Monday, December 8, 2008

Thesis vs Reality: More than Half of Homeowners with Modified Loans are Back in Trouble

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This story is exactly why it's so tricky to be an investor. The great hope now is 4.5% mortgage rates for all [Dec 4: WSJ Treasury Considers Plan to Stem Home Price Decline], modifying loans for all [Dec 4: Here Comes the Foreclosure Cavalry], and we can get this American engine of (over) consumption back on its tracks. That's thesis. Reality is millions now live in underwater homes (they owe more than the value), many are losing jobs, many who have jobs are being cut back to part time, and the cost of life relentlessly moves upward as median wages stagnate (at best). Hence even after they are modified MANY will fall right back into the trap and we're just forestalling the inevitable for millions. Which is why this is going to cost us untold trillions and most of it will be wasted money. I expect a massive amount of new initiatives to help home owners in early 2009 that will make the market sing with happiness. Then we'll see in fall 2009 how ineffective much of it was... this is why I'm cynical about a lot of the "realities" that will come from current hopes; yet recognizing the market is all about perception. The perception is this will all work. Here is the reality. The truth is we are going to throw a lot of our grandchildren's money at a problem, trying to avert the free market from working. And most of it will fail.
  • More than half of all homeowners who had their loans modified to make the payments more affordable in the first half of the year are already in default again, banking regulators said Monday.
  • The new data raise questions about whether government money may be better spent on creating jobs, rather than averting foreclosures, said John Reich, director of the federal Office of Thrift Supervision office at a housing industry forum sponsored by his agency. "I do have concerns about allocating federal resources" Reich said.
  • Nearly 36% of borrowers were more than 30 days past due on the loan payment three months after their loan was modified and nearly 53% were more than 30 days late after six months, according to the OCC.
  • "The results, I confess, were somewhat surprising, and not in a good way," Comptroller of the Currency John C. Dugan said in a speech in Washington, D.C. on Monday. Mr. Dugan said it wasn't clear whether the low success rate reflected the fact that the modifications weren't reducing monthly loan payments enough to be truly affordable, whether the mortgages were so badly underwritten that they weren't affordable, even with lower payments, or if both factors were at work.
So there you have it: 1 in 3 people were 30 days past due WITHIN 90 days of their modification. 1 in 2 people were 30 days past due WITHIN 180 days. I cannot stress enough how backwards this recession is; usually housing falls during the recession - people lose jobs and then the housing market falters as response as people cannot make payments. This is the only time the housing market STARTED the recession. So we are now going to layer on the worst post war recession on top of a demoralized housing market. None of this is a surprise. We should (in a normal recession) just this past summer began to see the effects on the housing market. Instead, we've already had 2 years of the housing downturn (and the most vicious one since the 1930s), and just now the "normal" recession pattern is being birthed. But never fear - the government will fix it all. So says the stock market.

The next round of modifications will be Fannie/Freddie led and be far more draconian - if you owe $250K on your mortgage, put nothing down and the house is now worth $170K, are late on your payments... POOF! MAGIC! The government will say you own $150K. The government will take the loss but not call it a loss (remember it's an investment that we'll all make money in the long run) and say you will be forced to share the profit on when you sell the house as "things return to normal in a few years" (what a dream). So in return for government generosity you have to give up some of the huge winnings you will make when you sell the home. So when you can sell the house for $200K in 2012, the government gets half the $50K gain and so do you! We all WIN in socialism!

Then when the house falls to $140K in 2010 we'll all look around and say that was a waste of money. But it's time to do a new program to help the homeowner in 2010! This time it will work - we'll move principal down to $100K! So you took the mortgage down out at $250K and put nothing in the house but the government essentially just gave you $150K since they have now valued the mortgage at $100K. Beautiful. But that's ok - our government pockets are endless. The message this sends to people who are playing by the rules is pathetic. Unless these new intiatives coming from Obama's team are air tight it's going to lead to many people who had been paying their mortgage to default as well so they too can be part of the government largess. Which is the irony of it all. The sucker who has been paying their mortgages? Nothing for them in this Ponzi scheme.

This is why it will be difficult to short the market effectively until the Obama news flow fades and the honeymoon is over. The level of government interference coming in the housing market is the next few months should be awe inspiring - interest rate buydowns, principal reductions, outright purchases of mortgages - it's all going to be on the table. I still think there is an outside chance of outright purchases of homes (to reduce supply on market) via federal funding to states. And Wall Street will cheer and whoop every moment of it - the nanny state has come to clean their mess. This will be socialism of the highest order that causes some of our European friends to drop their jaws at the things we are going to do.

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