According to CoreLogic, California is the 6th worst state in terms of negative equity after Florida, Arizona, Florida, Georgia and Michigan. Given the lack of evidence on the benefit of principal reductions in preventing default, the Bank of America solution is a compassionate approach to the horror of losing one’s home. The former borrower now rents their home instead of having to move.

The Bank of America mortgage to lease program doesn’t add to the already staggering shadow inventory of housing in the United States.

The mortgage to lease program is a win-win for households who cannot sustain their mortgage payments and Bank of America. While Bank of America would prefer borrowers to continue making their mortgage payments, this solution dominates foreclosure in terms of losses.

I love it when the private sector develops an innovative program to deal with a national problem.

The exploding Spanish housing bubble continues to degrade.

And their non-performing loans continue to grow.

When combined with slow GDP growth, this is a recipe for bank disaster.

The Bankia group, a Spanish lender nationalized earlier this month, needs 19 billion euros ($23.8 billion) of government money to restructure its business.

“Please Sir, may we have more gruel?”

Of course, government-seized Bankia no longer trades after being suspended by their regulator.

Banco Popular is still traded, but seems to be “Banco UNPopular.”

And their 5 year CDS is rising again after that attempts of the ECB to provide liquidity as a solution to their problems.

The good news? At least Banco Santander’s rating was affirmed! For the moment, that is.

Spanish sovereign yields continue to rise.

Hot fun in The Med!

But the important point is that initial jobless claims are at the same level as 12/16/2011. Essentially, there has been no change in jobless claims other than weekly fluctuations.

At least continuing job claims fell from 3,265,000 last week to 3,260,000 this week. After an upwards revision last week, of course, to 3,289,000.

However, average weeks of unemployment from last month is at an all time high.

Hmm. Continuing jobless claims continue to fall, but average weeks of unemployment hits an all-time high. One shows slow healing of the labor force and the other says it is getting worse.

At least FHFA showed the largest jump in house prices (for conforming loans) in history yesterday.

Let’s see what Case-Shiller says on Tuesday. But FNC’s 20 Metro index is showing a turn up in housing prices as well.

During our excellent session with Tomasz Piskorski (Edward S. Gordon Associate Professor of Real Estate, Columbia Business School), Mark Palim (Director of Economics, Fannie Mae) and me with Vincent Fiorillo (DoubleLine Capital) as the moderator, we discussed some of the problems with loan modification programs and why they have been a disappointment.

This lively and friendly debate prompted Nick Timiraos to ask me “You seem to imply that HAMP should not have been done by the Administration.”

That is exactly what I was saying.

I answered Nick’s question with the following analogy. “Suppose that Chrysler Motors is known to have lousy performing transmissions in their cars and Jeeps. Should the government step in and require that Chrysler pay for new transmissions for all current Chrysler buyers? Or force Chrysler to change the design?” That answer is no.

So why did the Administration and Congress pass HAMP legislation which threw a massive monkey wrench into the mortgage servicing industry when bank/servicers have historically perform loan modification when deemed appropriate?

Essentially, borrowers and activists were pleading with government to help out. I understand, but the standard boilerplate applies: be careful about opening the Pandora’s Box of government.

Of course, with staggering house price declines followed by surging unemployment, loan modifications would be a tricky proposition at best. So, the government came out with HAMP with was a failure, then keep changing the rules and eventually have put 14 different programs into play, including the infamous Attorneys General Settlement, Super HARP (or HARP II+) and the Obama proposal of principal write downs paid by taxpayers. Again, you asked for help and opened Pandora’s Box. Now the government wants more and more control and … programs.

The sad reality is that most don’t work and get people’s hope up. The Attorneys General Settlement is more like a bank bailout of underfunded State budgets with $1 billion going to the FHA to prevent them from going before Congress like Oliver Twist with an empty bowl of gruel.

So, rather than letting the market correct and heal, we have adopted policies that perpetuate the housing crisis.

We would have been better off doing nothing. But that is not a politically popular strategy.

Coming up on Thursday in the U.S. Senate is the HARP 2.0+ or HARP 3 legislation where Senators Boxer and Menendez are proposing to refinance virtually everyone with a Fannie Mae and Freddie Mac held or insured mortgage. That is, remove all the safeties in place on the housing finance torpedo.

This was my worst fear. HAMP didn’t work, so the government will keep pushing and demanding more control and interference.

Here is Thursday’s lineup. Christopher Papagianis from e21 will likely warn of caution of doing anything more in terms of housing finance stimulus. Mark Zandi from Moody’s will likely agree with Senators Johnson and Menendez (but beware of Zandi’s forecasts for economic stimulus – they are WAY TOO HIGH).

If I was at this hearing, I would have asked everyone the same thing I asked Nick Timiraos: “Where in the Constitution does it give the government ANY authority to do any of this?”

But even if it is Constitutional, we need to stop asking the government to intervene in the private market to solve our problems. Even if well intended. They are lousy at it.

To quote Dr. Ian Malcolm from Jurassic Park, “your scientists economists were so preoccupied with whether or not they could, they didn’t stop to think if they should.”

Economists and Congress members marvel at the creation of yet another government mortgage modification program.

The good news. Mortgage refinancing application volume continues to rise (although whether it is HAMP, HARP or one of the 12 other Administration programs is unknown). But it does seem that HARP 2.0 is kicking in.

The bad news. Purchase applications declined last week and seem stuck in “the red zone.” That is, since early June 2010, home purchase applications have been stable, but not growing.

New home sales, released today, continue to rise within “the red zone.” So, we are seeing some recovery across the board, but it is still a vulnerable recovery.

With tight credit for the mortgage market, can we have a sustained housing recovery with all cash and investors only?

Depending on Europe’s decision about the exit of Greece, we will see further yield deterioration in The Med (Greece, Spain, Portugal and Italy) and the U.S. 10 year Treasury dropped 5.7 basis points so far this morning.

Let’s see how mortgage rates react this week. But Europe’s ongoing crisis certainly impacts our Treasury, mortgage and … housing markets.

If we look at the numbers in chart form, existing home sales have been generally risk since January 2008.

The “surprise” number in the report is the median house price for existing home sales. It was up 8.3%!

But before you get too excited, notice that this happens in this data periodically. This is mostly because sales of different price point housing occurs in different regions over time.

If we compare a repeat sales index like Case-Shiller or FNC with Realtors Median Price index, we can see how noisy the Realtors index is.

Not bad for a housing recovery where there is a lack of housing finance!

But this morning in pre-market trading, Facebook fell below it’s $38 per share, the offer price. “Beware of Geeks Bearing Gifts” seems to be apt.

The NASDAQ CEO blamed the lousy trade execution on Friday on “bad software.”

“Computer systems used to establish the opening price were overwhelmed by order cancellations and updates during the “biggest IPO cross in the history of mankind,” Nasdaq Chief Executive Officer Robert Greifeld said yesterday in a conference call with reporters.

Well, the history of mankind is kind of stretching it. I don’t recall too many IPOs in ancient Greece, Rome, or other cultures. But the important part of the story were the cancellations. After all, IPOs are difficult to value, particularly when it is a social application with uncertain growth prospects.

The IPO price per share was $38.

The net income for Facebook has been growing rapidly.

And Q1 2012 Facebook net income continued to grow. You can see why there was excitement to jump aboard the train, especially given near zero interest rates on government bonds and a lackluster stock market that will likely need The Fed to pump up it’s deflating tires using another round of quantitative easing (or twisting).

So, what happened on Friday, May 18th?

Facebook opened at $42 and ended the day at just above … $38 (the IPO offer price). Not quite the $70 per share that some German invetors placed as orders!

As Maxwell Smart used to say, “Missed it by that much!”

The distribution of trade prices centered around $40 per share before closing Friday at just above $38 per share.

The trades were all over the board in terms of volume.

Just goes to show you. Despite the hype about the biggest IPO in history, many missed the boat on the IPO price after opening bell. Is this an example of another dot.com bubble where there is while speculation about the future profitability on an on-line social app for which the future is highly uncertain? Stated differently, are the bond and equity markets so stagnant that investors are willing to pay dearly for a “castle in the sky”?

“There are 11.1 million residential properties with underwater mortgages, only about 3 million of which are backed by Fannie and Freddie. Almost 80 percent of those 3 million borrowers, however, are current on their mortgage, demonstrating their commitment and ability to make payments without a principal reduction. Consequently, principal writedowns for them would simply transfer money from taxpayers to the borrowers — with minimal effect on foreclosure prevention.”

“Cry havoc and let slip the dogs of (class) war”

Principal reductions are part of the bigger Administration plan for wealth redistribution from banks and investors to households. As I have discussed before, the Administration has introduced 14 loan modification programs (e.g., HAMP, HARP, Attorneys General Settlement and the proposed principal writedowns from Fannie Mae and Freddie Mac). HAMP has been a disappointment although HARP 2.0 seems to be working in terms of refinancing volume. Yet, the Administration keeps pushing mortgage loan modifications (and pressuring Mr. DeMarco for principal reductions).

Of course, the 14 loan modification programs in the name of stabilizing the housing market and lowering mortgage defaults are actually STIMULUS 2.0 without explicitly calling it another stimulus package. But taking money from banks and investors and giving it to troubled borrowers (HAMP) and borrowers that don’t need help (HARP) makes an assumption that households will take their mortgage payment reduction and spend it, stimulating the economy. My estimates of the stimulus effect (along with Deborah Lucas’ estimates) are minimal as a percentage of Personal Consumption Expenditures.

Throw in the fact that the Attorneys General Settlement turned out to be “State Stimulus in Sheep’s Clothing” is very troubling. California is one of the states using the settlement funds to plug their fiscal holes (caused by excessive government spending). Oh and the FHA avoided slinking into Congress for a bailout since they carved out $1 billion of the AG Settlement for themselves. To quote Gomer Pyle, “Surprise, surprise, surprise!”

Taking The Safeties Off The HARP Torpedo

Laurie Goodman (Amherst Securities) and Chris Mayer (Columbia University) are big fans of removing the safeties from the HARP torpedo. If you believe in the Central government doing another economic stimulus package by allowing everyone to refinance their mortgage at 4%, then the Boyce, Mayer, Hubbard (or Boxer/Menendez proposal) is for you. I call this the “Herbert Hoover Refinancing Proposal” where very smart people are proposing a further intrusion of government into the private sector in the hopes of stimulating the economy. Perhaps it could.

But with mortgage rates at historic lows and 14 competing loan modification programs (and the Administration’s desire to get those principal reductions from Fannie Mae and Freddie Mac), I am very concerned that we could be throwing too much stimulus at the housing market. We have NO IDEA how the 14 loan modification programs will work together. Boyce, Hubbard and Mayer give a point estimate for their HARP proposal, but we know in prepayment modeling that it is unlikely that their point estimate will be correct. But it COULD be correct.

Between The Fed and the Administration throwing so much stimulus at the housing market (which was massively over-subsidized to begin with), we need to proceed with extreme caution.

Senator Jack Reed (D-RI) became angry with me when I made this recommendation at a recent Senate hearing. “People are suffering and you are telling us to do nothing?!” Precisely. We are blind with regard to how this will work and running full speed for an exit if a very dangerous idea.

Furthermore, the housing market is healing (particularly in non-judicial foreclosure states). Please, let the market heal and stop ripping off the bandages and squeezing the wound.

Good job, Gayer and Swagel!

Fannie Mae 30 year current coupons (the rate on Fannie Mae MBS) fell as well, but not to the lowest point in recent months.

As Europe continues to experience a financial crisis, investors continue to invest in our Treasury market (driving down yields). 30 year mortgage rates follow the 10 year Treasury yield.

Greece, Portugal and Spain continue to experience problems with excessive debt, Spanish debt (housing-related) and Greek turmoil.

Consumer Comfort and Unemployment Claims

Bloomberg released their consumer comfort index today and it looks like the downside of a big rollercoaster.

And initial jobless claims came in higher than forecast. BUT EQUAL TO THE UPWARDLY REVISED JOBLESS CLAIMS FOR LAST WEEK!

And the Philadelphia Fed has a BIG swing and miss. Survey was for a print of +10.0 and the actual print was -5.8!

Like Col. Kilgore, Fed Chairman Ben Bernanke is smelling QE in the morning.

While I might say to Bernanke that further Fed intervention is futile and dangerous, Bernanke would likely reply “Charlie Don’t Surf!”

Demand was 4.47 times the amount sold for the January 2015 debt, compared with 2.41 at the last auction and the bid-to-cover for the July 2015 securities was 3.01, compared with 2.88.

I don’t want to split hairs, but it is the massive government spending and entitlements that drove nations in to fiscal fiasco. The bond yields are simply the market’s pricing of the risk of default. And Spain now has considerable debt to roll over at these higher rates (barring a future decrease in market pricing of risk).

The yield curves of Germany (Bund) and Spain sum up the situation quite well. Spanish yields are over 400 basis points higher than Germany’s sovereign yields.

Meanwhile, Spain has seized one bank, Bankia, which just suffered a billion Euro withdrawal by consumers. Better known as a bank run (ala, It’s a Wonderful Life!)

Again, the fall of Spanish housing prices is leading to enormous bank stress.

And this morning, it appears that Moody’s will downgrade Spain’s banks which will have a negative impact on their already struggling bottom lines.

Here is today’s reaction in the bond market.

Don’t get me wrong. I love the USA and I love visiting France. Heck, I even like flying Air France! I am concerned about our respective economies and directions of both in terms of not doing anything about their massive debts and entitlements coupled with slow economic growth.

So, how are we doing when we need terrific economic growth in order to pay for our entitlements, government spending and … debt? Let’s look at the recent trend since June 2010. We are apparently “Franophiles” at heart.

Inflation

The Consumer Price Index, a measure of inflation, came out on Monday at … 0.0%. Well, that’s not surprising. Bernanke and The Fed have been TRYING to create inflation and can’t. [You need growth in aggregate demand to get inflation!]

Empire State Manufacturing Survey

The Empire State Manufacturing Survey came out on May 15th as well. It came in at a level BELOW June 2010.

Adjusted Retail Sales

Adjusted retail sales were released on Monday too. 0.1% and not going in the right direction!

MBA Home Purchase Applications

On Wednesday, the Mortgage Bankers Association reported that home mortgage purchase applications declined 2.3% from the previous week and have been fairly flat since early-mid 2010.

Savings Rate

The U.S. personal savings rate has fallen since June 2010.

while consumer credit has increased dramatically:

Even worse, much of the credit increase comes from the Federal government in the form of student loans.

Employment

Since June 2010, 2.2 million people have gone disability while 2.1 million people were taken out of unemployment. And average weeks unemployed hit a high point since the Great Depression. Hmm.

All this despite massive easing by The Federal Reserve, 14 Administration loan modification programs, and the almost $1 trillion stimulus package.

The good news for the US? Our real GDP is higher than France’s. The bad news? They are one of our trading partners.

The US economy is showing strain despite The Fed’s positive view of the economy. We can’t have a recovery based solely on autos sales, government credit, and declining savings rates.

Can we try something else? A snail’s pace isn’t good enough to pay for our entitlements or debt. And running trillion dollars deficits only adds more debt the our taxpayers (although only half of taxpayers actually pay any Federal taxes).

And what would be a “Last Train to Brokesville” post with a screen shot of usdebtclock.org!

EEKS! France has an external debt to GDP ratio of … 272%!

If you look at the chart of housing starts, this is a slow turnaround that is gaining momentum.

But housing starts for single structures (detached) are growing at a slow pace since 2008. This is not surprising given the MBA’s purchase application results today showing a weekly decline in application volume.

Mutlifamily rents in the northeast U.S. has risen sharply since the recession.

As you can see, 5+ unit housing starts (aka, multifamily) are still rising, attempting to meet the demand that has resulted in higher and higher rental rates. Since much of the financing of multifamily is coming from HUD, Fannie Mae and Freddie Mac (the government housing monopoly), we have to be careful about brewing an apartment bubble (the government LOVES to create housing bubbles!).

Building permits, a proxy for future construction, fell from a more than three-year high. This is a small wave rather than the big wave that some were hoping.

While 1 units are slowly making a comeback, multifamily starts are still paving the way to a housing recovery. Even though mortgage rates are at an all time low (10 year Treasury is the blue line, 30 year MBA rate index is the gold line).

Purchase applications are still slow by historic standards indicating that the housing “recovery” is still mostly cash purchases and investors.

On the mortgage refi front, you can see a steady increase in applications, thanks in part to HARP 2.0.

Thanks to Europe imploding because of their on-going debt crisis, the 10 year Treasury (blue) is low and the 30 year fixed rate mortgage is at all time lows.

How low can we go?

So, we are back to where we were in 2007. And the index is barely higher than it was in February and March. So, no significant change. The reaction in the equity markets for homebuilders was minimal.

I felt like Denzel Washington from “Philadelphia” saying “All right, Mr. Laird Plouffe, explain this to me like I’m a four-year-old, okay?”

Well, here is Plouffe’s “Philadelphia” explanation to Americans. Prepare to be spoken down to.

Good afternoon –

Thank you,
David
David Plouffe
Senior Advisor to the President

That presentation by President Obama’s housing adviser was … “Here you go, dimwits, let poppa tell you what to do.” And grossly misleading. How about talking to us like we are adults?

The Administration has 14 loans modifications programs going on plus the Attorneys’ General settlement. The Administration and Congress are leaning on FHFA Acting Director Ed Demarco to perform large principal reductions for borrowers. Their motto should be “Cry Havoc! And let slip the dogs of (class) war!”

Let us be perfectly clear. These loan modification programs represent a wealth transfer from investors, banks, Fannie Mae and Freddie Mac to borrowers. Nothing is free, despite what some of the loan modification advocates claim. And the biggest loser will be the American taxpayer.

Let me put on my “Philadelphia” hat and talk to you like you are four years old.

“If you have a 6.5% rate mortgage and you get a refi that lowers your rate to 4.0%, you win. But someone pays for that gift – investors in mortgages such as pension funds, banks and Fannie Mae and Freddie Mac.”

I am not opposed per se to mortgage refis as a matter of fiscal policy (the Boyce, Hubbard and Mayer proposal). I just think that it will be too big of a shock to predict the outcome (just like the National Homeownership Strategy coupled with setting capital gains tax rates on housing equal to zero was too much of a policy shock to predict and we had BAD unintended consequences.

From what I heard from Ed Demarco yesterday at the GWU housing conference, HARP 2.0 applications are skyrocketing (although danged if I see it in the MBA Refi Applications data). And if principal reductions become national policy, we could have a “Perfect Storm of Unintended Consequences.”

Unfortunately, Plouffee and Obama’s housing adviser left out that part of the story. 1) SOMEBODY pays for it and 2) it is a RISKY strategy since we don’t know how it will play out.

One more time, I am not opposed to loan modifications ordered by the Administration and Congress. It’s just that they haven’t done enough homework on the risks and possible unintended consequences.

Here is a chart of government and bank holding of Agency MBS. This ignores private label holdings as well as non-government investor holdings.

Point? A big miss could cost us dearly. Proceed with extreme caution, Mr. Plouffe.

This is the same strategy with which Washington D.C. tells us why we need to be regulated. By talking to us like we are four years olds and then inflicting damaging regulations on us.

And in the future, talk to us like we are adults. And read Diane Olick’s piece on the “responsible” borrowers in Reno NV who want a mortgage principal reduction AFTER taking $250,000 out of the home.

Would you explain to a 4 year old why a seemingly responsible homeowner who drained $250,000 out of their house is asking taxpayers for a handout? And the Administration wants to give it to them?

“Reasons for caution are clear, as we’ve been here before. Non-seasonally adjusted prices increased for a few months in early 2009, 2010 and 2011 – trends that all ended by summer, after which all the gains – and then some – were lost. As is true this month, those temporary increases were on low sales volumes – about 30 percent lower than at any point since 1998. Furthermore, the inventory of distressed homes remains high, which will continue to put a drag on prices.”

This follows on a similar CoreLogic report from a few days ago.

George Washington University Center for Real Estate and Urban Analysis Housing Finance Conference

Speaking of CoreLogic, I was speaking at a conference in Washington D.C. at George Washington University’s Center for Real Estate and Urban Analysis (a sell-out crowd of 250 with an excellent lunch!) and CoreLogic’s Mark Fleming gave his usual excellent presentation pointing to a recovery this year in housing. Mark Zandi from Moody’s Analytics echoed Fleming’s optimism. [Even Bob Shiller seems more optimistic these days!] Laurie Goodman from Amherst Securities chimed in on the state of the market and what needs to be done to return private market mortgage lending.

The lunch keynote speaker was Ed Demarco, the acting FHFA Director, who discussed their strategic plan for Fannie Mae and Freddie Mac conservatorship. I was anxiously waiting for Mr. Demarco to announced plans for principal writedowns from Fannie Mae and Freddie Mac, but alas, it was not to be. Fannie Nae?

The afternoon was devoted to the future of housing finance and what to do with Fannie Mae and Freddie Mac. It was a very interesting panel. Of course, I prefer a private market solution and cautioned everyone to be careful blaming Fannie Mae and Freddie Mac solely for the crisis since the rest of the world experienced a housing bubble and only the U.S. has Fannie Mae and Freddie Mac. [See: Scorcher VI: Global Meltdown (of Housing Prices) – U.S., Canada, Japan, UK, France, Denmark, Australia, Italy, Portugal and Spain]. There was a global housing bubble (or bubbles), so we need to identify the role of Central Banks, capital flows, too much housing subsidization, etc. rather than simply defanging Fannie Mae and Freddie Mac. If we continue to subsidize housing (interest deductions, low down payment loans, government subsidized mortgage rates, etc)., we are likely to create another housing bubble and resulting heart attack.

Andrew Davidson gave his talking points on creating a co-op securitization structure, Hans Bald from 20 Gates Capital pleaded for the government to stop changing the rules (sensible suggestion!) and Adolfo Marzol from Essent Guaranty discussed the return of private mortgage insurance for low down payment borrowers.

It was an excellent conference with fascinating speakers. Kudos to Bob Van Order, Tom Stanton and Rob Valero for organizing it.

The LPS and CoreLogic Numbers

Now on to the housing numbers. Here is the LPS house price report by metro area:

While there are market-to-market differences between LPS and CoreLogic’s measures, they are similar in the aggregate. In fact, LPS’s only negative house price growth in February were in California (LA, SF and San Diego).

CoreLogic, in their recent Market Pulse publication, gave a status update for foreclosures by state. [I wanted to focus on the Sand States of Arizona, California, Nevada and Florida as well states such as New York and Ohio, so I truncated the list. Please contact CoreLogic for the complete list of states]. As foreclosures slow down and housing prices stabilize, we may start seeing a rise in home prices in several market areas within a year.

California has over a quarter of a million pre-foreclosure filings! And Georgia isn’t doing too well either. But as serious delinquencies and foreclosures slow down, we should see a turn around in the housing market.

Consumer Confidence

Like CoreLogic and LPS’s house price indices, the University of Michigan’s Survey of Consumer Confidence is showing increased optimism. Last month’s survey was 76.4, the survey was for 76.0, but the actual print was 77.8.

Of course, we have been here before. February 2011 printed at 77.5 while January 2008 printed at 78.4. Both prints were followed by downturns.

Like house prices, be careful not to over interpret good news. Just because someone agrees to go to the prom with you (elation!) doesn’t mean he or she will be nice.

First, the MBA purchase application index. It remains low by historic standards and is still stuck in the post May 2010 box.

Second, the MBA mortgage refinancing index was up, but only by 1.8%.

I keep waiting for HARP to kick in. Waiting for Godot … again.

This is surprising given the historic low 30 year mortgage rates

and the plunging U.S. Treasury ten year rate (thanks to Europe’s rebellion against common sense).

The Administration has thrown everything and the kitchen sink at the mortgage market and it is slow to react.

Fannie Mae

The good news today is that Fannie Mae posted a $2.7 billion net income for Q1 2012 and will NOT be asking Treasury for more capital. This came on the heels of Freddie Mac asking for an additional $19 million about a week ago.

May 9 (Bloomberg) — Fannie Mae , the biggest backer of U.S. home loans, said it won’t seek Treasury Department aid after reporting net income of $2.7 billion for the first quarter. The company has drawn a total of $117.1 billion in aid while under government control.

Stabilizing home prices are certainly helping Fannie Mae, but $117.1 billion in aid AND required dividend payments to Treasury make it virtually impossible for Fannie Mae to repay their aid to taxpayers.

Sing along with The Beatles, “Thhings are getting better all the time” for Fannie Mae. And hopefully for Freddie Mac too.

Thanks to low prices (post bubble) and being a non-judicial state where foreclosures actually go fairly quickly, Phoenix is experiencing a rising from the ashes. Or re-bubbling.

Hot ‘Lanta (aka, Atlanta GA) remains stone cold at -8.1% along with Not-So-Sweet Home Chicago at -8.8%.

New York/White Plains/Wayne showed a 2% rise in home prices while Dallas in fast growing, low tax Texas experienced a 1.1% rise.

Los Angeles and Riverside CA fell again by -2.4% and -3.2%, respectively.

On a state by state basis, Delaware was the big loser at -10.6%.

And “Sweet Home Alabama” doesn’t look so sweet as the moment.

Highlights as of March 2012
• Including distressed sales, the five states with the highest appreciation were: Wyoming (+5.9 percent), West Virginia (+5.3 percent), Arizona (+5.1 percent), North Dakota (+4.7 percent) and Florida (+4.5 percent).
• Including distressed sales, the five states with the greatest depreciation were: Delaware (-10.6 percent), Illinois (-8.3 percent), Alabama (-8.0 percent), Georgia (-7.3 percent) and Nevada (-5.8 percent).
• Excluding distressed sales, the five states with the highest appreciation were: Idaho (+5.4 percent), North Dakota (+5.1 percent), South Carolina (+4.7 percent), Montana (+3.5 percent) and Kansas (+3.4 percent).
• Excluding distressed sales, the five states with the greatest depreciation were: Delaware (-7.6 percent), Alabama (-4.1 percent), Nevada (-3.9 percent), Vermont (-3.9 percent) and Rhode Island (-2.9 percent).
• Including distressed transactions, the peak-to-current change in the national HPI (from April 2006 to March 2012) was -33.7 percent. Excluding distressed transactions, the peak-to-current change in the HPI for the same period was -24.5 percent.
• The five states with the largest peak-to-current declines including distressed transactions are Nevada (-59.9 percent), Arizona (-48.6 percent), Florida (-48.1 percent), Michigan (-45.1 percent) and California (-42.7 percent).
• Of the top 100 Core Based Statistical Areas (CBSAs) measured by population, 57 are showing year-over-year declines in March, eight fewer than in February.

So, we have stabilization in much of the country.

Do not contact me about BoA’s principal reductions. Contact BofA, please!

Bank of America actually began making principal reduction offers under the program guidelines in March, initially concentrating on homeowners who were already in the modification review process. So far under this early initiative, about 5,000 trial modification offers have been mailed, providing a potential total of more than $700 million in forgiven principal. Homeowners are required to make at least three timely payments before the modification can become permanent.

The wave of mailings beginning this week will reach a broader base of customers who may be eligible for this principal reduction program. The letters provide each homeowner with a description of the program and an invitation to provide financial information to begin the review process. To be eligible for this program, a homeowner must meet certain criteria, including:
 Owes more on the mortgage than the property is worth today.
 Was at least 60 days behind on payments on January 31, 2012.
 Has a contractual monthly payment for principal, interest, property taxes, hazard insurance and any applicable homeowner association fees totaling more than 25 percent of gross household income.
 Has a loan that is owned and serviced by Bank of America, or serviced for another investor that has given the bank delegated authority to do such modifications.

Fannie Mae, Freddie Mac and FHA/VA are not participating in the principal reduction program, but other modification programs which may provide comparable reductions in monthly payments are available on those loans. [I am speaking at a Future of Fannie Mae and Freddie Mac conference on Thursday where FHFA Director Ed DeMarco is the keynote speaker - if he reports any news of Fannie Mae and Freddie Mac principal reductions, I will let you know.]

A key goal of mortgage modifications is to provide an affordable monthly payment, based on borrower’s ability to pay. Most modification plans begin with a reduction of the interest rate, then an extension of the number of years to pay off the mortgage, then if necessary, interest-free forbearance of principal to be paid back at the end of the loan. Bank of America has offered principal forgiveness, but in more limited, targeted situations to eligible borrowers with certain types of mortgages.

Under the terms of the government settlement, the bank will strive to provide an affordable payment to qualified under-water homeowners by first reducing the principal balance to as low as 100 percent of the current property value, then lowering the interest rate and forbearing additional principal, as necessary, to reach the target payment. The settlement terms require a final calculation to determine that the cost incurred by the mortgage investor to modify the loan does not exceed the expected loss to the investor if it goes to foreclosure instead, commonly known as positive net present value.

Their trial program had the aim of reducing borrower’s mortgage payment by 30%. It is best to focus on that number rather than the dollar amount of the principal writedown.

The Attorneys General Settlement is one of 14 Administration loan modification programs, so let’s see how well this particular one works in terms of responses and slowing defaults. Bear in mind that the AG Settlement revolved around the infamous “Robo-signing” where borrowers were not harmed since they would eventually have been evicted anyway. However, the banks/investors were harmed by borrowers defaulting on their loans and staying in the house after default.

And to see why Fannie Mae and Freddie Mac are NOT doing principal reductions (as of today), look at the Reuters’ Mortgage Writedown Calculator. Principal reductions are very expensive with questionable results, although some servicers have allegedly had success with principal writedowns on a small scale. It is when there is a “gold rush fever” for writedowns that it becomes problematic. The AG Settlement may have created moral hazard risk for servicers if current borrowers decide to go 90 days late on their mortgage if hopes of getting their loan written down to 100 percent of the current property value. [Bank of America will undoubtedly be checking for this problem, so my advice is don't go 90 days late in the hope of a principal reduction!]

This is not a negative comment about FHA or HUD. It is simply a matter of … taxpayers cannot guarantee everything, so can we try to prioritize the most important things?

“OVERSIGHT OF THE FEDERAL HOUSING ADMINISTRATION’S REVERSE MORTGAGE PROGRAM FOR SENIORS”
MAY 9, 2012
_____________________

Anthony B. Sanders
Distinguished Professor of Real Estate Finance, George Mason University and Senior Scholar, Mercatus Center at George Mason University

House of Representatives Committee on Financial Services
Subcommittee on Housing, Insurance and Community Opportunity

Chairman Biggert, Ranking Member Gutierrez and Members of the Subcommittee, thank you for inviting me to testify today. My name is Anthony B. Sanders. I am Professor of Finance at George Mason University in the School of Management and senior scholar at the Mercatus Center. I was previously Director of asset-backed and mortgage-backed securities research at Deutsche Bank and the co-author of “Securitization” (with Andrew Davidson) as well as numerous economic and finance publications on housing and the housing finance system.

EQUITY EXTRACTION IN HOUSING

Beginning in 1995, American households began extracting equity from their housing in ever growing numbers (see Figure 1). This effectively removed the equity cushion and increased the loss severity on mortgages when the housing bubble burst.

In the mid-to-late 1990s, the U.K. was trying to find a way to increase equity extraction from their housing market for seniors, ostensibly to diversify their senior’s investments towards bonds and equities and away from housing which tends to form bubbles that burst. The Bank of Scotland and Barclays used a shared appreciation mortgage structure that generated cash for seniors in exchange for forgoing a percentage of the appreciation of their house, enabling seniors to extract equity while staying in their homes. While it was enormously popular with seniors at first, complaints from consumer groups and family heirs removed some of the sparkle from this innovative approach to home equity extraction. But the real problem was that neither Bank of Scotland nor Barclays could successfully raise additional capital to fund this product by securitizing them. The rapid rise in housing prices in the UK (See Figure 2: from an index of 2,693.7 on December 31, 1995 to 9,738.6 on September 30, 2007 – almost a fourfold increase) resulted in seniors owing, for example, 75% of the gain in price of their house to the lender. But if house prices had dropped, the borrowers would have owed nothing and the lenders would have suffered losses.

The loan balance can increase over time if an interest rate is charge on the equity extraction amount. The UK reverse mortgage (or shared appreciation mortgage) had little default risk since the borrower was receiving payments rather than making them. But default or acceleration could be triggered by failure to pay property taxes or maintain the dwelling (since the lender can have up to a 75% share in the appreciation). The latter is the moral hazard risk that borrowers, once they have their equity extraction, have less of an incentive to maintain their property.

THE FHA’S REVERSE MORTGAGE PROGRAM FOR SENIORS

The FHA has a similar reverse mortgage program for seniors to the UK SAM. With the home equity conversion mortgage (HECM), the borrower must still repay the amount owed to the lender. If the borrower has insufficient funds to pay off the HECM, the house is sold and the proceeds go to pay off the borrowed amount. So in this respect, the FHA’s HECM program is a UK SAM without saying so: house prices still determine the amount owed to the lender by the borrower as well as the amount that the borrower can extract.

FHA insurance for HECMs protects the lender rather than the borrower. In the event that the amount owed by the borrower exceeds the value of the property, the loss to the lender will be covered by FHA. But under the reverse mortgage program, any payments due the borrower are also protected. HUD has a legal obligation to make such payments in the event that the lender does not. So, HUD is “on the hook” for negative equity in a home (as well as defaults due to failure to pay property taxes and maintain property insurance).

The costs to seniors, aside from the usual fees associated with lending are that FHA guaranteed HECMs may have an initial FHA Mortgage Insurance Premium (2% for HECM Standard product) as well as Annual FHA mortgage insurance (1.25% of reverse mortgage balance).

The costs to taxpayers are the losses absorbed by HUD for the housing price shortfall, default and support. As our population ages and reverse mortgages become more common, we have to be careful about projected losses to taxpayers from yet another housing subsidy program.

THE FHA’S DILEMMA

The FHA, HUD and the Federal government face enormous challenges going forward. Federal debt held by the public is currently $10.9 trillion which has increased $6 trillion since January 2007 and $4.6 trillion since President Obama took office on January 20, 2009 (See Figure 4).

The Federal government has been running trillion dollar plus deficits and will continue to do so (See Figure 5) which will result in even more Federal debt. Student loan debt is over $1 trillion and growing, another federally guaranteed program.

On the housing finance front, Fannie Mae, Freddie Mac and the FHA have captured the mortgage insurance industry with over a 90% market share. Fannie Mae and Freddie Mac have cost taxpayers $170 billion thus far and counting. And we do not yet know the final costs of the 14 loan modification programs from the Administration, including the Attorneys General Settlement. The Administration and Congress are pressuring FHFA to allow Fannie Mae and Freddie Mac to perform principal write downs and the costs could be staggering.

This brings us to the FHA. The FHA is deeply insolvent with insufficient capital. The FHA Is estimated to have a current net worth of –$12.05 billion and an estimated capital shortfall of $31–50 billion. The good news is that the total delinquency rate in March declined to 15.78% while the serious delinquency rate declined to 9.47%. But with the U.S. housing market is disarray and house prices continuing to decline in many markets (see Figure 6), the losses could mount for the FHA and American taxpayers even further. And with housing prices declining, the FHA continues to insuring and subsidizing 3.5% down payment mortgages.

The question remains as to why the Federal government is guaranteeing and subsidizing reverse mortgages for seniors. Stated differently, why do taxpayers have to subsidize seniors who want to stay in their homes when the simple solution is to let seniors sell their home and either rent another dwelling or purchase a smaller dwelling that meets their needs?

I am not against reverse mortgages as an equity extraction tool. But I do not see any reason for the Federal government to guarantee and subsidize it. And we need to stop micromanaging the home ownership decisions for American households. The Clinton Administration tried it in 1995 with the National Homeownership Strategy that contributed to a housing bubble and burst. Now Fannie Mae, Freddie Mac and FHA are raising credit standards encouraging those who can’t get credit to rent. And now residential rents are rising rapidly in urban areas.

SUGGESTIONS

At a minimum, the Federal government should get out of the reverse mortgage insurance and subsidization business, particularly since there is an easy alternative: seniors sell their home and buy a smaller dwelling or rent.

We have thrown enormous subsidies at the housing market and have tried to steer households into ownership, then renting and now steering seniors toward equity extraction. We need to think about how much of the housing market should be subsidized (mortgage interest deductions, subsidized mortgage insurance, low down payment loans, etc.). Clearly, the massive subsidization has distorted housing and housing finance market and changes should be made.

There are numerous proposals for ending the government housing monopoly. These include eliminating Fannie Mae and Freddie Mac or converting them to a public utility and reinsurance company. But no matter how we deal with the government housing monopolies, we must address how much we want to subsidize housing going forward.

SUMMARY

A reverse mortgage for seniors is a reasonable idea, but should not be guaranteed by the Federal government. It is an ownership decision and the Federal government must stop trying to micromanage this decision, particularly since there is an easy alternative that does not require government guarantees.  

Socialist Hollande’s simple solutions include:

=Taxes
*Impose a tax on financial transactions.
*Impose a 75 percent income tax on earnings above 1 million euros ($1.32 million) and raise the rate to 45 percent for the income bracket between 150,000 euros and 1 million euros per year.
*Repeal 29 billion euros of tax breaks over the next five years.
*Increase total tax level to 46.9 percent in 2017 from 45.1 percent in 2012 (payroll and profit).
*Increase tax on biggest companies to 35 percent.
*Scrap Sarkozy’s 1.2 percent VAT increase.

-Public spending:
*Raise state spending by 20 billion euros over five years.
*Allow those who have worked more than the legal minimum of 41.5 years to retire from the age of 60.
*Limit pay of executives at state-owned companies to 20 times the lowest wage.
*Hire 60,000 teachers and school employees and 5,000 police officers over next five years.
*Hire 150,000 youths in state-subsidized jobs over the next five years.
*Cut French president’s and Cabinet ministers’ pay by 30 percent.

-Banks:
*Pass legislation to split banks’ retail and investment activities as early as July or early August.
*Impose a special tax on banks (no details given).
*Curb bonuses, ban “toxic” financial products, ban French banks from operating in tax havens.
*Create a French public bank to support industry.
*Double the Livret A saving ceiling deposit to 20,000 euros and use the deposit to fund new social housing construction.

-European Central Bank and European Union:
*Request that the ECB expand its mandate to support growth, lend directly to states and give the European Stability Mechanism a bank license or allow the ESM to lend directly to states.
*Renegotiate the EU’s fiscal accord to allow for the issuing of joint euro bonds and for funding industry and growth measures.
*Amend the fiscal treaty to add growth measures and oppose European policy that’s based only on austerity measures.
*Opposition to balanced budget “golden rule.”

-Energy:
*Impose a carbon-emission tax at EU borders and create an EU energy policy.
*Cut France’s nuclear energy share of total electricity output to 50 percent in 2025 from 75 percent today.
*Freeze gasoline prices for three months after elections.
*Restore a “floating” fuel tax to allow prices to drop when the price of refined fuel products falls.
*Close the Fessenheim nuclear power plant, finish construction of the Flamanville nuclear reactor and abandon construction of Penly nuclear reactor.

-Other:
*Suspend sales of state-owned shares of companies.
*Impose limits on leveraged buyouts to exclude participation by financial firms.
*Build 500,000 housing units per year of which 150,000 are rent controlled.
*Creation of a public rating agency.
*Amend the constitution to make it say that France is a secular state.

Apparently, Hollande’s economic adviser is Glinda, The Good Witch From The North because it is going to take sorcery and plenty of pixie dust to make this work.

Why? Here is France’s current situation.

France has slow real GDP growth, much like the U.S. (only France’s growth is even lower than ours).

France has been running budget deficits for as long as one can remember, just like the U.S. Hence, Hollande and the French people opt for the simplistic solution of raising taxes on the wealthy and praying [Sorry, Hollande wants France to be a secular state] wishing that GDP growth doesn’t decline.

And France has a debt maturity structure much like the U.S. – lots of short term debt. And we both HOPE that interest rates don’t rise and drive the cost of debt service through the roof.

France has a 10% unemployment rate … and rising!

French unemployment among young adults (under 25) is 23.2%. I think I can guess who the schools and police will be hiring.

French house prices appear on the downside of a Double Bubble:

And stock market futures are down across the board. Sacre bleu!

Slow growth, high unemployment and staggering deficits and debts are a tumor on the economy. So, Hollande put on his ruby slippers and will be clicking his heels like crazy. Because their economic policies won’t work.

I wish France all the best with their new President and Socialist majority. But please keep Johnny Depp living in France with you.

Francois Hollande and the French people closed their eyes and clicked the heels of their ruby slippers three times saying “There is no place like Greece. There is no place like Greece. There is no place like Greece.”

After the election, President Hollande tells the French people, “You muh-muh-muh-mmm-m-make me happy.”

Of course, the letter only contains citations to emails and reports that support principal reductions. There is no mention of emails and reports that dispute the effectiveness of principal reductions, despite the fact that every person at Fannie and Freddie that I talk to is against such a policy.

Why?

Moral hazard risk. If it became known that going 90 days late on your mortgage would get your principal reduced (perhaps to the house value), it would create a sudden and massive surge in delinquencies. And we would not know how many of those people who get writedowns.

Congressman Darrell Issa (R-CA) and Patrick McHenry (R-NC) sent a response to Mr. Demarco acknowledging moral hazard risk with principal writedowns. Their argument is spot on.

But even with moral hazard aside, small cuts in principal would have little impact. So the cuts would have to be sizable, particularly in the sand states of Florida, Arizona, Nevada and California. Let’s use the writedown calculator to estimate the cost.

If FHFA allows principal writedowns on 1 million defaulted loan and 3 million underwater loans (up to 50% underwater), the cost to taxpayers could be $336 billion. And once again, that is without the moral hazard stampede to default. And this is in addition to the $180 billion that Fannie Mae and Freddie Mac already owe taxpayers.

I sympathize with Congressman Cummings, but I understand Mr. Demarco’s hesitation. We are truly in uncharted waters, particularly since we can’t properly quantify the psychological effects of the writedowns.

So, I agree with Congressmen Issa and McKnight. Throwing caution to the wind is generally a very bad idea, but particularly dangerous at this point in time with such a glacial economic recovery. We already have 14 Administration loan modifications and 30 year mortgage rates just hit an all-time low.

Let’s not overcook the economic goose that lays the golden eggs of prosperity.

One common theme was echoed. The US has subsidized the housing market to the point that it had a massive heart attack. Low down payment mortgages subsidized by taxpayers is a culprit in creating a housing bubble along with streamlined underwriting. Fannie, Freddie and the FHA had underpriced mortgage insurance and captured the residential mortgage market. All this was done in the name of “affordable housing” and “access to ownership.” Throw in the mortgage interest deduction to encourage bigger and bigger “McMansions,” and we have a problem.

Or as Larry White put it, “The government offers big subsidies for housing and housing prices go up.” When he put it that way …

The aftermath is that the government has 90%+ of market share for loan purchases and insurance with RISING credit requirements and household deleveraging.

While I mentioned this only briefly, “cheap” mortgage rates may have become another entitlement in our country. This presents a problem in trying to undo the subsidies that caused the housing crash in the first place.

To paraphrase singer Robert Palmer – “We might as well face it, we’re addicted to gov.”

Or state differently, massive housing subsidies are “simply irresistible.”

IS there any will to make down payments 20% minimum for the FHA? Is there any will to take away the mortgage interest deduction (which costs about $100 billion per year)? Is there any will to actually eliminate Fannie and Freddie?

I have my doubts. It IS feasible to privatize the mortgage system. But is there the will? That is, will we “take the pain” for a few years or is the entitlement culture so pervasive that politicians can’t bear pain?

Without a government guarantee, I have estimated that 30 year fixed rate mortgages would rise about 50 basis points. Andy Davidson estimates an increase of 100-250 basis points. But if Fannie Mae, Freddie Mac and the FHA actually charged the appropriate insurance fees, the difference would be zero. That is the subsidy effect.

Let’s face it. The government did no favors to low and middle income families by setting home ownership targets and then fiddling with the finance system to meet the targets.

If there is no will to cut back on the subsidies, then Fannie Mae and Freddie Mac becomes almost irrelevant since SOMEONE will deliver the subsidy. Shutting down Fannie Mae and Freddie Mac will simply shift the delivery to FHA.

But cut back the subsidies we must. He is a nice graphic of where we sit in the housing system as a result of too much subsidies for housing.

While “Take the pain!” is a famous scene in the Oliver Stone film “Platoon,” there is another famous scene epitomizing my frustration with how we so oversubidized housing in the USA:

Here is my Fox Business interview with Melissa Francis and Laurie Rothman just after the event.

The Good News: The seasonally adjusted purchase index gained 2.9%. But it still remains low by historical levels, particularly since Q1 2010.

The Bad News: The refinance index fell 0.7%. Talk about Waiting for Godot. The anticipated HARP Refi Boom that is supposed to jump start the economy is slow to ignite.

When I testified in the Senate last week on MORE HARP streamlining, I cautioned against moving too fast since we don’t know how many people will refinance their loans under HARP or the other 13 mortgage modification programs. This failure to ignite HARP loan modifications supports my point – the economic system is to complex to accurately predict how big changes will be impact the markets or WHEN they will impact the markets.

At least the average loan size for modifications is increasing by 0.86%.

On the employment front, economists were expecting 170,000 jobs to be created, but the ADP report today indicates that only 119,000 jobs were created.

Waiting for Godot – Again!

Credit scores have generally risen from 2007/2008 to today. After a housing bubble burst that caused a significant decline in credit scores for 30% of the population, a RISE in FICO scores for home loans of almost 780 is the proverbial “Bridge too Far” for many borrowers.

Loan level pricing adjustments (LLPA) are now fairly tight for credit (FICO) scores below 680.

Loan-level pricing adjustments (LLPAs) are mandatory loan fees based on a borrower’s specific default risk. First introduced in 2008, LLPAs were Fannie Mae’s and Freddie Mac’s logical response to massive balance sheet losses.

Far be it from me to say whether there is too little credit availability (or too much), but 30% of the population is effectively shut out of the housing finance market. At least with Fannie Mae and Freddie Mac. That makes it tough to stage a rapid recovery.

“Who let the dogs out?” Obviously, not Fannie Mae and Freddie Mac this time around.

Data from Andy Davidson at Andrew Davidson Company. Llpas from Fannie Mae.

And according to Nick Timiraos and Alan Zibel of the Wall Street Journal, “more Americans may feel less confident about property ownership after the steep price declines of the past six years.”

Yes, I think it’s safe to say that many potential home buyers are wary of a “Buy high, sell low” investment strategy in the housing market.

Here is a chart of home prices where you can see the housing bubble and collapse. It is the FNC 20 Metro house price index.

And the result of plunging home prices and millions of borrowers in foreclosure is a dramatic fall in homeownership rates. This is a chart of the homeownership rate.

Of course, the housing bubble was a result of the Clinton Administration encouraging low down payment borrowing and eased underwriting in an attempt to increase homeownership, particularly among under served communities. In other words, the Clinton Administration (and Congress) removed the safety from the housing finance torpedo and fish came back at us. To be fair, the Bush Administration pretty much left the safety off the housing finance torpedo too. There is plenty of blame to go around, but the Clinton Administration helped create what happened.

Hint to policymakers: don’t set targets for homeownership and urge low down payments and streamlined/eased underwriting regardless of how well intended they may be.

Hint to The Fed: try to avoid massive gyrations in the Fed Funds rate in trying to micromanage the economy. This is a chart of house prices and The Fed Funds rate.

Quantitative easing programs have helped bubble (or froth) the stock market, but the bubbles vanish when QE ends. So, do you think The Fed will NOT do QE3 or Twist 3?

One of my good friends in the mortgage industry had never heard about the National Homeownership Strategy (which HUD removed from their website). It included the following:

Action 11: Removing Barriers to Mortgage Financing for Starter Homes
Action 29: Alternative Approaches to Homebuying Transactions
Action 35: Home Mortgage Loan-to-Value Flexibility
Action 36: Subsidies to Reduce Downpayment and Mortgage Costs
Action 44: Flexible Mortgage Underwriting Criteria
Action 45: Public-Private Leveraging for Affordable Home Financing

NHSDream

Again, taking the safety off the torpedo.

*Jim Johnson, the Fannie Mae CEO, contributed to the big push with an “Opening Doors” campaign for homeownership in 1994 pledging $1 trillion in targeted housing finance that would serve 10 million low- to moderate-income families.

From “This is Spinal Tap”

Nigel Tufnel: “What we do is, if we need that extra push over the cliff, you know what we do?”
Marty DiBergi: “Put it up to eleven.”
Nigel Tufnel: “Eleven. Exactly. One louder.”

Despite the myth that Canada didn’t have a housing bubble, the evidence is that they did. However, their house prices rallied and then leveled off. Japan (in green) continues its pace of steady deflation.

Sadly, Spain had a housing bubble that continues to melt down. The Uk experienced a bubble, burst, rally and flattening much like Canada. Australia avoided house price declines until 2010, but their house prices are deflating too.

France and Italy show recent downward trends. Denmark, the poster child for what some call the ideal mortgage market, had a house price boom and bust much like the U.S. That is one reason why I am dubious about the claims that the Danish Mortgage System is far superior to our housing finance system. They look pretty similar to me.

The Netherlands is experiencing deflation in housing prices too. Here is a comparison with Denmark.

And here is a closer look at Portugal house prices versus Spain. Jesu y Maria! Portugal’s house prices are melting!

China is not immune to housing bubbles and bursts either. For example, here is an index of Chinese residential rents for residential properties.

The point is that despite the different housing finance systems, each country examined is suffering a continued housing meltdown. That is, global meltdown.

Who left the fridge open?

CoreLogic says a significant factor causing recent home loans to slide under water has been the availability of government-insured mortgages that require only a small down payment. These loans, insured by the FHA, require a down payment of as little as 3.5 percent of the purchase price, providing only a small cushion of protection against a drop in home prices that could drive a borrower into negative equity.

“This is creating a new wave of underwater borrowers,” said Gary Shilling, a veteran financial analyst and well-known housing market bear. “We have all three branches of government trying to keep people in four bedroom houses who can’t afford chicken coops.”

Now, I wish I had that quote before my testimony on the 14 loan modification programs of the Administration on Wednesday before Senate Banking.

But it is a point I have made before – low down payment loans in a declining house price market is not sound housing policy. There are constant Congressional hearings where advocates plead for mortgage write downs claiming the borrowers are suffering, yet the FHA continues to put borrowers in “instant negative equity” loans which will require principal write downs as long as home prices decline.

Of course, low down payment loans guaranteed by Uncle Sam are popular with borrowers, home builders, Realtors, “affordable” housing advocates and others. And it is politically popular, particularly when house prices start to rise again. But the real problem is as Garry Shilling suggests. This is very frustrating since alternatives exist to home ownership such as Bank of America’s excellent (and compassionate) “Mortgage to Rent” trial program.

If the recent signs in the housing market are correct (e.g., multiple bids for the same house and rising new home purchase commitments) and house prices start rising again, then I would still argue against government guaranteed low down payment loans. Why? Because they contribute to rapid price increases (remember President Clinton’s well-intended, but ultimately tragic housing policy decisions)? Look at the first half of the housing price chart above.

But if you really want to finance your housing with an FHA 3.5% down payment mortgage, please don’t eat for an hour before entering the water. The undertow is severe!

Thanks to Carola Von Hoffmannstahl-Solomonoff for the Undertow movie suggestion!

Separately, DeMarco has been equally worried of creating a moral hazard by incentivizing homeowners who are current with their mortgages to default in order to tap into the government’s program. Three out of four deeply underwater borrowers in Fannie and Freddie’s book of business are current on their loans.

I am relieved that Mr. DeMarco has made that decision. As I testified in Senate Banking on Wednesday, there are 14 loan modification programs that the Administration has under way, it is prudent of FHFA to further assess how all these moving parts work together. [Thanks to Virginia Senator Mark Warner who supported my testimony!]

A reminder to those who doubt the expense to taxpayers of principal write downs, please look at Reuters’ Write Down Calculator. The costs could be staggering for the Administration’s ambitions for write downs.

The trend is deteriorating and is below zero.

This flies in the face of Bernanke’s upbeat forecast of the economy that he gave yesterday. Or is the Chairman trying to calm the animal spirits of nervous Americans?

Let’s see how tomorrow’s GDP report turns out.

On the other hand, Yale Economist remains depressed about the future of housing and says that U.S. housing may not rebound ‘in Our Lifetimes‘.

So, who is correct?

I have said before that housing is bouncing along the bottom in terms of new home sales. Existing homes have been level for years (other than the Administration shuffling the deck chairs with their tax credit silliness) and home price declines have slowed down. Today’s pending home sales increased, giving Zandi goosebumps.

New Home Sales

Existing Home Sales

Home Prices

Pending Home Sales

By Lorraine Woellert – April 26 (Bloomberg) — Signed contracts to buy U.S. homes rose more than forecast in March as low interest rates drew buyers back into the market.

The index of pending home purchases rose 4.1 percent to 101.4, the highest level since April 2010, after a 0.4 percent gain in February that was revised from a previously estimated 0.5 percent drop, the National Association of Realtors reported today in Washington.

The answer: BOTH are correct. The housing market is SLOWLY healing even though housing prices could fall several more points. As foreclosures continues to be absorbed, the prices will continue to fall.

As I warned in the Senate yesterday (which only Virginia Senator Mark Warner acknowledged), we are still suffering the hangover from Clinton’s Trifecta of Housing Policies that removed the “barriers” to home ownership (government code for encouraging low down payment mortgages) and “streamlining” underwriting (government code for easing underwriting standards). Throw the removal of capital gains tax on the “streamlining” and “removing the barriers” and you have a strange brew.

Senator Jack Reed (D-RI) blasted me in the hearing for daring to advocate doing nothing during a crisis. And then turned to someone else and didn’t allow me to respond. So, Senator Reed, here is my response.

“Senator Reed, the Administration and the Federal Reserve are having a massive heart attack with all the programs (14 loan modification programs) and unprecedented Fed policy. So, FOR ONCE, can you think about what you are doing given that our experience with Clinton’s housing policies proved to be so disastrous? when there is so much stimulus being thrown at the problem?”

I still like my analogy to “Hunt for Red October” concerning taking the safety off the torpedo. Alas, this is an election year.

Purchases dropped to a 328,000 annual rate, a decline of 7.1 percent from a revised 353,000 pace in February that was stronger than initially projected, figures from the Commerce Department showed today in Washington. Economists forecast a rate of 319,000 last month, according to the median estimate in a Bloomberg News survey. Inventory declined to a record low and the median selling price rose from a year ago.

Median price of new home sales fell 1.01% (although average price increased 7.97%.

Yes, housing remains in the “House Latitudes” much like the horse latitudes that plagued sailors during the wind-powered Clipper era. Tradition states that sailors gave the region of the subtropical high the name “horse latitudes” because ships relying on wind power stalled; fearful of running out of food and water, sailors threw their horses and cattle overboard to save on provisions. (It’s a puzzle why sailors would not have eaten the animals instead of throwing them overboard.)

The S&P/Case-Shiller index of property values fell 3.5 percent from a year earlier, the smallest 12-month drop since February 2011, a report from the group showed today in New York The median forecast of economists surveyed by Bloomberg News projected a 3.4 percent fall. The index climbed from the prior month on a seasonally adjusted basis for the first time since April of last year.

Here is the Case-Shiller 20 City Home Price Index since 2000.

On a city by city basis, Phoenix was actually up from January to February while Atlanta and Chicago are the biggest losers.

The Case-Shiller 20 NSA compared with FNC’s 20 RPI reveals that they are very close (and FNC is released a week earlier).

Here is a chart of the Fed Funds Target Rate (green) against the Case-Shiller and FNC 20 city house price indices. I guess this means that The Fed will leave the Fed Funds Target rate at near zero.

Chubby Checker’s Limbo Rock housing market continues. How low can you go?

Graphically, you can that house prices continue to deflate.

And here is a comparison of the Case-Shiller 20 index versus the FNC RPI 20 index.

“How Low Can You Go?”

The Chubby Check “Limbo Rock” housing market continues to fall, albeit it a slower rate of speed.

Can we try something different in national housing policy? Clinton’s “Great Leap Forward” in home ownership didn’t work out so well, particularly for the targeted low income households they meant to help.

Senator Menendez and distinguished members of the Committee, my name is Dr. Anthony B. Sanders and I am the Distinguished Professor of Finance at George Mason and a Senior Scholar at the Mercatus Center. It is an honor to testify before this committee today.

The proposal to be discussed at this hearing is the expansion of affordable refinancing of mortgages held by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. The expansion represents changes in HARP that eliminates Loan Level Price Adjustments (LLPAs), eliminates representations and warrants for cross servicer refinancing and appraisal streamlining and orders Fannie Mae and Freddie Mac to contact borrowers directly about HARP opportunities. Discussion Draft on Refinancing

It can be argued that Fannie Mae and Freddie Mac are resisting loan modification to protect their retained portfolios. Hence, fewer borrowers are able to refinance their mortgages. This proposal would remove the safeguards from HARP and encourage more refinancing by borrowers.

Even so, I would encourage a detailed examination of the projected benefits to consumers and costs to American taxpayers of these proposed changes by FHFA, the Congressional Budget Office and The Federal Reserve Board before you proceed. Administrations and Congress have undertaken large policy changes in housing and housing finance (particularly since 1995) and these changes had unintended consequences. Removing the safeguards may be appropriate, but we need detailed studies of the 14 Federal Government loan modification programs and how they interact with each other and The Federal Reserves’ monetary easing strategy.

Lessons from Jurassic Park

The Clinton Administration embarked on a well-intended strategy of increasing the home ownership through the expansion of credit to lower-income households. The first leg in the “housing finance trifecta” was the National Homeownership Strategy: Partners in the American Dream (1995).

“The partnership should support efforts to increase local lender awareness and use of the flexible underwriting criteria established by the secondary market, FHA, and VA.”

The result was
* A focused effort to target the “low income” borrower through extensive outreach
* The drastic reduction of minimum down payment levels from 20% to 0%

And the “partners” for this “Great Leap Forward” in homeownership included Fannie Mae and Freddie Mac who are now in government conservatorship under the Federal Housing Finance Administration.
The second leg in the “housing finance trifecta” was President Clinton’s desire to set capital gains tax on housing to zero (1997).

“Tonight, I propose a new tax cut for homeownership that says to every middle-income working family in this country, if you sell your home, you will not have to pay a capital gains tax on it ever — not ever.”

— President Bill Clinton, at the 1996 Democratic National Convention

With the first two legs of the housing finance trifecta, the Clinton Administration was encouraging riskier low down payment mortgages coupled with no capital gains tax on housing, a recipe for a massive increase in housing prices. This coincided with an explosion of GSE debt (mostly Fannie Mae and Freddie Mac) to fund the required mortgage debt expansion (see Figure 1).

The third leg of housing finance trifecta was the repeal of parts of the Glass-Steagall Act of 1933. Deregulation per se is not damaging to the economy (and is often beneficial), but the shock of such a major regulatory change in conjunction with two large shocks in housing policy make it extremely difficult to predict the outcomes and unintended consequences. This is especially true when the Clinton Administration insisted that no merger may proceed if any of the financial holding institutions, or affiliates thereof, received a “less than satisfactory [sic] rating at its most recent CRA exam”, essentially meaning that any merger may only go ahead with the strict approval of the regulatory bodies responsible for the Community Reinvestment Act (CRA). The Clinton Administration stressed that it “would veto any legislation that would scale back minority-lending requirements.”

Taken together, the trifecta clearly was a major policy change to an extremely complex economy. I am unaware of any research at HUD from their Policy, Development and Research group examining how the three legs would work together and what the joint intended and unintended consequences would be. This type of major policy shift can have Jurassic Park type of unintended consequences for the housing market, the mortgage market and borrowers. The Clinton trifecta ultimately resulted in the taxpayers being eaten by the monster that was created (as in $7.4 trillion in household equity being lost and millions of borrowers in default or foreclosure).

In summary, I strongly believe that any change in policy for the housing and mortgage market must be accompanied by sound theory and econometric models of the policy impact. If we don’t have the appropriate theory or data, we shouldn’t do it. It will simply unleash more taxpayer-eating dinosaurs on the economy.

The 14 Federal Government Loan Modification Programs

There are currently 14 Federal government loan modification programs:

Home Affordable Modification Program (HAMP)
Principal Reduction Alternative (PRA)
Second Lien Modification Program (2MP)
FHA Home Affordable Modification Program (FHA-HAMP)
USDA’s Special Loan Servicing
Veteran’s Affairs Home Affordable Modification (VA-HAMP)
Home Affordable Unemployment Program (UP)
Second Lien Modification Program (2MP)
Home Affordable Refinance Program (HARP)
FHA Refinance for Borrowers in Negative Equity (FHA Short Refinance)
Treasury/FHA Second Lien Program (FHA2LP)
Home Affordable Foreclosure Alternatives (HAFA)
Housing Finance Agency Innovation Fund for the Hardest Hit Housing Markets (HHF)
Attorneys General Settlement for Mortgage Servicers (AGS)

We anxiously await the results on HARP 2.0 and the Attorneys General Settlement has yet to kick in. In addition, there is pressure from the Administration and Congress on having FHFA approve principal reductions for the GSEs.

The Evidence So Far

The U.S. Department of Treasury provides us with a limited summary of the magnitude and effectiveness of HAMP and other programs. But the number that stands out is that approximately 25% of modified mortgages go into re-default after 1 year. True, the data is from 2010, but the trend for most recent modifications shows the same daunting trend.

According to the Mortgage Bankers Association (MBA) Mortgage Refinancing Index, mortgage refinancing applications have been increasing since the beginning of 2011 (see Figure 2). With historically low mortgage rates, unprecedented intervention by the Federal Reserve, and the continued European debt crisis that is driving investors into the U.S. Treasury market. We are in unchartered territory on Fed intervention and mortgage rates and we have to be careful not to create more unintended consequences that could devastate American taxpayers.

While this proposed expansion of HARP does not include principal write downs, bear in mind that it is virtually impossible to accurately predict the outcomes of HAMP and HARP if FHFA agrees to principal reductions AND the Attorneys General Settlement (which includes principal reductions). Before proceeding, I suggest a study from the Congressional Budget Office, FHFA and The Federal Reserve on the joint effects of all programs kicking in together.

I appreciate the difficulties faced by FHFA and others about predicting the success rates for HAMP and HARP. We simply do not have adequate data to make a sensible recommendation, particularly with regard to principal write downs. Reuters made an attempt to model principal reductions from Fannie Mae and Freddie Mac and estimated they could cost taxpayers $128 billion. This is a much bigger number than FHFA has indicated ($2.1 billion) and far more than the available TARP funds ($41.7 billion). Likewise, we can only guess at the final success of HARP and the Attorneys General Settlement. And there is the moral hazard of principal reductions that must be considered in any analysis (that is, will borrowers fall behind in their payments simply to qualify for a mortgage write down?).

Please exercise extreme caution and wait until we have more data as to the effectiveness of the collected efforts of the 14 loan modification programs AND the principal reduction proposals for FHFA. And bear in mind that we only have data on loan modifications since 2008 and virtually no data over a long period (4 years) on principal reductions.

Section 4 – Having Fannie Mae and Freddie Mac Contact Borrowers Directly

Section 4 requires that Fannie Mae and Freddie Mac contact borrowers directly about the possibility and benefits of a mortgage modification. In addition, Fannie Mae and Freddie Mac must post relevant refinancing information on their web sites (see Table 1 for examples of existing web sites).

Of course, this is an unprecedented change from current procedures. Given the plethora of media and links on bank web sites and government web sites concerning loan modifications, I can’t see how any borrower interested in a loan modification could possibly not be aware of the possibilities. And again, the lessons from Jurassic Park teach us that large changes in government policy can produce unintended consequences (14 government mortgage modification programs PLUS individual bank/servicer/investor private mortgage modification programs). We must be careful to avoid a firestorm of unintended consequences.

Should We Have Non-GSE Banks/Servicers Remove the Safeguards As Well?

I am on record above stating that careful analysis of the joint impact of the 14 Federal Government loan modification programs should be undertaken before any more changes are made (or new programs are created). So, my answer is no, at least until the appropriate studies are performed.

At some point, the collective impact of these programs could drive our banks into bankruptcy. This possibility must be included in the analysis before any further steps are taken.

Another reason that I am opposed to removing the loan modification safeguards is that the banks and investors are private market concerns, not private market concerns in conservatorship. Once again, this could be a Jurassic Park moment where we signal to the world that the U.S. will pass laws at will to alter contracts and dramatically change investor expectations.

In summary, I encourage the Senate to request detailed studies on the impact of this legislation before proceeding further. I strongly suggest:

1. Take into consideration the cost of each proposed change to taxpayers and the expected decline in default and re-default rates.
2. Take into consideration how these changes will interact the 14 existing loan modification programs from the Federal government AND the proposed principal write down proposals for Fannie Mae and Freddie Mac.
3. Ignore private market estimates of the costs and benefits if the analysis comes from a firm that benefits from any of these proposed changes or has ties to the Federal government.

Let us be wary of creating another Jurassic Park policy change. We are in unchartered waters for housing finance and Federal Reserve policies and further changes should be enacted with extreme caution.

Thank you for the opportunity to testify.
 
Addendum: This is NOT part of my testimony. But remember the scene from “Hunt for Red October” with Sean Connery as a Russian sub commander with a Scottish brogue?

Capt. Vasili Borodin: Torpedo impact, 5 seconds.
[the torpedo slams into the bow of Red October and breaks up on impact]
Commander Bart Mancuso: I’ll be damned!
Jack Ryan: What happened?
Commander Bart Mancuso: Combat tactics, Mr. Ryan. By turning into the path of the torpedo, the Captain closed the distance before it could arm itself.
Jack Ryan: So that’s it?
Captain Ramius: Not quite. Right now Tupolev is removing the safety features on all his weapons. He won’t make the same mistake twice.

So, this bill will remove all the safety features on HARP. Let’s hope it doesn’t have the same effect. Unlike Tupolev, the Senate seems to want to make the same mistake twice.

Konovalov Crewman: Torpedo, Dead Ahead!
Andrei Bonovia: [to Captain Tupolev] You arrogant ass! You’ve killed us!
[just moments later, the Konovalov explodes.]

And The West is not the best. Down 7.38%.

But at least median house prices for existing home sales rose.

On a related note, The Bloomberg Consumer Comfort Index rose, but still negative. Like capacity utilization, this Administration has yet to see a positive number. Only shades of negativity.

And U.S. Treasury rates fall as investors run for cover. (Bad job report, bad existing home sales, bad European debt crisis). This is a recovery?

Do I smell QE3?

Bernanke: “I love the smell of napalm quantitative easing in the morning. Smelled like [sniffing, pondering] victory. Someday this war’s recession’s gonna end…

Here is a screenshot of Dan’s calculator showing that mortgage write downs would cost taxpayers $128 billion.

I wish I had this calculator when I spoke at Brookings.

The details of Reuter’s calculator are found here: Principal Reduction Calculator Final.

For the sake of argument, suppose that we max out on possible mods and increase the underwater balance to 50%. The taxpayer loss would jump to $332 billion.

You can use the calculator to play “Moral Hazard!” Rather than caring about tax payers, you too can plunder Fannie Mae and Freddie Mac (as well as Treasury) depending on how extreme you want to get.

Refi applications are mounting thanks to the 14 Administration mortgage refi programs AND the Euro Crisis (throw the Fed’s fiddling with rates into the stew as well).

Purchase applications remain in the “red zone.”

The refinance share of mortgage activity increased to 75.2 percent of total applications from 70.5 percent the previous week.

32 percent of this refinance volume was for HARP loans. The average loan size of all loans for home purchase in the US was $233,381 in March 2012, up from $225,463 in February 2012.

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,500 or less) decreased to 4.05 percent from 4.10 percent,with points increasing to 0.45 from 0.43 (including the origination fee) for 80 percent loan-to-value ratio (LTV) loans.

Freddie Mac is trying to speed up the HARP short sale approval process and this should increase refi applications in the future.

With all Obama’s horses and all The Fed’s men, let’s see if they can put housing together again.

Now you can see why homebuilder optimism slipped yesterday.

Construction of single-family houses eased 0.2 percent to a 462,000 rate.

Work on multifamily homes, which include townhouses and apartment buildings, dropped 17 percent to an annual rate of 192,000. The decrease followed gains of 13 percent and 17 percent in the prior two months.

Building permits, on the other hand, exceeded expectations with a print of 747,000 compared to expectations of 710,000.

Here is a chart of building permits and housing starts. A surge in permits has historically meant increased housing starts.

All this despite the massive monetary stimulus provided by The Fed.

Now you can see why Dave Stevens (far right) and I were receiving scowls when we spoke recently to the Virginia Association of Realtors!

Here is a chart of NAHB Homebuilder Sentiment and the Fed Funds Target rate. Can you say “Liquidity Trap?”

While consumer traffic has increased and 30 year fixed-rate mortgage rates return to near lows, homebuilder optimism took a turn for the worse.

Remember the huge shadow inventories of homes from foreclosure (and in the pipeline) combined with tight mortgage credit conditions. All systems are NOT green.

Between the weak jobs report and the decline in homebuilder optimism, the Federal Reserve may be looking at QE3 if these trends persist.

Jobless claims increased 13,000 in the week ended April 7 to 380,000, the highest since Jan. 28, the Labor Department reported today in Washington. The median forecast in a Bloomberg News survey called for 355,000 claims. The number of people on unemployment benefit rolls and those receiving extended payments declined.

On a non seasonally adjusted basis, oops!

On the positive side, continuing jobless claims dropped on a SA basis.

As my friend Rebel Cole at DePaul will undoubtedly be commenting, it has been a warmer than usual winter. Here is the weather abnormality for March 2012. So, hiring may have been overheated (pardon the pun) compared to previous years because of the warm weather. Has the labor market used up its slack?

The IMF’s Christine Lagarde is in the USA saying that the austerity in the Eurozone is painful and the USA needs to pony up big bucks so big spending, debt-riddled countries don’t have to pay for their policies. She is trying to raise $400 billion (of which the US will have a large share).

“Mr. Obama, may I have some more gruel, sir?”

Need any additional evidence that Lagarde is Oliver Twist?

It reminds me of Fed monetary policy under Alan Greenspan (and to a lesser extent Ben Bernanke). It bears a strong resemblance to a roller coaster.

Perhaps The Ohio Players should record a new version called “Fed Roller Coaster.”

Today, the dovish Fed Vice Chair Janet Yellen spoke at NYU today and announced that the roller coaster is over (my words) and is closed for repairs.

“I see no good reason to doubt that our nation’s high unemployment rate indicates a substantial degree of slack in the labor market. Moreover, while I recognize the significant uncertainty surrounding such forecasts, I anticipate that growth in real gross domestic product (GDP) will be sufficient to lower unemployment only gradually from this point forward, in part because substantial headwinds continue to restrain the recovery.

“keeping the funds rate close to zero until late 2015“

Yellen is saying that we are no longer on a roller coaster, because we broke the ride. Unfortunately, only the stock market seems to operating on the roller coaster. Real estate is the broken car.

In her speech, Yellen discusses the Taylor Rule. We are clearly not a full employment (and Yellin makes it sound like we will never get back to normal), but the Taylor Rule indicates that the Fed Funds Rate should be increased (blue line) to choke off inflation.

And here is the Taylor Rule Outlook Matrix where you can see what the Fed Funds Rate should be for different combinations of unemployment and inflation (as measured by CPI). I am not a believer that The Fed can influence unemployment (so I wish they would stop trying). Trying to fix the unemployment with monetary policy is Mission Impossible!

For a further look at the Taylor Rule, here is Taylor’s “Introductory Remarks on Monetary Policy Rules.”

On a side note, the Patriot Gary Sinese who plays for our troops (and played Lt. Dan in “Forest Gump”) looks like the lead singer in a Megadeth cover band in “Reindeer Games.”

The euro rose and Spanish bond yields declined as Coeure’s comments reassured investors that the ECB will act again if needed to stem the crisis. With Spain’s three-month-old government struggling to reduce the budget deficit and crack down on overspending by regional administrations, borrowing costs have surged, nearing the levels that precipitated bailouts for Greece, Portugal and Ireland.

Not only did Spain’s 10 year sovereign yields decline, but Greece’s, Italy’s and France’s as well. Portugal was the odd duck out and actually saw an increase in their 10 year sovereign yields.

Despite the ECB’s flooding of the Eurozone with liquity, Greece, Portugal, Spain and Italy remain above 5.50%. Compare that with Japan’s 0.941% and Switzerland’s 0.747 10 year sovereign debt yields.

It is clear that global central banks are continuing their flooding policies and the U.S., Canada, France, Netherlands, UK, Germany, Sweden, Switzerland are all at sub 3% levels on their 10 year sovereign debt.

On the Euro bank front, 5 year CDS prices are trending up again after falling since February.

So, instead of building an Ark, the U.S. and European stock markets are celebrating the coming flood.

Remember that hideous levels of unemployment and slow economic growth are still present in both Europe and the U.S. Flooding only buys time, it doesn’t correct the underlying problems of too much government spending and debt.

And what will be in the wake of the flood?

Yesterday, FHFA Director Ed DeMarco said that HARP 2.0 applications were really taking off. I assume that the 30-60 lag is causing the 2.4% DECREASE in refinancing applications. Or with the 14 Administration refi programs (and the oft-discussed principal reductions from Fannie Mae and Freddie Mac), are borrowers waiting to see if another even more advantageous program is around the corner?

The seasonally adjusted Purchase Index decreased 0.5 percent from one week earlier. Bear in mind that last Friday was Good Friday, so there is a natural drop in activity.

Still, we appear stuck in “The Red Zone” of slow growth for purchase applications since 2010.

According to the MBA, the 30 year rate on Fixed-rate mortgages continues to be at near historical lows. So, the red zone for purchase applications is dispiriting given the level of mortgage rates.

And thanks to the fondue of Europe debt, the 10 year Treasury yield is once again lingering around 2.00%.

Are we stuck in a housing version of a liquidity trap? I hope not. Let’s see if a full week of applications changes anything.

DeMarco reiterated that forbearance saves taxpayers more money than principal reductions. And there are other programs like Bank of America’s “Mortgage to Rent” program which avoids principal reductions, but allows borrows to gracefully transition to renting AND stay in their homes.

But the most important point is that FHFA needs more time to examine the issue of principal reductions. Other than anecdotal tales of how principal reductions help avoid foreclosures, there is very limited data available in order to make a sensible policy decision. When in doubt, DON’T DO IT!

As I said at Brookings, we have very little empirical evidence (other than anecdotal stories) that principal reductions work. We have not been through 3-4 years of mortgage modifications with principal reductions to see if they are as effective as forbearance in preventing defaults. FHFA (like principal reduction advocates) are reliant on NPV calculations that are very subjective. DeMarco’s PhD advisor Henry Aaron (no, the economist) hammered DeMarco on the empirical tests of FHFA’s report. But Hammerin’ Hank, that cuts both ways. We simply do not have ample empirical evidence to embark on a major public policy shift such as principal reductions.

Here is the Brookings Institute meeting with DeMarco as keynote and me as a panelist (on the far left). And here is my interview with Fox’s Peter Barnes on the Brookings conference.

I remember when Shaun Donovan said that he would only undertake public policy decisions on housing if there was empirical evidence. I ask you, Secretary Donovan, where’s the beef? Particularly given Bank of America’s “Mortgage to Rent” pilot program which could also reduce foreclosures WITHOUT principal reductions.

And don’t forget the glaring moral hazard problem with principal reductions. “We will write down the principal on your mortgage to your house value if you go 90 days late!” Let’s see – my house is worth $150,000 and I owe $350,000. And the government will write down $200,000 of debt. I shudder to think of the reaction.

Frankly, I think DeMarco should receive the President’s Medal of Freedom (but somehow I don’t think that will happen). Rather, I think of the film “Barbarians at the Gate” with DeMarco guarding the gate with a single sword.

Remember Jurassic Park. We got into this mess by well-intended housing policies (e.g., National Homeownership Strategy until Clinton) that took on a life of their own. But this time, the T-Rex killed homeowners financially (loss of $7.4 trillion of borrower equity).

So, be careful about massive policy decisions concerning housing and the mortgage market without ample empirical support about the costs and impacts. There are still T-Rexs and raptors lurking in the background.

Taxpayer running from Principal Reduction Advocate

Here is part of the interview.

Q: Why should Fannie and Freddie be forced to do write-downs?

This isn’t that hard a problem to design around. Take the mortgage-servicing settlement that we recently reached. In that case what we’re doing is putting in place protections so that we avoid some of the risks of strategic default. For example, in that case many of the servicers are simply going to set a date at which you’re eligible based on delinquency and what that means is there’s nothing you can do. You can’t make yourself eligible. You can’t start to default on your mortgage and all of a sudden start to get a windfall from that by getting a principal reduction. And so while I understand the concerns about this, I think one the vast majority of homeowners are not at risk for strategic default. And two, even for those where there is some risk, there is a way to design it so that … it avoids those risks.

FHFA Director Ed DeMarco wants to help borrowers as well, but is weighing the principal reduction decision against losses to Fannie Mae, Freddie Mac and taxpayers. I agree with Mr. DeMarco that forbearance achieves the same goals of lower mortgage payments, but without having to lower the Loan-to-Value (LTV) ratio.

Another way (that I have recommended to HUD, Treasury and Freddie Mac and to the U.S. Senate, but to no avail) is a debt-equity swap for underwater borrowers. This would be done in the form of a shared-appreciation mortgage (SAM) where negative equity amount of debt is swapped to the lender (or investor) in exchange for giving up (or forgoing) some percentage of future appreciation on the home. It is more complicated than that, of course, but the idea is sound. But no one in Washington DC wants to do it.

Hopefully, Secretary Donovan is referring to Shared Appreciation Mortgages!

I will be sure to include SAMs in my discussion at the Brookings Institute event this Tuesday entitled “Addressing the Weak Housing Market: Is Principal Reduction the Answer?”

Where have I heard that before? Oh, now I remember. President Obama touted “shovel ready” projects in his pleas for the $800 million stimulus package.

The basis of his argument is that the NAHB/Wells Fargo homebuilder confidence index is rising. And he argues that this index has a strong correlation with housing starts of 0.7. Here is his chart:

Is this a compelling argument? As a fan of Darrell Huff’s “How to Lie with Statistics” and Deirdre McCloskey‘s “The Cult of Statistical Significance: How the Standard Error Costs Us Jobs, Justice, and Lives“, I am skeptical about bold statements based on a simple statistical factoid.

If we look at Hatch’s chart more closely, we see that increases in NAHB/Wells Fargo homebuilder sentiment can be followed with a plunge in housing starts (see red oblongs). But when homebuilder sentiment starts below the 50 ;eve;, there were two increases in housing starts (green oblongs) before 2000. After 2000, there have been been two false signals (rapid rise in NABH/Wells Fargo honebuilder sentiment followed quickly a decline in housing starts).

Are you convinced that this latest rise in homebuilder sentiment will be followed by a big, shovel-ready increase in housing starts? There simply isn’t enough information in that chart to be meaningful and it has false turnaround signals in it.

What else should be considered?

1. The staggering shadow inventories of housing waiting in the dark like the rescue panther in that Geico commercial. Take your pick from LPS, CoreLogic, Amherst. They are all in the millions, although the “sand states” have more shadow inventory to clear than other states. According to LPS Mortgage Monitor, the average home is taking an average of 611 days to repossess once a homeowner begins to miss payments to when the bank actually repossesses the house. 1.35 million foreclosed properties are already on the market with 4 million more waiting in the wings.

2. Mortgage credit is still tight. According to the Federal Financial Institutions Examination Council, more than 2 million people in 2010 were denied a mortgage loan. The Mortgage Bankers Association estimates that 50% of all home refinances and almost 30% of all home loan applications were rejected in 2010.

3. The economy is growing at a snail’s pace and unemployment (and nonemployment) is still a major problem (exemplified by the employment to population ratio which has been stuck since the middle of 2009).

4. House prices continue to decline (albeit at a slower rate than 2008).

To be sure, our population continues to grow and housing is more affordable than it has been in a decade (thanks to Europe melting down and our own Fed pushing down interest rates). So, it is possible that housing starts will rise in 2012 continuing the upward trend that started last year.

Here is a closer look at homebuilder confidence in white (still beneath 50, but improving) and 1 unit housing starts in blue. There appears to be a dramatic disconnect rather than a bold prediction.

Bottom line, look for an increase in housing starts, but keep expectations reasonable. The housing market is shovel ready, but our government-dominated mortgage market isn’t turning on the water. To a certain extent, the intervention in the housing and mortgage market by the Administration and The Fed has resulted in a housing and mortgage market that is an illusion. Much like the “realism” of the actors in this old John Wayne movie (note the fake beard!). It is an illusion that will evaporate if interest rates rise and the Administration withdraws its massive adrenalin needles or Real GDP slows further.

Will all the stimulus for housing and mortgages eventually be removed? From the US Department of Agriculture (the same agency that distributes food stamps) has the following words of wisdom:

“Bears that are accustomed to people can become too bold and lose their fear of humans. To avoid this behavior, do not let bears become habituated to human sources of food.”

That was about bears. What about humans?

“Bears Humans that are accustomed to people other people’s money can become too bold and lose their fear of humans taxpayers. To avoid this behavior, do not let bears humans become habituated to human taxpayer sources of food mortgage financing.”

There. Fixed it.

“It has been well-publicized that there is one form of loan modification that FHFA has not embraced, that being principal forgiveness. To be clear, the disagreement is not about helping borrowers. FHFA, with the Enterprises, has been making great efforts to assist troubled homeowners with underwater mortgages who have the ability to make a mortgage payment and a willingness to do so. While we are currently evaluating the recent Treasury changes to HAMP regarding principal forgiveness, I would like to explain the position we have taken to date.

Moreover, this approach recognizes that three out of every four deeply underwater borrowers in Fannie Mae’s and Freddie Mac’s book of business today are current on their loans. These borrowers are demonstrating a continued willingness to meet their mortgage obligations. This should be recognized and encouraged, not dampened with incentives for people to not continue paying. As I have stated previously, we are currently evaluating the recent Treasury Department proposal to HAMP regarding principal forgiveness and expect a decision this month.”

Of course, forbearance is one way of helping distressed borrowers (except that the investors receive a lower present value of principal because it has been stretched out even further). Another is Bank of America’s recently implemented trial “Mortgage to Rent” program that permits distressed borrowers to gracefully transition from their mortgage to being a renter. The Fed has just come out in favor of programs like Bank of America’s “Mortgage to Rent” program.

Despite the compassionate “Mortgage to Rent” pilot from Bank of America and DeMarco’s logical argument about forbearance dominating principal reductions in helping borrowers, any number of principal reduction advocates have been trumpeting “Free Government Money” ala Matthew Lesko (who hangs out at the Johnson Center at George Mason University in Fairfax, Virginia).

As DeMarco and I have both argued, principal reductions are very expensive for taxpayers, do little to solve the housing crisis and there are better ways to deal with the problem.

But how can politicians resist the Matthew Lesko approach to economic policy?

Let’s see what DeMarco does with principal reductions from Fannie Mae and Freddie Mac. And he decides to bend to the pressures from the Administration and Fed, may I suggest using Matthew Lesko to advertise principal reductions?

Note: I am speaking at The Brookings Institute along with Mr. DeMarco on April 10th in Washington D.C. at 9:30am. I guess you know what I will say. Should I borrow that coat from Matthew Lesko for my presentation?

There, I fixed it to include the Administration and Fed’s desire to give away taxpayer money for principal reductions.

Mortgage purchase applications rose 7.24% from the previous week on a seasonally adjusted basis. They are at the high end of the slumber in purchases applications since May 2010 (the “red zone”). A good sign for a Spring/Summer “recovery” in housing. [Recovery relative to the "red zone"].

Refinancing applications were up 4.02% from the previous week and is disappointing given the low level of mortgage rates and The Fed’s effort to stimulate both home purchases and mortgage refinancing. While 4.02% sounds big on a weekly basis, look at the gain relative to previous weeks since 2007.

The general trend in the 30 year mortgage rate has been downward.

CoreLogic Report: Home Prices Rise in February (MoM)

According to today’s report from CoreLogic, excluding distressed sales, month-over-month prices increased 0.7 percent in February from January. The CoreLogic HPI® also showed that year-over-year prices declined by 0.8 percent in February 2012 compared to February 2011.

Highlights as of February 2012:

• Including distressed sales, the five states with the highest appreciation were: West Virginia (+8.6 percent), Michigan (+5.8 percent), Florida (+4.7 percent), Arizona (+4.5 percent) and South Dakota (+4.1 percent).
• Including distressed sales, the five states with the greatest depreciation were: Delaware (-11.2 percent), Connecticut (-7.9 percent), Rhode Island (-7.8 percent), Illinois (-7.1 percent) and Georgia (-6.6 percent).
• Excluding distressed sales, the five states with the highest appreciation were: South Dakota (+5.9 percent), West Virginia (+5.6 percent), Maine (+4.5 percent), Utah (+3.7 percent) and Montana (+3.6 percent).
• Excluding distressed sales, the five states with the greatest depreciation were: Delaware (-8.7 percent), Connecticut (-4.9 percent), Nevada (-4.6 percent), Vermont (-4.0 percent) and Minnesota (-3.3 percent).
• Including distressed transactions, the peak-to-current change in the national HPI (from April 2006 to February 2012) was -34.4 percent. Excluding distressed transactions, the peak-to-current change in the HPI for the same period was -24.6 percent.
• The five states with the largest peak-to-current declines including distressed transactions are Nevada (-60.2 percent), Arizona (-49.8 percent), Florida (-48.6 percent), Michigan (-44.0 percent) and California (-43.7 percent).
• Of the top 100 Core Based Statistical Areas (CBSAs) measured by population, 67 are showing year-over-year declines in February, nine fewer than in January.

And Phoenix is up 7% YoY!

So, MBA purchase applications are on the rise, mortgage refis are disappointing (given the Administration’s hope for HAMP and HARP so far) and Phoenix is rising from the ashes! [At least until cash buyers dry up!]