When an economic bubble bursts, normalcy can only return when price excesses created during the bubble are wrung out of the market. A recession is often the painful but necessary market mechanism that corrects the pricing distortion and consequent misallocation of capital that occurs in a bubble. When government intervention prevents the mispriced asset class from fully deflating, capital continues to be misallocated and economic malaise lingers on. This is the takeaway message from Peter Schiff’s Wall Street Journal editorial:

Schiff defended his thesis on CNBC:

Schiff’s holiday forecasts have become a regular feature on this blog. As long as his prognostications prove to be more right than wrong (as we’ve seen over the last five years) it is a tradition we will continue to observe. I do not find it particularly difficult to appreciate the wisdom in his common sense analysis. In fact, I find it much more difficult to understand how anyone could expect that a problem that was:

• Triggered by Federal government market-distorting social engineering policies intended to permit people to buy homes they cannot afford…
• Enabled by Federal Reserve Bank expanding the money supply and keeping interest rates artificially low to create the illusion of affordability for overpriced housing…
• Fueled with massive deficit spending…

could be solved by:

• More federal government market-distorting social engineering policies intended to allow people to to stay in homes they cannot afford…
• Even more Federal Reserve Bank expansion of the money supply enabling even lower artificial interest rates perpetuating the illusion of affordability for overpriced housing and…
• Fueling it all with even more massive deficit spending.

Definition of insanity anyone?

UPDATE: 1/4/10
Instead of insanity, how about Insana? On Friday last, Ron Insana opined specifically to refute Schiff’s thesis. Basically he is saying there is so much pent-up demand, real estate prices are so low, and the economy is improving enough that the housing market will stabilize here:

^{Cross-posted from “Divided We Stand United We Fall“}

I know this is the case because a good friend recently walked away from his home because there was too much paperwork to fix it and the value of the home wasn’t enough to justify saving it. And my guess is if this is happening in Missouri, it’s happening across the board.

From CNN:

The program is beset with problems, say borrowers, housing counselors and even the president himself.

Loan servicers are overwhelmed by the numbers of homeowners applying for loan modifications or refinancing. Borrowers are frustrated that their paperwork is being lost, and calls are not returned. Administration officials are racing to roll out new features to improve the program.

So what does Obama have to say about it?

Refreshingly, he’s not hiding the fact that there are problems…

“Our mortgage program has actually helped to modify mortgages for a lot of our people, but it hasn’t been keeping pace with all the foreclosures that are taking place,” Obama said last month.

Here’s the thing…at least he’s being honest. This administration is admitting difficulties and promising to revise. A far cry from the rosy, dishonest information we were fed the last eight years. And I’m confident that if they’re publicly acknowledging this, they’re already working on fixes to get this moving again.

One of those fixes might be to light a fire under the banks since it seems like they’re seriously dragging their feet…

Even many of those whose applications are deemed complete say they never receive final approval or are told they can’t be helped now because they haven’t missed a payment.

“We are trying to refinance but are getting the runaround from the bank,” Janeen, a Los Angeles homeowner, wrote on a CNNMoney.com Talkback. “[T]hey keep stalling, missing appointments and forgetting to send us paperwork.”

More as it develops…

Criminal fraud may be one of the most underreported aspect of our current financial crisis.

This is Lagan at ANP.

In this “Road to Ruin” report, former subprime lenders from Ameriquest, once the country’s largest lender, describe a system rife with fraud. They describe how a “by-any-means-necessary” policy pushed employees to cut corners and falsify documents on bad mortgages and then sell the toxic assets to Wall Street banks eager to make fast profits.

It’s happening a lot more now that other loans besides the subprimes are coming due.

From North County Times:

Ward Hanigan, a San Diego investor who purchases foreclosures, agreed that the longer foreclosure procedures produce artificially low inventory numbers, with no recovery in sight for the region’s housing market.

“It’s like an oil pipeline; it used to be five miles long and it’s been stretched three more miles,” Hanigan said. “So now it’s dribbling out until it gets full. And that’s what happening, it’s getting full. And then it’s going to gush.”

Default notices shot to new highs in areas of Carlsbad, Rancho Bernardo and Rancho Penasquitos. On the other hand, notices in foreclosure-prone neighborhoods such as Oceanside and Escondido were below peaks reached earlier.

In fact, one region of Rancho Bernardo saw more default notices in March per 1,000 homes than Oceanside’s 92057 ZIP code —- the most foreclosure-prone neighborhood in North County over the last two years.

But in Southwest Riverside County, there was no indication of a plateau for the most foreclosure-prone areas.

A ZIP code in Temecula shattered the regional high for most default notices in a month with 252 in March, cementing Southwest Riverside’s status as the leader in foreclosures locally. By contrast, the most default notices ever seen in a North County ZIP code was 127 in north Oceanside’s 92057 in July 2008.

No doubt this is happening a lot more in places where speculation ran wild, but in locales like my stomping grounds of Kansas City…prices have remained fairly steady. Maybe it’ll hit us eventually, but maybe we just didn’t have as many people acting irresponsibly and buying more house than they could afford.

Thoughts?

Some are positioning this as a bit of good economic news, and it is…but a bit of perspective is needed.

Not everybody is suffering right now, and if folks can buy homes at a 20 to 30% discount with historically low interest rates, why wouldn’t they? There are a lot of bargains out there right now, and just because people are going bargain shopping doesn’t mean the economy is picking back up. However, it may mean that the economy is at least bottoming out.

NY Times…

The National Association of Realtors said Monday that sales of existing homes increased 5.1 percent to an annual rate of 4.72 million last month, from 4.49 million units in January. It was the largest sales jump since July 2003. [...]

February’s median sales price was up slightly from January, which recorded the lowest median price since September 2002. Prices are down about 28 percent from their peak in July 2006.

In contrast with the housing boom, when buyers took out ever-riskier loans and maxed out their home equity lines, “homebuyers are not over stretching” said Lawrence Yun, the Realtors’ chief economist. “They want to stay within their budget.”

By summertime, sales are expected to get a lift from a $8,000 tax credit for new home buyers included in the economic stimulus package signed by President Obama last month.

Anybody else out there thinking about buying a house right now? What kinds of deals are you seeing?

Do tell.

Remember when I highlighted a 60 Minutes piece back in December that talked about this?

Well, now it’s happening.

From WSJ via Calculated Risk:

Standard & Poor’s Ratings Service on Monday placed its ratings on $552.8 billion worth of U.S. first-lien Alt-A residential mortgage-backed securities issued between 2005 and 2007 on watch for downgrade, saying it sees an increase in losses from the transactions issued in those years.

S&P said it believes continued foreclosures, distressed sales, an increase in carrying costs for properties in inventory and more declines in home sales will further depress prices and lead to higher losses.

And you know what’s next after this? The Option ARMs. And then the commercial real estate market is up to bat.

All told, we’re looking at another trillions more in potential losses.

Yes, trillions.

Get ready for a lot more pain folks. It’s coming.

The topic?

Their favorite restaurants in D.C.

No, of course it’s the economic crisis and the housing situation and the banks and TARP and and and and and and…

Most of the pundit shows really don’t have the time to give complicated topics like the economic crisis the attention they deserve. So what we usually see is a mishmash of simplistic talking points.

Not so with Charlie Rose.

I wish all interviews could be like that.

If you missed CNBC this morning, here’s Rick Santelli going off about Obama’s mortgage bailout plan and the strongly positive reception it got from the traders on the floor:

Frankly, I think this is a sign that the criticism of Obama’s mortgage “relief” plan — especially the argument that it is rewarding irresponsible practices by lenders and homeowners — might just hit a nerve.

Cross-posted from Below The Beltway

The plan is pretty straight forward.

Bankruptcy judges can modify loan terms and lenders will get assistance if the agree to modify existing loans so people aren’t paying more than their homes are worth.

From Bloomberg:

Obama intends to make loan modifications the centerpiece of plan that also gives bankruptcy judges more power to help borrowers keep their homes, said people familiar with the matter. Obama, in Phoenix on the second stop of a two-day swing through the U.S. West, will announce details at 10:15 a.m. local time as he campaigns for his economic recovery package, deputy White House spokesman Jen Psaki said.

“We must stem the spread of foreclosures and falling home values for all Americans and do everything we can to help responsible homeowners stay in their homes,” Obama said yesterday in Denver, where he signed legislation providing $787 billion in spending and tax cuts intended to revive the economy.

Record foreclosures in the past year are swelling the glut of properties on the U.S. market, forcing down home values and undermining homebuilders’ efforts to revive demand and lighten inventory by cutting prices. The housing market lost an estimated $3.3 trillion in value last year and almost one in six owners owed more than their homes were worth, online data provider Zillow.com said Feb. 3. The U.S. economy shrank 3.8 percent in the fourth quarter, the most since 1982.

So where is the money coming from?

The existing TARP funds…

The administration on Feb. 10 presented an overhaul of a $700 billion financial rescue plan, passed last year under former President George W. Bush, to shore up bank balance sheets and revive lending to businesses and consumers. The Treasury Department will use the remaining funds, at least $50 billion, on the housing relief plan to prevent millions of foreclosures, said a Democratic official briefed on the plan.

Here’s CBS’ story and Eric Cantor’s response…

I think Cantor’s point that “93% of America’s families are current on their mortgages” is probably the most telling statement about how he doesn’t get this problem. Just because your mortgage is current doesn’t mean you aren’t seriously struggling to make payments. And it doesn’t mean that your loan isn’t worth more than the value of your house. I bet a fairly significant number of those 93% Cantor cites are in either or both of those situations and not because they’re speculators.

Cantor and the GOP have to get a new schtick if they want to stay relevant. They can’t just be opposed to everything this President is going to do, especially when he’s not even asking for any additional money right now.

Just because President Obama has now signed the gargantuan stimulus bill into law doesn’t mean he’s done addressing the economy. Up next: solving the housing crisis.

The ambitious plan [Obama] was announcing at a Phoenix high school Wednesday was expected to offer government cash to mortgage companies that reduce interest rates — and therefore monthly payments — for homeowners in danger of default, according to several people briefed on the plan. What remained unclear was how the government will decide who qualifies for relief.

One Democratic official familiar with the plan said it also would allow homeowners to refinance their mortgages if they owed more than their homes were valued. Still another section would give bankruptcy judges more authority to change mortgages. That last provision has been opposed by lenders, who said it would add risk and lead to higher interest rates.

This sounds like a classic carrot/stick arrangement. While details haven’t been leaked, the plan would apparently reward lenders who choose to lower interest rates and punish those who don’t by giving bankruptcy judges the authority to change rates as they see fit. Hopefully the President will give us more details today.

Considering the housing crisis is still unbalancing the economy, government action is arguably appropriate. What’s frustrating is that TARP was sold as a solution to bad mortgages. We’ve spent hundreds of billions and put our future prosperity in jeopardy in the hope of improving our current economic situation. But we’re just now taking serious steps to address the central problem of the recession. Obama can’t be blamed for the actions of his predecessor, but I hope he’s actually developed a serious and workable plan.

We’ll know more later today.

As widespread and difficult as the recession has become, it’s easy to forget it all began with a housing crisis. Not only is that crisis still ongoing, it still threatens the stability of our economy.

The Obama Administration is expected within the next few weeks to announce an initiative of $50 billion or more to help strapped homeowners. But with 1 million residences having fallen into foreclosure since 2006, and an additional 5.9 million expected over the next four years, the Obama plan — whatever its details — can’t possibly do the job by itself. Lenders and investors will have to acknowledge huge losses and figure out how to keep recession-wracked borrowers making at least some monthly payments.

In a typical economy, home loans are a stable business because they come with excellent collateral. If the homeowner defaults, the bank reposes and sells the home, recouping their investment if not turning a small profit. Problem is, the housing crisis isn’t just about an inordinate number of bad loans, it’s about the collapse in home prices. Banks can reposes homes but they can’t unload them except at huge losses.

The situation is bad, but banks still don’t seem willing to make the hard, necessary choices.

[T]he industry’s contention that it has done as much as possible to limit foreclosures seems hollow. Some statistics it cites appear to be exaggerated. Even pro-industry figures such as Steven C. Preston, a Republican businessman who headed the Housing & Urban Development Dept. late in the Bush Administration, concede that many lenders have dragged their heels. “The industry still has not stepped up to the volume of the problem,” Preston says. One program, Hope for Homeowners — which Bush officials and banks promised last fall would shield 400,000 families from foreclosure — has so far produced only 25 refinanced loans.

Part of the problem is banks are worried that, because of accounting practices, refiguring the value and the mortgage for even one home in a region would require them to refigure the value for all the region’s homes. That could give the banks an on-paper loss of well over one trillion dollars. Obviously, that’s a problem. But sitting tight and praying for a miracle rebound in housing prices in the middle of a bad recession hardly seems to be a smart strategy.

I’m not sure what needs to be done. I thought the $700 billion in TARP money was supposed to help rectify these problems. But the bill’s rush through Congress and mismanagement by the Bush Administration derailed what was originally supposed to involve a heavy dose of bad mortgage bailouts. So far, we’ve seen little bang for our billions.

Even the massive amounts scheduled to be spent on economic stimulus are not going to pull us out of recession so long as the housing crisis persists. It’s time for banks to suck it up and make the hard choices. Unscrupulous lenders and careless homebuyers conspired to create this mess. Homeowners can’t be the only one’s expected to suffer the consequences, especially when it’s the banks getting the lion’s share of federal aid.

Liquidity Crisis 2.0 is right around the corner.

From WSJ:

Nearly $750 billion of option adjustable-rate mortgages, or option ARMs, were issued from 2004 to 2007, according to Inside Mortgage Finance … Rising delinquencies are creating fresh challenges for companies such as Bank of America Corp., J.P. Morgan Chase & Co. and Wells Fargo & Co. that acquired troubled option-ARM lenders.

As of December, 28% of option ARMs were delinquent or in foreclosure, according to LPS Applied Analytics … An additional 7% involve properties that have already been taken back by the lenders. … Just over half of subprime loans were delinquent, in foreclosure, or related to bank-owned properties as of December. The nearly $750 billion of option ARMs issued from 2004 to 2007 compares with roughly $1.9 trillion each of subprime and jumbo mortgages in that period.

And here’s the scariest part…

Nearly 61% of option ARMs originated in 2007 will eventually default, according to a recent analysis by Goldman Sachs.

61% of $750 billion? What’s that math?

Oh yes, I’ve got it: this = really + bad

Looks like the cramdown provisions will be taken out of the stimulus bill, but this is frankly puzzling to me. Because Americans need to have mechanisms to renegotiate the values of their homes, and thus their mortgages. And every single person I’ve read on this subject has said that this will result in fewer foreclosures which means fewer toxic mortgages and banks will be able to stabilize their balance sheets.

Why would Republicans be against that?

Greg Sargent reports…

As I noted below, anonymous House Dem staffers told Politico that Nancy Pelosi and the House Dem leadership were dropping from the bill the so-called “cram downs,” which give judges the power to renegotiate mortgages on terms that are better suited to homeowners who are in trouble. House liberals wanted this, and it was unclear why the leadership had done this.

I’ve just confirmed from a senior House Dem aide that the House leadership did this at the behest of Obama aides, who asked the leadership to chuck the provision. This is the second such move: It comes after the news this morning that Obama had personally appealed to Pelosi to drop family planning funds for low-income people from stim package — also to placate Republicans.

Do know that the speculators who bought multiple homes with internest only loans hoping to flip them for profit can do currently do cram downs on their multiple properties.

Again, a curious request by Republicans, but another move by the Obama administration to build consensus for the bill.

More as it develops…

And it’s set to get worst before it gets better.

From WSJ:

WASHINGTON — More than 2.3 million American homeowners faced foreclosure proceedings last year, an 81% increase from 2007, with the worst yet to come as consumers grapple with layoffs, shrinking investment portfolios and falling home prices.

Nationwide, more than 860,000 properties were actually repossessed by lenders, more than double the 2007 level, according to RealtyTrac, a foreclosure listing firm based in Irvine, Calif., which compiled the figures.

Moody’s Economy.com, a research firm, predicts the number of homes lost to foreclosure is likely to rise by another 18% this year before tapering off slightly through 2011.

Still, foreclosures — which keep breaking records going back 30 years, according to the Mortgage Bankers Association — are likely to remain well above normal levels for years to come, and that will continue to keep home prices from rebounding.

The current legislation we’re hearing about that will allow homeowners to renegotiate the value of their mortgage will help some, but that’ll take at least 6 to 9 months to really get moving…and people will have to miss payments in order to take advantage of that. That won’t seem very fair to most Americans, so I wonder if they can even pass it.

More as it develops…

This is a pretty big reversal, but I can understand why the big banks are starting to figure out that helping people adjust their debt is preferable to foreclosure.

From CNBC:

Until now, banks have been ardently opposed to the proposal, which key Democratic lawmakers hope to attach to President-elect Obama’s economic stimulus legislation.

The so-called “cramdown” proposal has been backed by Democrats over the past year as a potential solution to the foreclosure crisis.

Under the change, bankruptcy courts could alter the terms of mortgages, subject to certain conditions:

1) Only mortgages entered into prior to the date of enactment of the bill would be eligible for the treatment. All loans, and not just subprime, are eligible.

2) Borrowers have to show they made a “good faith” attempt to work with the lender before considering this bankruptcy provision. Bankruptcy cannot be the first option, and borrowers have to prove it wasn’t.

3) Bankruptcy judges can strip away a lender’s credit or rights if they violated the Truth in Lending Act or other state and federal laws.

this is the type of idea that can get housing prices back to the levels they need to be so a recovery can happen sooner rather than later. The last thing we need is another massive mortgage failure and with higher priced homes and business real estate starting to default, this legislation needs to pass immediately.

Interest rates are at historical lows so many homeowners are calling banks and trying to get in on the action.

Only problem? Housing prices have fallen so much so that now people owe more on their homes than they’re worth…making refinancing an impossibility.

From Miami Herald…

In South Florida, four in 10 homeowners who bought or refinanced over the past five years owe more on their home than it is worth, according to sales and mortgage data analyzed by Zillow.com, a web-based real estate services firm. Many of them chose adjustable-rate loans and other expensive mortgages because that was the only way they could afford the payments.

Justin Miller, a broker with Resource Mortgage Group in Plantation, said the current rates, which essentially amount to ”free money,” are, in a sense, unavailable to those most in need.

”This is only putting people who are in a good position in a better position,” Miller said.

So let me get this straight…

• …bankers put together trillions of dollars worth of questionable loan packages for people in every single income bracket…
• …new rules allow the bankers to immediately repackage the debt and sell it off to other banks…
• …banks start making A LOT of money off of this…
• …so more questionable loans are created and more debt is sold off…

MEANWHILE…


• …people start defaulting on those loans…
• …bankers continue to sell the mortgages, but they are quickly becoming too toxic…
• …home prices start dropping because foreclosures are happening left and right…
• …thus creating a credit shortage…
• …thus crippling the economy…
• …thus necessitating the need for the federal government to pump nearly a trillion dollars into the system…
• …thus forcing the Fed to drop interest rates so, among other things, people can refinance their homes with the new money available…

HOWEVER!


• …only the people who paid enough equity into their homes to break even are now allowed to refinance because the “market” for homes has decided that our homes aren’t worth as much now? And who decides the value? Oh yes, the people hired by the banks who assess the value of the home. But let me ask you all something…how many of homeowners, at the time of purchase, had the value of your home come back at the exact same amount as the loan? Because I did…exactly. You know why? The bank tells them the value of the loan and wants to make sure that your property isn’t valued for more than the loan so they can keep you at the interest rates they signed the loan at!

How do I know all of this?

Because I recently tried to refinance my home and came face to face with this backwards logic.

Mind you, I’m not in any trouble financially, but because the values in my area had dipped a little bit I was unable to take advantage of these lower rates without coming up with a big pot of money to put towards the equity.

The irony here is that ALL of these banks don’t even have hardly any money to begin with. They merely had a little bit of cash and the blessing of the Fed to create more money out of thin air to lend it. That’s right, banks just create money they don’t have. That’s why you’re seeing all of these banks fail…because the amount of loans they created out of “fake money” was defaulted upon and exceeded the amount of actual cash reserves they had.

And the double whammy is they they get to charge a fixed interest rate on this fake money and we can’t do ANYTHING about it. And this was an interest rate that was gamed in the first place because the value of the property was determined before the person assessing the value even got there. Because, let’s remember, the value was created by the loan, not the actual market around the home.

Folks, I’m starting to become convinced that our entire banking system is predicated on systemic fraud and not one single bank has enough skin in the game to actual foreclose on ANY home since they never even had the money to lend in the first place.

And to that point, does anybody know of any legal precedent that basically states that a bank has to actually have the money they say they’re lending in order to lend it? Because that would seem to be the basis for all property law. And if they don’t have the money, if they just created it out of thin air, it would seem that every single homeowner can essentially tell the bank that if they don’t refinance they’re home, they will sue them to take their property back from the bank because the bank didn’t have any right to make the loan in the first place.

The economy apparently doesn’t realize this is a season of giving. The latest data present us with two major Grinches. 1) the 0.5% GDP decline in the third quarter has been confirmed and some expect as much as a 6.0% GDP decline in the fourth quarter. 2) Median home prices have suffered the worst decline since the Great Depression as existing home sales dropped 8.6% last month.

What worries me about the duel problems of a recession and a collapsing housing market is that our recovery will be hampered by our workforce’s immobility. If people are stuck in homes they can’t afford to sell, they can’t follow the jobs. And if new industries can’t attract the right labor, they won’t grow as quickly or may not succeed at all.

This worry is overly negative to be sure, but I do believe that a dynamic, mobile workforce is the key to our success in the global marketplace. When we as a culture started treating one of our most essential commodities (the abundance of quality, reasonably priced housing) as a get-rich-quick investment, we did more than wreck the banking industry. We wounded one of the great advantages of American existence: the ability to get up and go where the money is.

We will recover, but the combination of a recession and a poor housing market will make turning the economy around all the more difficult.

The subprime mess was just the beginning.

Because this time it’s not the low income mortgages.

This is truly frightening stuff folks. I can’t help but think it’s going to get REALLY bad before it gets better.

As we all know, no sector of the economy has been hit by the recession as hard as the housing market. Now, new numbers indicate that American home values have lost $2 trillion in value during the first three quarters of 2008. Around 11.4 million homeowners are now “underwater” on their homes, owing more than their homes are worth.

For financially sound homeowners who are not planning to move, a decline in home values is more of an annoyance than a crisis. Values will rise again eventually. But for homeowners who’ve lost jobs or bought too expensive of a home to begin with, being underwater in a home loan is a major problem. If you need to sell your home but can’t sell it at a price that will cover what you owe on the mortgage, you’re financially trapped.

Unfortunately, our housing market got caught in a cycle of rampant speculation which drove prices above sustainable levels. There is no simple solution for homeowners who bought at the top of that cycle and are now burdened with more debt than assets. But finding a solution will undoubtedly be a focus for the new administration.

From Reuters:

With a pretty red-brick downtown lined with stores, good schools and a railway line to nearby Chicago, Hinsdale has been popular among wealthy doctors, lawyers and executives.

It has also seen a 37 percent jump in foreclosure filings this year, according to research firm RealtyTrac, and local data shows the average home sale price has fallen to $1.07 million from $1.15 million in September 2007.

The consequences of years of devil-may-care mortgage lending during the U.S. housing boom were first felt among America’s poorer home owners. But if that is where it started, it did not stop there.

“People think this is just a lower-income problem,” said Mabel Guzmann, a Century 21 realtor in Chicago. “It’s not.”

And let’s be clear here…it takes a lot more of the subprime foreclosures to equal just 1 of these higher income foreclosures. So when areas like this are seeing a 37% spike in foreclosures, I hope we can all agree that people from all walks of life have acted irresponsibly too.