Friday, March 09, 2012

RECOVERY OF THE HOUSING MARKET OR…
FOR WANT OF A NAIL …..

We've all heard the metaphor …”For want of a nail the shoe, the horse, the rider, the battle, and the war was lost”. Well, sometimes, when all you have is a hammer, every problem looks like a nail. And that just might be an apt description of the Federal Government’s and the residential housing market’s inability to stabilize the falling house values that have left, according to Case-Shiller, 6+ million homeowners with first mortgages upside down, with an average decline of $51K, and 4+ million with first and second mortgages upside down, an average decline of $84K.

Sure, it was the “perfect storm” … banks seized up, liquidity dried up, unemployment exploded, and the housing market collapsed like a demolished building … toxic assets flooded the food chain. What's the government to do? Well, for starters, President Bush walked into a room one day in October of 2008 with Paulson on one shoulder and Bernanke on the other, and he said to the camera, essentially, “I know I've been telling you people that we've got some problems in the economy, but that it's fundamentally sound. Well, we're here today to tell you that’s over, and we have just 48 hours to straighten this mess out, or the world is coming to an end. But don't worry, because my friend, Hank, here has just the remedy. It's a plan to get the banks $800 billion, and don't worry about having a depression, because he's got it all detailed here on this three-page document. In fact, just go to the nearest mall and shop till you drop.”

Upon cursory inspection these problems … bank liquidity, toxic assets, foreclosures, and unemployment … all seemed to be inextricably intertwined. Like a snag in a fishing reel line… if you tug on it, you get another snag, and then you tug on it in another place, and you get more snags. So what does the new administration do? Well, they take out that hammer and …. they create programs and throw a lot of money at the housing problem.

But don't get me wrong. I'm an amateur economist. I understand that a viable democratic country needs to have a standing military and a functioning banking system. I also understand that if the markets aren't working effectively and we don't have cash circulating in the economy, we could have a crisis on our hands worse than the Great Depression, which was not a credit-based economy. I do ascribe to the stimulus plan approach, but I think it was too little. Banks, businesses, and families were short of adequate cash, and credit was in limbo. The economy needed money in circulation. Who had money … the government of the people, by the people, and for the people.

But, for today, let's just focus on the housing problem … foreclosures, persisting plunging values, and, oh yeah, that liquidity problem. A funny thing happens on the way to a recovery when housing prices are in free-fall … only owners who must sell their houses put them up for sale, the vast majority of which are FORECLOSURES. Owners who can wait for prices to recover do. So you have an imbalance in the for-sale inventory.

But if you put that hammer down, and you look outside of the box, there just may be a simple solution to this problem. But first a question ….”What is the justification for appraising a foreclosure and including that appraisal in the comps that are required by lenders?” Is it even realistic to appraise foreclosures? After all, a foreclosure is an “as is” sale, has no right of inspection to determine the defects, and no after sale warranty. With undetermined damage that could even include termites or other structural damage, how could anybody appraise a house in foreclosure properly? The appraisals and the comps are necessary because lenders want to ensure that they have managed the risk of their investment.

But this process is comparing (comps) houses in two vastly different categories … known risk and unknown risk, like a car bought from a junkyard. Including the appraisals of foreclosures in the comps can’t help but have the effect of decreasing the value of perfectly good houses. So, if foreclosed houses’ appraisals are NOT included in comps, what could be the likely result? While not necessarily a silver bullet (or silver nail), the values of the "good" houses would stabilize much more quickly, because the transactions for them would only involve the appraisals of other "good"houses. Foreclosed properties could have appraisals to establish some arbitrary, but acceptable, level of risk for the buyer and/or the buyer’s lender, but they should not be included in comps for "good" houses.

It is a simple adjustment to a complicated and broken process that could also move the other economic problems onto a faster path to being resolved. Addressing instability in housing prices is bound to improve that all important consumer confidence. In Atlanta, the value of houses has declined in 2012 to values of the year 2002. But 2012 values aren't really reflective of the value of the "good" houses. And at some point in time when the foreclosure inventory shrinks, many houses will continue to return to a reasonable value, if not the peak value.

But we don't have to wait for the foreclosures to evaporate in order to improve the situation. Just have Fannie Mae and Freddie Mac modify their loan products to eliminate foreclosures from comps, and most of the other lenders will follow suit. I fully anticipate that some may scoff off at this idea and even come up with some bureaucratic reason why foreclosures have to be appraised and included in comps for sales. However, as a former vice president of sales and marketing for the Fannie Mae Corporation, I invite anyone with a valid reason to contact me and I'd be happy to retract my opinion.