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March 06, 2009

Hope Now: Once More, with Feeling
by Adrian Ash

"Any house bought for 'No Money Down' should become a no money home, a free gift to the debtor. How's that for putting a floor under prices...?"

REMEMBER the great hope for Hope Now...?

"Let's not harp on about the costs, absurdities or risks of governments meddling in real-estate bubbles when they burst," wrote BullionVault as the Bush administration pushed the initiative front-and-center in Dec. 2007.

"This is about hope. Hope now. Let's worry about tomorrow some other time."

Too bad tomorrow's turned up, but with 917,000 homes foreclosed since then regardless. A further 1.3 million foreclosures are now in progress according to Hope Now's own data, with nearly one-in-twenty of all US mortgages standing 60 days late or more on debt service.

Some 8.3 million mortgages risk being drowned by negative equity, too. So even if the lender moves to foreclose, the asset won't cover the debt - if they can find a buyer at all - making the net loss of wealth truly systemic for America's banks.

Which is kinda where all this began, only the other way round.

"Mortgage performance steadily declined each month in 2008," says Hope Now in its full-year data. "One in 10 loans was delinquent in some way by December," despite Hope Now itself helping modify and refinance almost a quarter-million loans that month. It helped modify and refinance a quarter-million loans yet again in January. By then, however, US real estate had lost $2.4 trillion of its value year-on-year, reckons First American CoreLogic.

Puff! It was gone, just like that. Which kinda makes you wonder where it all came from in the first place.

"There is broad agreement that until we begin to stem the tide of foreclosures, you will not get an end to the current crisis," says Barney Frank, Democrat chair of the House Financial Services Committee, pointing to the, ummm, foreclosure crisis.

Put another way, "The remedy for [today's] deflationary delevering and mini-depression is simple and almost axiomatic," as Bill Gross, head of the Californian bond giant, wrote last month:

"Stop the decline in asset prices."

Such a happy truism; stop prices falling, and you'll stop pricing falling. But how to achieve it? Maybe Gross doesn't quite mean what he says. Not as simply as he says it, at least. Not without trimming his (occasional) moustache into a neat little paintbrush. You know, more like that highly-strung German chap who stole Charlie Chaplin's look (minus the hat and cane) in the 1930s.

But that word "delevering" - it throws up the real problem sparked by declining asset prices: the gap between what they're now worth, and how much money was borrowed to buy them.

"One in five US homeowners with mortgages owe more to their lenders than their properties are worth," First American CoreLogic goes on, as quoted by Reuters, "and the rate will increase as housing values drop in states that have so far avoided the worst of the crisis." That army of drowning, not waving debtors now threatens to swell by one-quarter if home prices slip only 5% further from here, as well.

Negative equity, of course, doesn't in itself force default. It's inability to pay, most often sparked by loss of income, which forces late payments. But negative equity makes the problem systemic. Because it gears up the net loss and spreads it from debtor to lender, levering the pain of foreclosure from the hurt of the home-loser to the net lending loss suffered by banks.

Lenders end up out of pocket - and so too might their lenders in turn - even if they can sell the house reclaimed to settle the mortgage. All of which, as we say, just replays the merry-go-round spiral of soaring house values and E-Z credit in reverse.

"Making Home Affordable will offer assistance to as many as 7 to 9 million homeowners," said the Treasury on Wednesday. (Note the friendly, if all-too pessimistic, use of the singular "home"). Yes, the new commander-in-chief is leading a fresh charge against house-price deflation and the still-surging surge in foreclosures.

Once more, with feeling!

"The Home Affordable Refinance program will be available to 4 to 5 million homeowners [who] would be unable to refinance because their homes have lost value," the Treasury went on, "pushing their current loan-to-value ratios above 80%...

"The Home Affordable Modification program will help up to 3 to 4 million at-risk homeowners avoid foreclosure by reducing monthly mortgage payments."

Now throw on top the one million mortgagees expected to declare themselves bankrupt when Obama's "cram down" bill wins the day in Senate (which it will), and up to 10 million American home-buyers look set to refinance or re-modify their loans, just 15 months after Dubya Bush and Hank Paulson swore blind that refinancing and re-modifying would stem the depression in housing.

Might it work this time round instead? Given that the cram-down act will enable federal judges to extend mortgage terms, slash the interest rates agreed with lenders, and cut the outstanding debt owed by insolvent homeowners, and you might expect the flood of foreclosures to slow. Destroying 1,000 years of contract law should achieve nothing less, you might hope. And that might stop home-prices tumbling. Right?

"Throughout 2008, the re-default rate ranged between 30% and 40%," explains Hope Now, defining such recidivist shame as "any mortgage that is 90 or more days delinquent or in foreclosure 6 months after the date it was first modified."

One-third of bad loans turned bad once again, in other words, even after the lender cut the debtor some slack. So perhaps the new hope for housing should just cut straight past the chase and go to the credits. Y'know, the bit where the state seizes outstanding home-loans entirely, and re-modifies their terms to give houses away free to what once were called "the buyers".

Any house first bought for "no money down" should become a no money home, a free gift to the debtor. How's that for putting a floor under prices!

"More householders than ever own their homes," said the Census Bureau in 2001. Way up at 66.2%, however, that record ratio wasn't high enough either for government or the finance industry. Hence the non-stop shilling by President Bush of home-ownership as a way to defeat racism, poverty, Bin Laden, you name it.

The number of owner-occupied homes had in fact swelled by nearly one-fifth in the previous 10 years. And since the 1990s marked prosperity (and even a shrinking fiscal deficit!) as interest rates ticked lower, runaway growth in home ownership was surely been an unalloyed good. Only an anti-American fanatic would think otherwise, you'll agree.

But smothering fresh chunks of California, Nevada and Florida in hard-top failed to concrete over the basic facts of economics, however. Because where demand finds itself sated, but supply continues to build, over-capacity follows and prices start to fall back. And even before the housing recession became a depression, excess capacity was building fast in the US housing supply. The rate of occupation slipped from 87.5% to 86.4% between 2005 and 2007, while the total number of units crept higher to 128.2 million on the Census Bureau's latest data.

Trying to stall or reverse this cold fact will clearly take more money - and more stupidity - than even the Bush administration could throw at the task. Such as, say, via fascism or hyper-inflation. Put a floor below prices, beneath which it's illegal to sell; or allow house prices (if not the S&P too) to slide only in real inflation-adjusted terms, printing money to inflate the cost of living while nominal realty prices hold steady.

That would allow the slide in real asset values to continue, even as nominal prices stay flat or fall. Because short of socializing all houses and so taking their value to zero - a trick tried to sad effect across Eastern Europe c.1917 to 1991 - this tinkering and tweaking is just fighting a trend that cannot be stopped.

In this credit deflation, where the nominal price of all things is shrinking, that which inflated the most should now shrink the fastest. Both its share of total economic value and its absolute pricing are working to reverse their misallocation over the last decade and more.

And double the inflationary trouble means double deflation once the bubble has burst - as the financial services industry is only just finding out as well.

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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