Friday, July 13, 2007

Foreclosure damage to be worse than expected

Real Estate Articles from Inman News
Mortgage market commentary
Friday, July 13, 2007

By Lou Barnes
Inman News

Mortgages are relatively steady in the 6.75-6.875 percent band, but they are the only semi-stable financial instrument out there. The money world is thrashing around, trying to identify the true extent of the housing/mortgage trouble.

June retail sales fell a surprise .9 percent -- maybe the often-forecasted, ultimate fade by consumers, maybe just a modest pullback from an outsize 1.5 percent gain in May.

Markets always oscillate across baseline, overdoing it one way, then another. However, the last year has been unusual in that all the lurching has had one cause, re-played again and again, one long Groundhog Day.

A year ago, as the Fed reached its current 5.25 percent, many bright and well-informed financial operators were just sure that the housing market would knock over the economy. Over and over and over again, the "just sure" bought bonds in anticipation of the recession to come, and within a week or a month were clobbered by resilient data.

Now it's changing. This week the rating agencies acknowledged error, and are re-rating with tougher methodology. That's the trigger for the two-part end-game: If we have huge losses, where are they? Who is exposed? And, if housing distress is as bad as it looks, where is the effect?

Part one, the mortgage losses. Very little money has been "lost." The market value of the securitized mortgages in question has fallen 30-70 percent, but if you don't sell, you don't have to recognize loss. The re-rating of this stuff to junk will force institutional investors to sell, to recognize, and probably depress value farther. We will also learn who has lost, and it's going to be an embarrassing and painful parade. This week, S&P, Moody's and Fitch downgraded no more than 1 percent of the trash outstanding; the outcome for the other 99 percent is sure as sunrise, the holders in frozen panic.

Market losses from forced sales are near, but there is still little actual credit loss from defaulted mortgages -- that's still ahead, and the loss magnitude will depend on the depth and length of the housing recession.

Part two, the housing market. Housing moves slowly, in an aching grind. Sellers resist discount, preferring to hold vacant, or to rent at a loss, or to stay put. Loan servicers are slow to foreclose: they are not staffed to do so (or to do anything except to send you all that mail trying to get you to buy insurance and pre-pay programs), fiddle endlessly and pretend to negotiate workouts of hopeless cases.

The housing picture is changing -- not selling, just changing. Foreclosure data is notoriously bad (every county and state has different procedures and law), but RealtyTrac's trend is probably about right, if only in consistency of error. The pattern is stark: national foreclosure filings are up 56 percent year-to-date, but mortgage defaults are up 86 percent -- foreclosure lag. Based on housing markets early to the distress party, Colorado the leading example, Bubble Zone foreclosures will increase for at least the next three years (announcements of bottom in 2008 are fantasy-based).

Do some math. Home resales run a tad over 6 million annually, plus another 1 million new-builds. Re-sellers still want to re-sell, and builders, desperate to unload land and to maintain survival volume, are still building at undercut prices. Demand is off (un-affordability and anxiety), but a new seller has arrived: first-half '07 foreclosure filings just short of 1 million. Pull-through from filing to foreclosure is unpredictable, but it looks as though re-sellers and builders will soon be joined by another million foreclosure re-sellers (or two, or three...). That's market saturation, not clearing.

We are going to get spillover into GDP. Book it. And we're going to see a serial credit panic. However, the disaster mongers are mistaken. Credit losses are distributed globally, and there is great long-term strength in housing (population growth, land scarcity, wealth...). The forecast here continues to be for a long period of flat prices in the Bubble Zones, but vastly more foreclosure damage from flat prices than previously modeled or imagined, the Great Hangover from the '01-'06 Mortgage Credit Party.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at

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