Fannie, Freddie, & IndyMac: What’s up, what’s down, & what to do

(7/12/08, 11 p.m.) I’ve been selling Los Angeles and Orange County real estate for 28 years. I’ve seen conforming loans at 18% in the early 80’s, S & L failures of the late 80’s and massive job losses in the early 90’s but I’ve never seen anything quite like the ongoing drama that’s unfolding before our eyes.

After working through the weekend, the Federal Reserve and the U.S. Treasury announced late Sunday a series of moves designed to show strong support for the two semi-private bulwarks of U.S. mortgages. (Details here.)

This is more of a reaction to the housing and mortgage mess than any real solution. They’re not stopping the bleeding–just trying to keep it from increasing at an even faster rate.

In the short run Sunday’s actions keep the collapse in housing values from accelerating even more. Over the longer term they may actually reduce interest rates, and actually slow the ongoing downward cycle.

How We Got To This Point:

In our humble opinion the current mortgage and housing mess was caused by a combination of:

1. Excessive stimulus by the Fed after 9/11 at a time when the housing prices appeared to be heading towards a correction. (Essentially, interest rates were dropped and housing was used to keep the economy from crashing, possibly a wise move in view of the circumstances.)
2. The Fed delaying too long in raising rates, further prolonging the boom.
3. Perversely, fixed mortgage rates staying low when the Fed finally began raising the overnight rates they control, because long-bond investors sensed a downturn would result from the Fed rate increases.
4. The creation of unique but poorly designed and highly risky “sub prime” loans further extending the bubble. 4. (For a more detailed explanation, see “How we got into this mess.”)

The end result was a nightmare combination of extremely overvalued homes that were 100% financed or refinanced to shakey borrowers. Did I mention that many of the loans were written at ridiculously low “teaser” interest rates, which are now doubling, tripling, or worse.

All bubbles eventually burst, but the longer they last the further they must fall. Many of these loans, however, were based on the false premise that “real estate always goes up.” When the market stopped moving up, millions of serial refinancers had no place to turn, and the foreclosure parade began.

Eventually, prices dropped so low that even “prime” borrowers who put 20% down found out that they were upside down, which is how even Fannie and Freddie’s best loans began defaulting.

How’s that? The typical cost of selling a home is around 8 – 12% of a home’s value. That includes fees, escrow or closing, commissions, title insurance, termite, repairs, and, in this market, points for the buyer. Even without negative amortization, a 20% down borrower can’t break even after just a 10% decline in value. We’ve now passed a 25% decline in many Southern California markets. That doesn’t mean a borrowers with a fixed loan and good credit will defalut. . . . until one of them loses their job, or they get divorced, or have to relocate. Then they can’t sell the home, so their options are dramatically reduced. (For some of the options they still have, see “Trouble making your mortgage payment? 7 ways to get back on track“)

So, the lower prices go, the more people get in trouble, and the lower prices go, and the more people get in trouble, and the lower prices go. . . .

All of which makes investors very nervous about mortgage backed securities. Which makes it harder to qualify for mortgages, and also makes them more expensive. And which also makes it hard for Fannie Mae and Freddie Mac to sell their mortgage-backed securities. Which makes mortgages even harder to get and even more expensive. All of which makes prices go even lower.

That’s the vicious downward spiral we’re now in. That’s why I’ve been screaming that we desperately need the Federal Mortgage Act (bailout bill) that the Senate finally passed on Friday. (See “Better than I thought: Taxpayer protections in the “bailout” bill.”)

What the government did over the weekend was to take steps to simply keep solvent Fannie and Freddie, the guarantors of up to 80% of the mortgages now being originated. (Most of the other 20% are backed by the FHA or VA, although some S & Ls still “portfolio” or keep some of the loans they originate, rather than selling them off via Fannie, Freddie or FHA.)

The fall of IndyMac Bank, the third largest bank failure in U.S. history (in terms of dollars, but probably not adjusted for inflation), added further emphasis to the need for help.

So What’s Next?

The strong activity from buyers this year into summer gives good evidence that, even with rising interest rates and hard-to-get loans, prices have corrected enough to bring back buyers. But the ongoing flood of foreclosures expected well into 2009 will eventually swamp the limited pool of buyers, especially as we move out of the peak buying season. (See “Predictions 101: Our 2 market cycles“)

The weekend’s federal actions will at least keep the mortgage pipeline open, but it doesn’t solve the underlying problems. The Foreclosure relief bill will probably be fast tracked, but it will only help a limited number of borrowers. It will put a dent in the problem, but it won’t even come close to solving it.

Ongoing job losses in housing, finance, construction, home furnishings combined with auto industry problems and the huge losses being absorbed by investors don’t bode well for the future either.

(If you’re a homeowner or investor and are starting to feel a little like the Biblical patriarch, Job, you might appreciate my Pastor’s thoughts on the topic. For me, it helps keep things in perspective.)

We’ve been predicting further declines through this winter and possibly for another year or two. But, as we’ve been saying since November (See “How low will prices go?“), there are so many variables in play that nobody can predict what’s ahead with certainty. (Were you expecting this spring’s dramatic gas price rise?)

Bottom line: today’s prices are great, but they may be going lower. Maybe a lot lower. But there’s no way to know it’s hit bottom in advance. Because nobody really knows what’s ahead.

So you want to know”What to do when nobody knows what’s next.” Well, we already wrote that post, and it’s just a click away.

Note to potential sellers: The market has not died yet, and we have been consistently selling our listings in under 30 days by a combination of aggressive marketing, preparation, staging and negotiating plus accurate pricing. No, they’re not foreclosures, either. For details, check out “How to sell your So Cal home for top dollar in 30 days.” It could be a long time before prices return to today’s levels.

Buyers Southern California prices are expected to drop over the next 5 months and possibly for a lot longer, but you should also consider your personal situation and potentially rising interest rates. One thing’s for sure, if you buy today you’ll be paying a lot less than you would have a year ago! In any case, now’s definitely the time to start saving a down payment & get your finances in order, so you’ll be ready when you decide the time is right. Don’t run out and overspend on a car because you’re not buying a home.

For years I’ve been advising buyers to buy in November or December, but almost nobody has the time then–which is why it’s a great market for buyers. (For more thoughts for buyers see “Time to buy?“)

What we think needs to be done

Here’s where I’m taking an unexpected turn. The root problem became abundantly clear as gas prices rose this spring.

Because of our huge trade deficit, the U.S. is essentially becoming a third world nation, watching while Arab shieks buy up everything from Rancho Santa Fe horse property to the Chrysler building. And our oil dollars finance Al Queda, Hamas, and Iran’s nuclear program!

Meanwhile, we’re sitting on more untapped petroleum reserves than any other nation on the planet. I say it’s time to carefully open up offshore and Alaskan areas to oil drilling, but with a difference. As I understand it, current law allows oil companies remove oil from federal lands for free. I’ll bet Iran & Saudi Arabia don’t do that!

So I say, charge oil companies fair market for the oil they remove from our lands, but split that money between paying down the federal deficit and developing renewable energy sources. Let’s make the U.S. the number one source of clean petroleum alternatives.

Can you imagine the number of good jobs that would create, and the stimulus to our economy?

That’s what I think–& we’re eager to hear your thoughts!

Chapman’s Affordability Study Predicts Another Double Digit Home Price Drop for Southern California

Just as the National Association of Realtors’ forecasts tend to be overly optimistic (see this morning’s post), Chapman University’s tend to be quite pessimistic. I think they’re still mad that Gary Watts made them look foolish several years in a row, or it could just be something inherent in their system.

Anyway, as part of their coming June “comprehensive forecast of key economic variables,” Chapman’s Economic Research Center today released their projection of Los Angeles County, Orange County, and Inland Empire housing prices based only on one variable, affordability.

To reach the historical average affordability rate, Chapman says L.A.County median home prices need to fall an additional 23.3% and Orange County by another 13.7%. The Inland Empire, which has had the more severe overbuilding and foreclosure rates, need “only” fall another 8.2% to reach Chapman’s magical median.

Now for the bad news:

“It is likely that home prices will decline even more . . . since corrections usually drop the affordability index below the historical mean.”

Their math assumes modest income increases and flat interest rates. Declining rates could significantly decrease the amount of “correction” needed, while more modest pay increases could offset at least some of that.

I think historical trends in L.A. and Orange Counties are skewed by many years of affordable land.  Today’s situation of being practically built out on the coastal plain should result in higher affordability rates, in our opinion.  That doesn’t totally invalidate Chapman’s conclusions–we’d just pick more modest numbers.  We’re also hopeful that continue declines in mortgage rates will increase affordability.

It seems to us that both Chapman University and Gary Watts are like broken clocks.  Gary’s stuck at sunrise:  He always thinks prices will keep going up.   Chapman’s stuck at midnight:  The worst is yet to come.  They’re both right once in each economic cycle, like a broken 24-hour clock that’s right once a day.

Still it’s one more thing to consider.  We think a 5% – 10% additional price drop will hopefully do it for the coastal plain at least.  (See “A Change in Our Projections“).

Like we keep saying, nobody knows for sure (See “How Low Will Prices Go?”).

For Chapman’s full report, including some nifty charts, in PDF form, click here.

And click here for “a little perspective” on our real estate woes, here for “a little more perspective,” here to find out “what to do when nobody knows what’s next,” or here to find out “how to sell your So Cal home for top dollar in 30 days.”

As for me, I think it’s time to get outside in this beautiful weather & go for a jog.

DataQuick’s March median numbers: What to expect & what it means

Update from David Emerson: We wrote the following post early 4/15, in anticipation of DataQuick’s release of their March closing statistics for all of Southern California, including L.A. & Orange Counties, Lakewood, Long Beach, Los Alamitos, and the surrounding area. As we predicted, DQ’s March numbers showed an increase in sales which was quite modest by seasonal standards, and also a modest firming in prices.

We’ll insert excerpts from today’s DQ report at appropriate points through the post below. We’ll indent them & put them in italics. We’re leaving our earlier projections and commentary unchanged, because it’s still applicable:

“DataSlow,” as we like to call them, should be out today with their March closing statistics for Southern California. Here’s our preview & interpretation. We’ll update this as needed once the numbers are out.

Data quick reports Southern California two statistics every week and every month: sales volume and median sales price.

It looks like both will be down from March 2007, which will probably get most of the attention. But the month over month figures should be more hopeful.

We expect sales volume to be up a tad from February,

[Here's what DQ reported:] A total of 12,808 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties in March. That was up 18.8 percent from 10,777 the previous month but down 41.4 percent from 21,856 in March 2007.

and median prices to be pretty close to February’s numbers.

The median price paid for a Southland home was $385,000 last month, the lowest since $380,000 in April 2004. Last month’s median was down 5.6 percent from February’s $408,000, and down a record 23.8 percent from $505,000 in February 2007. That peak median of $505,000 was reached several times last spring and summer.

[Dave here. This is still a reduction in the rate of decline, and it was caused by some of the problems with median statistics, details below. When isolated by county, the stabilization is more apparent. For example, Orange County's March median of $506,000 was down less than 3% from February's OC DQ median of $520,000. More significantly, OC's $506k March median was actually up from DQs last 4 week OC reports, which both came in at $500,000. Pretty much what we predicted--but don't read too much into that, bulls (details to follow)

Now a word about what that would mean.

It's important to bear in mind what these numbers actually are. First, in terms of today's rapidly moving market, DQs numbers are ancient history. That's because Data Quick today will report Southern California real estate sales that closed escrow during March.

That means the purchase offer was most likely written 45-60 days earlier: Someplace between January 1 and February 14.

Second, DQ's price numbers are medians. If more homes are selling in stater neighborhoods, the median price will drop even if prices are rising. (For a more detailed discussion of the problems with DataQuick's numbers, see "Two big problems with DataQuick's median prices.")

The sharp and sudden drop of the Southland median price reflects a combination of factors, mainly depreciation, especially in areas hammered by foreclosures, and a big shift in the types of homes selling. Since last August, when the continuing credit crunch hit, sales have plunged for more expensive homes financed with "jumbo" mortgages, which until recently were defined as loans over $417,000.

Sales financed with these larger loans, which the credit crunch made more expensive and harder to get, accounted for just 15 percent of Southland sales last month, down from about 40 percent a year ago.

[This is the problem with medians. DQ explains it, but only in the ninth paragraph of their report.]

Even with their problems, however, DQs numbers can be useful. These should offer something for everyone, but some caution is in order.

Housing bears shouldn’t focus too much on the year over year numbers to the exclusion of some possible modest improvement from February to March.

Likewise, housing bulls should be wary of reading too much into what might just be a normal seasonal increase in activity and prices (see “Southern California’s 2 housing market cycles“).

Over the past 20 years Southland sales have risen by an average of 38 percent between February and March. Last month’s 18.1 percent increase from February was the lowest in DataQuick’s statistics, which go back to 1988.

We don’t think today’s DQ numbers will change our own position on what’s ahead (See “A change in our projections?” for our April 4 projection post, or our “classic” November post on this market, “How low will prices go?“)

DQs report is available here. You might also want to check out Peter Hong’s concise, well-written article on today’s DQ numbers.

For a little longer term perspective, you might want to click back to either of our last two posts, (“A little more perspective”) and (“A little perspective“).

A Pretty Good Summary of National and Local Trends

The Wall Street Journal released their quartlerly survey of housing-market conditions in 28 major U.S. metropolitan areas today, along with an analysis that’s rings true with what we’re seeing throughout our region.

 The article’s title pretty much sums it up:  “With Buyers Sidelined, Home Prices Slide.”  The survey itself reveals that what we’re experiencing locally is being repeated across the country, with some areas doing worse than us but more areas doing better. 

To see the complete article and the survey results, just click here: http://online.wsj.com/article/SB119326355265670448.html?mod=googlenews_wsj