I saw this article today and thought it was a perfect indicator of what is REALLY going on in the foreclosure markets nationwide.
In my previous post I touched on the market manipulation that led up to the "bubble burst": artificial demand through cheap and fraudulent capital causing explosive supply, followed by massive defaulting of that artificial demand leading to a massive over-supply, all driving down real estate values, and driving up REO bank inventory (see Part IV for the full story).
According to this report: “For California, Deutsche Bank projects that as of Q1 2009, 54.3 percent California homeowners were underwater on their mortgages, and that within two years, 67.9 percent will be under water. Projections for areas like Modesto and Stockton are more extreme with 2011 estimates at nearly 90 percent”.
Let's really confront this. More than Half of all homes in California are upside down (homes worth less than the unpaid principal balance of their mortgage) and that number could go as high as 90% within 2 years in some communities.
The sheer magnitude of this is staggering, and if the country, as it usually does, follows the trends of CA then we have only scratched the surface of REO inventory as of 2009.
I recently worked on a trade with one of the Majors in California. It didn't consummate. We (my client and I) were told that 70% was the floor of any bulk discount. We couldn't get to this number. And yet the pool we worked on sold in smaller chunks and in "one-off" contracts for 75-80 cents of current AVM.
So here is my question. With MILLIONS of homes already in foreclosure and/or REO and with MILLIONS more homes going into foreclosure, and the Banks clearly withholding their inventory to artificially prop up prices by artificially restricting supply (thus driving up "competition/demand" on what they will sell, and thus keeping prices "high") then how or more importantly WHEN will REAL VALUE be established for REO inventory? And when will the Majors start selling in Bulk, at a real enough discount to entice private capital?
I asked this question in my last post, and I got some very interesting answers. One viewpoint was to let the banks "trickle" the inventory onto the market over time, so that prices could stabilize. That's a great idea. But with several million homes currently in and going into foreclosure in the near future, this "trickle" will take many years. Do we simply wait for this process to run its course before new housing starts and other Real Estate indicators can ever recover?
Let's look at it from a Banks' perspective. A bank keeps a loan on its books as a performing asset so long as it DOES NOT affect it's TIER ONE capital requirements. Meaning, as soon as a loan defaults and is labeled "nonperforming" the bank MUST compensate with a % of NEW capital. So when the Majors took billions in TARP funds what they essentially did was prop up all those distressed assets. Why should I sell my distressed assets (whether loans or REOs) when I can just borrow all the Tier One capital I need from the American taxpayer to offset my books. What motivation do I have to let the market WORK and sell these distressed assets. The answer is NONE, and there is the problem.
Due to Gov't meddling, the Major Banks have not had to sell their distressed assets at the volume they would otherwise need to raise capital to offset their losses. They can default the loan, take back the home as REO, all the while "propping up" their capital requirements with tax payer borrowed money.
And when they do sell the REO, they can "one-off" them at or near current market value. They don't need the capital! They got it from the Tax Payers. So why sell the millions of REOs they have in Bulk at a discount to private firms? There's no need. They'll just sell them, slowly, and pay back the Tax Payer over several years. Seems reasonable enough, doesn't it?
But as we all know, there is only so much "bailout" any of us can take or will tolerate. At some point the Banks will not be able to "prop up" their books, and they will be forced to sell their assets on the open Market. I don't know if that will happen this year, or next, but at some point, there will be NO MORE MONEY for them to prop up their books, and at some point I think they will all be FORCED to start Bulk selling these Millions of homes to private funds to raise the money they need to operate.
The "X" factor I see here is the role of the FDIC. Right now that agency is strapped for cash. Yet every week I get my FDIC notification of the 1-5 or more banks "taken over" by the Gov't, and in each instance hundreds of millions or billions of dollars worth of notes and REOs are put into Gov't recievership for liquidation. And currently there are over 1000 banks on the distressed "watch list". There simply isn't enough money for the FDIC to take over all these banks.
So whether the banks themselves, or the FDIC, there will be a "tipping point" and Bulk Sales of SFR REOs, at a significant discount to entice private capital, will have to ensue. The only question is when?
What do you think?
Addendum: Rather than make this a separate post, I wanted to add this article that I just read (Saturday 7 Nov) that I think drives home my point. REO inventory is declining while foreclosure filings continue to rise . We are in for a much longer haul than the talking heads on TV want us to believe. And this should be a blessing to those of us working in the distressed asset space. Opportunities abound.