Here’s a quick update on the impacts we are seeing from “Robo-Gate”. For those that missed this major foreclosure news item, robo-gate refers to the foreclosure freezes implemented by various lenders after revelations that foreclosure filings were being attested to in a robotic fashion that may not have met legal requirements. In the beginning the freezes were limited primarily to 23 states that use the judicial foreclosure process, but on October 8th the impact grew when Bank of America announced a national foreclosure freeze. You’ll find our initial take, back on October 1st, here: Free Homes? Unlikely. Foreclosure Delays? Absolutely.

Let’s start by saying that by and large it has been business as usual in California and the other non-judicial foreclosure states that we cover: Arizona, Nevada, Oregon and Washington. Foreclosure sales are down, but activity is well within typical ranges with notable exceptions below. Note that we are the only service that has same-day foreclosure sales data for a large service area including 3 of the top 4 foreclosure states. As such we’ve been able to see the impacts of these announcements weeks ahead of any other foreclosure information service in the areas we cover.

We’ve read a number of stories that suggest investors have fled the market and are no longer buying properties at the trustee sales held on the courthouse steps. The numbers say otherwise. Since the beginning of the year investors have purchased an average 20.8 percent of all foreclosure sales in California, and though we did see a drop to 15.5 percent the week following the Bank of America announcement, numbers in that range aren’t unusual. Further, 20.1 percent of foreclosure sales were purchased by investors last week clearly indicating that normal investor activity continues unabated.

Bank of America

As announced Bank of America did halt foreclosure sales starting the week of October 11th in our coverage area. On October 18th Bank of America announced they were lifting the freeze in 23 states, but continuing the freeze in 26 other states. We can confirm that the freeze has continued in our coverage area through today Thursday, November 4th.

More interesting has been conjecture over the impact of the foreclosure freeze on foreclosure filings, including Notices of Default and Notices of Trustee Sale. Bank of America has not only continued with foreclosure filings, but their activity has actually increased as a percentage of total filings each week. For the year they have averaged 11.2 percent of foreclosure filings in California, and between October 11 and October 29 that had increased to 16.9 percent. Similarly, Notice of Trustee Sale filings increased from an average 14.9 percent to 18.2 percent over the same time period.

GMAC

GMAC halted foreclosure sales for one week, from October 11 to October 15th, then returned to business as usual. That same week they also slowed filings of Notice’s of Trustee Sale, but again resumed typical filing volumes after a jump the following week where they made up for the missed filings the week before. Same thing with Notice’s of Default, except a week earlier with a drop in filings the week of October 4.

PNC Bank

While PNC Bank represents a very small portion of foreclosures in our coverage area, they did clearly halt foreclosure activity across the board. Foreclosure sales halted the week of October 11, and filings of foreclosure notices began noticeably dropping the week of October 4.

MERS

Many stories related to robo-gate have discussed the controversy surrounding Mortgage Electronic Registration Systems or MERS. The system originated as a way for mortgages to be traded between parties while avoiding the need to record each transfer, or assignment, with the county recorders office which is a costly and error prone procedure. The failure to record those assignments, however, has led some to question the validity of foreclosures, or even the mortgage itself. Adding to the fire surround MERS, a number of lenders, including JP Morgan Chase, have recently announced they will no longer use the system. The reality, however, is that lenders began abandoning MERS long before now – at least in the foreclosure process. In 2008 8.5 percent of foreclosure sales were held in MERS name, in 2009 that dropped to 4.7 percent, and to date in 2010 it has averaged just 3.0 percent.

And that’s it. We see no other impacts from any other lenders in our coverage area. While Bank of America’s exit will certainly impact total foreclosure sales for October given their size, we don’t believe the decline will be sufficient to have any measurable impact on the housing market in the months to come.

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My phone and email have lit up over the last week as GMAC purportedly halted foreclosures in 23 judicial foreclosure states, and JP Morgan Chase yesterday announced they’d be delaying 56,000 foreclosures. Tonight it appears more lenders may be affected as well. The core issue in both cases appear to be that affidavits were signed by people who did not have personal knowledge of the facts involved despite claiming that they did. Some, however, are making it out to be something much bigger.

The theory behind the “tip-of-the-iceberg” argument is that lenders must produce the original note (loan document) signed by the borrower in order to foreclose, as well as properly recorded transfers of that note from the original lender to the current holder of the note. This seemingly simple task has gotten amazingly complicated over the last decade as loans were securitized and traded among institutions. In an effort to simplify things, lenders created the mortgage electronic registration system (MERS), but even that has been challenged as not meeting the legal requirements for foreclosure. If lenders were actually required to produce the original note and documented chain of ownership before foreclosing the belief under this theory is that foreclosures would largely grind to a halt, past foreclosures would be overturned, and that homeowners might be able to challenge the validity of their mortgage altogether. Free homes for all! Except of course for those who actually paid for them.

Readers of this blog know that I place far more of the blame for this crisis on lenders and government than I do on homeowners. That said, I DO NOT believe paperwork errors should lead to free homes… or frankly even foreclosure delays.

It’s one thing if the paperwork error lead to a lender trying to foreclose on someone who IS making their payments. By all means that person should get their day in court, and the foreclosure should be stopped. But that’s not the argument here. Instead they are saying they should get to stay in their home even though they stopped making their payments and are now legitimately facing foreclosure as a result.

Nothing about that makes sense to me.

While the wild conjecture is entertaining, I remain convinced that these affidavit and chain of custody issues will ultimately be resolved and amount to nothing more than foreclosure delays and a lot of  attorney fees as folks tilt at windmills.

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Almost everyone has seen the following chart that accompanied Robert Shiller’s book Irrational Exuberance, Second Edition. What everyone notices at first glance is, of course, the steep increase in prices on the right side. But when I first saw it something else caught my eye.

What I noticed immediately was that if you bought a house in 1955 and sold it in 1999, the house actually lost value. Seem ridiculous. Those of us in California immediately think this couldn’t apply to us given the price increases we’ve seen over the years.

But it can, and it does. The thing about this chart is that it has been adjusted for inflation. The reality is that most of what we think of as home price appreciation is really inflation. In other words, it’s not the value of the house going up, but the value of the dollar going down. And it’s not just home prices that have risen.

The second thing I noticed about this chart was the dramatic price increase in the 1940’s, and the home price bubbles in the 20′s, 30′s, 70’s and 80’s. While much research has been done on these price increases and bubbles, I began to suspect one simple cause that in hindsight is blatantly obvious… and has nothing to do with irrational behavior on the part of buyers as some have recently concluded.

In the early 1920’s, mortgage debt tripled due to lax lending standards. In the 30’s, you had the creation of the Federal Home Loan Bank, the FHA, and Fannie Mae. In the late 40’s, the GI Bill was passed introducing government subsidized 100% financing for returning servicemen. In the early 70’s, Freddie Mac was created and Ginnie Mae issued the first mortgage-backed securities – both were efforts to make homeownership more affordable. In the 1980’s, adjustable rate mortgages were introduced at the same time interest rates began to drop. In the late 90’s and the beginning of this decade, we had the Taxpayer Relief Act of 1977, the Gramm Leach Bliley Act, the Commodity Futures Modernization Act (these last two worked together to shift mortgage default risk off the banks and ultimately on to taxpayers, allowing lenders to make ever more aggressive and exotic loans), and finally the lowering of interest rates by the Federal Reserve.

That’s right. Every single significant increase in home prices in the last 100 years was immediately preceded by government intervention. The evidence is irrefutable. Every time the government works to make housing more affordable, prices rise. This actually makes perfect sense.

Buyers always have, and always will, buy as much home as their banker tells them they can afford. If you make financing cheaper you increase the amount buyers can pay. But instead of getting more home for their money, prices simply rise to reflect the change.

Worse yet, with the exception of the GI Bill in the 1940’s each subsequent rise in home prices after government intervention was short lived and immediately followed by a steep decline.

With my new thesis in hand, I attempted to apply it to the most recent housing price bubble. The chart below shows median home prices in California from 2000 to 2009, together with median incomes, and the home price one could afford based on the most aggressive, but popular, loan product available at the time.

Amazing. Prices doubled, yet the payment one could get at those ever increasing prices remained relatively flat. Furthermore, payments didn’t drop much once the market crashed.

Hopefully at this point you are seeing a bigger picture. Home price appreciation is largely just inflation, and housing bubbles are a recurring failure of our government to learn from its past mistakes. Rather than looking at the big picture, government officials, and our representatives, continue to jeopardize our future with the latest quick fix to a problem they don’t seem to understand. Whether through tax benefits, subsidized financing, or regulatory easing, expect prices to rise with the onset of our government’s next grand experiment in making homes “affordable”. Just remember that you now know what comes next.

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I spoke last week at a real estate investment club and shared with the audience my belief that foreclosures will trickle out over a very long time rather than come as a wave of foreclosures as others continue to inaccurately predict.

I do however, understand the nature of those predictions. Given the number of households that aren’t paying their mortgage (delinquencies) we should be seeing a massive wave of foreclosure notices, and ultimately foreclosure sales. It’s a logical conclusion. But this has become a political problem in a world of financial fantasy, so I don’t believe that simple logic applies.

The reality is that through financial engineering (interest only, subprime, swaps, option ARMs, negative equity, stated income, etc.,) we created trillions in excess mortgage debt that has left millions of homeowners underwater, financial institutions on the brink of collapse, and the FDIC nearly insolvent. Back in September 2008 it became clear that financial collapse was imminent, and the federal government did what it does best – bailed out those who caused the crisis while leaving taxpayers holding the bag for the losses. Pulling this hat trick off required one simple ruse – getting everyone to believe that those losses ultimately wouldn’t be very big.

To do this the government changed the rules. The FDIC who previously forced banks to get bad assets off their books became a leading proponent of saving homeowners with loan modifications that likely just delay the inevitable. With a little government pressure, the supposedly independent Federal Accounting Standards Board was pressured into letting banks account for loans at theoretical values based on computer models rather than current market value.

Next they began rolling out an acronym soup of programs, which they promoted as being help for America’s homeowners – HAMP, HAFA, HARP, 2MP and more. But the reality is that to date these programs have resulted in little more than delays. The government and lenders say that these failures are due to complexities of implementation, difficulty reaching homeowners and a sundry other things. But what if these programs were never intended to succeed? What if they were simply intended to create delays, provide false hope, and maybe get the banks a bit more cash out of homeowners in the form of trial loan modification payments?

Sounds like a crazy conspiracy theory, I know, but hear me out.

The problem faced by both lenders and the government is that they can neither afford to kick homeowners out, or bail them out. For lenders, either scenario forces losses to be recognized, while thanks to mark-to-model accounting rules, and little or no pressure to foreclose from the FDIC, they can instead leave non-paying homeowner in place and push those losses into the future. Many believe that most major corporations manage earnings, what could be more perfect than getting to choose when, and if, they recognize mortgage related losses. For the U.S. government either scenario is political death. Politicians have no appetite for allowing banks to put families on the street en masse through foreclosure, nor forcing banks to deal with the problem through bankruptcy cram-downs or other means. At the same time they realize their constituents who do pay their mortgage (or rent) simply won’t stand for a taxpayer funded bailout of their upside down neighbor. Instead, it seems they believe bailouts should be saved for the truly deserving like the executives and corporate shareholders of banks, AIG, GM, etc.

If we aren’t willing to either kick non-paying homeowners out of their homes, or bail them out, what other option is there? The answer is clear. It’s the same thing we’ve done with national deficits for years. Trade tomorrow for today, with a policy of extend and pretend. I have no doubt this is the present policy, and that this will be the policy for years to come as we work through wiping out the trillions in excess negative equity that was created during the bubble.

A member of the audience during my talk asked if this policy was really possible, after all we can’t just let non-paying homeowners stay in their homes forever. If paying homeowners figured that out, everyone would stop paying, and then our financial system would crumble.  I agree, and it’s clear the banks realize this too. But it is a problem that is easily solved by the diabolical game of Russian roulette. So long as lenders continue to foreclose on at least a handful of homeowners each month, in what from all appearances is a completely random game of chance, they’ll keep those willing and able to pay their mortgage doing so. Those who decide not to pay their mortgage will find themselves playing today’s update on the Russian game, Foreclosure Roulette, wondering each month whether they’ll get another free month in their prison of debt, or finally be shot and forced to move.

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Today I came across a recent study on foreclosure sales and house prices by an MIT economist and two Harvard researchers. MIT just issued a press release so the study is now making headlines.The researchers looked at 1.8 Million transactions in Massachusetts over the last 20 years and came to the conclusion that homes sold after foreclosure sell at a particularly large discount of 27% on average. Further they find that “each foreclosure that takes place 0.05 miles away lowers the price of a house by about 1%”. Wow. I sure hope there haven’t been 100 foreclosures near you.

I’ve long believed that foreclosures DO NOT cause price declines, and after reading this study my view has NOT changed. My view instead is that price declines cause foreclosures, but there’s a twist to this view, that I believe threw these researchers off track and led them to a faulty conclusion despite an otherwise interesting paper. They are not alone. I think most people actually believe foreclosure cause prices declines. The key to the author’s error, I believe, can be found in the following sentence: “To the extent that house prices drive foreclosures, low prices should precede foreclosures rather than vice versa.” Through various regression tests they found this NOT to be the case, which would seem to strongly support their conclusion over mine.

Here’s the rub – home prices are a function of income and loan terms. As such the price buyers in a given area can afford to pay often declines PRIOR to being actually reflected in market sales. Massachusetts unemployment went from 6 to 9% in 1990, hitting many households and leaving them unable to pay their mortgages, and impacting what potential buyers could afford to pay as well. In 2007 over-indebted subprime borrowers with 100% LTV, teaser rate, neg-am, loans and no skin in the game began walking away as builders started discounting the same homes those borrowers were told would only go up in value. Those subprime defaults led lenders to pull the exotic loans that previously enabled buyers to “afford” twice as much home as they could using more traditional loan products. Sales then stalled as unforced sellers were unwilling or unable to drop prices.

This leads to the part that seems to confound everyone, including this study’s authors. Banks taking back foreclosures are forced to sell at the price buyers can afford. Thus foreclosures are the first sales to begin occurring in large numbers at the price level that buyers can now afford. As they do, nearby unforced sellers come to grips with the new market reality, while others that don’t have foreclosures nearby cling to the hope that their home won’t be affected. That hope is kept alive by a trickle of sales that continue to occur at prior price levels as not all buyers are impacted by economic changes equally.

Thus even though foreclosures are the first to sell at lower prices, they are not the CAUSE behind those lower prices.

I’ll leave you with this simple example: there was little decline in California’s median price, despite mounting foreclosures and an increasing percentage of foreclosures sales, until the September 2007 credit crisis. At that point the median price began to rapidly tumble to a level the median income family could afford using the more traditional loan products that remained available in the market. Bottom line, the typical homebuyer can only afford as much home as their banker tells them they can afford. As such changes in household incomes typically due to rising unemployement and/or the tightening of loan terms used to qualify buyers are what cause price declines, not foreclosures.

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In a recent paper, the New York Fed studies the likelihood of a continuing drop in homeownership. To address the question the authors propose that anyone who is underwater in their home should be considered a future renter:

“According to Haughwout, Peach and Tracy [the authors of the study], negative equity homeowners will face such daunting saving requirements to retain their home or purchase a new home that they will very likely convert to renters over time.”

See the study here: http://www.newyorkfed.org/newsevents/news/research/2010/rp100604.html

Bottom line: While the official government message is that underwater homeowners should do everything they can to hang in there, one could argue the New York Fed is already writing them off.

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In 2004, a Brentwood, CA couple purchased a new property from a builder for $690,000 and spent the next few years adding value to the home through interior and exterior improvements. When they later refinanced, the appraisal came in at $1,350,000, almost double the purchase price.

Fast forward a few years. The adjustable interest rate on that refinance kicked in and life intervened in other ways, as the couple decided to separate. Neither could afford the new loan payments alone, so they did what everyone recommended and called their lender to work something out. This led to 18 months of negotiations with their servicer, Bank of America, for a loan modification. They followed up monthly and were assured by the servicer that the process was moving forward, even though foreclosure notices were filed and the foreclosure sale was set and then postponed on multiple occasions.

A while back I wrote on Foreclosures and the Five Stages of Grief. If you map the grieving process to the foreclosure process, it seems to me that negotiating for a loan modification is the bargaining stage, the desperate attempt to restore better times.

Despite their efforts the owners recently got a phone call from BofA advising them that their home would go to trustee sale in ten days. The surprised owners asked why, especially given the recent announcements that BofA would soon be offering principal balance reductions. BofA responded that the decision was final, and that even if they qualified for the new program, BofA wasn’t willing to postpone the sale long enough to find out.

The couple’s home went to auction and was sold on the courthouse steps ten days later. That same afternoon, BofA called the owners at home in order to update it’s records on the owners pending loan modification, completely unaware the property had actually been sold on the courthouse steps earlier that day.

This story reminds me of the Peanuts™ cartoon where Lucy pulls the football from Charlie Brown as he tries to kick it. BofA led the couple to believe that a loan modification was on the way, then suddenly it pulled it out from under them. As a kid I always felt bad for poor Charlie Brown when Lucy pulled the football. Not this time. BofA did these folks a big favor, even if they don’t yet realize it yet.

Despite the fact that loan modifications should make sense for all involved, the truth is that most loan modifications available today are even worse than the mortgages they’re replacing. Despite the recent headlines about new loan modification programs featuring principal balance reductions, a simple look under the covers reveals these new programs still fail to adequately address the core problem – negative equity. Instead they simply put a band-aid on fatal wound, while telling onlookers everything will be ok.

Five years from now, as those “lucky” enough to get one of these toxic loan modification face the payment increases they agreed to, our Brentwood couple will have long since completed the grieving process, with worries of negative equity just a distant memory.

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There’s been a lot of housing market activity in both the public and private sector recently.

• Modifications to the HAMP and FHA programs to address loan modification failings and more negative equity
• Launch of the HAFA program to promote foreclosure alternatives including short sales and deeds-in-lieu of foreclosure
• Modifications to Bank of America’s National Home Ownership Program to extend coverage
• Citigroup, JPMorgan Chase, Wells Fargo and Bank of America joining the 2MP program to address loan modifications for second mortgages
• Bank of America offering to forgive up to 30% of the principal in underwater mortgages
• The end of Federal Reserve purchase of mortgage-backed securities
• The coming end of tax credits for home buyers

When it comes to foreclosures, the latest news makes it seem as if the government and lenders are finally getting serious about the core problem, negative equity. As we’ve discussed here before, it is only through the elimination of negative equity that homeowners will escape their prison’s of debt, allowing them to once again participate in our consumer driven economy.

Unfortunately I don’t expect dramatic results from any of these programs because of another core problem. Our financial institutions can’t afford to forgive all the debt necessary to eliminate negative equity and remain solvent, and neither can the FDIC or, with this ballooning deficit, the federal government itself.

Instead, I believe these programs will run into the same delays, oversights, and design failings that doomed their predecessors. Perhaps that is the point. These announcements provide Wall St and politicians political cover, while buying time.

These failings combined with the Fed’s exit from purchasing Mortgage Backed Securities and the coming end of the homebuyer tax credits is leading some to predict the worst for housing in the coming months.

While I believe we are far from the return of a truly healthy housing market, supported by reasonable equity levels and manageable debt, I don’t personally think housing we’ll see a dramatic double-dip, especially in those areas that have already seen a significant correction.

My reasoning is simple. If there is anything we’ve learned over the last couple of years, it’s that our elected officials, and their appointees at the FDIC, Federal Reserve, etc, will do whatever it takes to limit foreclosures and stimulate housing.

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We just posted our latest California Foreclosure Report: DOWNLOAD HERE

Highlights from this report:

• Notices of Default increase by nearly 20%
• Foreclosure sale decreased by 12%
• Auction discounts drop
• Percentage of trustee sales purchased by 3rd parties highest since we began tracking in 2006

Sign-up for our FREE monthly California Foreclosure Report by email

Video version: COMING SOON!

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While I’ve previously written about the confusion around the term shadow inventory, it is now increasingly used to refer to properties that are delinquent, or in foreclosure, rather than unlisted bank owned homes. Standard & Poors recently posted a well written analysis of shadow inventory, and has jumped to the conclusion it will likely “undo U.S housing price gains”.

They estimate that the current backlog of distressed mortgages will take just under 3 years to clear. They call that estimate conservative… I think it is likely optimistic given that delinquency rates are still climbing. Still it is a reasonable guess. Here in CA we have one million homeowners who are already delinquent, and we seem to be clearing about 25-30k a month based on foreclosures and short sales (which are the only “solutions” that are actually clearing the distress by eliminating negative equity). Divide one million by 30k, and you come to the same 33 month conclusion they reach.

Another interesting part of the report deals with recently cured loans… those no longer delinquent, primarily due to loan modifications. They suggest that these should be included in calculations of shadow inventory, as they have had a nearly 70 percent rate of recidivism – in other words, most become delinquent again because the loan mod failed to address the core problem of negative equity. Seems like a reasonable conclusion to me.

Where I take some issue with Standard & Poors assessment is there conclusion that liquidation will lead to lower housing prices. They come to this conclusion based on the simple idea that an increase in supply will lower prices. There is some truth in that notion. For example we certainly have seen some pricing strength recently due to efforts to slow foreclosures which have clearly constrained supply, while at the same time demand has been stimulated with low interest rates and tax credits.

But this simple supply/demand theory of housing prices fails to adequately consider the fact that housing is highly leveraged, and that price is primarily a function of income and loan terms, and only secondarily supply and demand. Worse, this over-simplistic supply/demand model has led many to believe that foreclosures cause price declines, when in fact it is exactly the opposite… price declines cause foreclosure.

Note that the foreclosure crisis started in earnest in late 2006, however, price declines did not start until lenders removed the ridiculous loan products that enabled people to over pay in August of 2007. At that point we had a precipitous drop in price… not due to foreclosures, but instead due to the fact that people simply couldn’t afford the prices reached during the bubble without those loan products.

Foreclosures and housing supply grew rapidly during the price correction, but those who think the correction was due to either these foreclosures or the growing supply are terribly mistaken. Instead it was simply a correction back to reasonable prices, that buyers could afford based on their incomes and the more traditional loan products that remained available.

Unfortunately the belief that foreclosures and supply caused those declines remains all too common as yet again evidenced by the conclusion of this report. It is a belief that is delaying our recovery as government works to artificially constrain supply by slowing foreclosures, leaving homeowners stranded in prisons of debt, and buyers with little available inventory to choose from.

The reality is that there is a bottom to housing prices. People need a place to live and are willing to spend a certain portion of their income on housing to do so. Investors need to find returns, and there is a point where buying homes as an investment make sense. In many parts of California we’ve returned to those prices levels. And in those areas that have already corrected withholding supply won’t return prices to prior levels… people simply can’t afford it. And contrary to Standard & Poors’ analysis increasing supply is just as unlikely to cause further price declines… people need a place to live, and investors are too desperate for reasonable returns.

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