Sunday, August 03, 2008

The prospect of a future collapse...

I have opined, in several places over the past few months, that the non-prime mortgage "crisis" in the US would lead to a total collapse of the US economy.

Now comes a second factor - of which I was not aware until this morning when I was listening to the radio news in bed...

But when I google through the thought, the first rumbles were there as long ago as March...
There were more homes on the auction block in California in January than actually sold through traditional channels. And with more notices of loan default going out in January, there is little doubt that the state's real estate crisis is far from over.

Since only 2 percent of the homes auctioned off through the state-mandated foreclosure process actually received a bid according to auction tracker ForclosureRadar, the vast majority of those homes reverted back to the lender, only to show up again in a cycle that may not end until the bulging supply of homes dwindles.

Nearly 20,000 foreclosed homes in California were auctioned off in January, up from about 13,000 in December.
Sharp said that while he is getting a lot of calls, selling a home through an online auction is not a good solution for a homeowner who finds he owes more than his house is worth.

"To make a good auction you've got to be willing to sell that day," Sharp said. But what's happening is that homeowners in default who want to sell their homes for less than they are worth need approval from their lender, and banks are taking weeks to approve a sale.

"With these types of auctions, we need to be able to give the buyer confidence he can buy this home today," Sharp said. "So far, banks aren't that aggressive (in approving a sale). I think they might get there."

Bringing that up to this morning with the Beeb piece...
With the American housing market in its worst crisis since the Great Depression of the 1930s, President Bush is authorising new legislation to pave the way for massive new government intervention designed to slow the slide.

The intervention would come as a little known quirk of US law threatens to drive down house prices even faster.

Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from homes and their mortgages.

The "little known quirk of US law"?
In California and much of the rest of America, there is a powerful incentive for homeowners such as Ms Trainer to walk away from their mortgage obligations.

Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes.

Consequently, by walking away from her apartment, Ms Trainer has also walked away from the loss on her property.

That "protection" does not - directly - exist in NZ. There are quite legal protections that can be put in place that might have a similar effect. The "family trust" for example could be seen to limit losses in a situation such as falling property prices. However, in totality (for the owners of the trust) the loss still is taken at that level. Not, as is the case in a good part of the US, by the lender.

The Beeb article concludes...
Total disaster

It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages.

But Professor Nouriel Roubini of New York University, one of the first economists to warn of the dangers of the American house price boom, believes the number of people positively choosing to walk away is growing rapidly.

"This is becoming a tsunami of voluntary defaults," Professor Roubini says.

"The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion.

"You could have most of the US banking system wiped out, so this is a total disaster."

Which is why it is not just US policymakers who are hoping America's new, multi-billion dollar initiative to stabilise the housing market will succeed in its aims and thus make walking away less attractive.

Because if it fails, the economic fallout could be felt far beyond America's shores.

And that is a mighty scary thought.

And here, with no support for its truth other than the plausibility of the "tale" is just one instance of how another aspect of the "system" works...
This property is only worth some $375K maximum (if the original loan was 80% LTV). The property was resold as $625K, with $125K down payment from a "mysterious” person/company. Since $125K is 20% of $625K, it would make the loan to be at "80% LTV”, while in reality, the buyer has no skin, and it's really 100% financing. The seller got a net of $500K minus the $30K that he shared with the straw buyer. So the seller walked away of $500K - $30K - $375K (estimated property value) - $20K (for remodeling) = $75K profits. The buyer will walk away with $30K, and if the loan later gets reset and become unaffordable. At the end, WellsFargo will probably end up with $500K - $400K = $100K loss on the primary loan again.

Actually, WellsFargo will probably resell this loan to Fannie Mae, which gets bailed out by taxpayers' money. Fannie Mae will sustain a $100K loss, but in the name of propping up the mortgage & housing markets, it "would be okay".

There were similar scams being perpetrated in NZ about ten years back. They came to light when specific mortgagors defaulted on what turned out to be 120% lending - due in that instance to inflated property valuations prepared by (supposedly) "independant" valuers. The difference in NZ is that the mortgagor (borrower) is not entirely isolated from the loss. The bankrupt does have some protections - the family home for example does not get included in the bankrupt's "estate". What has to be proved is that the "home" is appropriate to his family's requirements. So a 20 room mansion in Remmers or Hellers for a family of four would probably not be "protected". But more to the point, the existence of unethical - and quite illegal - practices led to criminal convictions and severe financial penalties for the perpetrators.


Eugene Tan said...

Honestly, Probligo, I love this dark side of yours. The doomsayer.

I wonder what's more exciting - a "The Day After Tomorrow" event triggered by global warming or the Second Great Depression triggered by a global meltdown of the financial markets.

I can't wait for this day to come.

The probligo said...

The truth of the matter is really that my confirmation bias does seem to home in on stories like this. It is not a case of "my dark side" so much as there is a certain logic and sense of inevitability in so many of these reports.

If there is a probligo dark side it is that which waits to watch so many people get their come-uppance; that Capitalism is no better system for the betterment of mankind generally than was communism or any other system of economics.

The real problem is people. As the Maori say "He tangata, he tangata, he tangata." And yes, I am aware of the provenance of that response and it is quite different to my use of it here.

T. F. Stern said...

Sitting on the side lines here in Houston where the housing market has been more stable over the past several years, I have noticed the insane prices for housed in many areas of our country. The west coast was due for a major hit because of a false value system, one which could not long out pace reality. Reality is in the process of coming down hard on many who speculated that there was still time to play the high stakes gambling game; but I believe that time has run out.

Glad I live in Houston, hope the rest of the country eventually finds reality without too many folks getting hurt.

This could turn into an economic lesson; nah, better leave that alone.

The probligo said...

TF, I think that the best "economics lesson" of the present circumstances comes in fact from Mr Micawber -

"Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."

You need not worry, NZ is about to elect a right-whinge government. Look to about 2011 for the bankruptcy notices. No,, Eugene, it might not be that bad; but the history and memory of times past dies slowly. When I hear a political party promising "massive" tax cuts in addition to "massive increases" in spending my bowels do tend to get rather watery... and those promises come from the right-whinge, not the socialists.