Schiff- Home prices are still too high

An Opinion piece by Peter Schiff in the Wall Street Journal today. The ironic thing is that Mr. Schiff is a notorious 'inflation' hawk. I've always disagreed with in certain respects, but this article indicates that he would probably be categorized in the skewflation camp.

Nevertheless, as pessimistic as it may seem, Mr. Schiff makes a lot of points that are awfully hard to dispute.

AP- Most economists concede that a lasting general recovery is unlikely without a recovery in the housing market. A marked increase in defaults and foreclosures from today's already elevated levels could produce losses that overwhelm banks and trigger another, deeper financial crisis. Study after study has shown that defaults go up when falling prices put mortgage holders "underwater." As a result, the trajectory of home prices has tremendous economic significance.

Earlier this year market observers breathed easier when national prices stabilized. But the "robo-signing"-induced slowdown in the foreclosure market, the recent upward spike in home mortgage rates, and third quarter 2010 declines in the Standard & Poor's Case–Shiller home-price index—including very bad October numbers reported this week—have sparked concerns that a "double dip" in home prices is probable. A longer-term view of home price trends should sharply magnify this fear.

Even those economists worried about renewed price dips would be unlikely to believe that the vicious contractions of 2007 and 2008 (where prices fell about 30% nationally in just two years) could return. But they underestimate how distorted the market had become and how little it has since normalized.

By all accounts, the home price boom that began in January 1998, when the previous 1989 peak was finally surpassed, and topped out in June 2006 was extraordinary. The 173% gain in the Case-Shiller 10-City Index (the only monthly data metric that predates the year 2000) in those nine years averaged an eye-popping 19.2% per year. As we know now, those gains had very little to do with market fundamentals, and everything to do with distortionary government policies that mandated loans to marginal borrowers, and set off a national mania for real-estate wealth and a torrent of temporarily easy credit.

If we assume the bubble was artificial, we can instead imagine that home prices should have followed a more traditional path during that time. In stock-market terms, prices should have followed a trend line. When you do these extrapolations (see lower line in the nearby chart), a sobering picture emerges. In his book "Irrational Exuberance," Yale economist Robert Shiller (co-creator of the Case-Shiller indices along with economists Karl Case and Allan Weiss), determined that in the 100 years between 1900 and 2000, home prices in the U.S. increased an average 3.35% per year, just a tad above the average rate of inflation. This period includes the Great Depression when home prices sank significantly, but it also includes the frothy postwar years of the 1950s and '60s, as well as the strong market of the early-to-mid 1980s, and the surge in the late '90s.

In January 1998 the 10-City Index was at 82.7. If home prices had followed the 3.35% annual 100 year trend line, then the index would have arrived at 126.7 in October 2010. This week, Case-Shiller announced that figure to be 159.0. This would suggest that the index would need to decline an additional 20.3% from current levels just to get back to the trend line.

How has the market found the strength to stop its descent? No one is making the case that fundamentals have improved. Instead, there is widespread agreement that government intervention stopped the free fall. The home buyer's tax credit, record low interest rates, government mortgage-assistance programs, and the increased presence of Fannie Mae, Freddie Mac and the Federal Housing Administration in the mortgage-buying business have, for now, put something of a floor under house prices. Without these artificial props, prices would have likely continued to fall.

Weitz - this is the story no one talks about. The measures taken to 'prop up' the market were unsustainable. Now, the tax credit has run it's course, and interest rates are creeping back up from historic lows. I still maintain that a second leg down in prices is imminent. The extent of the drop is hard to predict, but I would be very surprised if it did not exceed the 5% drop that many 'experts' are predicting.

Where would prices go if these props were removed? Given the current conditions in the real-estate market, with bloated inventories, 9.8% unemployment, a dysfunctional mortgage industry and shattered illusions of real-estate riches, does it makes sense that prices should simply fall back to the trend line? I would argue that they should overshoot on the downside.

With a bleak economic prospect stretching far out into the future, I feel that a 10% dip below the 100-year trend line is a reasonable expectation within the next five years, particularly if mortgage rates rise to more typical levels of 6%. That would put the index at 114.02, or prices 28.3% below where we are now. Even a 5% dip would put us at 120.36, or 24.32% below current prices. If rates stay low, price dips may be less severe, but inflation will be higher.

Weitz - if Mr. Schiff is correct, our "recovery" will most certainly be short lived and things will likely get worse before they get better...a scary proposition indeed.

From my perspective, homes are still overvalued not just because of these long-term price trends, but from a sober analysis of the current economy. The country is overly indebted, savings-depleted and underemployed. Without government guarantees no private lenders would be active in the mortgage market, and without ridiculously low interest rates from the Federal Reserve any available credit would cost home buyers much more. These are not conditions that inspire confidence for a recovery in prices.

In trying to maintain artificial prices, government policies are keeping new buyers from entering the market, exposing taxpayers to untold trillions in liabilities and delaying a real recovery. We should recognize this reality and not pin our hopes on a return to price normalcy that never was that normal to begin with.

Mr. Schiff is president of Euro Pacific Capital and author of "How an Economy Grows and Why it Crashes" (Wiley, 2010).

Higher rates threaten recovery

A nice video on the overview of the recent uptick in mortgage rates. Higher rates will obviously lead to lower purchasing power for buyers, and presumably lower prices in housing. This will be an interesting trend to follow in the year to come.

Fannie and Freddie consider principle reduction loan modifications

Fannie Mae and Freddie Mac are in talks with Obama administration officials to join fledgling government programs aimed at reducing loan balances of mortgages where borrowers owe more than their homes are worth, according to people familiar with the situation.

Weitz – while I commend the administration for trying to help out homeowners, I fear this would create a ‘slippery slope’. What about those that aren’t 'underwater', or those that have been renting during this crisis.

An agreement with the two government-owned mortgage giants to write down so-called underwater loans could reduce the threat to the U.S. housing market from the glut of homeowners believed at risk of default should their personal finances or home prices worsen. A deal would deepen losses at Fannie Mae and Freddie Mac, which already have cost taxpayers about $134 billion.

Weitz – Fannie and Freddie are explicitly backed by the US Government. Losses for them are irrelevant at this point.

Fannie Mae and Freddie Mac, which own or guarantee about half of all first-lien mortgages in the U.S., have been highly reluctant to reduce loan balances, especially for borrowers who are still making payments.

The Obama administration is pressuring Fannie Mae and Freddie Mac, through their primary regulator, the Federal Housing Finance Agency. The administration wants the firms to join a program run by the Federal Housing Administration that allows banks and other creditors, which agree to write down mortgages, to essentially hand off the reduced loans to the FHA.

Weitz – take note we’re going to use the FHA to absorb all these loses for banks, Fannie and Freddie. I’m OK with this, but would really want the banks to have share in the burden (rather than exclusively being the problem of the US taxpayer).

Federal officials estimate that 500,000 to 1.5 million homeowners could benefit from the program—a fraction of the estimated 11 million borrowers who were underwater as of June 30, according to CoreLogic Inc. That figure represents about 23% of all U.S. households with a mortgage.

Industry executives say the FHA program—as well as a related initiative by Treasury—will be only marginally helpful to the housing market without the participation of Fannie Mae and Freddie Mac. The program completed three loan modifications during its first three months and received 61 applications

Participation by Fannie Mae and Freddie Mac would put additional pressure on the nation's biggest banks to follow suit. Banks have shown little enthusiasm for the programs without the two mortgage giants.

David Stevens, the FHA's commissioner, said resistance by lenders has been exasperating. Obama administration officials have given lenders "a responsible way to address borrowers with negative equity, he said, "and if institutions are blatantly refusing" to participate, then that is "short-sighted."

The arm-twisting is the latest sign that loan-modification efforts aren't doing enough to address the threat that more borrowers will default on so-called underwater properties.

"Letting the status quo continue is going to be much more expensive than people think," said Kenneth Rosen, a professor of economics and real estate at the University of California, Berkeley. "We've got a downward spiral in housing here, and they'd better break the back of this with some shock and awe.''

Weitz – Mr. Rosen, what about allowing the market to self adjust. The government can do nothing but prolong the agony. Just look at the tax credit effectiveness...turns out it was a waste of taxpayer money.

The ongoing discussions underscore the sometimes awkward relationship between the Obama administration and FHFA, which has overseen Fannie Mae and Freddie Mac since their takeover in September 2008 and is charged with stemming taxpayer losses. An FHFA spokeswoman said participation in the FHA and Treasury loan-modification efforts is under review.

The two mortgage companies rarely reduce loan balances—only 10 of the 120,000 loans modified during the second quarter of 2010, according to the Office of the Comptroller of the Currency.

"We have historically counted on the fact that the vast majority of borrowers-even borrowers who are underwater-continue making their payments," said Don Bisenius, a Freddie Mac executive vice president.


Weitz – The question is how long people will continue to pay full price for a house that has dropped significantly in value. I’ve read articles that indicate when the home drops to 70% of the mortgage value, the chances of default rise dramatically…only time will tell.

Fannie Mae and Freddie Mac are reluctant to reduce principal because it limits their options to recoup losses. Typically, the companies collect claims from mortgage insurers or force banks to buy back certain loans when a loan defaults. Those options are relinquished when writing down loan balances.

In addition, Fannie Mae and Freddie Mac, along with other mortgage investors, are reluctant to approve principal reductions if banks that own second mortgages on the same properties also don't take losses.

Weitz – good point on this one. What’s the point of lowering balances on a first when a second still exists on the property that would keep the homeowner 'underwater'?

Unlike most loan-modification efforts, the FHA program is open only to borrowers who aren't behind on their payments.

Weitz- that I really like. An incentive that doesn’t benefit only those who default.

The Treasury Department initiative to reduce loan balances builds on HAMP, in which banks reduce monthly payments for distressed borrowers by lowering interest rates and extending loan terms.Starting in October, banks were able to receive additional subsidies if they first write down loan balances for borrowers owing at least 15% more than their home's current value. Fannie Mae has said it won't participate in the Treasury program. Freddie Mac says it is still reviewing whether to join.

Weitz - This is an interesting development that I will definitely keep track of and update the blog accordingly.

For more information on your options with distressed real estate, consider contacting a Seattle Strategic Default Attorney.

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Weitz Law Firm, PLLC
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Banks Benefits extend beyond TARP

Whoa!...this is big. A recent article from CNN-Money.

The Federal Reserve made 9 Trillion in Emergency Loans to banks during the Crisis.

Weitz - Yes, that would be Trillion (with a 'T')...Gee, I wonder how they paid back the 700 billion that Congress "loaned" to them via the TARP Program!! 700 billion looks like peanuts compared to this. I'm going to copy the text of this article below, and give a lot of my thoughts (and I've got many) throughout.

NEW YORK (CNNMoney.com) -- The Federal Reserve made $9 trillion in overnight loans to major banks and Wall Street firms during the financial crisis, according to newly revealed data released Wednesday.

Weitz – First, it is important to note that the “Federal Reserve” is not a truly government agency. It is actually a private organization that was created by powerful bankers. More importantly, we have NO IDEA what is actually on their books. They typically do not allow audits of the Fed so there is no way to truly know what they have “lent” out and what has been repaid.

The loans were made through a special loan program set up by the Fed in the wake of the Bear Stearns collapse in March 2008 to keep the nation's bond markets trading normally.

The amount of cash being pumped out to the financial giants was not previously disclosed. All the loans were backed by collateral and all were paid back with a very low interest rate to the Fed -- an annual rate of between 0.5% to 3.5%.

Weitz – This is just the beginning. The Fed makes HUGE loans everyday via at a interest rate which has been close to 0 for several years (See Fed Fund Rate). There is no way of knowing exactly how much the fed has lent out to the big banks.

Still, the total amount was a surprise, even to some who had followed the Fed's rescue efforts closely.

"That's a real number, even for the Fed," said FusionIQ's Barry Ritholtz, author of the book "Bailout Nation." While the fact that the markets were in trouble was already well known, he said the amount of help they needed is still surprising.

"It makes it very clear this was a very serious, very unusual situation," he said.

Weitz – the problem remains very serious. If forced to actually report the current valuation of assets (see easing of 'Mark to Market'), many economists believe the big banks would be forced into bankruptcy.

Sen. Bernie Sanders, the Vermont independent who had authored the provision of the financial reform law that required Wednesday's disclosure, called the data that was released incredible and jaw-dropping.

Weitz – Good for you, Bernie Sanders!! The fed would never have released this without you!!

"The $700 billion Wall Street bailout turned out to be pocket change compared to trillions and trillions of dollars in near zero interest loans and other financial arrangements that the Federal Reserve doled out to every major financial institution," Sanders said.

He said that even if the Fed was right to make the loans to keep the economy from toppling into a depression, it should have made stronger demands that the banks help American consumers and small businesses.

Weitz – Absolutely right. Amazing how the economy (see employment rate, record foreclosures & bankruptcies) is still in the dumps, yet the banks are paying record bonuses again.

"They may have repaid their loans, but that's not good enough," he said. "It's clear the demands the Fed made were not enough."

Weitz – there is zero chance they have repaid this. What actually happened is that the banks went directly to the real US government (the US Treasury), and let the government borrow the money from them….only the govt (taxpayers) have to pay the banks a higher interest rate.

The Wall Street firm that received the most assistance was Merrill Lynch, which received $2.1 trillion, spread across 226 loans. The firm did not survive the crisis as an independent company, and was purchased by Bank of America just as Lehman Brothers was failing.

Citigroup which ended up with a majority of its shares owned by the Treasury Department due to a separate federal bailout, was No. 2 on the list with 279 loans totaling $2 trillion. Morgan Stanley was third with $1.9 trillion coming from 212 loans.

"As we have previously disclosed, Morgan Stanley utilized some of the Federal Reserve's emergency lending facilities during a time of immense financial turmoil throughout the banking sector and the broader market," Morgan Stanley said in a statement Wednesday. "The Fed's actions were timely and critical, and we commend them for providing liquidity and stabilizing the financial system during that period.''

The largest single loan was by Barclays Capital, which borrowed $47.9 billion on Sept. 18, 2008, in the days after the Lehman bankruptcy. The loan financed Barclays' purchase of Lehman's remaining assets.

Weitz – Barclays?!?! They are a foreign bank (UK)!! Terrific, we paid $50 Billion to a foreign company to buy a crappy US company.

Some Wall Street firms disputed the way the Fed reported the numbers. An executive from one of the firms said that many of the overnight loans were rolled over for days at a time, and that each day it was counted as a new loan. "It's being double, triple, quadruple counted in some cases," said the executive.

Not all the major banks needed much help from the Fed. JPMorgan Chase received only three loans from this program for a total of $3 billion.

Weitz – No, Chase just does it every day from different, more ordinary programs.

The last loan was made under the program in May 2009, and the program, known as the primary dealer credit facility, was officially discontinued in February of this year.

The Federal Reserve revealed details of that program as part of a large scale release of data on all the steps it took to stabilize the nation's financial sector during the markets crisis of the last few years.

The central bank posted details of more than 21,000 transactions with major banks and Wall Street firms between December of 2007 and July of 2010. In addition to the loan program for bond dealers, the data covered the Fed's purchases of more $1 trillion in mortgages, and spending to back consumer and small business loans, as well as commercial paper used to keep large corporations running.

Weitz – this is ‘code’ for handing money to banks and other corporations by buying their crappy assets at full price. Think of it as someone voluntarily paying you $100,000 for your 2002 Hyundai…not a bad deal if you can get it (ie. Hidden Bailouts) .

The rescues of the investment bank Bear Stearns in March of 2008, and insurance behemoth AIG in September of that year, were also revealed in far greater detail, as were programs to make dollars available to foreign central banks in return for their currency, in order to keep international trade flowing.

Most of the special programs set up by the Fed in response to the crisis of 2008 have since expired, although it still holds close to $2 trillion in assets it purchased during that time.

Weitz – Shocking…maybe because the assets they ‘purchased’ are worthless.

The Fed said it did not lose money on any of the transactions that have been closed, and that it does not expect to lose money on the assets it still holds.

Weitz – To be closed, the account would have to be paid back…isn’t this obvious?? To clarify…the Fed hasn’t lost money on the accounts that have been paid back. As for the ones that haven’t been paid back?....those aren’t important;)


The details of which banks participated in the Fed's emergency programs, and how the banks benefited from the transactions, had never before been revealed.

The Fed argued that revealing the information could cause a run on the banks that needed to draw cash at the discount window. But under the financial regulatory reform act that was passed in July, the Fed will reveal future discount window transactions following a two-year lag.

Weitz - Here's the bottom line - with so many folks enduring so much pain, I find it incredibly difficult to see banks giving out record bonuses and not doing a darn thing to benefit the country or home owners in this foreclosure/ small business crisis. Simply put, it's inequitable and unjust the banks have received so much from the taxapyer with no strings attached. There is no easy solution to the problems we face, but I propose we force our leaders to at least be HONEST and TRANSPARENT about this financial issues in front of us... We can't fix what we don't acknowledge.