VALUES TAKE A DIVE
PART 2 of 2
Jon Christian Ryter
December 20, 2008
As the solvency of the US banking system continued to be threatened by Treasury Secretary Henry Paulson's inept mismanagement of the $800 billion taxpayer-financed bank bailout fund, and the lack of liquidity in the consumer credit market because the banks who received bailout money specifically earmarked to jumpstart the consumer credit markets, used the money to offset their own subprime loan losses, or to buy other banks hard hit by their own subprime losses.
With fewer Fed dollars available for consumer credit, the economy is contracting at a time when consumers should be spending. Retail stores that usually hire more at this time of the year did not hire. Many, in fact, began their after-Christmas layoffs before the holidays. Unemployment is rising. Mom and pop companies that usually pick up the slack, hiring experienced help left jobless by the factory-exodus to the third world couldn't afford to hire since their sales are impacted by the credit-crunch, and many of them are paying their company bills with their personal credit cards because they can't get short term credit from their local banks.
Completing the vicious circle, the newly unemployed have now joined the subprime mortgage defaultees as casualties of the housing crisis. Only, the new foreclosure inductees aren't defaulting on subprime mortgages. Over 50% of all new foreclosures are homes financed with conventional, fixed rate mortgages. Many of them are homes purchased 10, 20 or more years ago. Sadly, homes with no more than 5 or 10 years left on the mortgage that, in the past, could easily have been refinanced with much lower, more manageable mortgage payments, are arbitrarily declined for refinance because the home owner is now unemployed. (When Congress drummed up consumer support for the bailout bill, they promised that the money would be used to keep homeowners in homes threatened with foreclosure and not to fatten the already "fat" fat cats.) The first $350 billion of the Emergency Economic Stabilization Act of 2008 was to fund the Troubled Asset Relief Program. TARP was legislated to buy the toxic subprime mortgage securities from the investment banks which issued them, restoring confidence to the industry and freeing up capital to finance new homes and infuse the credit markets with capital which was to be loaned to consumers, rekindling the failing economy.
Instead, the economy is staggering under increasing joblessness. Escalating layoffs across the broad employment horizon are fueling a troublesome recession that is looking more and more like 1930. Rising unemployment—over 1.9 million lost jobs in the United States in 2008—is pushing large numbers of previously stable mortgage holders to the precipice of personal financial ruin, adding to the economic morass of the nation.
Increasingly, the mortgage holders who are now impacting the foreclosure statistics are middle class homeowners with traditional fixed rate mortgages who are now living paycheck to paycheck as they scramble to stockpile cash reserves in anticipation of joblessness. Many of them, with good credit scores, are now finding their revolving lines of credit canceled or suddenly unavailable as banks tighten credit. Many homeowners with ARMs are finding it hard to refinance even though the $100 billion of the bank bailout funds were supposed to be specifically set aside to help those with toxic mortgages refinance to fixed rate mortgages.
The problem with securing that promised refinancing is the rapidly declining value of homes across the land. Artificially-high home prices peaked in late 2006 and began the slow downward spiral in 2007 with the first reports of inordinate numbers of foreclosures of minority-owned homes in urban and urban-suburban areas. The housing price boom, fed by heavily-leveraged "no-down-payment" loans and non-qualifying HUD loans to credit-unworthy buyers with histories of ignoring their debt obligations created an unrealistic demand for homes that triggered skyrocketing prices.
Peter Schiff, president of Euro Pacific Capital in Darien, Connecticut noted recently that "...[w]e will never see these prices again in our lifetime...These were lifetime peaks." Susan Wachter, a professor of real estate at the University of Pennsylvania noted that, in the 1930s, the loss of home values were the result of economic forces. Today, she said, the housing price collapse is the cause of the nation's economic troubles, not the effect of it. "Homes are different than other goods and services," she said. "The fragility of our banking system is tied to the value of our homes...If we have another 20% decline in prices, we'll need another bailout of banks similar to what we just did."
Wachovia (Wells Fargo) optimistically sees the crisis as half full, not half empty. "The one saving grace," they said, "is the population is growing by 3 million people a year. They need to live somewhere. That means more roofs." In reality, it means more roofs in 2 or 3 decades. Today's homeowners are drowning as value of their homes are shrinking well below the mortgage balances making refinancing toxic mortgages an impossibility.
Ask 57-year old Rick Wallick of Maricopa, Arizona. In Oct., 2005, Wallick made a $70 thousand down payment and purchased his new 3-bedroom home for $200 thousand. Earlier this year the software engineer, who is disabled, put his home on the market in order to move back to Oregon to care for an ailing family member. His home will not sell. Why? Because the mortgage is $200 thousand and his home is now appraised at $80,000. "We're so far underwater it's not funny," Wallick noted. His initial investment in that home, $70,000, is lost. The home will be foreclosed in January.
Today, roughly 90% of all of the homeowners in Mountain House, California woke up one day last month and realized the value of their homes were in freefall, averaging about $122 thousand less than the balance of their mortgages. According to FirstAmerican CoreLogic, over 7.6 million homes across the nation are now officially "underwater"—the homes are worth far less than the mortgages. Another 1.2 million homes are sitting on the brink if something does not happen quickly to stop the decline in home values. (Most of these 8.8 million homes were sold during the last five or six years.) The asking prices were inflated by realtor-builders, or artificially-stimulated by market demand. In any event, they simply weren't worth the asking prices that eager buyers were willing to pay, and as the housing market continues to weaken throughout the balance of this decade, home values will continue to correct—regardless of the mortgage balances—until they plateau at pre-2000 values, with homeowners owing more to the bank than the home is worth, creating problems for the banks' asset to debt ratios, and making it more difficult for those banks to loan money to consumers. Thus, the problem is going to be felt by every consumer everywhere and not just those with "underwater" mortgages.
What that means is that consumer spending will continue to shrink as the money supply continues to contract. Home prices will continue to drop. Consumer spending will continue to drop proportionate to the shrinking home values causing more bank failures because, on paper, there will be growing gaps in their asset-to-debt ratios because the assets that guaranteed their debt will be diminished by whatever amount the collateral is reduced by home value corrections.
Unless the bailout money is used to physically purchase those underwater mortgages from the banks and assign them to an asset management company like the government-owned Resolution Trust Corporation, any money given to those commercial banks from the bailout fund to jumpstart the economy will be used by those banks to offset their asset-debt ratios.
Looking at the escalation of home prices in ten metropolitan urban/suburban markets that saw home price rise by close to 100% from January, 2000 to the peak of the housing boom in December, 2006, we see that Miami, Florida led the price boom at 178%. Next was Los Angeles, CA at 174%; followed by Washington, DC at 150%; San Diego, CA at 140%; Tampa, Florida at 138%; Las Vegas, NV at 134%; Phoenix, AZ at 127%; San Francisco at 118% and New York at 115%. Nationwide, home prices have fallen an average of 19% from their peaks in Dec. 2006. Statistically, they need to drop another 17% to reach their traditional relationship to household income. From 1950 to 1999 home buyers could qualify for a home priced at up to three times their annual income. In 2006, the average household income in the United States was $66,500. That means the average home buyer in the United States could afford a home priced at $199,500. Instead, they bought homes priced at least a third more than they could afford. The average price of a home sold in America in 2006 was $301,000.
Mortgage companies increasingly sold toxic mortgages from 2002 to 2006 that offered the home buyer "optional payments." Twenty-nine percent of home buyers in 2005 opted to pay interest only, with many of them paying only part of the interest due for one, two or more years, with the balance of the interest tacked on the back-end of the loan. Half of the mortgages sold in 2006 were closed with little or no documentation on the incomes and job stability of the home buyers, virtually qualifying them with no evidence that they could afford the mortgage they were buying Most of those homes were sold with either no down payment, or token down payments. No down payments, or low down payments with Arms gave home buyers tremendously-increased buying power that exceeded their ability to pay for the mortgages they were buying.
America has been notoriously weak on learning from history. Anyone who has studied the Great Depression knows the 1920s was the decade of prosperity. The postwar economy exploded as US factories churned out goods for a world recovering from WWI, with most of the factories of Europe still silent from the bombs of war. There was a housing bubble in 1923-1929 just like the housing bubble from 2000-2006. Banks expanded the money supply and relaxed lending standards to give every American family a shot at the great American dream?home ownership. Typically home buyers in the 19920s put up 50% of the asking price and were able to finance the balance of the mortgage for up to 5 years.
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In 1929, the housing bubble burst with the collapse of the stock market. By the spring of 1930 millions of out-of-work factory workers lost their homes as banks scrambled to find enough money to keep their doors open—just as banks, are doing today. National Association of Realtors chief economist Lawrence Yun told the mainstream media in a recent interview that home prices will continue to fall through 2009. Yun, however, predicts that within three years home prices will return to their 2006 level. The return to the bubble may happen, but not in three years. It will take up to five years for the housing industry to stabilize—providing the bank bailout money is actually used to purchase the underwater mortgages and get those "liabilities" off the ledgers of the banks who are struggling to maintain fiscal solvency because of them. For part one click below.
Click here for part -----> 1,