A Flood Will Humble Thee
Eight million homes with delinquent mortgages represent a staggering 300% of the normal supply of existing homes for sale. With 3.63 million units now on the market, one million above the long-term average, an inundation of foreclosures represents a fatal death blow capable of inflicting brutal damage on the largest financial market in the world.
The inventory of existing homes is now over supplied by one million units – an excess almost identical to two months of sales. The delinquent mortgage accounts represent an additional 17 months of sales.
If all mortgage delinquencies and current units for sale are combined, they represent 24 months of average sales. A rule of thumb says six months of supply is a balanced number of units “for sale”.
The current oversupply represents approximately 35% of the normal inventory. Add in the delinquent mortgages, and the inventory equals more than 400% of the average inventory. That would be a power-crash creator.
Given the huge intrusion which new foreclosures represent, only the most risk-hungry cash-fat and street-smart investors should be considering a purchase at this time.
Get Thee To A Nunnery
Any ordinary person thinking about buying or renting today should choose renting. There is no question about it. The element of risk created by delinquent mortgages and negative equity represents profound risk. Joe and Jane Homebuyer are not meant to buy into a market laced with profound risk.
The hard facts show a total of 3.63 million existing homes are currently “for sale” according to the National Association of Realtors. The long-run inventory average is 2.66 million. With average monthly sales of 482,000 units in the last ten years, the excess supply of 970,000 units is equal to two months of sales. This in itself is not frightening or insurmountable.
Prices of existing homes have stabilized according to major indexes including Case-Shiller. Many hope we have hit bottom in the massive price crash which has destroyed 30 percent of home prices since June 2006. Has a new floor been established and it is safe to go swimming again?
The recent numbers and their good trends cannot anticipate the factor which scares the daylights out of any breathing analyst — the wild bubble blowing up in delinquent mortgage accounts.
“Can You Tell Me, Where Is the Point of No Return? How Do I Know I Am There?”
Foreclosure is a toxic substance for property values. The Mortgage Bankers Association reports that 14.41% of all mortgage accounts are delinquent. It’s a record. The record delinquencies represent approximately 8 million borrowers — based upon the assumption of a total pool of homes with mortgages equal to 56 million homes.
Given the cure rate for past-due mortgages has decreased to near zero in the land of milk and negative equity, if you add in the 8 million delinquent accounts to the current existing-homes-for-sale pool of 3.6 million units, you now have a total supply for sale of almost 12 million. The long-run average inventory of “for sale” existing units is 2.6 million.
You take what you want from the comparison of 12 million units “for sale” and 2.6 million as the target inventory. The first is abnormal. The second is normal.
I make no predictions of Armageddon. I don’t mind making basic calculations and letting those numbers define my best guess. If foreclosures appear in the great numbers described as possible here, one would expect prices will fall forever or they will fall quickly to zero. It’s not promising.
Only a berserk fool is buying real estate today. Only a criminal is recommending to someone else that they buy a home.
***
Please check my math and send corrections:
Michael David White is a mortgage broker in Chicago.
Thanks for carrying this story:
housingstory.net 
Many good comments. A couple of additional points:
1. It appears mod statistics are being horribly misrepresented. Not only have a low % of the eligible “gotten” mods, but it turns out that a very low % of the “trial mods” are becoming permanent. The majority are apparently headed for foreclosure or limbo-land, until the lender can afford to take the loss.
2. Pooling and servicing agreements for securitized loans provide servicers with a strong financial motivation to find any excuse NOT to modify, leading to many denials of borrowers who should have received them.
3. None of the projections seem to consider the negatively compounding effects of additional foreclosures. I.e. more foreclosures lead to lower home prices, which lead to more foreclosures, which lead… Foreclosures also lead to more un/underemployment, which also leads to more foreclosures. So the final count could be much higher unless we stop this quickly.
4. The only quick (but partial) remedy is to pass the Chapter 13 cramdown legislation.
5. As a lawyer who also has many years inside the mortgage system, it is clear to me that Judge Montgomery has little understanding of the mortgage system. Compare the D.C. Circuit case and the many bankruptcy and state court cases that are increasingly finding for the borrowers.
6. On the bright side, unless rents start plummeting, they may put a floor under real etate prices, as we can now buy homes that cash flow immediately, which is creating a hot market at the lower end (in CA).
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One more thing, I expect Barney Frank, Loretta Sanchez, LAURA RICHARDSON and a few others to push to make residential mortgage modification a government entitlement under the law sometime in the next 2 years.
I know Barney is an architect of this crisis. He might as well put his experience to work. Thanks for your note. mdw
Thursday, NYU Real Estate institute had it’s yearly Commercial RE Industry Conference.
Sam Zell as keynote speaker told every CRE firm in attendance that it’s extend and pretend to 2013 at the earliest.
IMHO, The same will hold true for Residential RE, the only banks that will liquidate their Res RE will be those with management about to be fired during a FDIC takeover of the bank.
A AP headline from earlier int he month:
“Loan Modification Plan Has Helped 20 Percent Of Eligible In California, Nevada And Arizona
ALAN ZIBEL | 11/10/09 04:45 PM |”
Lines G and H in your model will be constantly shifting, in relation to the employment level in the largest bubble markets. That then refers back to the CalculatedRisk post in your entry.
If the loan mod program ramps up, and the unemployment rate does not stabilize…
When the loan mod program ramps up and the banks have to writedown the modification difference, they will be even less inclined to foreclose on defaulters in later time periods.
Tragedy of the Commons , where ‘the Commons’ is access to government backing of fiat currency in the loan modification pools.
From the AP article:
“One legal challenge to the program was rejected this week, when a federal judge dismissed a class action lawsuit filed by a group of Minnesota homeowners who sought to block foreclosures in that state. The lawsuit claimed the program, failed to give people proper notice when they were rejected or the right to appeal.
U.S. District Judge Ann Montgomery dismissed the case Monday, saying the federal government has never made loan modifications an entitlement.”
If we extend-and-pretend on mortgages, the high-delinquency record will kill the pretend. Thanks for the note. mdw
To Effective Demand: Correct that not all 8mm will become inventory soon. On the other hand, the 8mm only represents those loans that are in distress now. Many others that are now current will default over the next 2 years as more people lose jobs and as potential strategic defaulters face reality and decide to act in their best interests. The real question is what % of the 56mm loans oustanding will get forclosed in the next 3 years. My guess would be a minimum of 25% or 14mm. Also, a lot of new loans will also default as we are seeing with FHA loans. The likely straw to break the back will be a bank selling a portfolio of a few thousand homes at a 50% discount to prevailing prices because its cheaper than holding them for years. The great asset flush will happen and more and more residential assets are building up soon to be joined by commercial. I’d guess 2011/12 or 13 as the year of the massive asset flush. The flush is always 2to 4 years after the crisis becomes apparent as we saw with the S&L crisis.
I didn’t know there was such a long delay between the fall and the write off. Send anything good you have to read on this. Thanks for your note. mdw
Where did you get the data on # of delinquent mortgages?
Data on delinquent mortgages is from the Mortgage Bankers Association. Thanks for the note. mdw
Items N and O are incorrect it presumes all delinquent houses get put up for sale approximately at the same time.
The plan is to extend the problem over many years, you will lose some to foreclosure, some to short sale (some of which are currently accounted for in item B) and some will get loan mods. In the interim many will sit without paying and not be flooding the market with inventory anytime soon. That has been clearly the plan since early this year and is currently being enacted. This is why inventory for sale is dropping not rising.
Until the houses hit the market it ain’t for sale. With the banks forebearing and regulators and politicians bringing tremendous pressure for them to do so that doesn’t appear it will change anytime soon. That is the flaw in the model and not something easily quantified because regulators are playing it fast and loose with the rules on defining loans as non-performing and so the banks can pretend a loan is performing and not take a hit to capital.
Many banks CAN’T take the capital hit by recognizing losses, the system is in that bad of shape so they must continue to pretend everything is fine. A foreclosing bank is a strong bank, it is strong enough to say “I can take the losses”. More foreclosures actually means the financial system is in better shape and should be taken as a positive sign as to the health of the banking industry. I don’t expect we will see such positive signs anytime soon.
I am going to read this tonight Thanks for the note. mdw
The story should not have given the impression that all delinquent mortgages will default. The graph and the story meant to provide guidance about the significant fallout which will likely result from a very large pool of past-due mortgages. Thanks for your note. mdw
I agree with that point. While I think the inventory is staggering, the changes in mark-to-market accounting have enabled the banks to avoid recognizing losses until there is an actual sales transaction. There is no mark-to-market accounting that can hide the loss of a short sale. If the banks granted all the short sales that they already know are inevitable, the whole system would be insolvent. They are trying to drag it out long enough to offset losses with profits elsewhere and the fed is trying to give them all the ammo it can to fuel profits that it can by maintainig short term rates at zero. I don’t believe that enough profits can be generated to offset the losses and the banks will be forced to release properties as homeonwers become more and more delinquent. The carrying cost of NOT releasing bad assets will become more painful than realizing the loss now. When that day comes, buckle up.
Based on the number of delinquent mortgages, the fall out looks serious. Thanks for the note. mdw
Michael,
Did you happen to read the research report from Amherst Securities? It basically came to the same conclusion. 7 million homes that are destined to become foreclosures that will pressure the market for some time.
I think your conclusions are spot on. Working this through the system will take a lot of time, and will make an 8k incentive to buy a house appear to be a very poor decision a few years down the road for those that do choose to buy a home.
I did read the Amherst Securities report. It was great. It does appear that many new buyers are going to paint themselves into a corner. Totally unfair to do that to the uninitiated. Thanks for the note. mdw