewer in number, have control of any upside for a huge number of properties. The banks are also awash in all the cash created by the FED that right now is not entering the money supply because banks do not want to lend.

Ask yourself what happens to assets held and controlled by banks should the banks need those assets to go up in value?

They go up in value.

This would be a real world modelling of Level III accounting.

Return to our example. Now the bank has an income of $720 on the home they own the upside on. They can mark the value of the holding as they see fit. Later, buyer John wants to move in to Joe's home and Joe would like to move on. Bank X sends out their appraiser for the home and by magic, the home is now valued at $225,000. Amazing! Bank X is only more than happy to loan John the $225,000 irregardless of credit quality because they know all the other banks are doing the same thing! The market in real estate would be fixed by the banks.

There are many angles to this that I want to flesh out, but I am a bit pressed for time. Use the comments section to offer your own thoughts.

What this appears to be to me is a backdoor way to re inflate the housing market. What adds to the hilarity is the CPI would be depressed (for all you deflation lovers) as the new rents would be used as the housing component. The process of inflating home prices could go on with easy money for a long time this way.

A cunning plan indeed and I would expect nothing less than this kind of craven theft from our banking system and promoted by the government under the silly guise of "helping troubled homeowners".

Have a good night.

14 comments:

watchtower said...

“If the American people ever allow private banks to control the issue of our currency, first by inflation, then by deflation, the banks and the corporations that will grow up will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.”


Thomas Jefferson

As Keith of Housing Panic used to say:
"It hath been fortold"

Lisa said...

This "plan" will never get off the ground. There's really no upside for the owner to give up the equity, if any, and there is a tax issue in this as well. The housing market will come to an absolute stand still, in my opinion. Not to mention the outcry from the majority of hard-working, mortgage paying citizens. Would like to hear Gawain's take on this one.

getyourselfconnected said...

Watchtower,
great line to use for this example.

Lisa,
I wish I could agree that this turd will never see the light of day, but it makes sense in a banking sense so I would not rule it out.

Lisa said...

The audacity of the banks and administration are reaching heights previously unknown. I'm not sure the country will take much more. This type of plan may indeed be good for the banks, I'm just not sure the people, our whole society, will be able to bear it.

Anonymous said...

Gysc,

What about all the people who are living in their homes now and not even making payments, some for over a year, why rent when you can stay there for free. If the bank kicks them out they have to mark the house to market. That would be one reason for this little rent scheme. If the bank can rent it to the ex-Herby homeowner they don't have to foreclose and thus mark the home to market. I also wonder how many of these are owned by Fanny and her fat little brother Freddie which are really owned by the US government.
It'll be interesting to follow but it ain't gonna fix anything but perhaps kick the can down the road for another day.

Kevin

getyourselfconnected said...

Kevin,
great poit that this will enable banks to skip markdowns of the books. The reason I am afraid of this plan is that it accomplishes all that the PPIP, TARP, etc plans were aimed at, but just streamlines the process. It seems a tad too well put together to just be a random thought. Scary.
Night All.

Anonymous said...

GYSC

Here's one you may have missed from earlier today. This isn't an if, it's a when.

WASHINGTON, July 14 (Reuters) - The U.S. House of Representatives will work to extend jobless benefits "when it becomes necessary", House Majority Leader Steny Hoyer said on Tuesday.
http://tinyurl.com/mqhq2c

Kevin

Lisa said...

Well, hell, who needs to work anymore?

watchtower said...

Lisa said:

"Well, hell, who needs to work anymore?"

It's not called "funemployment" these days for nothing : )

Anonymous said...

July 15 (Bloomberg) -- Pacific Investment Management Co.’s Paul McCulley said the Federal Reserve should push inflation above its long-term target to coax consumers to spend money if the U.S. economy stays mired in recession.

“The way to make monetary policy effective is for the central bank to promise to be irresponsible,” McCulley wrote in a July commentary posted to Pimco’s Web site, citing a 1998 paper written by Princeton University economist Paul Krugman.
http://tinyurl.com/kto2uw

These guys need to be drug out in the street and given the beat down for being so damn stupid.

Kevin

Lisa said...

Beating is too good for them. Tar/feathers more like it. Good thing I'm not a violent person :)

The said...

Well, as to Goldman Sachs, it certainly helps if you have your alums staffing the highest levels of government to redirect taxpayer money to you so you can cover your bad bets on credit default swaps, doesn't it? Profit, my ass. Theft is more like it.

Anyway, as to this whole housing bubble thing, what the administration is proposing is a joke, and a bad one at that. People toss around the word "homeowner" like it means something. Actually, it means nothing.

You don't own the home until you pay off the note. It's that simple. Until such time, you are a debtowner. Period.

Fannie Mae currently has a program whereby if the house is occupied by a renter, and the actual owner defaulted, the renter is allowed to continue to pay rent, with the option to buy the home and the full understanding that the house is now on the market for sale. Which makes sense. I mean, we certainly don't want to throw people out onto the streets after they sent money to the owner who failed to make payments on the loan.

I had to deliver a notice of foreclosure to a renter-occupier last week. He thought he was buying the home on a lease-purchase plan. He had given the owner $20,000 down and made regular monthly payments. And he was stunned that the house had been foreclosed on.

"How can this happen?" he asked.

"It's very simple, really. The owner failed to make payments on the loan."

"Simple?!" he screamed. "What about all the money I put into this home?"

I explained to him that he had the option to continue paying rent, accept cash for keys, and to make an offer to purchase the house.

"If I had the money and the credit, I would have bought the house to begin with."

Excuse me. You had $20,000 cash to give to the previous owner and the income to afford regular monthly payments, but you didn't have the credit to take out a mortgage and buy the house? That doesn't make any sense. How bad does your credit have to be?

What this all comes down to, to me, is financial ignorance. Real estate was, is and remains a solid investment. But it's a money game. If you do not have the money, do not play the game. You'll only lose.

This idea of giving homeowners (read debtowners) the option to rent smacks of bailing out banks who made questionable loans. I cannot support that. A contract is a contract is a contract. If you do not or cannot understand the contract, much less afford the payments, do not sign it.

The American people did not sign up for paying taxes to make banks whole on their bad bets or keep buyers in homes they cannot afford.

Frankly, I'm disgusted by all of this.

GawainsGhost said...

Once again Google has confused my sign in name. Either I have to stop posting on sports sites under the name The Soothsayer, which Google for some strange reason only recognizes as "The", or I have to be more attentative to what screen name is being used before I post. This is a pain.

Anonymous said...

GawainsGhost,

I glad you clarified who "The" was for me.
I'm totally disgusted too although not surprised. I read Who will Tell The People by William Greider a long time ago.

Kevin