Foreclosures: The Next Wave is Coming

From the Washington Post, New Round of Foreclosures Threatens Housing Market:

The housing market is facing swelling ranks of homeowners who are seriously delinquent but have yet to lose their homes, and this is threatening a new wave of foreclosures that could hit just as the real estate market has begun to stabilize.

About 5 million to 7 million properties are potentially eligible for foreclosure but have not yet been repossessed and put up for sale. Some economists project it could take nearly three years before all these homes have been put on the market and purchased by new owners. And the number of pending foreclosures could grow much bigger over the coming year as more distressed borrowers become delinquent and then, if they can’t obtain mortgage relief, wade through the foreclosure process, which often takes more than a year to complete.

This is what we call “shadow inventory.” This shadow inventory will take years to work through, and as this growing backlog of inventory hits the market, housing prices will naturally fall.

The following is a graphic of the percentage of homeowners who are seriously delinquent on their mortgage. As you can see, serious delinquencies are still rising.

Rising Repossessions

The rate at which J.P. Morgan Chase seized properties, for example, peaked in the middle of 2008 and fell steadily last year, according to a February investor report. But the bank expects repossessions to increase this year, nearly doubling to 45,000 by the fourth quarter.

“Some of the positive housing data may not be signaling a true turning point, as many servicers are holding back on foreclosures and the related houses are not yet being offered for sale,” said Diane Westerback, a managing director at Standard & Poor’s. Westerback said it could take 33 months to clear the backlog.

Repossessions are likely to rise in 2010, after a lull in 2009, due to the expiration of temporary government stop-gap measures. The lackluster response to massive government stimulus shows that the housing market will be unable to experience organic growth once stimulus is removed.

It’s Prime Time

Today’s delinquent borrowers, for the most part, differ in a key regard from those who were caught up in the surge of defaults in 2008. That earlier wave, which precipitated the financial crisis, consisted largely of subprime borrowers who defaulted when their risky loans became unaffordable.

The borrowers in trouble now are, for the most part, people who have better credit and safer loans and have become delinquent because they’ve lost their jobs or are dealing with other economic setbacks, economists said. More than 75 percent of the borrowers who are now seriously delinquent — meaning they have missed at least three monthly payments — have traditional prime loans, according to First American CoreLogic. Most of these borrowers have not made a mortgage payment in six months.

These borrowers are among the most difficult to help. Homeowners with economic troubles such as extended unemployment often cannot make even reduced mortgage payments. And the longer borrowers stay delinquent, the more difficult it is to fashion a mortgage relief plan for them.

The rising delinquencies amongst prime borrowers shows why jobs are central to any economic recovery. It’s just common sense, but sustainable home price appreciation is only possible with income growth. Unfortunately, we real wages have been stagnant for decades.

The biggest misconception about housing is that it is a great investment in the long run. Most people would probably be shocked if I told them home prices appreciated an average of 0.2% in real terms from 1900-2000. At best, homes are a hedge against inflation.

There is really no solution to the housing crisis other than simply allowing prices to fall. Yes this will be painful for Baby Boomers who have no savings to speak of besides the equity in their homes, but the alternative of massive inflation is far worse for everyone. Let’s just hope the government doesn’t interfere too much with the foreclosures coming down the pipeline so that there can be some genuine price discovery in housing.

The Phantom Economic Recovery Continues

The propaganda about an economic recovery is reaching epic levels. It has gotten to the point where the government must conjure up ridiculous excuses for our economic perils, such as the pernicious phenomenon known as…. winter.

By my calculations, the phantom economic recovery has been dragging on for a year. In that time frame, economic conditions have clearly worsened. Fundamentally, and perhaps most prosaically, there are no jobs. Yet we are to believe the economy has recovered simply because the government says so. It baffles me that anyone still listens to the same people who led us off the cliff in the first place.

Recent economic reports suggest that the economy is still weak, and that this weakness is likely to persist.

Record Monthly Budget Deficit

The government just announced a record $221 billion dollar deficit for February, which brings the total deficit for the first 5 months of the fiscal year to $651.56 billion dollars. This puts us well on track to exceed last year’s record $1.4 trillion dollar deficit. There is no doubt in my mind that we are on our way to fiscal ruin.

Government spending is fine as long as it helps the average person without imposing burdens on the taxpayer that exceed benefits. Unfortunately, the government has irresponsibly spent trillions of dollars of taxpayer money with the only measurable effect being outsized bonuses for bankers. Of course these bonuses were well-deserved, since according to Obama, resident banking gurus Dimon and Blankfein are “savvy investors.” Sureeee. Savvy investors that can’t survive without billions of dollars in implicit and explicit government guarantees. But I digress.

Foreclosures Slowing?

The latest spin is that foreclosure filings are increasing at a slower rate. Foreclosures were only up 6% from last year in a clear sign that “green shoots” are sprouting left and right.

While the 308,524 foreclosure figure is pretty horrific historically (for some perspective, 405,000 households lost their homes in 2007), the figure is actually skewed since many of the 1 million homeowners who qualified for a temporary modified mortgage under the Home Affordable Modification Program (HAMP) will not receive permanent modifications. We should be seeing many of these homes hit the market in the months ahead.

Unemployment Remains Elevated

Today the Department of Labor announced that 462,000 individuals filed for initial unemployment claims. The 4-week average increased by 5,000 to 475,000 in a sign that the unemployment picture remains weak.

Small Businesses Remain Bearish

The index of small business optimism fell in February to 88, with small business owners citing poor sales as their main concern. Due to the weak sales environment, more firms announced plans to cut jobs than to add jobs.

The optimism index has held below 90 for an unheard of 17 straight months, which in the past has suggested a recessionary environment.

It’s logical to pay attention to what small business owners are saying, especially since they are responsible for over half of the employment in America. Because of their effect on hiring in America, and since in the real world a recovery cannot occur without an increase in hiring, small business owner sentiment serves as a reliable leading indicator.

At the very bottom of the 1982 recession, a net 47% of small business owners saw improving business conditions ahead. Currently, a net -9% see improved business conditions in the months ahead. It’s pretty clear that the outlook is bearish on main street.

The fairy tale that our economy is improving truly defies logic. While another round of “less bad” economic statistics can potentially create the illusion of a recovery in the months ahead, I believe by the end of 2010 and into 2011, it will be nearly impossible for anyone (besides the government) to deny that we are in one serious economic downturn.

Mass Dollar Bullishness- A Contrarian’s Dream

There’s nothing I love more than being a contrarian when sentiment reaches extreme levels. In the case of the dollar, extreme dollar bullishness amongst investors is signalling a potential turn. This is obviously very bullish for gold, which is off only 8% from the inception of the power dollar rally. From Bloomberg:

Investors are the most bullish on the dollar since the collapse of Lehman Brothers Holdings Inc. on speculation the U.S. economy will expand at a faster pace than in Europe and Japan, a survey of Bloomberg users showed.

The world’s reserve currency will rise over the next six months, according to respondents in the Bloomberg Professional Global Confidence Index. Sentiment toward the U.S. economy rose among the 1,612 participants in the survey, even as the outlook for global growth fell for a second consecutive month.

The dollar strengthened this month to the most since May against the euro on concern Greece’s struggles to close the biggest deficit in the European Union as a percentage of gross domestic product will weigh on the region. The Federal Reserve will raise interest rates before the European Central Bank and Bank of Japan, according to the median estimate of more than 30 economists surveyed by Bloomberg.

The high for the index was the 68.86 reading in September 2008, when Lehman’s bankruptcy drove investors to the dollar as a refuge. The Bloomberg Correlation-Weighted Index for the dollar rose the next two months.

Let’s see what happened the last time dollar bullishness reached extreme levels in September 2008.

The dollar rallied quite powerfully from 76 to 88 on the dollar index over a 6- month period. As most of you will recall, September 2008 was a very volatile period in markets when companies were falling left and right. “Safety” became paramount, which to investors meant buying U.S. dollars.

The subsequent multi-month decline in the dollar made clear that the structural issues of the dollar haven’t been resolved.

Now let’s see what gold in this time frame. Since bottoming in September 2008, gold rose about 50% into March 2009, rising along with the dollar. Keep in mind that the stock market and real estate were getting crushed into March 2009.

Gold lived up to its historic role as a safe haven during the worst of this ongoing crisis. However, unlike the dollar, gold continued to rise into 2010.

European Debt Crisis Bullish for Dollar?

The dollar has been touted recently as a safe haven from the problems of the Eurozone. Since the debt problems in Greece are so huge, the Euro has been described as a currency to avoid. After all, Greece accounts for a staggering 2% of the European Union’s GDP.

In contrast, the bankrupt state of California accounts for over 13% of America’s GDP. New York just recently announced increased borrowing and draconian cuts to plug their huge budget gaps. How can the dollar be a safe haven with these structural fiscal problems from our largest states? Well it’s not. The media has simply been successful in creating a convenient red herring.

There will be a time in the next few years when the volatility in the dollar and gold shocks people. We have been shoving the debt problem in America aside for far too long, and the day of reckoning is approaching.

China Buying U.S. Treasuries Over Gold?

This is one of the more amusing articles I’ve read in some time. From the headline of the Reuters article, China says committed to U.S. debt, wary on gold, I was sure China announced some kind of monumental shift in policy. But alas, upon reading the article, I realized China was playing the same game Soros did when he called gold “the ultimate bubble”- before, of course, doubling his holdings of gold and investing $75 million dollars on a gold mining company. From Reuters:

“The U.S. Treasury market is the world’s largest government bond market. Our foreign exchange reserves are huge, so you can imagine that the U.S. Treasury market is an important one to us,” Yi Gang, head of the State Administration of Foreign Exchange (SAFE), told a news conference.

Yi dampened hopes of gold bulls that China might be itching to add to the 1,054 tonnes of the metal in its reserves.

On a 30-year horizon gold was not a great investment, he said, and China would simply drive up prices if it piled into the market.

“It is, in fact, impossible for gold to become a major investment channel for China’s foreign exchange reserves. I have 1,000 tonnes now, and even if I doubled that holding, according to current prices, that would be about $30 billion,” Yi said.

Yi Gang is actually wrong. Gold was a horrible investment for a 20-year period, not 30. He should know, since China has increased their gold reserves from 454 to 1054 tons since 2003- a period in which gold has risen from $340 dollars an ounce to $1,120 dollars an ounce. Indeed, what a “horrible” investment.

I don’t know what Yi Gang told us that we don’t already know. Of course gold, which currently makes up 1.5% of China’s forex reserves, can’t make up a significant portion of China’s portfolio. (For some perspective, France and Germany hold over 64% of their reserves in gold). But that’s exactly what makes the outlook for gold so bullish, since even a modest increase of gold’s allocation in China’s portfolio would send gold prices to the stratosphere.

It’s interesting that people are so quick to latch on to what China says, and not what it does. China is not only adding to its gold reserves, but it has pared its holdings of U.S. treasuries. No one in their right mind would own U.S. debt for the long run. It’s going to be pretty clear in the years ahead that gold trumps U.S. Treasuries as an investment.

Government to Homeowners: Please Sell at a Loss!

From Obama’s plan to ban foreclosures to the perpetual extension of “temporary” homebuyer tax-credits, I think it’s safe to say government intervention in housing is getting ridiculous. In the latest example of government largesse at the expense of taxpayers, the government is proposing to dole out cash to all parties to incentivize short sales. From the New York Times, Short-Sale Program Will Pay Homeowners to Sell at Loss:

In an effort to end the foreclosure crisis, the Obama administration has been trying to keep defaulting owners in their homes. Now it will take a new approach: paying some of them to leave.

This latest program, which will allow owners to sell for less than they owe and will give them a little cash to speed them on their way, is one of the administration’s most aggressive attempts to grapple with a problem that has defied solutions.

For the administration, there is also the concern that millions of foreclosures could
delay or even reverse the economy’s tentative recovery — the last thing it wants in an election year.

Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.

What the government doesn’t realize is that incentivized short sales will, ironically, bring down home prices. Essentially, short sales “lock in” lower home prices, pressuring surrounding home prices in the process. If the sole purpose of government intervention is to keep home prices elevated, then the government should take on a hands off approach, since banks are already doing such a great job of perpetuating the myth of stabilizing home prices.

What Benefits?

Under the new program, the servicing bank, as with all modifications, will get $1,000. Another $1,000 can go toward a second loan, if there is one. And for the first time the government would give money to the distressed homeowners themselves. They will get $1,500 in “relocation assistance.”

Should the incentives prove successful, the short sales program could have multiple
benefits. For the investment pools that own many home loans, there is the prospect of getting more money with a sale than with a foreclosure.

This doesn’t make sense to me. Short sales by definition are more beneficial to servicing banks than foreclosures- that’s the whole logic behind them. It’s doubtful that $1,000 dollars will have much effect on banks’ incentive to complete short sales on homes that are worth, on average, hundreds of thousands of dollars.

What will likely happen is that the government will be handing out money to multiple parties on short sales that would have occurred anyway, which is idiotic, but entirely in line with what I’ve come to expect from the government.

It’s interesting that the government has essentially reversed its policy of forestalling foreclosures. It’s pretty clear the government now realizes there won’t be a rebound in home prices anytime soon. If the government thought home prices would recover, they would be doing everything to keep people in their homes so that the rise in home values would improve equity positions. A supposedly improving employment picture would further decrease the likelihood that homeowners would foreclose.

All of these projections are straight from fantasy land, and the government knows it, since they’re the ones who manipulate government statistics. Read between the lines and realize that a housing recovery is not forthcoming.

Marc Faber: Bailouts in Europe and U.S. Coming

Marc Faber is characteristically bearish. He believes the impending crisis will be severe because of our incredibly high debt levels. Marc Faber predicts 30-50% of tax revenues will go to debt servicing- which will obviously lead to a reduction in services and stagnant growth.

“Everyone should accumulate gold over time.”

Unemployment Rate Holds Steady at 9.7%

From the BLS:

Nonfarm payroll employment was little changed (-36,000) in February, and the unemployment rate held at 9.7 percent, the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and information, while temporary help services added jobs. Severe winter weather in parts of the country may have affected payroll employment and hours; however, it is not possible to quantify precisely the net impact of the winter storms on these measures.

There were no huge surprises in this report. One thing to keep in mind is that the government is currently hiring a record number of Census workers. 15,000 census workers were hired in January, and the government plans to hire over 1 million temporary census workers over the next couple of months. So a temporary boost in employment in the next couple of months can be expected.

While the Federal government is adding temporary jobs, states and local governments are continuing to shed jobs. 25,000 state and local jobs were lost in January. With budget crises in states reaching a crescendo, expect public sector unemployment to increase.

Keep in mind that we have shed about 8.5 million jobs in this recession and that we must start adding jobs on a consistent basis to experience an economic recovery. We are far from a recovery, and the longer we remain in a weak labor environment, the greater chance we have of experiencing what will seem like a sudden drop in economic activity.

Part-Time Workers for Economic Reasons

The number of individuals working part-time for economic reasons increased by 475,000 to nearly 8.8 million. This follows a January report which saw a substantial dip in the number of people working part-time for economic reasons. This suggest the labor environment is still weak, and that firms are still very hesitant to bring on full-time workers.

U-6 Unemployment Rate

The U-6 unemployment rate, which is the broadest measure of unemployment, rose to 16.8% in February from 16.5% in January. In each of the previous 2 recessions, we never maintained a 10% U-6 rate for more than 11 months. In the current recession, we have seen double-digit U-6 rates for 21 months. This is not good for the prospects of an economic recovery.

I am seeing very little evidence that suggests we are experiencing an economic recovery. We will likely muddle along the first half of 2010 before really seeing some fireworks in the 2nd half of the year into 2011.

Pending Home Sales Hit 9-Month Low

The short-lived economic “recovery” sure is running out of steam. I guess over $10 trillion dollars in in stimulus and pledges on behalf of taxpayers just doesn’t buy what it used to. From Finance Yahoo, Pending home sales fall 7.6 percent in January:

The number of buyers who agreed to purchase a home fell sharply in January, a sign that demand for housing is sinking this winter as stormy weather slammed Eastern states.

Record snowstorms in January and February had many Americans shoveling sidewalks and driveways instead of combing through listings for open houses. Partly as result, seasonally adjusted index of sales agreements fell 7.6 percent from December to a January reading of 90.4, the National Association of Realtors said Thursday.

It was the lowest reading since last April and a disappointment to economists, who had expected it would rise to 97.6.

The weakness, however, was not confined to the wintry Northeast. The biggest month-to-month drop was in the West, where sales fell 13 percent. Sales fell almost 9 percent in the Northeast and Midwest and 2 percent in the South.

From the way the media spins things, you would think a couple of blizzards are doing more damage to our economy than decades of unsustainable debt accumulation. It’s pretty comical, especially since the biggest month-to-month drop in home sales came in the West coast. But hey, let’s not let facts get in the way.

The reason home sales are cratering is a matter of simple economics. The government merely shifted demand forward via its first-time homebuyer tax-credit, which provided a temporary boost to sales. There really is no free lunch- the tax-credit induced spike in demand must be balanced by weakness in demand in subsequent months.

Furthermore, without job creation, there can be no sustainable recovery in housing. Anyone who thinks otherwise is living in fantasy land.

The weather isn’t the only culprit, wrote Jennifer Lee, an economist with BMOCapital Markets. “The impact of government incentives … appears to be running out of steam, which is, frankly, a scary thought,” she wrote.

The index is considered a barometer for future sales because typically there is a one- to two-month lag between a signed sales contract and a completed deal. A reading of 100 is equal to the average level of sales activity in 2001, when the index started.

The index has declined for two out of the past three months because home shoppers feel less rushed after a deadline for a homebuyer tax credit was extended from Nov. 30 to April 30.

Home shoppers aren’t feeling “less rushed” because of the recent extension of the homebuyer tax credit- they’re feeling “less rushed” because they’re dead broke and have no access to credit. Please refer to the chart below, which shows real estate loans are contracting at an epic clip.

Notice how real estate loans stabilized and turned up in every single economic recovery since WWII. Apparently “this time is different” and the economy is magically recovering while access to credit is absolutely cratering. Sorry, but I’m not buying it.

Initial Unemployment Claims Fall to 469,000

From the Department of Labor:

In the week ending Feb. 27, the advance figure for seasonally adjusted initial claims was 469,000, a decrease of 29,000 from the previous week’s revised figure of 498,000. The 4-week moving average was 470,750, a decrease of 3,500 from the previous week’s revised average of 474,250.

Last week’s surprise initial claims reading of 496,000 was revised down slightly to 498,000. While the 4-week moving average was slighlty down, it should be moving back up based on the recent upward trend in unemployment claims.

The number of people in extended federal unemployment programs rose to 5,687,574, an increase of 207,632 from the week prior, and an increase of 2.7 million from a year ago. Unemployment is clearly becoming a long-term problem as jobs simply aren’t being created.

Borrowers Experience Refinancing Woes

The government has been active in purchasing agency debt and artificially pushing 30-year mortgage rates to 5%. For the 1 in 4 Americans who are underwater on their homes, this should be good news. Unfortunately, very few are able to refinance and benefit from low mortgage rates. From the WSJ, Borrowers Miss out on Billions in Savings:

The Federal Reserve has pushed mortgage rates to near half-century lows, but millions of U.S. homeowners haven’t benefited from that because they can’t—or won’t—refinance.

Falling home prices have left many owners with little or no equity, making it harder to qualify for refinancing. Moreover, stricter lending standards and higher fees by banks and mortgage giants Fannie Mae and Freddie Mac and declining incomes have made it tougher and less attractive for borrowers to seek new loans.

The government has done pretty much everything to bail out speculators, at taxpayers’ expense, who gambled on homes that supposedly never go down in value. The bail outs obviously are having very little direct effect on the housing market. Existing homeowners are unable to refinance at low rates, and as I mentioned recently, new home sales are cratering.

Keep in mind that new and existing home sales tend to rise and fall together in close correlation. However, we are now seeing a growing disconnect between new and existing home sales, which strongly suggests that existing home “sales” are of the distressed kind. This is why home prices are coming under pressure even with massive government intervention.

The last time mortgage rates were at current levels, in 2003, refinancing activity hit $2.9 trillion, according to trade publication Inside Mortgage Finance. Last year, refinance volume reached $1.2 trillion, the highest amount since 2003 but not nearly as much as expected, considering how low interest rates have fallen.

Traditionally, borrowers have an incentive to refinance when they can reduce their mortgage rate by one percentage point or more.

Borrowers who are refinancing tend to be those who need it least. Fannie and Freddie refinanced 4.2 million borrowers last year. On average, borrowers who refinanced through Freddie Mac saved $2,600 annually. But the savings on the whole have gone to “very, very good credit borrowers and it really isn’t going very far down the credit spectrum,” said Michael Fratantoni, the head of research and economics for the MBA.

Since refinancing is being extended to only the most prudent borrowers, the housing crisis, which is a product of the imprudent, will move ahead on schedule. It should be clear at this point that banks won’t extend credit in an environment they still perceive to be weak.

Understand that this is a very tenuous situation. There are a wave of option ARM resets coming due, and I suspect many homeowners are counting their lucky stars since their option ARMS are resetting at a low rate.

Once mortgage rates start rising, there will be a mad rush to refinance and lock in low rates. Expect these homeowners to be blocked from these attempts, which will force them to foreclose as their mortgage payments rise exponentially.

The following chart showing the wave of resetting loans suggests that the next 2 years will be very challenging for housing.

Homeowners got way too overleveraged for this crisis to be cured by lower mortgage rates alone. In reality, the only cure for lower prices, are lower prices. The government must allow people to default so we can clean up all the bad debt from the system and transfer ownership of homes from weak to strong hands. This is the only logical thing to do, and the only thing that has worked historically.

Instead, we are creating zombie banks and a weak credit environment, which translates to a weak economic environment.