The Market Ticker - Housing

The Warning Shot Fired Yesterday

nospam@example.com (Karl Denninger) — Thu, 05 Nov 2009 07:59:00 -0500

So few commentators have made this point..... indeed, I think I was the only one. Let's revisit the FOMC statement:

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.

In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

That's the key part of the statement: it is a warning to The Administration and Treasury.

What I said yesterday was:

We bought it all. We're no longer part of the market, we are the market! We have no freaking clue how to exit from this, and we know that when we do rates will spike higher. Unfortunately we also know that if Fannie and Freddie continue to bleed red ink we will blow up instead of them by doing this, so in March we pinky-promise to stop, even though that will destroy what's left of the housing market.

Read that again.

Now consider this:

The Federal Housing Administration abruptly delayed the release of a long-awaited independent audit of the financial soundness of the agency, citing potential problems with the accuracy of some of the study's economic models.

Economic models eh? You mean an institution that is levered 50:1 (which the FHA currently is, if I'm doing the math right) could have a wee problem should something go wrong? What could go wrong? Oh, maybe things like this:

Most banks rejected Ms. DeForte because her debt level was too high and her credit score too low. But Lend America put Ms. DeForte into a $402,000 loan backed by the Federal Housing Administration, a New Deal-era agency that Washington and Wall Street were relying upon to pick up the slack in the mortgage market as private lenders pulled back. Ms. DeForte fell behind on payments six months later and is seeking a loan modification. Taking the loan was "a stupid mistake," the 46-year-old office manager said.

It may have been a stupid mistake but the principle of asymmetric information meant that the FHA knew damn well what it was doing, and did it anyway. Ms. DeForte might not have understood it at the time (and now recognizes that it was a stupid mistake), but both Lend America and The FHA don't have that excuse.

Indeed, as I've documented, the FHA has been willing to write paper with their guarantee on loans with DTIs (debt-to-income) ratios exceeding 50%!

Congress is barking but has yet to bite:

"If not addressed promptly, problems at the FHA may result in yet another massive taxpayer-funded bailout that this country cannot afford and which the American people will not accept," wrote Republicans Darrell Issa of California and Spencer Bachus of Alabama in a letter, released Wednesday, to Housing and Urban Development Secretary Shaun Donovan.

Really?

I love 'ya Darrell, but neither you or anyone else on Capitol Hill have done a damn thing about Fraudie and Phoney! Indeed, close to $100 billion in taxpayer funds have been larded into those institutions to prevent their utter collapse but the bogus lending has simply shifted as a matter of formal policy over to the FHA, which is then selling the paper back into - you guessed it - Fannie and Freddie!

Fraudie and Phoney are not new to trouble. Documents from 2004 show that the "massage the earnings" game was well-embedded into these institutions as early as 2001, yet nothing was done.

Seven years later, the taxpayers are on the hook for $100 billion, the firm's capital continues to erode as their default rate skyrockets by the month and yet not one of the people responsible is sitting in the dock - or in a prison cell.

The Federal Reserve's statement is, I believe, a clear statement and warning to the Congress and Treasury: Figure out what to do with these two firms, and do it, prior to the end of the first quarter of 2010, or we will cut them off and stand back, as we're not going to be the one holding the grenade when it goes off.

The reason for the warning should be clear - FHA may be writing the insurance on these notes but most of them are being foisted off on Fannie and Freddie. Rather than solving the problem we have Barney Frank making public statements that intentionally making bad loans is a policy - when The Fed is the one buying the paper generated by those bad loans!

The proper Congressional role of regulation - that is, write laws which The President then signs - has been perverted by a Federal Reserve that has had two successive chairmen who have "knelt before Zod" and performed an obscene act - with Zod residing both in Congress and Wall Street. This was all in the name of "economic stability", but now it threatens The Fed itself.

Consider that The Fed will have over one trillion dollars of potential putrid trash on its balance sheet by next spring. MBS and Debt that have no formal guarantee from The Federal Government, contrary to the strictures on Fed ownership embodied in the black-letter law of Section 14 of The Federal Reserve Act.

The "detonation risk" on these securities is very real, and when one considers that said securities will back more than half of the reserves in the system under Fed control, this should be keeping Bernanke and company up at night.

The Fed has in fact been the handmaiden of both Congress and Treasury through this entire mess. Under the guise of "systemic risk" The Fed has monetized over a trillion dollars of debt for the explicit purpose of bailing out the outrageous actions of both Wall Street and Congress. But unlike the relatively small exposure of Maiden Lane I-III, totaling some $60 billion, the outrageously bogus lending practices ensconced in Fannie, Freddie and the FHA have exposed The Fed to well over $1 trillion of garbage paper.

Congressfolk must zip up and get to work, for The Fed has made a clear statement that it will not be coming back to kneel shortly.

Fannie and Freddie must be wound down. Whether Congress likes it or not, mortgage lending must return to sound principles - 20% down payments, 36% back end ratios - period. It must become reasonably safe and profitable to portfolio loans - not play "hot potato" with them so as to generate nothing other than fee income, relying on that for profit instead of making sound lending decisions.

Yes, this means interest rates will rise to a market rate.

We have spent more than two years trying to avoid recognition of fundamental mathematical facts - average home prices cannot exceed 3x average incomes, and on balance home prices cannot rise faster than income over long periods of time.

Mean-reversion isn't a suggestion, it is a mathematical reality. As a homeowner with a fully-paid-off house, bought with cash, I certainly would prefer my home to have a value closer to 2005's price than 1995's.

But what I prefer has nothing to do with what is mathematically sustainable or what can be supported by the broader economy, and my personal desire to be able to "flip" my house or use phantom "wealth" to extract a lifestyle I cannot afford does not and cannot change the reality of what stability in the economy, on balance, requires over the intermediate and longer term.

Property prices must contract to sustainable values. If this causes banks to fail, so be it. If this causes consumer bankruptcies for those who used their homes as ATM machines, so be it. If this causes me to lose half of the "value" in my home, so be it.

I believe The Fed sent a message to Congress yesterday in recognition that the wall is fast approaching at 120mph: do the right thing and do it now - or else.

Here It Comes... (Option ARMs)

nospam@example.com (Karl Denninger) — Thu, 29 Oct 2009 14:15:00 -0400

Hmmmm....

Despite that fact, delinquencies have moved steadily higher with the 30 day + delinquency now reaching close to 50% of all outstanding Option Arms.

"I told you so!"

These loans were never designed to lead to actual home ownership.

They were sold as a means to "buy" a home, but the lenders knew full well that this could never, ever happen given the structure of the note.

These notes were more akin to a levered bet placed on commercial real estate, in that they were worse than the typical commercial "interest-only" loan in their inclusion of a requirement that values continually increase to stay ahead of the negative amortization.

These loans cannot be cured.

The typical OptionARM customer was qualified on the initial rate on the minimum payment, which was usually 2%, interest-only.

For a typical $500,000 California or Florida home, this resulted in a monthly payment requirement of roughly $850 (2% of $500,000 is $833 a month.)

The "real rate", however, on the loan was typically around 6 or 7%, and the rest of the principal and interest was "capitalized". If the amortizing rate was 6% on the note then the P&I for a "full payment" would be $2,982.83, resulting in about $2,100 a month in negative amortization.

If you try to "work these out" and manage to go "to the wall" on the note with a 40 year, 4% amortizing refinance, the note still comes up to $2,082.75 - more than a clean double of the original payment!

The "homeowner", however, can't afford the doubling of the payment. Further, the house isn't worth $500,000 any more - at best it is worth $300,000, which is a big part of why he stopped paying.

These notes were the worst sort of abuse and they're littering the landscape. I know people who have them here in Florida and have defaulted, and there are a scad load of them in California. My prediction originally was that half or more of them would wind up being worth recovery value at best, and this appears to be the case. Since these were nearly all written in the bubble areas, recovery will be fortunate to be 50% of face value.

How many of these are out there? Good question. I have seen numbers from $200 - $500 billion, all from reputable sources. Why don't we have an accurate number from the banks and Fed on these things?

In the "best case" this is another $50 billion in losses and about 25% of the homes purchased in bubble areas from 2003-2006. In the "worst case" this is well over another $100 billion in losses and perhaps as much as half of the homes purchased in those areas during the bubble years.

Either way you slice these losses have not been recognized or accounted for nor has their impact on home inventory and price.

MERS: This APPEARS To Be Unlawful!

nospam@example.com (Karl Denninger) — Tue, 20 Oct 2009 11:09:00 -0400

This is interesting....

In mortgage foreclosure cases, the plaintiff has standing as the holder of the note and the mortgage. When MERS forecloses, MERS is the mortgagee and it is the holder of the note because a MERS officer will be in possession of the original note endorsed in blank, which makes MERS a holder of the bearer paper. MERS will not foreclose unless the note is endorsed in blank and held by MERS.

There's a key question as to whether those "assignments" by MERS are actually being performed by MERS, or whether they're effectively forgeries, as has been talked about before (e.g. it appears that the endorser is in fact an employee of the recipient of the note, not an officer of MERS), but we'll leave that one alone for now.

But....

The use of bearer bonds for avoiding taxation became more popular after World War I, and illegal activity involving bearer bonds continued over the following decades until various nefarious criminal activities involving bearer bonds resulted in the Tax Equity and Fiscal Responsibility Act of 1982, which outlawed any new issuance of bearer bonds in the United States.

Uh........

More specifically, for private bearer debt instruments:

The sanctions included disallowing the deduction of interest expense by issuers of bearer bonds and denying the holder of bear bonds the tax exemption for interest earned on the bonds. In addition, TEFRA imposed an excise tax equal to 1 percent of the principal amount of the debt multiplied by the number of years in the term of the bonds. These measures effectively ended the issuance of bearer debt instruments, and all debt securities are issued in registered form now.

Every such "endorsed" debt instrument that has been converted to bearer form by endorsement in blank appears, from this description, to have created an instant excise tax liability in the amount of 1% of the face value times the number of years in the term of the mortgage, and of course this excise tax as with all taxes must be declared and paid.

So exactly how is it, again, that MERS is in possession of Bearer Instruments, and is not the endorsement in blank of such an instrument by the originator (creating a bearer instrument) a prohibited act (unless the tax was declared and paid, and you know full well it wasn't) under Federal Law?

The IRS describes what is subject to tax:

Registration-Required Obligation - Section 4701 (b)(1) provides that the term "registration-required obligation" has the same meaning as when used in Section 163(f), except that such term shall not include any obligations required to be registered under section 149(a). Section 163(f) provides that the term “registered-required obligation” means any obligation (including any obligation issued by a government entity) other than an obligation which -

(i) is issued by a natural person,
(ii) is not of a type offered to the public,
(iii) has a maturity (at issue) of not more than 1 year, or
(iv) an obligation is issued where there are arrangements reasonably designed to ensure that such obligation will be sold (or resold in connection with the original issue) only to a person who is not a United States person, and
(v) in the case of an obligation not in registered form -
I. interest on such obligation is payable only outside the United States and its possessions, and
II. on the face of such obligation there is a statement that any United States person who holds such obligation will be subject to limitations under the United States income tax laws. (Internal Revenue Code Section 163(f) (2)).

Obligation - The term “obligation” includes bonds, debentures, notes, certificates, and other evidence of indebtedness regardless of how denominated. (Treasury Regulation §46.4701-1(b)(2))

Hmmmmm..... let's see, mortgages are "obligations" that are evidence of indebtedness, the mortgages in question were not issued by natural persons (they were issued by banks and other lending institutions), they all (or nearly all) have a maturity of more than one year, and they are in fact traded publicly.

Oh my... I wonder how much in uncollected taxes could potentially be due here? Is anyone at the IRS paying attention?

Waterboard JP Morgan and The Mortgage Bankers Assn

nospam@example.com (Karl Denninger) — Wed, 14 Oct 2009 08:13:00 -0400

How to give an economics writer a coronary:

Recommend something that has been done twice before, and both times led to disaster, including being a major contributor to The Great Depression.

Well guess what: JP Morgan and the other banks are doing exactly that.

Oct. 13 (Bloomberg) -- Banks will push the Obama administration to expand its mortgage-modification program to allow interest-only periods on reworked loans, seeking to bring more homeowners into the initiative while recognizing concern that it may only postpone defaults, according to JPMorgan Chase & Co.

MAY?

Can I remind people of history?

Prior to the depression of the 1920s, there was a mortgage loan product used by many of the American people, known as the interest only loan. Why did this long disappear? And why has it suddenly reappeared? Let’s take a moment to answer each question, and hopefully provide some food for thought.

During the 1920s and into the early 30s, many of the citizenry of this country chose to live above their means. They chose the interest only loan because it allowed them to purchase a larger home for less money. What happened when the stock market crashed and jobs were scarce, and there was no income? Many of these people were left without homes; as they had chosen to simply pay the interest on their mortgage there was no equity built into their homeownership. When no equity builds, and the income ceases, the bank forecloses and residents are forced from their homes.

If our government allows this it will guarantee a GREATER DEPRESSION. Whether it comes now or in a few years, it will happen. This is the precise same stupidity that led to the 1930s and it will have the exact same outcome this time.

Here's the problem folks, in one sentence:

The banks are STILL insolvent.

They are sitting on over a trillion of dollars of this paper (about $1.1 trillion to be exact) and several hundred billion is severely impaired or even worthless. Wells Fargo, just as one example, has (as of its last 10Q) $106 billion of second lines outstanding on balance sheet, and God only knows how much in SPVs (Wells is known to have significant off-sheet exposure "inherited" from Wachovia.) Let me put this in perspective for everyone.

Essentially all of the first mortgage loans written in California and Florida after 2003 are underwater. Even in parts of the state (such as my area of Florida) that have been "relatively" untouched (compared to, for example, Naples) homes are below 2003 prices. In "bubble" areas prices have in many cases returned to levels such that anything purchased before 1995 or thereabouts is underwater. In some parts of SW Florida you can buy a home that sold for $500,000 for $50-75,000, cash, right now. Those are 1970s and early 1980s prices. While that is an extreme example the most bubbled areas are the ones with the greatest over-representation of paper from Wells (and ex-Wachovia), JP Morgan/Chase (ex-WaMu) and Bank America (ex-Countrywide.)
Many of the homes in these areas, especially in Florida, that have undergone this sort of collapse in price have a literal negative value. That's because the former owner has departed and the power was shut off for non-payment; the banks have constructively abandoned these homes. In Florida if you do this within a reasonably short period of time mold will become established inside the sheetrock. Once that happens the home must be gutted to the studs or razed, and the cost of doing so exceeds the value of the bare lot. Then there are the delinquent property taxes, frequently in arrears for two years or more at this point. Many people have said that "oh there's a decent recovery" on all this paper. No, in many cases, there is is in fact no recovery at all, and that's a fact.
In essentially every case a 2nd Line (HELOC or "Silent Second") behind a first in Florida and California taken out since 2003 is worthless if the primary note goes into foreclosure. That's because such a second is a subordinate lien and entitled to nothing until the first is fully satisfied. But the first can't be fully satisfied as the home's value is less than the first line's balance. As a consequence these loans are worth zero - literal zero. Wells may have as much as $25 billion of this worthless paper on balance sheet all on its own and Bank America may have as much as $30-50 billion. (Pinning down the exact amounts is impossible as the companies do not disclose geographic concentration metrics necessary to do so.) It is not unreasonable to believe that $200 billion in junior lien losses are being hidden - right here and now - which is sufficient to detonate these institutions even without the primary mortgage losses being counted!

This is the truth behind the housing mess and our government and banking regulators are engaged in an active cover-up to prevent recognition of the truth. Banks were given the ability to do other than "mark to market" earlier this year, and they have roundly abused this privilege to hold both first and second lines at ridiculously above market value. But Treasury is also interfering with contract law in an attempt to "protect" bank balance sheets. How? By violating lien priority - again - exactly as they did with Chrysler and GM.

The Truth is that there has been no material completion of these "modifications" promised under HAMP:

Only “a couple thousand” conversions have been completed, Maggiano said. To aid the process, the government last week streamlined documentation requirements, and granted borrowers and loan servicers on initial trials an extra two months to complete the work, which typically must be finished after three months of timely payments, she said.

"Streamlined documentation requirements" = You can lie about income and assets. Again. Once again, fully-documented underwriting is not being required, all in the name of preventing the truth from being recognized - the banks are insolvent as they are holding hundreds of billions of dollars of worthless trash, almost assuredly $100 billion or more of it in second lines alone, at or near 100 cents on the dollar.

An unresolved piece of the administration’s program, she said, remains a plan to have second-mortgage owners rework that debt whenever first mortgages are changed, an initiative that U.S. officials said would likely be in effect by June when outlining it in April.

Again, we're back to the basic problem:

If you recognize these losses the second lien holders all blow up. If you roll the second into the first mortgage then the property is so far underwater that not only is the mortgage unaffordable but there is no reason for anyone to take the deal. If you force first lienholders to take damage that the second should take then you destroy the securitization market for mortgages as you force losses on people that should be protected from them under black-letter law.

In any event there are plenty of detonated (and actively hidden) first mortgages that have blown up too, and we've not even talked about commercial real estate exposure yet.

On the document changes:

To help move more borrowers out of trials, the Treasury last week dropped a need for them to provide tax returns, Maggiano said. Servicers instead will be able collect documents allowing information to be pulled directly from the Internal Revenue Service, a process it’s trying to enhance with new forms and processes, she said.

Uh huh. That was done during the housing boom too. It was known as a 4506-T and was a routine part of even "Stated Income" loans. However the verification wasn't done, which is why we had tens if not hundreds of thousands of WalMart employees buying $500,000 houses while making $30,000 a year - on an OptionARM mortgage that was guaranteed to detonate in their face a few years down the road.

Other document changes mainly involve creating more “customer-friendly” layouts, Schwartz said. The changes aren’t similar to the “stated-income” lending popular during the housing boom that later created high defaults, she said; pay and employment information still is verified.

Riiight. If pay and employment information is verified what's difficult about it? Is it too much to ask for a current pay stub? Who (that is actually employed) doesn't have a new one every couple of weeks? Nobody I know!

All these new "proposals" are doing is attempting to once again screw the American public, turning them (once again!) into debtors and renters while lying to them about being a "homeowner." In addition if the original mortgage was a purchase money first an effective refinance into an interest-only product will destroy the non-recourse nature of the note in those states where it applies, leading those who are trapped in these loans a couple of years from now to lose not only their house but everything else they possess.

Yes, I know, JP Morgan reported "good" earnings this morning. If their earnings are so strong, and the franchise so healthy, why are they arguing for "interest only" exploding mortgages as a modification tool?

There is one and only one way to solve the housing crisis that will actually work, as I have said now for more than two and a half years:

Withdraw the fraud and lies, allowing home prices to contract to sustainable levels so that ordinary Americans can actually afford to buy a home with 20% down and a maximum 36% "back end" or DTI ratio.

At the same time force the banks to recognize the bad paper they are carrying - both on firsts and seconds. If this detonates them then so be it. There are banks who are not insolvent and those who were not and are not fraudsters deserve to prosper in a capitalist system for doing the right thing, not be punished for failing to engage in fraud as is now the case.

Those who are displaced by their homes will indeed be foreclosed upon, but in a year or two after rebuilding their credit they will be able to buy the same house back (or one similar to it) at a price that represents no more than three times their income with a sustainable, 20% down fixed-rate mortgage.

THAT is how we solve this crisis; those banks and the Mortgage Bankers Association who continue to demand that bogus and unsustainable lending be shoved down the American people's throat must be run out of Washington DC on a rail, AFTER being waterboarded as a consequence of demonstrating to the world their own particular brand of financial terrorism.

The American people have HAD IT with the lies and theft.

IT IS TIME TO TAKE THIS NATION BACK FROM THESE SCAMMERS.

Here Be Chickens (And They're Roosting!)

nospam@example.com (Karl Denninger) — Tue, 13 Oct 2009 08:58:00 -0400

We got a little problem here.....

A progress report released last week by the Treasury Department showed that only 11 percent (about 95,000) of Bank of America's delinquent borrowers who were potentially eligible for the program had been given a loan modification. That compares with 27 percent, or 117,000, for J.P. Morgan Chase, and 33 percent, or 68,000, at Citigroup, the Treasury reported. The figure for Saxon Mortgage Services, which is owned by Morgan Stanley, is 41 percent, or 32,000.

There are too many conflicting currents here, which is what will ultimately doom this program, as has doomed all the previous ones.

First among them is the simple question: How many of these people who allegedly "qualify" for a modification will wind up with a sustainable mortgage if they get one?

This is a key question, yet one that hasn't been asked in public, nor have there been public answers tendered. The truth is pretty ugly - without significant principal forgiveness (not "forbearance") a huge, perhaps even majority percentage of these loans are not sustainable even if modified.

The problem is simply that on any reasonable set of assumptions the income of the household does not support the principal balance. "HAMP" calls for modifications to reduce principal and interest for all outstanding mortgage liens (firsts and seconds, if any) to 31%.

Here's the "waterfall" process, as shown by MGIC (one of the mortgage insurers who has been hammered severely by this mess)

The problem here is that several of these steps don't do much. If you "capitalize" arrears all you're doing is adding them to the principal balance of the loan. This "cures" the instant default but does nothing to solve the underlying problem that caused it in the first place (unaffordable payments.)

Reducing the interest rate helps only if the owner started with a "reasonable" rate up front. If their original loan was an "OptionARM" with a teaser, and they qualified on that teaser, they're unlikely to get to sustainable payments even with a reduced interest rate.

The third step, extending terms, does little as well. A $200,000 loan @ 5% over 30 years has a P&I of $1,069.19. The same loan over 40 years (the maximum extension) has a P&I of $960.39. $100 matters (it's about a 10% payment reduction) but if the difference of $100 makes it possible for you to pay then you're still one unscheduled calamity (e.g. your car needs a new alternator) away from being delinquent again.

The fourth step, "forbearing" principal, is not principal forgiveness. It is simply deferment, turning your note into what amounts to a balloon. This last step is particularly nasty for homeowners in that it will preclude you from being able to move for a decade or more, making it impossible for the workforce to follow job opportunities, as you would have to pay off the balloon in order to sell the house.

Then you have attitude:

Even as the administration urges lenders to do more to help homeowners, some Bank of America employees continue to express skepticism about whether all of those seeking assistance really need it. "There's a difference between hardship and entitlement," said Jerry Durham, Bank of America's vice president of home retention.

Oh really? Let us remember that Bank of America "acquired" Countrywide Financial, the king of making unsustainable and outrageously risky loans that were pushed like a drug junkie shoves his smack under the nose of debt addicts. Never mind that Bank of America seemed to think it was "entitled" to tens of billions of taxpayer dollars. Now the bank suddenly thinks that other people being "entitled" is such a bad thing? Who set the example?

The article also cites a disturbing trend:

On a recent morning, Tiffany Palmer was on the line with a frustrated borrower looking for help with his mortgage. He was $6,000 behind in his payments.

"Do you have a 401(k) or savings -- liquid assets that can be quickly converted into cash?" she asked him. He was going to have to come up with money for the mortgage. Because his monthly mortgage payments represented less than 31 percent of his income, he made too much to qualify for a modified mortgage under the federal initiative. "You will not be eligible for the program," she said.

This sort of "advice" should be barred under Federal Law and result in criminal sanction, especially for banks that have received taxpayer funds (of which BAC is particularly exposed.) Why? Because 401k and IRA money is protected in the event of a bankruptcy, with few exceptions. As such it is outrageously irresponsible to suggest that a debtor in trouble liquidate retirement accounts to come current, especially when nothing is being done to make the loan sustainable in the long term. Better to file bankruptcy and shove that loan up the bank's behind!

Never mind this sort of advice:

Could she skip her credit card payments, about $400 a month?

Oh, so that's nice - screw someone else so we get ours? Uh huh.

The conflicts of interest here are huge:

The banks have "Servicing Rights" (or MSRs) that require them as servicers to advance principal and interest payments to the noteholders. There are several risks involved in such an enterprise, of course, including the risk that the debtor won't pay at all, but in addition there is "prepayment" risk - that is, anything that causes the loan to terminate early (short sale, refinance, etc) decreases the value of that loan to the bank holding the servicing rights. These "MSRs" were "written up" in a major way in the first and second quarters. Was that a fantasy? Probably.
Forbearance, interest rate reductions and similar games sound good but they decrease cash flow. Remember that the ultimate holders of these notes through securitization have to agree. When this is Fannie or Freddie this simply forces their heads further underwater, but when it is someone else they have no mandate to agree to take less than they contracted for. In most cases securitization documents permit some small percentage of modifications without investor approval (e.g. 5% of the loans in the pool) but once that threshold is crossed the story changes.
In addition, and perhaps most importantly, a loan that is modified but which re-defaults is one where the investor made a good faith change (reducing his or her cash flow) believing that it was cheaper than prosecuting a foreclosure, but then wound up with both the lower cash flow and the foreclosure! This is perhaps the most serious problem and unlike the others it is not really a conflict of interest, it is simply the expression of the fact that in nearly all cases the first loss you can take and clear your board is the best loss; the more screwing around you do the worse things are.

The bottom line is that there is no evidence that HAMP is working or can, and the Congressional Oversight Panel has seen through the ruse:

The Panel found, "The result for many homeowners could be that foreclosure is delayed, not avoided." HAMP modifications are often not permanent: For many homeowners, payments will rise after five years, and although the program is still in its early stages, only a very small proportion of trial modifications have converted into longer term modifications. The Panel is also concerned about homeowners who face negative equity or are "underwater" - that is, the value of the loan exceeds the value of their home. For many borrowers, HAMP modifications increase negative equity, a factor that appears to be associated with increased rates of re-default.

Yep.

At the time I said that these efforts would fail as there is no actual solution other than forcing those who made bad loans to eat them. HAMP, and all other programs like it, are inherently just another gimmick promulgated upon the public by our government - another form of "extend and pretend", that when boiled down to its essence is legally-sanctioned accounting fraud.

The solution to unaffordable mortgages, as I have repeatedly noted, is foreclosure and a forcing downward of housing prices whether Congress and The Administration want to admit it or not. Affordable housing requires not gimmicks but houses that are inexpensive enough for people to be able to purchase and afford on an ongoing basis. We're not there, despite the crooning of The National Association of Realtors and other associated pressure groups.

This is directly contrary to the stated policy of Congress as expressed by Barney Frank, who has said that making bad loans on purpose is A POLICY to prevent home prices from contracting to long-term sustainable values.

In other words the bankers and Realtors have effectively bought Congress and goaded them into keeping home prices unaffordable for the average American. Refusing to reverse course on this policy will guarantee that sustainable economic growth will not return to America.

We will not and cannot, mathematically, exit this crisis until the bad debt is flushed from the system. This same sort of gimmickry and game-playing was attempted in the 1930s and was directly responsible for The Depression extending for a decade, ending only when World War II began.

You would think that we would have learned from this history lesson that all the game-playing in the world will not solve a debt problem, nor will shifting debt from one hand to another (e.g. to the federal government) lead to a sustainable economic recovery.

Those institutions that made bad, unsustainable loans must be forced to recognize their losses, even if it results in business failure. Only through contraction of these asset prices to sustainable levels where people can afford to purchase them on an ongoing basis given the actual employment prospects that exist (including the consequence of offshoring all our call centers and most of our manufacturing!) will we exit this crisis.

Housing prices must come down significantly - very significantly - from here. This will bankrupt many lenders who made unsustainable loans and that must be not only allowed to occur but encouraged so as to result in truly sustainable home ownership.

An environment of excessive debt, fostered by the improper and ridiculously negligent and intentional acts of both Congress and The Federal Reserve, cannot be resolved with more debt, any more than you can solve a drunk's problems by handing him another bottle of whiskey.

US Senate: STOP BEING STUPID

nospam@example.com (Karl Denninger) — Thu, 01 Oct 2009 12:32:00 -0400

Dick Durbin is once again flapping his gums instead of actually addressing problems:

The legislation, introduced today by Senator Jack Reed of Rhode Island, would require lenders to evaluate all borrowers for affordable loan modifications before initiating foreclosure. It would also require banks to offer and approve a loan modification if the restructured mortgage returns more money, the so-called net-present value, to investors than would foreclosure.

The proposal would establish new penalties and would let borrowers overturn foreclosures if lenders fail to comply. It would also place new limits on fees charged in foreclosure.

The reason we have this crap going on is quite simple, and fixing it is also quite simple:

Banks are holding homes back and foreclosing when they should be modifying as a direct consequence of the policies and actions of the government.

As just one example the "loss share" agreement made with the buyers of IndyMac has set up a perverse incentive system where the usual incentives to modify loans have been intentionally and wantonly destroyed.

If you remember this was the deal announced:

As part of the deal, the FDIC entered into a loss-sharing agreement with IMB HoldCo. IndyMac will assume the first 20 percent of losses on a portfolio of "qualifying loans," after which the FDIC will assume 80 percent on the next 10 percent of losses, and 95 percent on losses thereafter.

Ok, so we have a maximum loss that the investors (which include George Soros and Michael Dell, by the way) can take which is:

20% + 2% (80% of 10%) + 3.5% or about 25% of the total is theirs - but note that "theirs" is all at the top - once you get into the "meat" of the losses only 5% of whatever is left is theirs.

Here's the problem: As part of the deal they also get to write down the portfolio as of the date of the deal. They took that, taking roughly a 25% mark against the assets at purchase (in other words, they bought $20.7 billion of assets at a discount of $4.7 billion)

Now here's the issue - in a deteriorating market the incentive to modify a loan exists only when the loss on a foreclosure will be materially higher than the loss on a modification.

But if someone "else" (like THE TAXPAYER) will eat (almost all, in this case, essentially 95% of) the loss, then your incentives shift - in a big way.

See, if you modify, you stop earning "fees" on the delinquent note. You can't charge late fees any more, you can't charge "special servicing costs" and similar types of things that you can (and do) get to add to a delinquent note that is "headed for foreclosure." These are all immediate cash - and they're all yours, never mind that if just 1 in 10 of these notes "cures" (after you hound the living hell out of them to pay somehow by hook or crook) you win huge since you got to buy at a 25% discount up front!

These "incentives" to NOT modify are usually outweighed by the much higher loss you'd take if you foreclose.

BUT THESE FOLKS ARE PROTECTED BY THE "LOSS SHARE" AGAINST ANY MATERIAL AMOUNT OF LOSS (95% IS EATEN BY SOMEONE OTHER THAN THEM!)

So now the incentives are wildly tilted toward them telling borrowers to go stuff it up their backside, and they are.

These "loss share" deals are a big, big problem.

It gets worse.

Regulators are refusing to force a mark-to-market on this paper. We continue to see banks fail where the FDIC reports 20, 30, 40, up to nearly 50% losses, with some sector-specific losses of 60%! Colonial, again, had a 39% realized loss against their balance sheet claimed values when BB&T came in and purchased them.

The argument for permitting cost-basis (or other forms of "mark to mythology") accounting is that the market price is in fact "not real."

That's a nice fantasy put forward by the banking industry and lobby but we now have nearly 100 bank failures under our belt and in fact the market price seems to be about where these things wind up - putting the lie to any claim that market prices are "too pessimistic." Indeed I have yet to find one instance of a failed institution where balance sheet values ended up being too pessimistic once the regulators came in and started selling things off.

Such "extend and pretend" games, in addition to the ridiculously false view this presents of a financial institution's balance sheet effectively precludes either modification or foreclosure and resale of the property, because either of those events "finalizes" any embedded and hidden loss and thus forces a mark to be taken. That could be a wee problem if the bank or other institution doesn't have sufficient capital to absorb these losses, never mind the hit to so-called "earnings" even if they do have the money.

The reason banks are not modifying loans in good faith and are playing these games is because the regulators AND LAWMAKERS are PERMITTING THEM TO LIE and HIDE losses.

Then, in compounding the error they are entering into "loss share" deals where there is NO INCENTIVE to modify because on a strict financial analysis IT IS MORE PROFITABLE TO "PURSUE FORECLOSURE" since the loss differential IS NOT THEIRS while the fees they can earn from NOT modifying ARE!

Finally, adding insult to injury you have the impact on local and state governments - these properties are not paying property taxes either, being in arrears in some cases by as much as two years. Yes, this will eventually be recovered via tax certificate sales but the state and local governments deserve to get paid NOW - not five years down the road, when the cause of the delay and non-payment is intentional game-playing by regulators and banks.

Folks, this is really simple: If you want to see those modifications that make sense get done, including but not limited to principal forgiveness where it makes sense, and foreclosures to be prosecuted and properties resold at the market, thereby clearing it, you need to do the following:

Force recognition of past-due loans on their current recovery value - all of them - as soon as they go past due.

Force banks to foreclose on all loans more than 90 days past due in a diligent fashion. To punish failure to do so provide that a foreclosure not diligently-prosecuted results in a clear deed being conveyed to the homeowner (that is, 100% loss to the bank!) That will get their attention - FAST.

Force banks to sell into the market at absolute auction all property held by them no later than 90 days after foreclosure. They get 90 days to market privately for a higher price, after which it goes to the courthouse steps.

Force ALL off-balance sheet exposures onto the balance sheet immediately, and prohibit as a matter of law the hiding of exposures off balance sheet (such as the infamous Wachoiva CDS)

In short if you want modifications that make sense to happen you have to stop making it profitable for banks to play games with the accounting so that they are forced to recognize losses as they are realized in the market rather than hiding them in the hope that they will magically "self-cure" (when the data says that is a statistical impossibility.)

You must also get rid of the perverse incentives that make it more profitable for the corporate raiders - who have been given a "no lose" proposition in their acquisition prices - to foreclose instead of making sustainable modifications.

As for the States, I have a solution there too - and perhaps that's where we should focus our ire, since we can't seem to get anyone's attention in Washington DC given all the bribed, er, "lobbied" lawmakers

Change state tax certificate laws. Sell off delinquent taxes in the fall following the delinquency (assuming a spring "due date") thereby putting the certificate in someone's hands six months after non-payment and shorten the allowed redemption ("cure") period to 12 months - after which the certificate holder can pay the delinquent taxes in full and gain a clear title. This will put an immediate stop to banks refusing to foreclose or dispose of delinquent properties, leaving them vacant (since they will wind up losing them to a tax sale) and it will stop the bleeding at the state revenue level. As a beneficial side effect it will force a clearing of the market and re-establish occupancy, maintenance and upkeep of these homes.

The Banking System Is Insolvent

nospam@example.com (Karl Denninger) — Tue, 29 Sep 2009 13:56:00 -0400

Following up on the quick mention now that I have a story to cite from Amherst:

Cure rates for these distressed loans remain low. Amherst noted a near 0% cure rate of all loans in foreclosure, 0.8% for 90 plus days delinquent, 4.4% for 60 days delinquent and 26.5% for 30-day delinquencies. All told, Amherst expects 12.42% of units (from the 13.54% of properties delinquent and in foreclosure) to eventually liquidate.

Let's put some numbers on this.

There are roughly 125 million single-family homes in the US.

Of those, roughly 30% have no mortgage on them at all. This leaves 87.5 million single-family homes with mortgages.

Let us assume the average outstanding balance is $200,000 across the entire set and will take a 40% loss severity. This is less than S&P has estimated for subprime loans and only assumes a roughly 20% market deficiency in the home price (the rest is from legal, rehabilitation and marketing expenses.)

These numbers are, with a high degree of confidence (90%+) low - that is, losses will exceed these estimates, perhaps dramatically so. It is, for example, quite reasonable to believe that due to the concentration of defaults in higher-priced areas (e.g. California and Florida) that the average outstanding balance could be close to double that $200,000 value and the loss due to negative equity higher.

From this we can develop a "cocktail napkin" view of the losses to be taken in home mortgages for single-family homes (remember, this does not include condos, apartment buildings and similar "commercial" paper.)

$200,000 X 40% = $80,000 loss per foreclosure.

87.5 million homes with mortgages X 12.42% = 10,867,500 foreclosures.

10,867,500
x 80,000
=============
$869,400,000,000

or $869 billion in losses remaining in single-family mortgages alone.

What if the average outstanding is higher and negative equity greater than 20% (which is likely)? Losses will almost certainly be well north of a trillion dollars.

The entire banking system and likely The Fed, given the quantity of Fannie and Freddie paper it has been and is "eating", is insolvent. These facts are why the government is lying - they're well-aware of the near-zero cure rates and know that these facts mean that the banking industry has nowhere near sufficient capital to withstand these losses without folding like a paper cup getting stomped on by an elephant.

(Remember that these numbers do not include any commercial real estate losses and we have found that banks are frequently over-stating their claimed values for these loans by 50% or more - as was seen with Colonial.)

It gets better. The FDIC has a negative balance both in its fund balance and the reserve ratio projected for the end of the quarter, which is, big surprise, tomorrow. Oh, and there is this pesky problem that the FDIC has - contrary to its mandate - been issuing bond guarantees for banks, so if and when that banking insolvency is recognized the FDIC will implode into a gravity well also, since it is on the hook for the entire deficiency of those bonds that were issued with its "guarantee" should they default.

Care to argue with the math folks?

CORRUPTION: More FHA Bad Underwriting Proof

nospam@example.com (Karl Denninger) — Tue, 22 Sep 2009 08:49:00 -0400

In response to my article on FHA underwriting practices I've been flooded with a passel of emails.

Here's one that I have redacted to black out the specific borrower information, but note the following:

41.59% HOUSING expense ratio .vs. gross income.
53.40% TOTAL DEBT TO INCOME.

Oh, and what's better? The Loan's purpose is a cash-out refinance. Into an adjustable rate loan at the bottom of the interest-rate market, just as happened in 2003 when Greedspan exhorted people to use "adjustable rate" mortgages - again - at the bottom of the rate market.

Yes, LTV is low. So what? This loan is a foreclosure waiting to happen - a lifestyle loan that someone is taking out to "pull money from their house like an ATM" without regard to whether they can pay. As the interest rate environment rises over the coming years it is a near-certainty that the borrower will find it impossible to cover the payments - that is, if their roof doesn't leak and require replacement first.

Isn't predatory lending wonderful? In this case The FHA is unlikely to realize a loss, but the borrower is very likely to lose their home to foreclosure.

I think it's great when our government lending programs are in fact predatory devices used to steal homes from people for the benefit of banks - don't you? Remember the commercial that used to run as a PSA? "Such a lovely house...."

CORRUPTION: Government Housing Programs

nospam@example.com (Karl Denninger) — Mon, 21 Sep 2009 09:17:00 -0400

It is time to call "BS" on the so-called "reform" in the mortgage lending industry, along with the government's "progress" in this regard.

The current FHA report is now out for servicing delinquencies and defaults, and as expected it is indeed worse, not better. The administration continues to LIE about claimed "improvements" in the character of home finance.

22.9% of all FHA loans are either delinquent or in foreclosure.

Here's the previous report:

Let's see - 30 days are up, 60 days are up, 90+ days are up, default+foreclosure is up and 60+ including foreclosures are of course up.

Improvement? Where? This is current as of August now and the internals continue to deteriorate.

Why? Try this on for size:

This is directly from HUD's web site, which links to a Ginnie Mae calculator for an FHA loan. Assumptions were $50,000 annual income, married, 2 dependents in San Francisco, no declared reserves, one car with a $300 payment monthly, approximately $5,000 in credit card debt at a 5% minimum payment and $100 in additional monthly debt payments (e.g. student loans, etc.)

A lower-income person in California.

Ginnie claims that this person can spend 36% of their gross income on housing, or the front-end ratio (they also include $342 monthly for other housing-related costs, presumably homeowners insurance and utilities) and 49% of gross income on housing and all other mandatory debt service, or a 49% DTI.

This is preposterous. Such a loan will leave this couple with $1800 in monthly income - pretax!

Now let's take out the required FICA + Medicare tax and $322.91 comes out off the top monthly. This leaves you with under $1,500 monthly.

From this you must pay:

Federal and state income taxes
Car registration and insurance
Child care for those two dependents
Food
All other employment-related expenses (transportation, whether in your vehicle or mass transit, uniforms or clothing as required, etc.)
Health insurance contributions (if covered under an employee plan) along with all co-pays and other non-reimbursed expenses.
Retirement contributions (401k/IRA)

and on and on and on.

A family of four on $1,500 a month for everything other than the house eh? Yes, this might work - if you don't make any retirement contribution, you never get sick, you don't lose your job and are unable to find a new one for even one week, your car does not break down and your "great housing opportunity" doesn't require a roof, a furnace, or a water heater.

This much is certain - you won't be saving anything for a rainy-day fund, you won't be paying for child care, and if any of the ordinary calamities that hit families from time to time (see the above for a partial list) hit your family you will almost certainly fall behind on your house payment.

Since you have no extra earnings capacity or slack in your budget once that happens you're doomed - there is essentially no chance you can catch up which means you will wind up foreclosed upon.

This is exactly the sort of BS "lending" that went on during the housing bubble; while it is SOMEWHAT-less egregious than the "OptionARM" games the fact remains that under any sort of actual underwriting standard where CAPACITY is evaluated this loan is manifestly unsound and, on the objective evidence, should be considered PREDATORY.

Yet this is what our government is willing to underwrite and issue a formal federal full-faith-and-credit guarantee upon.

Oh, and the real topper? The $6,190 you need to come up with at closing could be entirely monetized from the $8,000 "first time future foreclosure victim tax credit", meaning that you don't even have to demonstrate that you can save up $6,000 first.

This is an outrage!

The safe limits for underwriting have for years been known to be 28%/36% and this is the reason why. At a 36% DTI the same family has $2,666 monthly pretax instead of $1,800 - a critical $850 that is the difference between being able to eat real food and cat food, having something with which to pay for child care, being able to afford a failed transmission in your car or a new water heater, and being able to make some sort of contribution to a retirement account.

This outrageous and corrupt attempt by our government to pump housing for the explicit purpose of shielding banks from having to take their losses as well as catering to the homebuilder and Realty industries is beyond the pale. These "affordability" ratios will do nothing other than generate millions of new foreclosures in the coming years, and the responsibility for each and every one of them rests directly with the present administration and the GSEs.

Everyone involved in this predatory conduct both within and beyond our government should find themselves in new housing - the graybar motel.

Hattip to "Do_the_math" over on the forum for a lot of back-story legwork. There are a few people left who understand the "5C" model of credit qualification - too bad they replaced all of this with a computer and threw the Cs in the trash!

FHA: Boom or KA-Boom?

nospam@example.com (Karl Denninger) — Fri, 18 Sep 2009 08:43:50 -0400

The expected report is out....

The Federal Housing Administration has been hit so hard by the mortgage crisis that for the first time, the agency's cash reserves will drop below the minimum level set by Congress, FHA officials said.

"It's very serious," FHA Commissioner David H. Stevens said in an interview. "There's nothing more serious that we're addressing right now, outside the housing crisis in general, than this issue."

Part of the reason it's so serious is that the FHA and HUD appear to be attempting to hide exactly how bad it is. Their own reports, for example, do not jive with the servicer reports (oops - you forgot those, didn't you?) which I've reported on before.

There is a serious debate that needs to be held here, but the bottom line problem is the same as it is in other areas of the financial system - that is, leverage.

It's too high. Allowing DTIs over 36% is ridiculous. Allowing people to buy homes through a Federal insurance agency with zero down payments (irrespective of how - whether through SFDPA - which has ended - or through "monetization" of tax rebates) is idiotic. Providing financing even with a 3.5% down payment is asinine as that still represents 100:1 or more leverage in real terms, since the standard Real Estate commission remains at or near 6% and on a resale that comes out of the transaction, meaning that even with a cash 3.5% down payment the buyer is in fact underwater and has infinite leverage at loan origination.

All of this is due to a misguided belief that artificially high home prices are good.

But it is axiomatic that they're good only for home builders and existing owners.

If you do not own a home, you obviously would like home prices to be low, just as you want iPOD prices to be low, car prices to be low, milk, cheese and egg prices to be low and fancy cruise vacation prices to be low.

Buyers never want prices high for obvious reasons, yet everything the government has done is intended to do one and only one thing: attempt to prop up a popped asset bubble that their policies created in the first place.

An honest discussion of this face is of course anathema to politicians who are recipients of tremendous lobbying pressure from the Realtors and Home Builders - the latter with a clear conflict of interest and the former who, paid on a percentage-of-sale based commission, obviously want high prices too.

The interest of the general public never enters into the debate - but it should, given what FHA's claimed mission in life is.

The truth, of course, is something different.

President Obama Speaks - And Lies (Again)

nospam@example.com (Karl Denninger) — Mon, 14 Sep 2009 12:58:00 -0400

President Obama stood in New York at "high noon" and talked about how we must have "change", and that we have "helped homeowners avoid foreclosures", how "we must put in place reforms" and that "we have helped come back from the brink" and "an irresponsible period of crisis."

In fact, in his speech he said:

So I want to urge you to demonstrate that you take this obligation to heart. To put greater effort into helping families who need their mortgages modified under my administration's homeownership plan. To help small business owners who desperately need loans and who are bearing the brunt of the decline in available credit. To help communities that would benefit from the financing you could provide, or the community development institutions you could support. To come up with creative approaches to improve financial education and to bring banking to those who live and work entirely outside the banking system. And, of course, to embrace serious financial reform, not fight it.

Really Mr. President?

Perhaps you would like to explain this - the outcome of the FHA under your Administration thus far?

Bluntly: You're lying when it comes to having these institutions make only sustainable, safe and sound loans, along with helping Americans keep their homes.

(The spreadsheet can be found here: http://spreadsheets.google.com/ccc?key=0AirpBiMjpGTLdHdfWkJlM2JBbHBiZkpuZk9vTldBV1E&hl=en) and reproduced off HUD's own web page at https://entp.hud.gov/sfnw/public/.

The worse news? The portfolio has doubled over the last two years, with 2.6 million loans added (of a total of 5.18 million.)

So what's the story on recent loans? We don't have an accurate number on that, but this much is clear: The claim that FHA only has a single-digit default and delinquency rate, and is helping Americans own and keep their homes is a BALD-FACED LIE.

Sustainable mortgages eh? "Helping homeowners" eh?

Not a snowball's chance in Hell according not to your lies but the mathematical FACTS as represented in ACTUAL default rates.

ONE IN FIVE FHA mortgages is either late or in foreclosure?

ONE IN FIVE?!

I'm tired of the lying and so is everyone else.

We The People demand THE TRUTH.

THE TRUTH is that:

FHA has been and still is putting Americans into loans they cannot afford, as is proved by the default and foreclosure statistics.

The housing and banking industry HAS NOT reformed its ways, specifically, pushing loans on people they cannot afford, and the FHA is blatantly conspiring with these clowns in APPROVING loans that statistically have a one in five shot at failure.

The claim that these mortgage programs are "helping Americans" is a damned lie. No program that winds up with one in five borrowers unable to pay - a rate double that of credit-card defaults - can be said to be "sustainable", "safe", or 'helping homeowners."

We must clear the bad, un-serviceable debt from the system. Papering it over or worse, transferring it to The Federal Government where you think people won't find it won't work.

The only solution to the housing crisis is that prices for homes must come down to where they are actually affordable on a long-term, sustainable basis. This means that we must demand 20% down payments, 28% front end and 36% back end ratios, without exception.

I have said this must happen for more than two years and now the results on "the alternative" pushed by the Federal Government, including Fannie, Freddie and the FHA are in: their promulgated "alternative" does not work, cannot work, and is leading to ruinously-bad default rates, leaving homeowners just as screwed as they were before - if not more so.

FHA and VA are today writing loans with 3.5% down (and in fact 0% down if you use the $8,000 "home buyers credit") and ignoring safe and sound front and back end ratio limits in a desperate attempt to prevent that which must happen to restore a sound housing industry: A decline in prices to sustainable levels.

THE EFFORT TO PAPER OVER THE TRUTH WITH MORE AND MORE LIES HAS FAILED.

I understand that the housing and lending "industry", particularly the latter, are desperate to prevent a contraction to sustainable pricing as house prices returning to sustainable levels will wipe out a huge number of banks - including some of our nation's largest institutions.

But whether they (or you) like it or not this has to happen and the longer we "resist" the inevitable decline all the way to sustainable pricing and closing the insolvent institutions you and The Fed are propping up through blatant accounting fictions the worse the outcome will be for America and our economy.

Thanks to Krista for digging up the facts. We cannot allow, as citizens, the outrageous lies of our government, delivered by a grinning teleprompter-reading handmaiden to those who have and continue to loot the public and its' Treasury, to stand unchallenged.

Foreclosures: They're Not Just For Breakfast

nospam@example.com (Karl Denninger) — Thu, 10 Sep 2009 09:00:00 -0400

Its also for lunch, dinner, and your midnight snack!

IRVINE, Calif., Sept. 10 /PRNewswire/ -- RealtyTrac(R) (www.realtytrac.com), the leading online marketplace for foreclosure properties, today released its August 2009 U.S. Foreclosure Market Report(TM), which shows foreclosure filings - default notices, scheduled auctions and bank repossessions - were reported on 358,471 U.S. properties during the month, a decrease of less than 1 percent from the previous month but still an increase of nearly 18 percent from August 2008. The report also shows one in every 357 U.S. housing units received a foreclosure filing in August.

"But there's more!" as the crooners on late-night TV say while trying to sell you a set of Ginsu knives.

The most important part of this is the intentional sandbagging by banks, as I have covered repeatedly in these pages.

While 1 in 62 houses in Nevada received a foreclosure filing in August (ouch!) and 1 in 140 in Florida (not good!) the fact remains that the banks are intentionally holding back on processing defaulted loans and taking possession of REO property (say much less selling it.)

The issue remains that banks are failing to clear the pipeline of all these homes where the putative owner can't afford the payments. "Hope for Homeowners" is a certified joke; yes, there are instances where it has helped people, but in essentially every case all that's happening is that we're kicking the can down the road with modifications that temporarily reduce interest rates and back-load principal forbearance (not forgiveness!)

For the odds of success in this endeavor I refer you to this graph that I have published before:

The key is the "income" line. Notice how it is not rising much over the last decade. It is up by 20% from 2000-2008, which sounds good, but in fact that's only about a 2.2% increase annually. When the 2008 numbers are released by Census (we have only through 2007 thus far) I suspect they will show an actual decline (torpedoing this annualized rate) and 09 may be even worse.

The fallacy of "extend and pretend" when it comes to any sort of credit is that you can earn your way out of the hole "if you just have a bit more time." But the record in this regard is clear - there is no capacity to do this. Incomes on a per-capita basis have risen at a rate substantially less than the price of the necessities of life have risen during the same period of time, especially when one considers items such as health care, food and fuel. When you remember that The Fed's stated target is to have inflation of 1-2% annually (and then look at their record - they essentially always miss, with inflation coming in over target), you quickly come to the conclusion that as designed the concept of "extend and pretend" is bankrupt.

While the government claims that disposable personal income has gone up since 2000 this is an obvious bucket of bilge. The per-capita personal income numbers are not wrong, and neither is the price increase in necessities. 2 + 2 = 4 no matter how many times the government tries to claim it's 6.

The result is that "extending" debt maturity in fact does harm instead of good, because the longer you wait the worse the final loss will be.

Yet every strategy employed since this crisis broke onto the scene in 2007 has been focused on extending maturity, pretending it is all ok, and believing that Santa Claus will appear and wave a magic wand to whisk away all the bad debt.

It hasn't happened and won't, because the consumer has reached his capacity to absorb and service more debt. Unemployment continues to grow; recall that we need to add roughly 150,000 jobs every month just to handle the increasing population of the nation, yet we are still losing nearly a million monthly (government "headline numbers" to the contrary notwithstanding.)

The Next Boom: FHA

nospam@example.com (Karl Denninger) — Fri, 04 Sep 2009 10:07:00 -0400

The WSJ picks up the gist of the problem, but misses badly on the cause:

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

The rising losses at the FHA, part of the U.S. Department of Housing and Urban Development, come as the agency has rapidly increased its role in guaranteeing loans in an attempt to stabilize the housing market.

In danger of? It is a mathematical certainty unless changes are made essentially "right here and now."

Rising defaults have eaten through the FHA's cushion. Some 7.8% of FHA loans at the end of the second quarter were 90 days late or more, or in foreclosure, according to the Mortgage Bankers Association, a figure roughly equal to the national average for all loans. That is up from 5.4% a year ago.

So says the WSJ. Oh, by the way, with 2% capital reserves and 7.8% of loans non-current (and beyond cure) the odds of going underwater with that capital cushion are high enough that you better ask for odds if you place a bet they won't - I wouldn't take that bet at less than 10:1 odds, in fact, as it is nearly certain on a mathematical basis (the ratio was cut by more than half in 2008 .vs. 2007, from 6.4% to 3% - what's another 3% place it at? Oops.)

The real problem is as "Do_The_Math" put forward in this post over on the forum, and which I have repeatedly highlighted - excessive leverage and inadequate underwriting in the FHA process:

Lunatic_fringe. Standard FHA DTI is 31/43. It used to be 29/41, but the ratios were expanded in 2005 after the Bush tax cuts. The logic was that the tax cuts allowed borrowers to allocate more of the their gross income toward housing and liabilities. These debt ratios are not cut and dry, and can be exceeded with significant compensating factors unless the borrower has alternative credit.

However, if the lender uses AUS TOTAL Scorecard to analyze credit and income qualifying, the debt ratios can be exceeded. I've seen AUS recommendations in the 40's/50's without compensating factors AND layering of risk. Fortunately, more lenders are implementing underwriting overlays that limit the back end ratio.

Eek. Oh, and let's not forget that instead of a safe and sound 20% down payment FHA permits 3.5% down, and with the $8,000 "home buyer credit" you can use that for the downstroke either in whole or part, so we have a whole lot of "new borrowers" with absolutely no skin in the game.

Of course when you keep adding people to a pool who haven't had time (yet) to default it makes the percentages look better. But this is a shell game - unless their performance is better over time than the remainder of the pool you are poisoning the well with certainty.

Unfortunately the FHA's ramping loan issuance hasn't been to higher-quality borrowers - it has been to people who are getting loans with multiple layers of risk, with the "new home buyer credit" another level of layering up.

The performance of these loans is likely to be horrifying, especially given the flat-to-worsening employment situation. This gambit is yet another instance of expectation of both an imminent turn in housing prices and generalized economic recovery - an outcome that is tenuous at best.

By my analysis this is just another attempt to "reflate" the housing bubble but you can't pump air into a popped balloon. Instead we are setting up yet another government lie factory for a huge explosion with this one threatening to detonate what's left of mortgage finance.

FHA must be reformed and the lie factory shut down here and now. 28/36 DTI (front and back end) ratios must be reinstated and strictly enforced. In addition, down payment requirements must go to 20% - cash - no gimmicks.

This will force prices lower on real estate but it will also stabilize the finance market for new loans. Yes, it will force recognition of the losses already made on the books of banks and other institutions, a lie that these institutions have managed to maintain now for more than two years on the back of bogus accounting changes and willful government complicity.

But that price adjustment will lead to buyers coming into the market with cash down payments of 20%, limited (no more than 5:1) leverage (as a result of the down payment requirement) and debt-to-income levels that are sustainable for the long haul. It will result in default rates on these new loans falling to the 1% range. It will result in a cessation of new homeowners being "trapped" in homes - a side effect of the "extend and pretend" lie that results in ramping unemployment as it precludes a homeowner from selling their home and moving to follow job opportunities (you can't sell a house that's underwater without cash you don't have, especially after you just lost your job!)

We desperately need higher-quality buyers in the market, not lower-quality ones and we must stop trapping people in houses when they lose their jobs, preventing them from following opportunity in the labor market. You cannot stabilize a market or economy with "one breath away from default" buyers on financed terms with no capital cushion - that path, which is what the FHA is doing today, is the worst kind of political BS in that it virtually guarantees a disaster in the immediate future.

Making Foreclosures One At A Time

nospam@example.com (Karl Denninger) — Wed, 02 Sep 2009 14:39:00 -0400

If you wondered how bad this recession is going to get - why we're going to have an all-on 1930s repeat - let me present to you CNN's "What I Bought With My $8,000 Tax Credit":

Location: Newport News, Va.

Property: 3 bed, 2.5 bath townhouse

Price: $257,000

When buying, the biggest problem I had was how to come up with a down payment. The house was $257,000, and I needed to put down 3.5% to meet the FHA rules. I didn't have all of the $9,000 required, but then I found out about the FHA's new program where you can use the tax credit for the down payment. Using the plan, which the FHA announced in May, I was able to buy the house without draining all our savings.

I got a great deal on the mortgage. The interest rate is just 3.5% for the first year and costs about $1,500 a month, with taxes and insurance. The rate goes to 4.5% the second year and caps after that at 5.5%, about $1,900 monthly, which we should be able to swing as our earnings go up.

Two problems: Townhouses come with assessments, which are an added bug-a-boo compared to a house. There are two sorts: Regular assessments which (usually) are level and easily planned for, and then special assessments that come from needs in the common areas (sometimes including roofs and such) or if someone (for instance) gets hurt in the common areas and sues.

If you can't save up the $9,000 down payment you also can't cover a blown-up washer, dryer, water heater or stove. You further have no chance of covering a special assessment.

Finally, what if your earnings don't go up? Pay any attention to the employment situation my friends? There is enormous slack in the employment market and a much greater chance you will experience an income decrease than increase over the next five years. One of you might lose you job, for openers. While you probably clear the income bar for sound ownership ($86k or so between the two of you) with both working, I'll bet neither of you does alone. You're a layoff away from instant disaster with no reserves.

Location: Portland, Maine

Property: 3-family home

Price: $255,000

I didn't want to dip into my retirement account for a down payment, and the tax credit let me buy a three-family house without emptying my retirement.

Again, no skin in the game. What happens if the price continues to decline? While a 3-family home for $255,000 is reasonably safe I suspect, the fact remains that now you're a landlord and if you have no savings (you need to hit a retirement account) you've also got no cushion against one of your units being empty for a while or (god forbid) a new roof or other significant repair. I also question the income-to-price ratio if you needed to do this in order to make the numbers work - cancel that objection if you make $85,000 a year or more and your job is secure, but the fact remains that with no liquid savings any interruption in income means trouble - fast.

Location: Adelanto, Calif.

Property: 4 bed, 2 bath Spanish-style

Price: $73,000

We lost out to higher bids several times, but we finally got initial approval four weeks ago on a short sale of a Spanish-style house. It cost $73,000. We're waiting for final approval. I don't know if it will come before the tax credit expires. I hope it does, but banks are so slow at processing things right now.

Ok. This one actually will likely work. Ignoring the $8,000 for a moment if this couple has a combined income of $30,000 (or more) they're well within the parameters of safe borrowing to buy a home that they will actually own some time in the future. I recommend a 15-year mortgage so you start building equity faster.

Location: Portland, Mich.

Property: 3 bed, 1.5 bath, 1,449 s.f.

Price: $115,000

My now ex-boyfriend was always after me to buy a home, but it wasn't until after we broke up that I did. I lost a louse and bought a house!

I'm a conscientious shopper and very careful about what I spend. I saved for several years to pay for the house and maintained great credit so I was able to get a low mortgage rate.

Ding ding ding ding ding! We have a winner! She saved for several years, did not need leverage, bought within her means, and has a home - not a speculative investment or something she has to stretch to buy. I know where Portland Michigan is, by the way - nice little town.

Location: San Carlos, Calf.

Property: 3 bed, 2 bath, 1,600 s.f.

Price: $750,000

We felt like we had to hurry and buy before the end of the year so we wouldn't miss out on the tax credit. That turned out to be truer than we thought: As we got closer to the end, we realized how much closing costs and other fees would add to the purchase price, which was high enough already.

The $8,000 tax credit is saving us. Wedding, new house, we're tapped out. We're definitely big fans of the tax credit!

Got a number for a good divorce lawyer on speed-dial and have you already borrowed the money on your credit card necessary to pay him or her, stuffing it where your wife/husband can't find it? You're going to need both.

To support a $750,000 home you need a combined household income of $250,000 or more. She cuts hair and he operates a crane. Odds of that adding up to $250,000 gross, even in the land of fruits and nuts? Zero. Oh, and they mentioned they're tapped out from getting married and all that's involved with buying the place. Great. Another "no equity, no savings, and God help me if I lose my job - or the credit card company decides to stop financing my lifestyle" story.

PS: Whether the house down the street sold for $1.2 million is immaterial.

Location: Baltimore

Property: 3 bedroom, 2 bath rowhouse

Price: $119,000

We looked for a year, but didn't find anything that was perfect. The tax credit helped change our minds, and we bought a rowhouse that was right where we wanted it, in the Canton neighborhood. The tax credit, along with some local grants available for restoring historic district homes, made it more practical to buy a fixer-upper.

A modest home that can be done on $40,000 in combined income. A graduate fellow and registered nurse don't make all that much, but between them they certainly should clear the income bar, and they're treating this as a home, buying a rehab and gutting it. I like it.

So let's add it up.

I have three impending disasters, with one certain enough that I'll give you 5:1 odds on it, and the other two even money.

That's a 50% FAIL rate and is just what we need in America - more foreclosures.

If the program was limited to the three sound loans it would be ok. Let's define "sound loan:"

20% down payment or more without using the credit.
Income of both earners at least 1/2 the price of the house if both are working, 1/3 the price if only one of a couple is working. (Why the higher requirement if both work? Because if EITHER person loses their job you're screwed if you rely on two incomes! There is more risk of one of a couple losing their job than the sole earner in a one-earner household being laid off or fired.)
28% front end and 36% back end ratio maximum (undisclosed in this series)

Notice that none of the stories that are likely to have happy endings needed the credit to buy, but it provided incentive to do so. For the disasters-in-waiting, however, the credit was the enabling device that will ultimately lead these folks into ruin.

Congratulations Washington.

PS: I bet the situation of about half the people who traded in their fully-paid-off "Clunker" for a nice new car payment are about to get a similar (and equally-ugly) surprise.

McStupid: Mortgage Banker's Association

nospam@example.com (Karl Denninger) — Wed, 02 Sep 2009 09:53:00 -0400

I thought I had seen it all when it comes to dumb. I was wrong.

This is idiotic. Let's count the ways:

A "strong regulator" eh? You mean like the FHFA? Fannie and Freddie had a so-called "strong regulator" that nonetheless allowed them to lever up at 80:1 (or 200:1 depending on how you looked at their books) which was clearly outrageous on its face and led to their demise.
That same "strong regulatory framework" had Fannie and Freddie buying other-than-actual-prime paper. It detonated. Any questions?
Fannie and Freddie turned into revolving-door agencies with the government, winding up as political tools on both sides of the aisle.

If the MBA wants "sound underwriting" there are simple ways to guarantee it and no government backstop is required.

Simply put, credit risk is controlled by imposing leverage limits on buyers. This is done by requiring down payments. A 20% down payment requirement limits leverage to 5:1, and unlike a political process it requires no regulation - you simply make it unlawful to give out mortgage money without 20% in cash on the barrel. Presto: credit risk problem solved.

This also prevents speculative asset bubbles in housing since as soon as house prices start to outstrip incomes the market gets shut down immediately by the down payment requirement. The feedback mechanism is immediate, it requires no regulation and it is self-policing.

Every time we claim to have a "strong regulator" they get bought off and we have a disaster. Banks, S&Ls, mortgages, credit cards, you name it, it happens. Why? Because its cheaper to bribe a Congressperson with a big campaign contribution than it is to earn your money honestly - the returns on lobbying "investments" and campaign "contributions" are often 1000:1 or more, while actually earning money requires work. With lotto-style payoffs you can and will get this sort of speculative game-playing and should expect nothing less.

I have continued to maintain that there is exactly one way to prevent asset bubbles in real property and there is one way to make sound mortgage loans, which not-incidentally require one another: strict leverage limits and proved capacity to pay.

That is, the 100-year-old set of standards:

20% down payments, in cash, are required
28% "front end" (all housing expenses) maximum ratio
36% "back end" (all debt service including housing) maximum ratio

Do those three things and even in severe recessions you don't have a major problem with defaults. You also don't get speculative property bubbles because as soon as prices try to rise above affordable maximums for the income in a given area the supply of buyers who can meet the ratios disappear.

Enact this into the law with a provision that any loan found to be funded outside of these ratios is deemed predatory and subject to rescission and the problem is solved.

Anything else is subject to being gamed and is simply an attempt to steal - again - from the taxpayers.

These lobbying and "trade" organizations need to be recognized as what they are - a blatant device to game regulatory processes for the purpose of foisting off risk to the taxpayer while pocketing as much money as is possible for private interests.

STOP THE LOOTING.