California Foreclosures: Foreclosures and Charting the REO Trend. Lord of the Mortgages.

28 08 2008

California Foreclosures: Foreclosures and Charting the REO Trend. Lord of the Mortgages.

Posted by: admin in Real-estate news

Many of you in middle school had the opportunity to read William Golding’s Lord of the Flies. The book looks at two boys, Ralph and Piggy who find themselves on an island next to a plane crash site. Soon they find out that they are not alone on the island. At first, all is civil […]
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Many of you in middle school had the opportunity to read William Golding’s Lord of the Flies. The book looks at two boys, Ralph and Piggy who find themselves on an island next to a plane crash site. Soon they find out that they are not alone on the island. At first, all is civil and cordial as they build bonds with the children on the island. Yet as time progresses one of the “others” branches out and begins to take on his hunter role more deeply. No, this isn’t Lost although the leader of the other hunter group is called Jack. Back to the story, one of the themes of the book is an examination into human nature and how culture created by man fails. What we have witnessed in California this past decade is a financial lord of the mortgages. People woke up one day and found easy access to credit and instead of harnessing this new found wealth diligently and prudently they savagely ate it up like a starving child trying to eat up all the food before his brother has any chance to eat.

Such is the mania that ensued during this housing speculation. There really was no one governing or regulating the industry. Think for a second how patently absurd zero down or no documentation mortgages are. Would you give a stranger off the street $10,000 because they told you they made $200,000 a year as some stunt double for a reality television show? Of course not. Yet banks over and over made $500,000 mortgages to strangers since it wasn’t their money which they were lending. Who really cares what happens to the money after all so long as you get your nice commission. Is it any wonder why FBI statistics show a massive jump in mortgage fraud over the last few years? This has been the largest financial heist in history and all it took was a bunch of people with suits and access to credit to perpetuate this mess.

And like Lord of the Flies, the group that has gone savage is attempting to capture Ralph who is still trying to get off the island and back to civilization. To capture Ralph, the others set the island on fire thus alerting a warship that is passing by even though they were trying to fry Ralph. The navy officer sudden arrival puts all the boys in order and is astonished at what has occurred. He expected better. Now we have politicians, authorities, financial institutions, and everyone else peering into the mortgage island and are “astonished” at what has been going on. Many of these lenders are still woefully optimistic that many of the Alt-A loans were made in good spirits and many of the borrowers will want to make diligent payments on a $600,000 home that is now seeing comps in the $400,000 range. Yeah right. Welcome to the island lenders.

Before we go on, I’m going to post a graph showing four very important items. Many readers have been asking for a graph highlighting the California median price, monthly sales, REOs, and notice of defaults. Here it is:

*Click to Enlarge

I know the chart is a bit busy but it is useful to put all the data in one quick glance to quickly see what is happening. Let me highlight each of the 4 data points individually:

(1) Median Price

For this chart we are using the median price dished out by DataQuick. The data provided by the California Association of Realtors has a much higher median price but we’ll go with this for the time being. It is worth noting that these two measures were divergent on the way up but now they are crossing paths at the bottom. The peak was reached in March, April, and May of 2007 at $484,000. The current median price for a California home is $318,000. A drop of 34% in one year is no small potatoes. Yet much of this furious price discounting is the massive amount of foreclosure and distress sales going on. Many are trying to argue that this is skewing the data but as an intelligent buyer, why in the world would you buy a home from seller looking for prime value when you can negotiate with a desperate bank and make them an offer that they most likely will take?

This leads us to the next point in the chart which is the monthly sales.

(2) Monthly Sales

Without a doubt, sales have been perking up since spring of this year. And this is good news. Yet you need to dig through the spin to understand why sales are going up. Sales are going up because prices are dropping like a rock in a lake (refer to point #1 above). Any good student of economics realizes that price can have an impact on demand. Sellers weren’t lowering prices so the market hit a wall for a few months. Yet now that banks and lenders are the major players in the market they are willing and realistic about the current market conditions and are not shy about chopping prices lower. They have to keep slashing prices since their inventory numbers are skyrocketing.

Which leads us to our next point, notice of defaults.

(3) Notice of Defaults

The recent trend in housing spin is that notice of defaults (NODs) have hit a peak and are trending lower. Take a look at the graph. These are historical highs. So the fact that we have backed off a bit isn’t much of a big deal. Here is some quick math for you:

July 2008 Data

NODs: 40,219

Total Sales: 39,507

As you can see NODs are now above the amount of actual sales. Compare this to January of 2007 when we had 32,245 sales and 16,225 NODs. The big issue with this is the amount of NODs that are actually converting over into REOs and foreclosures. Some of these NODs will be sold as a short sale but most likely these will be taken back by the lenders as REOs. Since the vast majority will convert to defaults the sales we just saw are essentially just enough to recycle the distressed property. 44.8 percent of all the sales last month were foreclosure resales. That is a stunning number.

Which leads us to our final data point, that of REOs.

(4) Real Estate Owned

Lenders are overwhelmed with the amount of inventory they are seeing. If nearly half the sales each month are foreclosures, and distressed properties are now selling for 50 to 60 percent off peak values you can rest assured that the median price is going to get hammered even further. I saw a few homes that were on the market in the Inland Empire for 5 figures! Just imagine when that property sells what that will do to comps.

Look at the chart again. Last month banks took back 28,795 homes! So even though the sales number of 39,507 looks promising, banks just got a nice batch of 28,795 homes to sell. That is:

39,507 (sold) - 28,795 (REOs back to lenders) = 10,712 drop in overall inventory

You really have to look at it this way. Even though banks are seeing a bump in sales it is largely due to the massive discounting going on with these foreclosures and financing that is happening in the conforming areas (i.e., government conventional loans). You can rest assured that many of those NODs are going to become REOs in the upcoming months and thus add more inventory in a market that is already saturated. And many of the cheerleaders forget that our economy is in difficult times. Why would anyone buy if they suspect they’ll be losing a job or seeing a cut in their income? They won’t and this will happen as time goes on.

In addition, you need to remember that many of the $300 billion in pay option ARMs in California are going to default without notice. That is, it was a nice 3 or 5 year teaser rate but once the anniversary date hits you can rest assured many folks are simply going to stop making payments. No struggle but a conscious move to stop making payments on an overpriced asset. Currently with the negative amortizing payment it may be cheaper than renting. But once that payment resets there will be no point and they can try selling the home but once again look at the graph and the trend in NODs and REOs. This frankly has the potential to grind the entire economy to a sudden halt for the next few years.

If the lesson isn’t evident, it is that people were not responsible enough to handle having access to ungodly amounts of credit. This is fine if it was contained to a single institution. Why should we care if a bank is so irresponsible as to loan its own money to unqualified candidates. That is their choice and that is between them and their shareholders. But when they look at the government for help (aka you and everyone else that has been diligent) it becomes society’s problem. Time to send these toxic institutions and mortgage programs onto an island once and for all.

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