The Federal Reserve System’s economists have assembled six maps dealing with the state of the U.S. housing market. They show where the popped bubbles were concentrated, as of the fourth quarter of 2007. The mortgage delinquency and foreclosure situation is much worse today, but the maps will not change much in 2008. The red and orange-colored counties will not get lighter. In 2009, hundreds of light-colored counties will get redder.
All of this was easily predictable. I warned my readers in April 2005 that this was coming, saying that it was time to sell your home if you lived in California.
If you are a home owner in any of the red-colored counties, you have my sympathy. You can view four of the six Federal Reserve maps here.
These maps show a disaster — a disaster created by the Federal Reserve under Alan Greenspan. The housing markets have depreciated substantially, but there is lots more depreciation ahead. This is a disaster in progress. This is a train wreck in which the locomotive and three passenger cars have gone off the tracks, but a long line of cars is still moving forward because of inertia. They are still on the tracks, but not for long.
Any family in a red-colored county who bought a home in 2005 through early 2007 has suffered capital losses so great that it is unlikely that the family will ever get its money back — money in today’s purchasing power, I mean. The family bought a dream just as the dream was about to end. The buyers signed mortgages that will hang over them until they finally pay them off 28 years from now, or until they declare bankruptcy. They thought that agreeing to pay anywhere from $400,000 to several million dollars was nothing. “I’ll make money on the deal!” No, they won’t.
Neither will the investors who loaned them the money.
“NO BIDS, EVERYBODY DOWN!”
On Monday, May 5, I read an article by Las Vegas banker Doug French. French reported on an auction for foreclosed houses. It was quite a show. It had a professional auctioneer. It had hype. It lacked only one thing: a single bid. There was nothing. The lenders had all placed minimum bids on the houses, and there was not one bid at or above the minimum bid. So, the lenders took back every property.
On Tuesday, May 6, at the other end of the country, my wife stood at the courthouse steps in a small town in Georgia. The town is a semi-rural suburb of Atlanta. My son-in-law is moving there. My wife went to see what would happen at an auction of foreclosed properties.
There were several people offering properties. Each of these people carried stacks of papers on the properties for sale. There was not one bid. The lenders took back every property.
Over the weekend, my son was attending a real estate seminar in Las Vegas. John Schaub was one of the speakers. My son reported to me on May 4 regarding a story one of the speakers had told. This story tells all.
The speaker said a friend of his who is a professional investor in homes spotted a foreclosed home in his town. He went to the lender to see if he could buy it. He was told by the local representative of the national bank that had foreclosed that the local bank had no authority to negotiate a sale. “Who can?” he asked. The national office. It had not yet released the property for sale.
The guy really wanted to buy the house. So, he got on a plane and flew to the bank’s division that is in charge of all of the bank’s foreclosed properties. The division is in the Midwest. He went to the building and located the office. The door was locked. He banged on the door. A uniformed guard opened the door. The guard told him that the bank does not deal with the general public. So, he flew home.
Within two months, vandals had stripped that home of everything moveable. It was probably worth at least 25% less than before the guy took his plane trip. It is lowering the value of homes on the same block. It is lowering the real estate appraisers’ estimates for the homes in the immediate area.
This is happening all over the country.
The lenders are huge, centralized conglomerates. They bought pooled packages of real estate loans. This was all very scientific, the lenders were told. It diversified risk.
This crisis is not like previous housing crises. There is no local banker who made the loan with his bank’s assets. There is therefore no highly motivated local seller of a foreclosed property. There is no one locally with the authority to negotiate. Centralization lowered costs getting into the deals. It has dramatically increased costs of getting out.
My son-in-law looked at a foreclosed house that is being offered for sale for $127,000. He was able to find out that it was repossessed with a mortgage liability of $80,000. The repossessing lender put $15,000 into the house to get it ready for sale. The lender wants to make over $30,000 on the transaction. So, the property gets no bids.
These people are babes in the woods. They have never been through a housing recession. They weren’t around in 1991. They surely weren’t around during the savings & loan crisis of the mid-1980’s, when Congress intervened with taxpayers’ money to bail out the over-leveraged industry. They have not read of bidders at auction buying homes with their credit cards, as happened in Houston.
There are today over 18 million empty houses in the United States today. Of these, 650,000 are in foreclosure.
Under these circumstances, lenders should be aggressively negotiating to get new buyers to take over the payments. They should be dropping prices to market levels. If they don’t, vandals will strip these houses of everything movable.
But the foreclosure system is paralyzed. The locals have no authority to negotiate. The distant bureaucrats are insulated from reality. They dream of a government bailout. They don’t want to sell at the newer, lower prices, because this will force them to write down their loans’ value. They refuse to declare losses that the market has already imposed.
The foreclosure market is in paralysis. No one in charge knows what to do. This includes Ben Bernanke.
BEN’S CALL FOR A BAILOUT
When FED policy creates a boom followed by a bust, the FED calls for Congress to bail out the banks or savings & loans. This is a perpetual scenario. Bernanke is merely following tradition.
First, a FED chairman pumps in new money. A boom ensures. Then bubbles appear. Then the FED chairman is replaced. A new austerity is imposed. The bubbles pop. The country goes into recession. The banks suffer huge losses. The FED then calls for Congress to bail out the banks. There was the Burns/Miller inflation boom of the 1970’s, followed by the Volcker austerity of the early 1980’s. Then Volcker reversed policy on August 13, 1982. A new inflation-driven boom ensued.
We have seen it again in this decade. Greenspan played Miller. Bernanke is playing Volcker. He will eventually reverse his austerity policy. But he is trying to hold out. He is swapping T-bills for (it says here) AAA-rated mortgage debt held by the banks.
Will he buckle and inflate? Of course. But he hasn’t yet. So, he needs help. The magnitude of the mortgage losses is too great. The asset swaps don’t include sub-prime and Alt-A loans. So, the FED can’t do much to help. Solution: call for a bailout.
On May 5, he gave a speech at the Columbia Business School’s 32nd Annual Dinner. This was appropriate. Grad students at the Columbia Business School were the source of a hilarious 2006 music video on Bernanke. It has all come true: falling demand, stagflation, the inverted yield curve.
Bernanke began: “President Bollinger, Dean Hubbard, Co-Chairman Kravis, and distinguished guests, I am very pleased to be here and especially honored to receive the Columbia Business School’s Distinguished Leadership in Government Award.”
CBS is smart. It hands out a freebie — an award — and it gets a free speech. The following is not true: “There ain’t no such thing as a free speech.” CBS counterfeits something of seeming value, and it gets the Counterfeiter in Charge to give a speech that will be used for fund-raising later. This is academia in action.
Dr. B pursued his usual script. He summarized what everyone knows.
As my listeners know, conditions in mortgage markets remain quite difficult, and mortgage delinquencies have climbed steeply. The sharpest increases have been among subprime mortgages, particularly those with adjustable interest rates: About one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure.1 Delinquency rates also have increased in the prime and near-prime segments of the mortgage market, although not nearly so much as in the subprime sector. As a consequence of rising delinquencies, foreclosure proceedings were initiated on some 1.5 million U.S. homes during 2007, up 53 percent from 2006, and the rate of foreclosure starts looks likely to be yet higher in 2008.
He could begin every speech with “As my listeners know. . . .” He then went on.
. . . if a foreclosure is preventable, and the borrower wants to stay in the home, the economic case for trying to avoid foreclosure is strong. Because foreclosures impose high costs, including legal and administrative costs as well as the costs of leaving the property vacant for a possibly extended period, both the borrower and the lender often are better off avoiding foreclosure.
Keep these words in mind: “If the foreclosure is preventable.” To determine if it is preventable, the following questions need specific, real-world answers:
1. Who can say if it’s preventable?2. Who is in charge to make this assessment?3. What are his incentives to sort out preventable vs. non-preventable foreclosures?4. Is there an existing hierarchy that knows how to assess the differences?5. Are there incentives up and down this hierarchy to differentiate the types of properties?6. Do local agents know what is happening?7. Do they have authority to take action?8. Who has the money to fund new mortgages?
You don’t need the Federal government to make this approach work. You merely need lenders who are ready to discount their barns full of turkeys, sell the inventory to investors, take back the mortgages, and wait for the next round of foreclosures, which are coming.
The trouble is, these are not today’s lenders. Today’s lenders are unwilling to admit to auditors what is clearly the case: they are sitting on hundreds of billions of dollars of losses. These losses will get worse when the vandals get finished with the capital in question.
Moreover, it is important to recognize that the costs of foreclosure may extend well beyond those borne directly by the borrower and the lender. Clusters of foreclosures can destabilize communities, reduce the property values of nearby homes, and lower municipal tax revenues. At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general. In the current environment, more-rapid declines in house prices may have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the financial system.
This is now happening. It is unlikely to be reversed in time. The lenders must act now, not a couple of months from now. But they are in paralysis mode.
When what Bernanke warns against happens, watch the wealth effect go into reverse. When home owners see at long last that their wealth is diminishing, they will cut back on spending. The recession will accelerate. The FED will get blamed, but not for the right reasons: Greenspan’s bubbles.
What is Bernanke’s first line of defense? Further study.
To determine the appropriate public- and private-sector responses to the rise in mortgage delinquencies and foreclosures, we need to better understand the sources of this phenomenon.
He then introduced the FED’s “heat maps,” as he called them. More free information!
He then summarized the FED’s programs to monitor the train wreck. As an academic, he believes in the power of monitoring. A professor stands on the sidelines and counts the train’s cars as they derail, one by one. This makes things better, apparently.
First, we have employed economic research and analysis, a particular strength of the Federal Reserve, to increase the sum of knowledge about mortgage and housing issues. For example, we are providing community leaders with detailed analyses identifying neighborhoods at high risk of foreclosures, analogous to the heat maps I showed you this evening.
Terrific. Just what we need. A weekly print-out of the wreck. Thanks so much.
To help address this problem, the Federal Reserve is joining in a partnership with the nonprofit NeighborWorks America to develop materials, tools, and training programs to help communities and others acquire and manage vacant properties. The goal is to support the provision of affordable rental housing and new homeownership opportunities in low- and moderate-income neighborhoods.
Oh, good. A nonprofit network. Nobody owns anything. Committees own everything. These outfits will spread the word: New homeownership opportunities! Don’t you dare ask: “Funded by whom?”
These new programs will put an end to the influx of crackheads who are moving in. After all, there is nothing like the prospect of owning a vandalized house to thrill low-income buyers. Credit-worthy low-income buyers, that is.
Prospectively, we are committed to promoting an environment that supports the homeownership goals of creditworthy borrowers. To this end, the Federal Reserve Board has proposed new regulations to better protect consumers from a range of unfair or deceptive mortgage lending and advertising practices.
The horse is out of the barn. The barn is now about to be occupied by crackheads or stripped by vandals. So, the FED issues new rules.
Why didn’t it issue them in 2001?
The Federal Reserve also is continuing its long-standing practice of providing educational and information resources to help consumers make informed personal financial decisions, including choosing the right mortgage.
That’s it! More brochures! Now, if we can just get the lenders to take market-clearing bids on these properties. Not possible? Well, then, let’s get Congress involved.
The Congress can take an important step by moving quickly to reconcile and enact legislation permitting the Federal Housing Administration (FHA) to increase its scale and improve its management of risks.
But that’s not all. “Separately, the government-sponsored enterprises (GSEs) — Fannie Mae and Freddie Mac — could do more.”
Thus, now is an especially appropriate time for the GSEs to move quickly to raise significant new capital, which they will need to take advantage of these new securitization and investment opportunities, to provide assistance to the housing markets in times of stress, and to do so in a safe and sound manner.
The question is: With whose money? Where will they get this money? From you, maybe. Not from me.
Most Americans are paying their mortgages on time and are not at risk of foreclosure. But high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It’s in everybody’s interest.
Then what about non-preventable foreclosures? Silence.
CONCLUSION
We are all in a large canoe. The canoe is headed for the falls. We can hear the roar of the water.
Meanwhile, Dr. Bernanke is giving us lectures about past scenery and future prospects if we can just find a new creek to go down.
I know what creek Dr. Bernanke is likely to choose. It won’t be down; it will be up. He has three paddles: fiat money, a dwindling supply of Treasury debt to swap, and footnotes.
I suggest that you get off the canoe and swim for shore. Soon.
May 14, 2008
Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.
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