Monday, February 15, 2010

Don't Hold Your Breath Waiting For A Housing Recovery

The problems in the residential housing market remain deep. Nationally, home prices are down by about a third from their 2006 peaks, creating millions of underwater borrowers.

Last fall, it was widely reported that one-in-four US mortgages had negative equity.

By various estimates, approximately 11 million to 14 million mortgages are underwater, and the problem is poised to worsen.

U.S. foreclosure filings rose 15 percent in January from a year earlier and exceeded 300,000 for the 11th consecutive month, according to RealtyTrac Inc.

The company predicts that bank seizures (known as REOs, or real-estate-owned) may rise to a record 3 million this year.

Modification programs that were designed to keep delinquent borrowers in their homes have failed and are expected to continue doing so.

That's largely because about 8.4 million jobs have been lost since the recession began in December 2007. The continuing job losses have led to growing delinquencies and foreclosures.

A rising supply of homes puts downward pressure on already slumping home prices. And sales could be slowed considerably when government support for housing, including the Federal Reserve’s $1.25 trillion purchase of mortgage bonds and a first-time buyer tax credit, ends as scheduled next month.

With foreclosure inventories on the rise, banks are rightfully worried. But, by lowering credit standards and unleashing a wave of speculative housing demand, the banks were the ones that helped drive home prices to unrealistic levels in the first place.

As a result, significant trouble still lies ahead for banks, communities, and homeowners.

Federal and state officials are bracing for the next tidal wave of foreclosures—adjustable rate mortgages (ARMs), particularly option payment ARMs.

Option ARMs let borrowers choose to make very low payments for the first five years. During that initial period, borrowers were allowed to pick their payment option, including just the interest.

Option ARMs became widespread starting in 2005, which is why the recasts and higher payments will pick up steam this year.

According to Fitch Ratings, 94 percent of option ARM borrowers elected to make minimum payments only. That portends the trouble that lies ahead.

Even though most option ARMs have not yet adjusted higher, many borrowers are already defaulting anyway. That's an ominous sign.

The bulk of option ARMs recast dates are spread out from 2010 through 2012, meaning the foreclosure waves could drag on for the next few years.

Deutsche Bank projects that 48% percent (or nearly half) of all US mortgages will be underwater by early 2011. That would affect some 25 million homes. If realized, such a projection would be a serious blow to the economy.

No one can be sure just how big the housing inventory really is. As of last August, 72% of foreclosures hadn't yet been put on the market because lenders were waiting to see how much additional loan modification assistance the federal government would provide.

With home prices having already declined by nearly one-third - peak-to-trough - since 2006, a glut of houses hitting the market will cause prices to fall even further. The concern is that they could stay depressed for years to come.

Last June, Deutsche Bank forecast that home prices – covering 100 U.S. metropolitan areas – would continue to decline through the first quarter of 2011, for a total drop of 42% from their 2006 highs.

Moody’s now forecasts that some home prices may not return to their pre-recession levels until 2030. This means that hundreds of thousands of Americans may find it impossible to sell their houses without paying off banks for underwater home loans.

At a minimum, Moody's says that many states (i.e. NY, IL, CA, FL) will not recover until sometime between 2018-2024.

Those waiting for a massive government intervention shouldn't hold their breath. It would cost about $745 billion, slightly more than the size of the original 2008 bank bailout, to restore all underwater borrowers to the point where they were breaking even, according to First American CoreLogic.

The fallout of the housing crash will be an ongoing process, and it appears that we are at least three years from a bottom.

Let's brace ourselves.

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