Skew-flation: What it is and why you should know about it

While this is not a typical post for a Real Estate blog, I thought I would introduce a concept that I believe will get a lot more attention in the coming months/years.

With all the talk of inflation vs. deflation, I would like to make the argument that both groups of pundits are right.

Skewflation (defined): falling asset prices and higher taxes, accompanied by a rising cost of core goods and services.

As to growing consensus the global economy is on the mend, I believe both government "macro" data and corporate "micro" data are painting a much rosier picture vs. actual reality. The real macro story is there's too much productive capacity around the world and not enough demand. Thus, private sector incomes are down while debt levels are up.

We are still in the middle of a massive debt crisis and emergency government programs (ie. mortgage purchases, tax credits, TARP, etc) have temporarily kept the global economy on "life support". Simply put, governments have little room left to continue to postpone the restructuring that's necessary around the world as deficits can only go run so high.

Other major issues:

1) A pending commercial real estate collapse / extreme softening will subject the banking system to another round of big losses.

2) On-going banking fraud of accounting as the banks are not being forced to 'mark to market' (ie. they can claim that a loan that hasn't been paid in 12 months should be valued at 100% of the loan value to maturity. Thus, banks are reluctant to lend for 2 reasons: 1) they don't have the money since they realize they have huges losses coming; 2) they can invest risk free in US Treasuries at approximately 4% - why would they invest in your risky business, auto loan, or morgtgage to perhaps make an additional 1%?

3) Governmental debt problems, coupled with falling revenue. Simply put, government at the local, state, and federal levels are all in over their heads.

So where is the inflation?

I believe as the US government continues to print money, the dollar will naturally fall against other currencies (EURO excluded) leading to higher prices for global commodities. Further, if countries like Brazil, Russia, India, and China (collectively 'BRIC' for market followers)continue to grow as they have been, the demand for global commodities will continue to rise which will push prices for goods like steel, food, iron ore, etc. to new highs.

How do you invest?

Stay away from 'catching a falling knife' in Real Estate. I believe Real Estate is still on a general downward trend. However, due to the inflation issues above, companies that have STRONG international exposure will fair 'better' over the next 5 years. If you can, consider buying ETFs that focus on places like Brail, Russia, India or other countries with good governmental balance sheets as pull backs take place.

That said, I believe you have to be nimble. Long term buy and hold will be a difficult way to make money in the next 5 years.

June US Home Sales raise more than expected....

Weitz - You have to love the Media!...this was the headline for the recent homes data. What the headline does not tell you is that the June Sales were the LOWEST EVER for the the month of June since stats were compiled (since 1963)

AP Article:

Sales of U.S. new homes rose in June more than forecast following an unprecedented collapse the prior month, a signal the worst of the slump triggered by the end of a government tax credit is over.

Purchases increased 24 percent from May to an annual pace of 330,000, figures from the Commerce Department showed today in Washington. The rate was the second-lowest in data going back to 1963 after May’s downwardly revised 267,000 pace.

The lowest mortgage rates on record may help underpin demand, stabilizing the industry that triggered the worst recession since the 1930s. Even so, increasing foreclosures are swelling the number of unsold existing homes, putting pressure on prices and keeping buyers on the sidelines as unemployment hovers near 10 percent and the economy cools.

Sales are “bouncing along the bottom,” said Eric Green, chief market economist at TD Securities Inc. in New York, who forecast an increase to 335,000. “The future is going to be dependent on job growth. There’s no demand because confidence is weak and employment is weak.”

Stocks extended prior gains following the report. The Standard & Poor’s 500 Index rose 0.7 percent to 1,110.16 at 10:17 a.m. in New York. The S&P Supercomposite Homebuilder Index climbed 3.1 percent. Weitz -Why?...this shows that Wall Street 'intelligence' may be over-rated...remember - Worst June on record!

Exceeds Forecast

Economists forecast sales would rise 3.3 percent to an annual pace of 310,000, according to the median of 73 projections in a Bloomberg News survey. Estimates ranged from 260,000 to 360,000.

The government had initially estimated May sales at a 300,000 rate and revised down figures for every month since March. The 37 percent plunge in May was the biggest on record.

Purchases increased in three of four regions, led by a 46 percent jump in the Northeast and a 33 [percent surge in the South, the largest area. Demand dropped 6.6 percent in the West to a record low 57,000 pace.

The supply of homes at the current sales rate fell to 7.6 months’ worth from 9.6 months in May. There were 210,000 new houses on the market at the end of June, the fewest since 1968.

To become eligible for a federal incentive worth up to $8,000, buyers had to sign contracts by April 30 and close deals by the end of last month. The surge in demand prior to the April deadline prompted the government this month to extend the closing deadline until Sept. 30 to ensure buyers had enough time to complete transactions.

Exiting Homes

Purchases of previously-owned homes, which are tabulated when a contract closes, fell a less-than-forecast 5.1 percent in June, sustained by a backlog of deals waiting to settle, figures from the National Association of Realtors showed last week.

With the deadline for signing a contract now past, it will be up to advances in the labor market to support home sales. Private U.S. companies added 83,000 jobs in June, fewer than economists had forecast, and initial jobless claims have averaged 449,700 this month, a sign firings remain elevated.

Mounting Foreclosures

Another challenge to new home sales is the rising tide of foreclosures. Home seizures jumped 38 percent in the second quarter from a year earlier, RealtyTrac Inc. said last week, putting lenders on pace to claim more than 1 million properties this year.

Weitz- More foreclosures = More inventory once the banks actually try to sell the properties = lower prices = even more foreclosures. As a natural optimist, I hate to be so pessimistic, but its hard to argue with Math.

Post Tax Credit Reality

Excerpts from an AP Post on July 21, 2010

The housing market, whose collapse pulled the economy into recession in late 2007, is stalling again.

In major markets across the country, home sales are deteriorating, inventories of unsold homes are piling up and builders are scaling back construction plans. The expiration of a federal home-buyers tax credit at the end of April is weighing on the market.

“The Tax Credit simply pulled demand forward. In my opinion, it was a huge use of tax payer dollars that acted as a short term band aid”

On Tuesday, the U.S. Census Bureau said single-family housing starts in June fell by 0.7%, to a seasonally adjusted annual rate of 454,000. The U.S. started 1.47 million homes in 2006, before the housing bubble popped.

Future construction looks even weaker. Permits for single-family starts fell 3% in June, following big declines in both May and April. "We're hovering at post-World War II lows," said Ivy Zelman, president of Zelman & Associates, a research firm.

Weitz- without a substantial pick up in construction, it will be nearly impossible for the job market to improve.

At the end of June, inventory was up 33% from year-ago levels in San Diego, and by 19% and 15% in Los Angeles and Orange County, Calif., respectively, according to data compiled by John Burns Real Estate Consulting. Rising inventory can lead to price declines later.(Weitz - See story in the Seattle area)

Even falling interest rates aren't enough to whet consumer appetites for housing. Last week, the average rate on a 30-year fixed-rate mortgage was quoted at 4.57%, according to Freddie Mac, the lowest since its survey began in 1971. But demand for home-purchase mortgages sits near 14-year lows, according to the Mortgage Bankers Association, down 44% over the past two months.

The government last fall extended tax credits worth up to $8,000 to home buyers who signed contracts by April 30, causing sales to surge early this year. Those buyers had until June 30 to close their sales until Congress, concerned that the backlog of sales wouldn't close in time, extended the deadline through September.

Analysts long expected the withdrawal of a federal tax credit, which had juiced sales, to lead to a slower-than-usual summer.

"It's the magnitude that's been the issue,'' says Douglas Duncan, chief economist at Fannie Mae. "The drop-off in activity has surpassed expectations.'' (Weitz - Not if you read our blog)

Reports should show that completed transactions of home sales held up through June. But newly signed contracts in May and June have plunged.

Low mortgage rates and falling prices have made homes more affordable in many markets than at any time in the past decade. But those affordability gains have been offset for many buyers by tighter lending standards, particularly for "jumbo" loans that are too large for government backing. Banks are requiring down payments of 20% and more and strong credit scores because they must hold jumbo loans in their portfolios.

More broadly, the housing market faces two big problems: too many homes and falling demand. More than seven million borrowers are 30 days or more past due on their mortgage payments or in some stage of foreclosure. Rising foreclosures will keep pressure on prices as banks put more homes on the market.

Weitz- I continue to believe that foreclosures will continue to rise as more and more folks turn to strategic defaults. Our policies, as a country, have favored the banks 100%. Many big banks received TARP money (which is often the only publicized tax payer handout). They also benefited from the PPIP program, and continue to benefit from the carry trade (borrowing at 0-1% from the Federal Reserve and investing in treasuries at 4% ....we should all be so lucky), as well as the repeal of 'mark to market' which has allowed the banks to lie their way to 'positive earnings'. Homeowners, conversely, are left paying debt service to banks based on prices that were artificially inflated by those very banks due to lack of lending standards, and creative (to put it kindly) financing structures so they could charge higher origination fees and get paid bigger bonuses.

Last month, nearly 39,000 borrowers received government-backed loan modifications, but more than 90,000 borrowers fell out of the program, the Obama administration said on Tuesday.

Moreover, the pool of potential buyers remains constrained by the unprecedented number of homeowners who are underwater, or who owe more than their homes are worth.
Mortgage-finance giants Fannie Mae and Freddie Mac also are starting to push more repossessed homes onto the market. The companies owned 164,000 homes at the end of March, up 80% from a year ago.

Another reason inventory is rising: "Unrealistic sellers have flooded the market" after reports of bidding wars and home-price increases earlier in the year, says Steven Thomas, president of Altera Real Estate, a brokerage in Orange County. The amount of time that homes there have sat on the market there has swelled to 3.78 months, up from 2.35 months in April.

"The sellers think the market's coming back. They've tacked on an extra 5 to 10 to 15%. The buyers aren't going for it," says Jim Klinge, a real-estate agent in Carlsbad, Calif. Over the next six months, "it's going to feel like a double-dip because sellers are going to have to lower their prices."

For more information on your rights in foreclosure, consider seeing a Washington Foreclosure Attorney.

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What's new with Lending standards?

An AP article from July 10, 2010


Dennis Davis has a nearly perfect credit score, equity in his home, considerable savings and a solid pension plan. But Mr. Davis recently found that his lender didn't want to refinance his mortgage.

The problem? Mr. Davis's income-tax return showed he had taken a loss on an investment he made in a small, family-owned business. That was enough to raise doubts about his otherwise strong financial condition.

Three years after the onset of the mortgage crisis, lenders continue to tighten credit standards. The initial moves were a natural reaction for a business badly burned by rising delinquencies and defaults. But conditions are now so tight that lenders are frustrating borrowers who have enviable financial situations but still can't easily satisfy lenders' rigid checklists.

"The pendulum may have swung too far the other way," Scott Anderson, a senior economist at Wells Fargo Securities, said in a report last month.

Some analysts thought that by this point in the business cycle, lenders would have started to relax credit conditions slightly after clamping down on the risky bubble-era practices. Instead, the screws are still tightening.

That is partly because lenders are taking every precaution to avoid being forced to buy back loans from mortgage investors Fannie Mae and Freddie Mac in the event of default. When a borrower defaults, Fannie and Freddie typically buy the loan out of the mortgage-security pool and pursue a workout or foreclosure. But they can force lenders to repurchase loans when they find flaws in the way they were underwritten. Repurchases were a minor nuisance when defaults were low but have escalated over the past year.

Fannie and Freddie have already tightened their standards: Borrowers with credit scores above 720 accounted for 85% of all loans purchased by Fannie and Freddie last year. But banks are being even more stringent to prevent repurchases and want several years of pay stubs, tax returns and other paperwork from potential borrowers.

During the first quarter of this year, Freddie kicked $1.3 billion in loans back to lenders, up from $800 million during the year-earlier period. At Fannie, repurchase requests jumped to $1.8 billion from $1.1 billion one year earlier.

To be sure, the government has taken steps to keep mortgage spigots open. The Federal Housing Administration allows down payments as low as 3.5%.

Weitz- This FHA loan program is a problem in my opinion. So it was reckless to have zero down loans, but 3.5% down is perfectly fine?...seems contradictory. Its a case of government trying to prop up home values, but at what cost? Some would argue it will simply delay the unwinding process of excessive credit from our society.

Borrowers who have received standard paychecks and have uncomplicated finances generally aren't getting tripped up. But others face hurdles. Self-employed borrowers, for example, document their incomes with tax returns that include business-related write-offs, which might understate their cash flow.

He hoped to lower his interest rate to less than 5% from the current 6% through a refinancing. But his mortgage broker, Steve Walsh of Scout Mortgage in Scottsdale, Ariz., said SunTrust Banks Inc. turned down the application, citing the investment-related loss, which Mr. Davis saw as a minor setback rather than a threat to his financial health. SunTrust said it doesn't comment on individual borrowers' situations.

Rather than continuing to shop around for a refinancing, Mr. Davis has decided to cash in some of his investments and pay off the mortgage.

People with complicated financial situations can still find some willing lenders, but "it takes more persistence than most people want to put forth," said Brian Berg, a loan officer at Priority Financial Network, a Calabasas, Calif., mortgage firm.

Recently, Mr. Berg arranged a refinancing for a borrower with a very high credit score and lots of home equity and debt payments totaling just 19% of pretax income. But Mr. Berg said the lender was worried about a credit report showing a $14 missed payment to a credit-card company in 2001. The lender insisted on proof the money had been paid, which Mr. Berg said was impossible to get.

"Who cares?" he said. "It's nine years ago, and it's $14." He appeased the lender by having the borrower write a $14 check, though no one knew where to send it.

Pete Ogilvie, a mortgage broker in Santa Cruz, Calif., hasn't found a bank that will refinance a $250,000 loan on a $1 million property for a borrower with more than $200,000 a year in income and a high credit score. Banks balked because the borrower, a technology executive, was out of work for nearly a year starting in 2008. "We're going to see that for an awful lot of people whose business disappeared unless the banks learn some flexibility," said Mr. Ogilvie.

Fannie put into effect a "loan-quality initiative" that requires more borrower information to ensure that Fannie ends up buying the same loan that it originally agreed to purchase. The effort has led lenders to pull a second credit report before a loan closes, and brokers say consumers should be very careful not to run up credit-card bills before closing on a mortgage.

"If there are inquiries on your report that you're shopping for a car, that's something that has to be answered for," said Dan Green, a Cincinnati broker. "It can delay a closing and, in some cases, it'll kill a closing."

WEITZ- Long term, this is a good thing that lenders are tightening standards. I would love to see 20% required down payment again. The real story here is the big picture that must be looked at...if banks were confident prices were going to start rising, I would imagine that they would be more inclined to issue loans as that is obviously how they make their profits. In my opinion, the lending standards issued by banks shows that they are uncertain as to where prices are headed.

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Strategic Defaults - a summer update

Happy 4th of July!!...An article this morning in the Seattle Times:

AP: With tougher mortgage underwriting rules a virtual certainty under Congress' new financial-overhaul legislation, lenders have begun confronting still another vexing issue: Can homebuyers who have high credit scores really be trusted not to pull the plug — strategically default — if the economy hits a rough patch and home values tank?

New research based on data from 25 million active consumer-credit files suggests the answer just might be no. Though people with the highest-ranking credit scores are less likely to default on their mortgage compared with people with lower scores, when they do default they are much more likely to do it strategically — simply stop paying with little or no warning in advance.

In a study released June 28, researchers from credit-bureau giant Experian and the Oliver Wyman consulting firm found that borrowers with "super prime" credit scores accounted for 30 percent of all mortgages outstanding in mid-2009 but produced just 5 percent of all serious mortgage delinquencies.

However, 28 percent of those elite scorers' defaults were calculated and strategic. This pattern, in turn, is forcing lenders and the credit industry to seek new ways to evaluate risk beyond traditional credit scores.

Charles Chung, Experian's general manager of decision sciences, said in an interview that "lenders not only are looking at credit worthiness" — as measured by traditional credit-scoring models — but also at applicants' likely "ability to pay" under scenarios where real-estate values drop.

In the future, lenders may need to adjust underwriting and risk-rating rules — higher minimum down payments, higher interest rates — to deal with loan applicants who fit the profile for walkaways in a depreciating real-estate market.

Weitz- Note that these policies will only push the median prices down further as fewer buyers will have the ability to make the down payment, and meet other qualifying criteria.

By examining payment patterns in individual credit files, Experian and Oliver Wyman estimate that about 19 percent of all mortgage defaults last year involved intentional, strategic walkaways.

Though there was some evidence that total defaults may have peaked at the end of 2008, the walkaway issue remains a costly and controversial one for the mortgage industry.

Fannie Mae announced in late June that strategic defaults have become such a problem that it is toughening its policy and will pursue walkaways for unpaid balances and penalties wherever permitted by state law. Click here for related story.

The Experian-Oliver Wyman study confirmed that geography plays a significant role in the strategic-default phenomenon. Homeowners in volatile boom-and-bust states such as California and Florida have been especially prone to walk away from deeply negative equity situations.

Weitz- should places like Seattle continue to falter in terms of market value, I expect we will see a similar situation as state law is heavily in favor of the foreclosing party....sometimes, foreclosing even provides more protection than short sales.

According to the researchers, in California and Arizona, where state law imposes restrictions on lenders' abilities to collect post-foreclosure deficiencies on principal residence mortgages, borrowers were more prone to walk away from their houses at lower levels of negative equity compared with borrowers in states such as Florida and Nevada, where lenders face fewer restrictions.

"This result suggests," said the Fed study, "that borrowers may factor into the costs of default the potential legal liabilities resulting from a foreclosure." (Obviously)

The Fed researchers concluded that the depth of borrowers' negative-equity positions is an important tripwire to their decision to send back the keys.

Borrowers whose negative equity is relatively modest appear to be much less willing to strategically default, probably because they hold out hope that market conditions will improve enough to restore them to positive equity one day.

But as negative equity approaches 50 percent — and borrowers see no prospects for higher real-estate values — roughly half of all mortgage defaults are strategic.

The Fed researchers cited a hypothetical case from Palmdale, Calif., to illustrate the economic logic of strategic defaulters: Purchasers there in 2006 paid $375,000 for a median-priced single family home. By 2009, the same house was worth less than $200,000.

Meanwhile, a three- to four-bedroom house in Palmdale rented for $1,300 a month at the end of 2009 — far less than what the deeply underwater borrowers were paying for theirs.

Why stay in a seemingly hopeless situation, bleeding money indefinitely? Both studies document that many borrowers asked themselves that very question — and decided to just stop paying.

Weitz: It is my personal belief that strategic foreclosures will become more prevalent in the Seattle area as borrowers who are cash strapped think there are better ways to allocate their capital than in an underwater mortgage.

For more information on your options when faced with mortgage difficulty, consider contacting a Seattle Foreclosure Attorney.

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