A Growing Housing Imbalance

The housing sector has struggled in recent years to find some balance between supply and demand. But equilibrium on a national scale seems to be slipping further away. As a result, a fully recovered housing market may not return until 2016.

Mortgage Banking

October 2011

 

By Robert Stowe England

 

 

Since the peak of the housing bubble in 2006, the housing sector has been struggling to find a bottom--so far without success.

 

There is still too much supply and too little demand. Indeed, lately it seems the imbalance of supply and demand has widened rather than narrowed, further postponing the date for a full recovery.

 

In the long process of healing in the housing sector, where are we today? “I think we are close to five years through a 10-year adjustment process,” says Douglas Duncan, chief economist at Fannie Mae. “That’s roughly parallel to the time it took to get to the crisis point.” That would put the full recovery in 2016.

 

Duncan traces the beginning of the downturn to December 2006, when HSBC Holdings plc, London, announced it would be taking a $9 billion write-down in its investment in Household Finance, a company active in subprime lending. (The write-down ended up higher at $10.5 billion when earnings were filed.)

 

“There were other things that happened prior to that, but that was kind of the first big shock to the market [signaling] that there were going to be serious problems,” Duncan says. That was nearly five years ago, he notes. “We have five more years to go from here” until the housing market returns to normal, he adds.

 

Duncan identifies a number of issues that stand in the way of a full recovery. For starters, there is the matter of dealing with a host of new regulations that will alter the shape of the banking industry, especially mortgage banking.

 

Also, there are 350 rulemakings overall to come from the Dodd-Frank Wall Street Reform and Consumer Protection Act, Duncan points out. “That whole rulemaking process is not only going to take time, but it is also going to take time for markets to adjust to it,” he adds. He estimates two years to get all the rules issued and more years after that for the markets to adjust to them.

 

Even after the Dodd-Frank rules are in place, “We will not have dealt with the Fannie Mae, Freddie Mac, secondary market structure issue,” he says. “So, it’s easy to see how we can get out to something approximating 10 years before the market framework is stable.”

 

Beyond the issue of regulatory barriers, there’s the question of when the new-home market might return to normal, signaling a full recovery of the market.

 

With a huge shadow inventory of homes yet to come on the market, the need for new housing is virtually non-existent. Duncan does not see housing recovering to a normal level to meet growing demographic demand until late 2014. When housing returns to normal levels, it can resume its substantial--if not critical--role in driving economic growth, Duncan predicts.

 

Souring consumer sentiment

 

Meanwhile, the problem with insufficient home-buying demand appears to be getting worse, not better, according to Fannie Mae’s surveys of consumer sentiment, Duncan points out.

 

Fannie Mae began surveying consumer sentiment in June 2010. It was not until the company had accumulated more than a year’s worth of data that it began to release in July 2011 the results of the survey, along with comparisons to year-ago levels.

 

“Basically, if you look at the survey, consumers say, ‘Well, we don’t like the economy any better today than we did a year ago. In fact, we like it a lot less,’” Duncan says.

 

“So, the share of people who think the economy is headed in the wrong direction is now 70 percent in the July [2011] data release [for June 2011]. That compares to about 60 percent a year ago [in June 2010] and a low of 57 percent a couple of months back,” he says.

 

Meanwhile, more consumers in Fannie Mae’s survey than a year ago are reporting that their expenses are growing faster than their incomes. Consumer expectations are that house prices will remain flat, while they expect rents to increase. Finally, surveyed households also expect mortgage interest rates to remain flat, according to Duncan.

 

“So, with all the uncertainties out there, [surveyed households] are basically asking the question, ‘Why do you think now is a good time for us to borrow $200,000 to buy a house?,’” Duncan says.

 

The bottom line, he adds, is that demand is weaker, as there are still a lot of foreclosures for the housing market to work through to bring supply back in line with demand.

 

Weak consumer demand for housing is now being driven more by worries about the economy than by worries over the housing sector, according to Duncan.

 

“While housing is obviously central to the issue, the concern of households about the larger economy and their prospects going ahead has actually surpassed issues related to housing specifically,” he says.

 

Do people think homeownership isn’t worth it anymore, or just not worth it right now? “I think it is ‘not worth it right now,’” Duncan answers.

 

“Actually, it is [more], ‘Why take the risk right now because we don’t believe the housing market is going to make any dramatic moves anytime soon, so we’d like to be more certain about our own financial situation before we make a move.’”

 

In Fannie Mae’s latest quarterly survey, released in August, which has different questions than those asked in the monthly survey, Fannie Mae found that 26 percent of households in which people are currently employed say there were concerned about the prospects for remaining employed.

 

Combining that 26 percent with the 9 percent who are unemployed, “you have now taken out a third of the labor force in terms of the demand side of the equation,” Duncan says. “And that’s a big hurdle for housing to overcome.” This worry about the labor market again points to household worries about the macro-economy, he adds.

 

Fannie Mae, too, has a less-than-rosy outlook. “We have significantly downgraded our macroeconomic forecast,” Duncan says, to 1.4 percent growth for the second half of 2011. “It’s 50/50 whether we go into another recession,” Duncan says. For 2012, Fannie Mae forecasts a 2 percent growth rate.

 

“We need better than 2 percent growth to bring unemployment down. So that is, in my mind, the key issue with regard to the recovery of the housing market. If the labor market doesn’t get going, then the housing market is not going to get going,” he says.

 

Fiscal troubles not helping

 

Duncan contends that consumer sentiment dramatically worsened after the debt-ceiling debate in July in Washington did not yield results the public found satisfactory. Consumers saw that debate “as a proxy for longer-term fiscal issues,” he says.

 

“In one eye they have that, and in the other eye they are looking at the turmoil in Europe and saying, ‘This obviously [affects me and] my interests; [and] if we don’t get our situation under control, that’s our destiny.’”

 

American consumers “are not happy about that destiny,” he says, and that unhappiness is being reflected in the negative turn taken in consumer sentiment.

 

“I think that they are going to sit on their checkbooks waiting for the next election to see if there’s some turn that’s taken in terms of seriously addressing the fiscal situation,” Duncan says. “That’s why I think the broader macroeconomic issues are going to dominate.”

 

Underscoring Duncan’s point, the Consumer Confidence Index® plunged to 44.5 in August, down from a revised 59.2 in July. The number, published monthly by The Conference Board Inc., New York, moved down to its lowest level since April 2009, when the reading was 40.8--a long way from the 90 level that indicates the economy is on solid footing.

 

Duncan thinks Washington erred in not realizing how engaged Americans are in the deteriorating fiscal condition of the nation. “I think the public gets it. They’re paying attention now. The survey data make that very clear,” Duncan says. “I think that Washington [underestimates] the degree to which middle America has grasped the fundamentals.”

 

If Washington had come together and achieved the $4 trillion in deficit reduction that the credit-rating agencies had suggested would be necessary to retain the AAA-rating for the country’s debt, it would have boosted the outlook for the housing market, according to Duncan.

 

“People will criticize me for making those statements and I understand why they would criticize that,” Duncan says. “On the other hand, some economists tend to focus solely on models and specific data points, and don’t focus on the larger picture--and here I think the larger picture is pretty important.”

 

Fannie Mae is forecasting mortgage originations to remain flat in 2011 and 2012, comparable to the levels of 2010. The composition of the volume will include more refinancings and few home purchase mortgages, reflecting the weak economy.

 

Shadow inventory

 

There has been a bit of good news in the number of homes in the shadow inventory, which is the total of borrowers 90 days or more delinquent plus properties in foreclosure and real estate-owned (REO) by mortgage servicers.

 

LPS Applied Analytics of Jacksonville, Fla., which has access to loan performance data for 40 million loans, calculates shadow inventory at 4.1 million loans. Their data base covers agency, non-agency and portfolio loans. They define shadow inventory narrowly as loans that are 90 days delinquent or in foreclosure. Of these 1.9 million are 90 days or more delinquent but not yet in foreclosure, while 42 percent of these loans have not made a payment in more than a year with an average delinquency of 397 days, a new record.

 

The good news is that first-time delinquencies accounted for only 25 percent of the new delinquent inventory.

 

“When we talk about inventory, we are talking about a pool of distressed loans that are likely to end up as REOs,” says Herb Blecher, senior vice president at LPS Applied Analytics.

 

Blecher sees improvement in the fact that the delinquency rate for loans that are 150 percent or more of the value of the home has fallen to 6 percent. In 2009 that delinquency rate was 18 percent.

 

“We have seen some burnout [the rate of new delinquencies] because home prices have stabilized to a degree and we are seeing general improvement in the overall seriously delinquent area,” Blecher says.

 

The shadow inventory remains large primarily because of a growing bottleneck in the disposition for foreclosed properties in states that require foreclosure go through the courts – so-called judicial states, according to Blecher. The judicial states, for example, have 111 months of inventory, which means it would take 111 months – nearly 10 years – to sell all the properties at the current pace of home sales. The non-judicial states, on the other hand have 32 months of inventory.

 

To the extent the markets are moving toward a balance of supply and demand, the movement has occurred in non-judicial states and has been delayed in judicial states, according to Blecher.

 

Standard & Poor’s (S&P), New York, which tracks loans tied to private-label mortgage-backed securities (MBS), also sees some modest improvement. According S&P, the supply of homes in the shadow inventory nationwide fell from 52 months worth to 47 months during the second quarter of 2011. That is the first improvement in shadow inventory since mid-2009.

 

So, from a shadow inventory of slightly over four years, S&P estimates the backlog has fallen to just under four years.

 

“The shadow inventory will continue to jeopardize the housing market’s recovery until servicers are able to improve liquidation times,” S&P stated in a report released Aug. 17, titled Second-Quarter 2011 Shadow Inventory Update: Is the First Months-to-Clear Decline a Sign of Good Things to Come? “However, if and when that happens, an influx of homes will likely enter the market, increasing the supply and driving prices down further.”

 

Importantly, each of the top 20 metropolitan statistical areas (MSAs) experienced declines in its shadow inventory. Yet, there continues to be a growing disparity between the pace of improvement between markets where foreclosures face the greatest barriers in moving to liquidation and markets where they face the least barriers.

 

The New York metropolitan area, for example, has a staggering 144 months of inventory, according to S&P. In the second quarter, the state saw its first decline since the crisis began, down from 146 months in the first quarter. The shadow inventory in New York represents 12 years of supply at the current rate at which homes are being sold. That translates into $40.9 billion in balance outstanding on mortgages with an original balance of $108.6 billion.

 

Considerable progress has been made in reducing the shadow inventory located in the four Sand States that experienced the worst price declines following the housing bubble--California, Arizona, Nevada and Florida--along with Michigan, which did not have a housing bubble.

 

Shadow inventory measures the difference between “what’s defaulted minus what’s been liquidated--so it’s kind of what’s flowing into the system” for foreclosure and liquidation, according to Diane Westerback, managing director, global surveillance analytics at S&P.

 

“The overhang is really how much the system is backing up once the loan defaults,” Westerback explains.

 

Regional differences

 

The worst shadow inventory numbers are concentrated in the Northeast. In addition to the dreadful backlog in the New York City metropolitan area, Boston has 83 months of inventory. High levels of shadow inventory also exist in many New York counties outside the New York city area, as well as Vermont, Connecticut, Massachusetts, Rhode Island, Pennsylvania and New Jersey.

 

S&P sees a number of factors behind the increasingly geographically diverse pattern of shadow inventory and imbalance in supply and demand.

 

“You have some interesting dynamics regionally,” Westerback says. “In Arizona, the default rate is pretty high. But because it is a non-judicial state, and for various other reasons, those properties are moving through the system. So, you have a relatively low shadow inventory in Arizona, which bodes somewhat well for the housing market in that what you see is what you get,” she adds. “There are no hidden surprises, in that there is not an unseen backlog hanging out there that is going to have a negative effect on the housing market.”

 

While states can be a combination of both types, they generally fall into two categories: judicial and non-judicial states. The foreclosure process generally depends on whether states use mortgages or deeds of trust for the purchase of property. Those states that use deeds of trust have non-judicial foreclosures, while those that rely on a judicial procedure request a court action to foreclose on a home.

 

New York, for example, is a judicial state, while Arizona and California are non-judicial states.

 

“It’s a positive sign that the hardest-hit states [in terms of price declines] are not the worst in terms of shadow inventory,” Westerback says. “If jobs were to turn around in those states, you will probably see a price rebound follow that,” provided consumer confidence does not remain low.

 

New York, of course, is on the opposite end of the spectrum. New York has a better-than-average frequency of default and a slightly better economy and lower unemployment than the average. Yet, New York’s shadow inventory is at astronomical levels.

 

“You have an extremely borrower-friendly court and you have some very restrictive mandatory arbitration rules imposed in New York that are slowing down the liquidation process substantially,” Westerback says.

 

“It’s just a much more complex judicial process in New York than even other judicial states,” she adds. “So, all of that means that a lot of loans are basically stuck in the system.”

 

The supply of homes for sale in New York is, thus, much lower than it would be if the liquidation process did not take so long.

 

“Everything in the shadow inventory is in limbo,” explains Westerback. “So, your supply in New York is possibly somewhat constrained because the liquidation rate is so slow,” she says. “So the market appears healthier because there are fewer distress sales and there’s a lower supply of properties on the market, so the imbalance is not as great.”

 

“[A]t some point these loans have to bunch up and go through the system. So, there would be some kind of wave that has to come,” says Westerback. At present, half of the defaulted loans have not even made it to court--so the backlog is not entirely the fault of the courts. “Servicers haven’t pushed them into the foreclosure process,” she says.

 

Could New York see dramatic downward pressure on prices at some point? “Yes, I would say it definitely could at some point. It’s unclear when that point would be. It doesn’t look like it’s in the immediate future because not enough is far enough in the pipeline. The REO numbers are very low in New York,” Westerback says.

 

“Either a lump of properties is going to come through, or, if the economy turns around, these loans could miraculously cure,” Westerback notes. She points out that in the past, more than half of the loans that went delinquent did ultimately pay in full or become current.

 

New York’s housing market also faces another problem--there has been a huge exodus of people leaving the state, reducing the pool of potential homebuyers. According to an August research bulletin from the Empire Center for New York State Policy, Albany, New York, 1.6 million residents or 8.27 percent of its population left New York to move to other states in the past decade.

 

The policy center’s bulletin, (ital) Empire State’s Half-Century Exodus: A Population Migration Overview, (end) was authored by E.J. McMahon and Robert Scardamalia. The net outmigration of 1.6 million residents is worse than it seems, given that the state is huge magnet for immigrants coming to America--with 21 percent of its population being foreign-born, the second-highest in the nation after California, with 27 percent. A slowdown in immigrants coming to New York in the last decade is one reason the state’s net population loss is so high.

 

A May survey by Marist College Institute of Public Opinion, Poughkeepsie, New York, conducted for NY1, the 24-hour-a-day local news channel for New York City, found that 36 percent of New Yorkers under the age of 30 plan to flee the state because of high taxes, the crippling cost of living and the lack of jobs.

 

According to an analysis by the Empire Center for New York State Policy, New York has the highest local tax levies and the second-highest state tax levels in the nation. All 15 of the top counties in the nation with the highest tax burden are located in New York state.

 

The lack of demand

 

Nationally, the problem is mostly a lack of demand while supply has been stable, according to S&P. Home builders have more or less stopped building houses. There is a slowly growing population, “but the people who could buy houses don’t have jobs or can’t get financing,” Westerback says. Echoing Duncan’s view at Fannie Mae, she adds that potential employed qualified buyers also “don’t have the confidence they will keep the job they have.”

 

Of the three factors driving down demand--unemployment, fear of unemployment and lack of financing--only the last one where the government could do something to “immediately influence” the housing market to improve demand. With the non-agency or private-label securitization market virtually dead, the amount of funding available to support mortgages is only about two-thirds of what it was before the crisis in 2008. “That’s why the bank can be so selective,” Westerback says.

 

If there were more buyers for distressed properties, then the losses on defaults and foreclosures would be less. “We are seeing some increase in all-cash sales,” Westerback says, but this activity means prices will be at the lower end of the market, and there are fewer buyers who can afford to pay all cash.

 

The cutback in the availability of mortgage funding has led lenders to tighten underwriting so they get “only the best,” Westerback says. “And the banks are under pressure--everybody is under pressure--to deleverage. So, the banks are supposed to deleverage, but they are also supposed to increase their lending. Those two things can’t happen at once,” she adds.

 

Lenders “are trying to be very prudent and make very good loans so that they have to have less capital . . . to hold against it. That may free them up to do another loan every now and then. They are under a lot of scrutiny,” Westerback says.

 

Banks, even if they may initially hold a loan in portfolio, “will always want to be able to flip the loan to Fannie or Freddie if [they] want to take it off [their] books. So, why would [they] underwrite in any way that didn’t qualify for Fannie and Freddie?,” Westerback notes.

 

This means banks are unlikely to take a chance on an investor property, even when the borrower has “a low LTV [loan-to-value ratio], a decent FICO® [score] and a decent rental income,” according to Westerback. So, investors may be pretty much limited to paying cash for investment properties to rent.

 

A happier heartland

 

The outlook for the midsection of the country--from Texas northward to the Canadian border--is perhaps the brightest of all regions outside of the Washington, D.C., area, where expansion in federal government hiring has begun to push up home prices.

 

“Two-thirds of the loans underwater are in five states: Arizona, Nevada, Florida, California and Michigan. That would tell you most of the rest of the states, especially the ones that have seen some employment gains, are probably closing in on some sort of balance” between supply and demand, says Fannie Mae’s Duncan.

 

“The key is employment. If there is a pickup in employment, some markets may do very well,” Duncan says. “In fact, some of them may experience price appreciation because the level of construction is so low. It’s hard to say builders have the labor in reserve to put to work immediately if there is demand increase, or whether there would be a lag of supply growth relative to demand growth that might lead to some price appreciation in some of those markets, which could be fairly significant,” he adds.

 

Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association (MBA) in Washington, D.C., says what the housing sector needs is “a pace of growth that leads to job creation” and pushes down unemployment. “The rule of thumb for the U.S. economy is this: if growth is above 2.5 percent, the unemployment rate will decline over time. If not, you will have a stagnant or rising unemployment rate,” Fratantoni says.

 

Unfortunately for both the economy and the housing secotr, “You are not likely to see the pace of economic growth above 2.5 percent in the in next year and a half. “Thus, unemployment will stay where it is through 2012,” he predicts.

 

In July, there were only 165,000 new homes for sale across the nation, representing 6.6 months’ supply at a 298,000 annual pace of sales for that month. Most of those homes, however, had not begun to be constructed (25,000) or were under construction (78,000), leaving only 61,000 finished new homes for sale in July.

 

That 61,000 is “an astounding number,” says Duncan. “That is the lowest number of finished new homes for sale since World War II--and our population has tripled since World War II,” he adds.

 

Texas is one of the states where home prices could climb rapidly. “They still have about 8 percent unemployment [in Texas],” Duncan points out. “But if [employment] started to strengthen appreciably, those markets would strengthen rapidly because they don’t have the excess supply issues. Their problem is a predominantly a demand-side phenomenon.”

 

New-home construction has ground to a virtual halt in some states. Indeed, according to a website called 24/7 Wall St. (http://247wallst.com), there are 10 states “where no one wants to buy a new home,” and where construction has nearly come to a complete halt.

 

The measurement for states with the weakest new-home construction is the current number of building permits as a share of total housing units. The worst states, in order of severity, are: Rhode Island (0.7 percent); West Virginia (0.9 percent); Illinois (0.09 percent); Michigan (0.9 percent), Connecticut (0.9 percent); Ohio (0.12 percent); Massachusetts (0.12 percent); New York (0.14 percent); Maine (0.14 percent); and Pennsylvania (0.15 percent). Many of these are also states with the most shadow inventory--no coincidence, according to S&P’s Westerback.

 

Factors driving excess supply

 

The question of what can be done to reduce excess housing supply prompted a study by the New York-based MBS Strategy Group of Amherst Securities Group LP, based in Austin, Texas.

 

The Amherst study, released in July, was authored by Laurie Goodman, senior managing director at the firm, along with co-authors Roger Ashworth, Brian Landy and Lidan Yang. The study, not surprisingly, finds “a sizable supply-demand imbalance.”

 

“This [imbalance] is created by the fact that the housing market faces a huge overhang of homes from borrowers who are either not making mortgage payments or will be unable or unwilling to do so going forward,” the report contends. The authors see the supply as being made up not only of the shadow inventory but also likely new defaults and re-defaults that have yet to come on the market.

 

The Amherst study estimates that one borrower out of every five is in danger of losing their home--10.4 million borrowers out of a universe of 55 million households with mortgages. Amherst defines non-performing loans as those currently delinquent for 60 or more days.

 

Relying on Santa Ana, California-based CoreLogic’s database of securitized loans, Amherst classifies loans into five groups, based on whether or not they are performing and the degree to which the mortgage is or is not worth more than the value of the house.

 

Amherst also did a more conservative estimate of 8.3 million defaults based on loan performance that would be better than recent experience.

 

Goodman argues that some action needs to be taken to minimize the impact of these coming defaults. Since underwriting has tightened, it makes it more difficult to clear excess inventory.

 

The Amherst study calculates that loans are liquidating at 93,000 to 95,000 a month. The study calculates the shadow inventory of homes delinquent or in default for 12 months or more plus REO at 3.36 million units. Liquidating all those homes at the current rate will take two and a half years.

 

Amherst calculates that all the homes destined to default will do so within six years, which the authors admit is “as an admittedly arbitrary assumption,” which would represent an annual default rate of 1.3 million to 1.73 million loans. If you add 500,000 units of new construction, this increases the annual supply by 1.88 million to 2.23 million a year, according to Amherst.

 

Meanwhile, on the demand side, new household formation has slowed considerably, the Amherst authors point out. The average rate of new household formation from 2007 to 2010 was 500,000--“very low by historical measures,” the authors state.

 

Goodman and her co-authors estimate that while household formation may rise to 1.2 million, new demand to own homes will rise by only 600,000 a year. Demand will also rise another 400,000 due to the obsolescence of current homes and another 200,000 for new purchases of second homes.

 

Subtracting the demand (1.2 million) from supply (1.88 million to 2.23 million) will generate an annual excess supply per year of 680,000 to 1.03 million. Over six years, this will translate into an excess supply of 4.1 to 6.2 million, according to Amherst.

 

Because underwriting has become so much more stringent, public policy needs to find a way to absorb the excess supply in the coming years, according to Goodman. One potential solution would be finding ways to qualify more investors to purchase homes and rent them out.

 

Goodman is particularly critical of the narrow definition of the proposed Qualified Residential Mortgage (QRM) from federal regulators, operating under the authority of the new Dodd-Frank Act. “They need to loose the definition [of QRM] to be less restrictive in terms of the borrower’s debt-to-income ratio, loan-to-value ratio and include investors,” Goodman says.

 

Ranieri and Rosen proposal

 

Secondary mortgage market pioneer Lewis Ranieri, founder of Ranieri Partners Management LLC, New York, earlier this year put forth a proposal with Rosen Consulting Group, Berkeley, California, to make it easier to turn the excess supply into rental properties.

 

Ranieri’s proposal, co-authored with Kenneth T. Rosen, Andrea Lepcio and Buck Collins, was released in an April 4 report titled (ital) Plan B: A Comprehensive Approach to Moving Housing, Households and the Economy Forward. (end) One element of the comprehensive approach is to convert excess housing inventory into rentals.

 

One recommendation was to convert both REOs and homes in default or underwater to rent-to-own properties for current homeowners, new potential homeowners, as well as for investors.

 

In their rent-to-own strategy, Ranieri and his co-authors propose that troubled homeowners could convert the loan obligation into a lease of three to five years. Or, in the case of a vacant home, Ranieri and his co-authors propose to have a qualified working family move into the house and sign a similar lease in the same rent-to-own program.

 

Under the proposal, the mortgagee (homeowner) could not sell the property for the duration of the lease unless he or she sells it to a renter should the renter at some point during the lease be able to purchase the home. During the time of the lease, the renter will pay market-based rents to the mortgagee. The renter maintains the house “as if it were their own,” including mowing the lawn and taking care of repairs up to a certain maximum annual expense, for example $200, beyond which the owner pays, the proposal states.

 

At the end of the lease period, the renter would have the first right-of-refusal to buy the house at a market rate. Whether or not the renter buys the house, the renter can receive 20 percent of the gain in the value of the house during the period of the lease.

 

The lender would benefit under this approach because there is immediate cash flow on a property that would otherwise be sitting idly, the co-authors argue.

 

The Ranieri-Rosen proposal also calls for a program to help small investors buy up local properties for long-term rentals. “The FHA [Federal Housing Administration] has done this type of program, as have the agencies [Fannie and Freddie] in the past,” the report states. “We recommend both FHA and the agencies take the lead in offering investor finance and encouraging private participation.”

 

Ranieri and his co-authors suggest a large down payment of 30 percent for the current sale price, with a possible lower down payment for investor properties in distressed neighborhoods.

 

Ranieri first proposed the idea of a rent-to-own program at a conference on the future of mortgage finance held at the Treasury building in August 2010. He said the proposal should be patterned on a successful effort of the government-sponsored enterprises (GSEs) called the Fifth Ward program in Houston, where millions of vacant units were converted to rent-to-own status. For investors, Ranieri said in August 2010, it was a “once-in-a-lifetime opportunity.”

 

Senator Reed gets involved

 

The idea for converting REO properties into rentals got a boost on Aug. 5 from Sen. Jack Reed (D-Rhode Island), who sent a letter to Federal Housing Finance Agency (FHFA) Acting Director Edward DeMarco suggesting that REO properties of Fannie and Freddie be pooled and sold to investors.

 

Reed’s idea appears to have gained some traction. On Aug. 10, the FHFA, the Department of Housing and Urban Development (HUD) and the Treasury Department issued a joint request for information (RFI) for ideas to convert the current and future REO of Fannie Mae, Freddie Mac and the FHA into rentals or to meet affordable-housing needs. Currently, the agencies and FHA own 248,000 properties, but many more are expected to come into their inventory.

 

The Aug. 10 RFI called for ideas for disposing of properties both individually and in large pools of properties “in situations where such pooling, combined with private management, may reduce enterprise credit losses and help stabilize neighborhoods and home values,” said DeMarco in a prepared statement.

 

DeMarco was upbeat about the potential benefits of renting REO properties. “Partnerships involving enterprise properties may reduce taxpayer losses and meet the enterprises’ responsibility to bring stability and liquidity to housing markets. We seek input on these important questions,” he said in a prepared statement.

 

Some of the properties may need to be rehabilitated before they can be rented. Another worry is that bulk sales could drive down the value of other homes in areas targeted for bulk sales. Michael Feder, president and chief executive officer of Radar Logic Inc., New York, sees a lot of downside for GSEs, the government and the taxpayer if FHFA, Treasury and FHA decide to opt for bulk sales.

 

“It is a bad idea,” Feder says of proposed bulk sales. “You will take big losses in bulk sales [that] will guarantee losses to the government,” he adds, and, thus, to the taxpayer.

 

The prices paid for REO houses sold in bulk will be heavily discounted because investors have to calculate the cost of restoring properties so they can be rented, then the cost of maintaining them and collecting rents, plus a return on investment. “This removes the recovery profit opportunity from homeowners and puts it in the hand of institutional investors,” Feder says.

 

Further, when the price of bulk sales is entered into local records, it becomes part of the record for comparable sales and puts downward pressure on the prices that other, non-distressed homebuyers can get when they sell their properties. So, it harms rather than helps the real estate markets.

 

Radar Logic is submitting a proposal to have the GSEs refinance homes for existing underwater homeowners with a principal reduction that would take the home out of the shadow inventory of homes likely to come on the market. Only borrowers who would qualify under existing underwriting standards could obtain new mortgages under this proposal.

 

Radar Logic estimates the shadow inventory of homes tied up in foreclosure, defaulted and likely to come on the market at 10 million to 12 million, just above the level calculated by Amherst. “That’s a nine year shadow inventory,” Feder says.

 

Under Radar Logic’s plan, the difference in the value of the old, higher-balance mortgage and the newer, lower-balance mortgage would be covered by equity participation certificates issued by Fannie and Freddie. Investors could earn 50 percent or more of the price of the appreciation in the home receiving the lower mortgage balance. Borrowers could also share up to 50 percent of the appreciation if they stay in the home a minimum amount of time and keep their loan payments current.

 

Radar Logic first went to Treasury’s Phyllis Caldwell, director of the office of homeowner assistance, back in March 2010 with their idea, which they say is patterned after policies that worked when the Resolution Trust Corporation (RTC) was set up two decades ago. Feder contends that Fannie, Freddie and the government can minimize their losses and avoid that steep 50 percent loss on mortgages expected from homes that go through foreclosure and are sold as REO properties.

 

Household formation could be key

 

A rebound in household formation, which has been depressed for years, could also improve demand for housing. “The latest pace is 800,000 a year--far above the lows between 300,000 and 400,000 in 2009,” says Daniel McCue, research manager at the Joint Center for Housing Studies at Harvard University, Cambridge, Massachusetts. It is also below the 1.2 million level that was common for many years.

 

Why is demand so depressed? For one thing, the pace of illegal immigration slowed, and with it, went demand for housing.

 

In the period from 2004 to 2007, the total number of foreign-born households in the United States rose about 400,000 a year. From 2007 to 2010, the share remained flat. A key factor is that households headed by illegal immigrants, which rose 200,000 a year from 2004 to 2007, fell by 200,000 a year from 2007 to 2010, mostly because of the recession and weak recovery marked by high unemployment. This decline in illegal immigration offset the 200,000 a year gains in household formation by immigrant citizens.

 

Another loss of demand comes from an increase in the share of young adults who are jobless and living at home and, thus, not forming new households.

 

“Immigration is a cyclical factor, more so than the downturn in household formation of young adults who are living with their parents,” McCue says. “I don’t see that as a lasting thing, but there might be some component [of that trend that is] cultural and that sticks,” he adds.

 

Another idea that could lead to an increase in demand is to launch a major national advertising campaign by banks and servicers to tout the advantages of homeownership, according to Stuart Feldstein, president and founder of SMR Research Corporation, Hackettstown, New Jersey.

 

“The degree of losses [by lenders and servicers] is so extreme that if you just took a small portion of the money you will be losing anyway and you spent it on advertising, you could create a saturation campaign,” Feldstein says. “A billion dollars would blanket the airways.”

 

What message might sell more homes? “There has never been a better time to be a homeowner. House prices are low and mortgage rates are low at the same moment. Affordability is strong,” says Feldstein. “It’s a great time to be advertising that there are absolute steals out there on buying a house.”

 

So far, however, Feldstein has found little interest in his idea.

 

Feldstein also supports the idea of renting out houses to reduce the supply. “That way, even if the demand side of housing remains moribund, you can reduce the supply to balance the equation,” he says.

 

Meanwhile, it is harder and harder to pinpoint when home prices will hit bottom. “The problem is that [each downturn in the pace of growth] delays that [rebound] in prices a little bit. At 3 percent growth, the bottom in prices happens earlier than if there is 2 percent growth,” Feldstein says.

 

Could the slide in house prices hit bottom next year? “It could,” Duncan says. “Our current forecast, which has not been adjusted for our downgrading of GDP [gross domestic product], has house prices bottoming in the first quarter of 2012. That could be pushed back.” Oh, joy.  MB

 

 

Robert Stowe England is a freelance writer based in Arlington, Virginia, and author of Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, published by Praeger September 30 and available at Amazon.com and other online book sellers. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

 

Copyright © 2012 Mortgage Banking Magazine

Reprinted with Permission

 

 

Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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