Home Prices Still Need to Decline More to be "Affordable"

Home affordability is a reltaive thing.  However, that affordability should not be based on interest rates.  It should be based on income and housing prices - in other words the cash value of the home.  According to this Wall Street Journal article, Home Prices: Low, But Still No Bargain, home prices do indeed need to fall more.  I agree with this overall assessment.  Of course this will lead to more foreclosures as more homeowners experience negative equity situations.  If you do factor in financing then there is another problem: the looming commercial real estate crisis (more on that soon).

President's "Making Home Affordable" Program Not Enough to Stop Foreclosures

According to this Inman News article, Negative Equity: a housing timebomb, President Obama's Making Home Affordable Program (MHA)  will only have a small impact on reducing foreclosures because it igores one of the key drivers of foreclosures: negative equity.  The article also mentions that investors being excluded is also a problem with MHA.

As usual, I predicted this before the "real media".  Per my blog post on March 5, 2009 regarding the new government foreclosure programs, since investors are excluded and many people have negative equity in their homes the government foreclosure programs (now labeled MHA) will not be successful in significantly reducing foreclosures.

Recent "Sales Uptick" Not Really Good News for Real Estate

According to this Forbes.com article, Riskiest Places for U.S. Homeowners, there are several places in the country (mainly parts of CA, FL, MI, TX and parts of the Midwest) where things will get significantly worse.  However, even outside of those places things are not likely to improve.

"While the National Association of Realtors estimates existing-home sales rose 5.1% nationwide in February, foreclosures are still on the rise. Dr. David Berson, chief economist of mortgage insurer PMI Group, says the sales uptick simply reflects re-sales of foreclosed properties.

"Sales will turn up before the recession ends," says Berson, but they will be at lower prices. That does little for those who already bought homes during the boom and now face the dual forces of negative equity and job loss. "Delinquencies and foreclosures lag behind unemployment," he says, "and unemployment lags behind the recession."

I think it is clear that while the recent sales uptick is nice and presents some people hope it is more likely just a sign that prices were dropped on distress sales and foreclosures.  It is only when the distress sales and foreclosures decline significantly and regular sales increase and prices increase can this poor real estate market be deemed "over".  Until then the market is still in decline.

A Brief Synopsis: How We Got Here and Where We Are Going

How We Got Here

• Government - The problems were caused by the relationship between Fannie Mae/Freddie and the Community Reinvestment Act (pushed by social agenda politicians (think Bill Clinton, Barney Frank, Chris Dodd, etc.).  The result was that more and more high risk loans were made to financially unstable and under-capitalized borrowers under the guise of social justice.
• Greedy Bankers - Pushed by the government, bankers soon realized that they could make more money lending to unstable and under-capitalized borrowers as a result of being able to make more loans and charging higher rates and fees.
  
• Foolish Consumers - Consumers started viewing buying a home as an "investment".  While that may sound good, the problem is that what most people classify as an "investment" is really noting more than speculation (i.e. gambling).  As a result people took on more and more debt to buy bigger and bigger homes since they were "investments".  In reality, the only investment part of owning a home is that in the old days you would buy a home and eventually own it free and clear instead of perpetually paying rent.  Now, "homeowners" just perpetually have a mortgage which is not much different from perpetually renting other than you benefit if the price goes up and get hurt if the price goes down.  This is made much worse by leverage (think 0-5% down mortgages).  In reality, owning a home was never meant to be an investment other than you would eventually own the home free and clear and maybe get some appreciation, which would protect you from inflation (not 20-50% annual appreciation, but more like 3-7% per year).  Owning a home was primarily meant to provide a lifestyle.   People just had the common sense not to buy a lifestyle that they could not afford.

Where We Are Going

• Some recent real estate news shows existing homes sales up 5.1% and new home sales up 4.7%, but home prices only improved 1.7%.  This is likely the result of more builders dumping their homes for cheap, but their median prices are still higher than resale homes so the overall prices went up a bit.
• Despite sales increasing a bit the number of homes in inventory increased for the first time since July 2008.  This means supply will likely increase.  Not good for prices.
• As soon as the general public thinks the market has improved there will be additional inventory added to the market as all those sellers that gave up on selling flood the market with their homes.  Again, this will not be good for prices.
• The problem now is the absurd Obama stimulus plan, which will surely drive up inflation (and as a result interest rates) and drive up unemployment as investors and companies pull back investments (i.e. in start-ups, equipment, facilities, etc.) due to higher future taxes (necessitated by the huge government spending in the Obama plan) reducing their future returns.  This is what will likely break the back of the real estate market in the mid to long term.  So while prices may increase a tiny bit in the short term, in the long term they will suffer.  As a result I do not see the real estate market rebounding back to the pre-2006 price levels any time soon.
  

Manhattan Real Estate Will Decline in Value to 50% of Market Peak

According to this New York Times article, Looking for Bottom in N.Y. Real Estate, Manhattan real estate prices hav already fallen by 25% according to some people involved in New York real estate.  In the summer of 2008 I told my wife that the Manhattan real estate market would collapse since it was absurdly over valued combined with the beginning of the financial meltdown layoffs.  I believe that prices will end up being 50% or less of the previous market peak.

Reuters: One in 8 U.S. homeowners late paying or in foreclosure

According to this Reuters article, One in 8 U.S. homeowners late paying or in foreclosure, 1 out of 8 US homeowners is behind on their mortgage, or already in foreclosure. This is absolutely stunning. According to the article even prime loans are experiencing higher foreclosure rates caused by job losses and overbuilding. The author of the article did not seem optimistic that Obama's foreclosure plan would work. I agree. This will certainly lead to more short sales and foreclosures and result in hurting the housing market even more. Since Tennessee has a higher than average number of foreclosures I expect the TN housing market to be hurt more than average over the next several years.

Bloomberg.com Article: U.S. Existing Home Sales, Prices Slumped in January

According to this Bloomberg.com article U.S. Existing Home Sales, Prices Slumped in January.

The gist ofthe article is that the declining economy is going to going to continue to drag down the housing market as consumer confidence also declines.

According to the article the economy will likley not rebound with respect to unemployment until 2011.

The article quotes Lawrence Yun, the chief economist for the National Association of REALTORS (NAR), as saying that the recent goverment actions may lift home resales by as much as 900,000 units this year.

Being a REALTOR myself, I have read Mr. Yun's predictions many times over the past 3 years. 

I have to say that he has said the market would improve in 2006, 2007 and 2008.

Each time he was wrong and he will be wrong this time as well. Despite what NAR would like

consumers to believe, homes are still not affordbale. NAR's way determining home affordability is

to factor in financing (see the NAR Home Affordability Index). The problem is that when financing

is abnormally cheap (i.e. like during the market boom) it lends itself to over-inflated prices (like during the market boom).

The result is that when rates increase the home owners cannot sell their home for as much as they paid and a whole

new problem starts just like what we see now. The fact is that prior to the huge run up in home prices that started

around 2000, the median home price in a given area was more related to the median income in that area.

For homeowners to be financially solvent the ration of home prices to median income needs to be around 2 to 1

with an absolute maximum of 3 to 1. Now even after the market declines that started in 2006

the median price of a home in most areas of the US is 3-4 times the median household income

meaning that 2 people now need to work to buy a home as opposed to just one worker in each

household. Two family incomes helped push up the median price and this was worsened by

consumers accepting more debt as being OK. Historically, the values of real estate were

determined by the quality of life that the location offered, the size and type of property and

local employment prospects. Unfortunately, during the most recent run up in prices the major

factor was the monthly housing payment versus household income. As rates went lower and

financing became more available, prices increased until the prices reached a popping point.

That cannot happen again, otherwise, we will see the same problems all over again. The solution

is that real estate prices need to continue to decline for a while longer in order to bring affordability

more in line with common sense criteria, not monthly housing payments.

In Bloomberg Interview, Harris of Barclays Capital Says President Obama is doing the "Right Thing" for U.S. Housing

Accroding to this Bloomberg interview with Ethan Harris, Co-Head of U.S. Economics Research for Barclays Capital, President Obama is Doing the "Right Thing" for U.S. Housing.

I disagree with his assessment.  This entire financial crisis was caused by:

1. Too much total consumer debt including real estate and non-real estate debt.
2. A natural waning of housing prices after a "too good to be true" run up in real estate prices.
3. A decline in the secondary market for debt instruments largely due to concerns about issues above.

Unfortunately, President Obama's plan is to try and solve a problem caused by debt with more debt to finance his massive spending plan.   Economists and media pundits are now referring back to the Great Depression to try to analyze the effectiveness of President Roosevelt's New Deal to compare it to President Obama's "Newer Deal".  Increasingly, economists are forced to admit that Roosevelt's New Deal did not stop the Great Depression, and in fact, according to some economists made the economy worse.  While that is still an issue to be debated, there can be no doubt that the current financial crisis differs from the Great Depression in one significant repspect: one major cause of the Great Depression, drought and widespread crop failures, are completely absent from our current situation.  Drought and crop failure is a tangible and understandable problem.  Our current financial crisis, on the other hand, is almost entirely due to poor financial decision making by banks (mortgage companies and investment banks) and individuals (the people who borrowed more than they ever could repay).  Therefore, I fail to see how a small number of infrastructure projects and some other haphazard spending can get us out of a mess caused by debt if those projects are going to be financed by debt.  In order to solve this problem total debt cannot be increased and debt payments must decrease in order to lessen the burden on consumers.

In order to properly address this current financial crisis I think a simpler solution would be for the Federal Reserve to take all the debt off of all the banks' books at current market value by:

• Swapping out all the residential mortgage debt held by US Banks (totals approximately $11.3 Trillion) in exchange for US Treasuries with a guaranteed yield of say 2.5% with provisions for the banks to sell of the Treasuries in controlled allotments in order to raise cash.  Currently the total value of all US Federal debt is $10.76 Trillion.  Therefore, this plan would essentially double the national debt.  However, since it is really a debt swap the total of all US public and private debt would remain the same at about $53 Trillion.
• The Fed would then alter the terms of all the mortgages "purchased" so that all people current on their mortgages and have equity would receive a reduced interest rate of 3%.  People who are current, but have no equity would receive 3.5%, people who have equity, but are delinquent (assuming they can pay the mortgage after the reduction) would get 4% and people who have no equity and are delinquent (assuming they can pay the mortgage after the reduction) would get 4.5%.  Any people with negative equity would have been dealt at the time of the Fed's "purchase" of their mortgages since the Fed would be paying a discounted amount for their mortgages (i.e. the banks would take a haircut by reducing the face values of these assets).  The delinquent homeowners with negative equity would also share the pain by agreeing to pay the Fed 10% of future home appreciation in order to make up for the higher rate of default.
  

The initial cost of this plan would be very little.  The long term cost to the Fed (and US Taxpayers) would be the risk of mortgage default, which would be spread over time anyway.  Since the banks would now have 100% performing and guaranteed assets on their books instead of non-performing mortgage assets they would be saved.  Since there would be a provision for the banks to sell off the Treasuries in controlled amounts their capital would be replenished in an organized fashion thus leading to a return of normal lending.  Since the problem in the economy was and is too much consumer and business debt including, but not limited to, real estate and the near complete evaporation of the secondary market for debt instruments this plan would work by creating the secondary market (the Fed) and reducing debt payment levels by reducing interest rates of homeowners.  In short this would be the same as a tax cut for homeowners thus putting more money back into the economy, some of which would surely be spent.  Since my plan is a debt swapping/debt shifting plan it will not increase total debt, thus not creating any additional burden on taxpayers or the economy.  Conversely, the President's plan of borrowing more money to spend will increase debt and probably make things worse in the long run.

Top 10 Things to Do When You are or Will be Behind on Your Mortgage Payments or are already in Foreclosure

The purpose of this blog is to help people who are or will be behind on their mortgage payments, or are already in foreclosure.  I know that being in that situation is very stressful.  I have seen it first hand as I have helped many clients through those difficult times.  I welcome questions and comments from people needing assistance.

 

As a first attempt at providing some assistance, I came up with the following list of the “Top 10 Things to Do When You are or Will be Behind on Your Mortgage Payments or are already in Foreclosure”.

 

1. Take a step back to reflect - Take a deep breath and regain your composure.  Getting behind on your mortgage payments or being in foreclosure is a difficult problem.  You cannot solve any problem if you panic and are not capable of reasoned thought.
2. Relax - What is the worst that can happen?  You will lose your home and possibly have to move in with relatives, or into an apartment at least for some time.  It might be embarrassing and even humbling, but it is not the end of the world.  No one is going to throw you in jail.  Your life is not over.  You can and will rebuild your life after you get through this.
3. Gather information - Put together a monthly budget of all your income and expenses.  Use your net take home pay (i.e. after taxes).  Be sure to include all your living expenses (i.e. food, health insurance, housing payment, vehicle payments, gas and vehicle repairs, meals, grooming, pet expenses, entertainment, child support, alimony, etc.  You need to know exactly where your income is going and how much you are really short each month.
4. Be honest with yourself - Ask yourself some difficult questions and be honest with yourself.  How did you get here?  Did you buy more home than you could reasonably afford?  Do you buy too many things on credit?  Are you a shopaholic?  Can you do without things?
5. Analyze - Put together your monthly budget (income and expenses).  Analyze your budget to see if you can eliminate things from your budget.  After cutting your budget see if there will be enough money left each month to pay your mortgage/housing payment?
6. Make your plans - If you cannot afford your home with your current mortgage even after you have trimmed your budget, you have 2 basic options: (1) contact your mortgage company to see if they will modify your loan terms.  (2) Sell your home.
7. Decide - If you prefer to try and stay in your home then a loan modification is your first option.  Call your mortgage company and tell them that you cannot afford your housing payment and that you need a loan modification.  They will likely send you to their loss mitigation department who will then fax or mail you their loss mitigation package, which you will need to fill out.  Your mortgage company will then review the information to see if a loan modification is desirable for them.
8. React promptly - If the mortgage company does not offer you a loan modification (or offers one that still will not help enough) then you need to sell your home.
9. Decide - You will need to make a decision to agree to the loan modification, or accept the sale of your home.  If you need to sell your home price it lower than any other home to get it sold fast.  Buyers will not pay retail prices for homes in foreclosure, or homes where the mortgage balance is greater than the market value (a short sale) due to the “as is” risk or to the lengthy time involved for a response in the case of a short sale.  In either case, you will need to price your home with this in mind.
10. Act – Regardless of what you decide to do you need to act quickly and decisively.  Letting the bank foreclose on your home will severely harm your credit for several years and in many states the bank can still come after you for their net loss after liquidating your home as an REO (this is called a deficiency judgment).  If you opt for the short sale you should be able to lessen the impact to your credit and eliminate the threat of a deficiency judgment.