September, 1 2009 | Mark
*Note – this report was first published as part of the Mortgage Pages research series on 1/30/09
-Credit Scores: “Past Performance Does Not Guarantee Future Results
– Credit Scoring Background – Bad Math, Smoke and Mirrors
- Fannie’s & Freddie’s Black Boxes – misused and manipulated for years
- ‘Beat the Computer’. Automated Decisioning – A disaster unfolding
- Buying better credit scores through more debt
- Exotic mortgages sold as a way ‘to improve credit scores’When the Dam Broke
- So, What Next — Will credit scores inhibit a recovery?
Like liquefaction following an earthquake that exposes bad math and engineering sometimes performed decades prior, the quaking of the financial markets has exposed the systemic stranglehold that credit scoring has on all lending. The lender’s, rater’s, and consumer’s universal acceptance and over-reliance upon it was in large part responsible for the ‘lapse’ in lending standards that led to the global credit crisis. On a go-forward basis, credit scoring may inhibit a robust consumer-led credit recovery despite how much money is spent to promote lending.
Finger pointing is rampant these days, and it shouldn’t be too long before some of the blame and inquiry properly flows to credit scoring and its sudden and systemic influence over all lending. Upon this realization, financial institutions will be staring into the abyss. Nothing has changed.
In past mortgage and housing cycles, credit scores were not used as they were during the bubble. Even during the 1991-1994 refi-boom and subsequent housing downturn that lasted until the late 90’s, scores were not used as a primary determinant. It was not until early this decade that credit scores evolved into what they are today to mortgage and housing.
Background
The two most important items found in every consumer loan are obviously a borrower/borrowing entity, and also a credit score. Many loans, such as credit cards, don’t even require collateral and rely solely upon the borrower’s perceived ability to repay derived mostly from a consumer credit score.
Down the road, as the crisis is analyzed to death from those looking to pin the blame on as many names as possible, perp-walks will become common. In this ‘discovery and hang ‘em phase’ it is probable that someone with power will realize that credit scores and their wide acceptance — as a primary metric when analyzing a borrower’s ability to repay — was the paper tiger that made for the start of the lapse in lending standards that has nearly taken down the entire system.
Credit scoring may also be a primary reason for banks unwillingness to lend and will lead to a continued contraction of consumer credit into the future. Because of continued over-reliance upon credit scoring and its aversion to excessive consumer debt, consumers simply don’t qualify for credit easily attainable in the past. It is now a world where those that need the credit can’t get it and those that don’t, can.
Why are the credit raters made to carry all of the blame when credit scorers that provided a primary metric used to make the loans for the securities that the raters rated, getting a free pass? Credit scorers perform their task long before the raters do on a class of loans or bonds. Without credit scoring there would be nothing to rate — or perhaps the loans they rate would have been made using time-tested forms of ability to repay such as income, cash-flow and collateral value
Credit Scoring Background – Bad Math, Smoke and Mirrors
Each of the three primary credit reporting firms, TransUnion, Equifax and Experian, has their own scoring systems. “FICO score,” incidentally, is to “credit score” much like “Xerox” is to “photocopy”. Both are cases in which proprietary corporate creations have evolved, often to the chagrin of the company’s involved, into generic terms at least in the eyes of the general public. Additionally, some banks and credit card issuers utilize their own scores and modeling.
Back in the mid-90′s when credit scoring was still nascent, the bureaus’ formulae weren’t as fine-tuned and it wasn’t uncommon for mortgage underwriters to see a high score on someone with obviously lousy credit (or visa-versa). But such anomalies didn’t much matter to the large lenders and Wall Street investors, whose high-math statisticians were able to “prove” correlations between various credit scores and default rates. “Someone with a 620 score was x% more likely to default than someone with a 680 score”, they said, and y% more likely than someone with a 720 score.
Over time, the perception built that very little mattered other than credit scores. Eventually the banks, Wall Street and the ratings agencies could point to credit scores with their corresponding “proven” default rates and risk-price their loans accordingly. But like so many other things during the bubble years, their black boxes were made of bad math, smoke and mirrors.
Fannie’s & Freddie’s Black-Boxes
Fannie and Freddie’s automated underwriting systems (AUS) and risk-based pricing models, that approved trillions of dollars in loans during the bubble years, most heavily weighted credit scores when decisioning and pricing mortgages. The GSE’s black boxes were thought to be so bullet-proof that until recently everyone assumed that every loan that came out of the GSE’s was ‘Prime’. The GSE’s with their ‘implicit, now ‘effective’, government guarantee were securitized and sold across the world as debt that rivaled US Treasuries and Ginnie Mae securities.
These black-box AUS were misused and manipulated for years. And for years I have been astounded at the quality of loans that the GSE’s would buy at ‘Prime’ prices because of their AUS output that were obviously Subprime loans. Over time, I am confident that defaults across the GSE universe will reach serious double-digit percentages.
Recent, hasty roll-out of foreclosure moratoriums and mortgage modification initiatives may kick the can down the road masking the problem a while longer, but just like we have seen time and again with similar programs…ultimately they will do more harm than good and the problem comes back at a greater pace.
‘Beat the Computer’. Automated Decisioning – A Disaster Unfolding
Everybody bought into it. The GSE’s AUS were engineered to generate loan approvals with reduced documentation requirements when credit scores were sufficiently high. Loans with AUS approvals were instantly salable.
As things evolved, income and asset documentation were no longer necessary for Fannie, Freddie, or, well, anybody. Credit scores were king. Alt-A loan applications – stated income, stated assets, “No Doc” etc. – skyrocketed. Since investors believed they could price out the risk for people with low credit scores as well, the subprime universe exploded literally overnight.
The GSE’s black box mortgage underwriting and decisioning became so detached from human involvement and automated that fraud was easy and rampant. Prior to the bubble years, the mortgage underwriting process consisted of the underwriter carefully reviewing all documentation and making a list of ‘conditions’ that the borrower needed to fulfill in order to make the loan salable to its target investor.
But by 2004, GSE underwriting became a game of ‘beat the computer’. In the GSE’s automated world the underwriter enters the borrower information into the system and an instant decision is given. But during the bubble years if the loan was not approved — or if approved with conditions that the borrower was unable to fulfill — anyone up or down the lender food chain with an AUS log-in and an interest in getting the loan approved could play with the inputs in order to get the decision and list of conditions most easy to fulfill. Things work mostly the same today but access to the systems is more closely monitored.
During the bubble years — when most of the loans that the GSE presently own were originated — If the system denied the loan because it was a borderline cash-out with a high LTV, simply raising the borrower’s asset level by $50k would easily change the declination decision to an approval.
An emailed or faxed document showing $50k in retirement was easy to obtain and would satisfy the underwriter’s condition. Some loans were re-run with new inputs dozens of times in order to get a Fannie/Freddie approval with only the conditions that the borrower or loan officer knew they could fulfill.
GSE loan pricing also became so detached from reality that based upon the AUS approval a borrower with a 580 credit score would get the exact same rate a borrower with a 700 credit score for a similarly structured deal. Appropriate risk was not being priced because it was believed that the almighty GSE credit score reliant AUS systems would never approve the loan, or assign it a lower grade status requiring pricing adjustments, if the loan was indeed risky.
The GSE’s were not the only firms highly reliant on black-box AUS. By 2005, Countrywide, Indymac and Chase also had proprietary system used for non-GSE loans.
In the past couple of years, the GSEs and other lenders have done much work ‘tightening up’ their systems. They have also added lender-specific loan guideline overlays and identified “declining markets” regions in order to get ahead of risk. But still, credit scores remain the primary determinant for AUS approvals and to the extent of documentation requirements.
“Past performance does not guarantee future results” — Buying a better credit score
But what everybody forgot was the oldest caveat in the financial world: “Past performance does not guarantee future results.”
As housing prices soared to historic levels, many home owners used their homes as an ATM machine, cashing out periodically via new first and second mortgages to pay off their credit cards and buy SUVs, plasma TVs, electronic gadgets, and (most notably) second homes and investment properties — which further helped fuel the upward spiral in real estate.
People sufficiently savvy to reap the tax benefits by paying off their installment and revolving debts with cash out from their home actually saw their credit scores improve. This was despite the fact that many of them were living well beyond their means. Once their installment and revolving debt was paid off, they went back to using it. Within a year or two following the funding of the original 50% debt-to-income ratio mortgage, the borrowers total debt ratio was 70-80% and future ability to repay completely dependent upon house price appreciation and home equity extraction. House price appreciation and equity extraction was a second job for millions from 2003-2007.
Indeed, over the past half-dozen years or so, consumers learned they could literally ‘buy’ improved credit scores through taking on more mortgage debt. Subprime loans – especially the Pay Option ARMs which had artificially low interest rates and exceptionally low payments for two years or less – were openly sold as a way to generate a strong mortgage payment history. Once established, this would improve a borrower’s credit score allowing them to refi into an A-paper loan at better rates before the payments increased.
When the Dam Broke
Once the real estate market peaked, however, borrowers were suddenly unable to refinance out of their financial predicaments. They were over-leveraged, both with respect to LTV/CLTV parameters (the value of their home was/is worth less than what they owe, sometimes substantially) and also vis-‘a-vis their debt-to-income ratios. Many even overstated their income on purpose in order to get in the game making for an incurable situation.
So we have what we have today – a snowballing decline in values and nothing less than absolute chaos and carnage in the mortgage and housing markets. The defaults and foreclosures may have started with the low-credit score subprime borrowers, but they have made their way into the higher grades such as Alt-A, Jumbo Prime and Prime borrowers.
So, What Next — Will Credit Scores Inhibit a Recovery?
To what extent is credit scoring are at all predictive? Have the credit scoring firms adequately tweaked and re-weighted the multiple criteria that go into one’s credit score? And if so, have they done so accurately? At this stage when we are learning more each week especially on the psychology of it all, how could they know? By overlooking the role that the credit reporting agencies played in all of this, perhaps even new vintage loans made in the last year during a period of unmatched house price depreciation are also destined to fail in large numbers.
The large banks and investors remain slow on the uptake. Although income, occupancy and LTV carry the most weight in “absolute” terms, loan approvals and especially loan pricing is still very much credit score driven.
The GSE’s now have multiple credit score/pricing tranches, up from one or two back in 2007. In addition, many banks have applied overlays to the underwriting guidelines prohibiting borrowers with certain scores from getting a loan even if the investor will accept lower scores. This will prohibit many with great income and a perfect record — other than having a few credit cards proactively shut down by the bank — from buying a new home for years, further delaying the recovery.
In the past year, I have witnessed perfect credit risks denied a loan solely because of credit score. In the new-era housing market with values down to affordable levels in some areas around the nation, one could argue that many with stable jobs, good cash flow and reserves — that recently walked away from an exotic loan 50% underwater — are much better credit risks that the scores would imply because they are finally de-levered. Being backward looking will not help to solve the housing crisis.
How can the scorers model credit risk accurately enough to reflect the fundamental shift that occurred during the bubble when a home became the ‘largest investment’ of one’s life vs. ‘a place to life’? With prices off 50% at the median in the bubble states and underwriting guidelines back in check for the most part, the home has again become a place to life. Arguably new vintage borrowers will act much differently with respect to real estate as an asset class than bubble-years borrowers.
How does the shift in behavior with respect to negative-equity, or the fact that being in default or foreclosure does not carry the stigma that I call ‘The Scarlet F’ that it once did, undermine the credit scorers attempt to be predictive?
All of these questions and more make for serious doubts about a consumer-led recovery, an end to the housing crisis and the quality of present vintage lending. By default, credit scores will continue to influence the lender’s contraction or future expansion. But what if the computers are still wrong? They do not have a good track record over the past decade. The future of lending depends upon getting back to basics or lending will continue to contract and brand new problems will arise that nobody can predict.
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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August, 29 2009 | Mark
Dear Blog Readers,
To those of you who are new, we are not perma-bear just data parrots. The following report is from my March ‘housing bottom’ series on which I focused intently earlier this year in The Mortgage Pages. This was one of the first reports of the series published March 18th, describes in detail why we thought at the time that the headlines were about to change to ‘housing is bottoming’ in the near-term, and lays out the data that led to this prescient call.
Although we saw reported prices greatly improving over the near-term obviously, unforeseen events such as gov’t stimuli, servicers keeping foreclosures off of the market on purpose, and the tax credits juiced the low end of the market more than we expected. But nevertheless the headlines were here a few months ago about when we expected them. Mark Hanson
Mortgage Pages Update – March 18th 2009
- Housing is “Bottoming” but Only in the Headlines
- Present-Value ‘Mix-Shift’ – The First Available Forward Look at House Price Movement
- What is Present-Value “Mix-Shift”?
- Foreclosure-Related Resales Dictate Prices
- What Will Cause Rise in Reported Prices
- Detailed Charts Highlighting CA Present-Value Mix-Shift at the REO and NOD Stages
*Note – this report was first published as part of the Mortgage Pages research series on 3/18/09
Housing is close to ‘bottoming’ but only in the headlines. The truth and the ‘reported’ national, statewide and MSA housing statistics are completely different stories. Most of you are affected by headlines but make real money by knowing the truth. These new data sets tell the truth.
What is Present-Value and Foreclosure-Related ‘Mix-Shift’
Based upon this research, beginning in March Existing Home Sales headlines should show a much smaller drop in median prices than February’s number did — perhaps even a leveling out of prices and subsequent rise at least in the West in the near-term. But this does not mean the entire housing market is getting better? On the contrary, due to most of the existing sales being from the foreclosure stock, it means conditions are changing for the selling season and getting worse in the mid-to-high end.
For months I have been closely watching all loan defaults and foreclosures for a shift in the loan-level detail – specific loan types, loan amounts and UPB’s. My thought was that when higher paper grades/loan amounts go through their respective ‘implosions’ and the higher value properties attached to the loans resell, it will push up reported median prices and cause the housing head-fake of the century. Although the housing implosion did swim up-stream in 2008, average original deed-of-trust amounts on defaults and foreclosures did not rise that much throughout the year; certainly not enough to offset the house-price depreciation.
With most of the foreclosure-related sales being from the lower-priced Subprime stock, median values have been pushed down fast. We have yet to see large numbers of higher original loan amounts/paper grades make it all the way through the foreclosure and resale process due to the lengthy foreclosure time line. From the time a borrower gets a Notice-of-Default — after 3-4 months of missed payments — to the time the home is taken back at foreclosure can be 7 to 10 months. Then, the resale cycle can take another 3-6 months. Therefore, a foreclosure-related resale that goes off today may have been from a first payment missed in 2007 – the heart of the Subprime crisis. Because of this, most have not been able to catch much of a glimpse of anything in the ’default and foreclosure mix’ that would push up house prices, especially if they are looking at specific loan-level detail as I had been.
Foreclosure Related Resales Dictate Prices
During the present slow season — in CA and most other bubble states — approx 60% total sales are foreclosure-related with organic sales (Ma and Pa Homeowner) being at the lowest levels on record. In my opinion, organic sales are one of the most important metrics of the true health of the housing market but that is for a different story. It is this massive group of foreclosures and subsequent REO resales that most influence future median house prices. Never before in history have we seen the majority of properties for sale being controlled by so few entities – the banks and servicers.
Near-term Rise in Prices will be caused by Increased Mid-to-High end Foreclosure Resales, More Organic Sales Occurring & Price Dumping During the Busy Season
Despite positive, market-moving headlines about the end to the housing crisis that may accompany a ‘reported’ median house price stabilization or slight move higher, ultimately it will be caused by a) significant price discounting in the mid-to-high end price bands leading to more organic sales, b) higher-priced properties going through their respective ‘implosions’ and resale, c) and a seasonal shift away from the majority of sales being from the foreclosure stock to the majority being from the organic stock. Obviously, on a macro-economic level this isn’t great — the consequences of body-slamming the mid-to-upper end earner/homeowner at this point in the economy’s fragile state are unknowable.
Bottom Line - The present value of the massive pool of properties in the foreclosure process — and that make up 60% of total sales in CA — most influence reported median house prices. Therefore, tracking the real-time present value of properties throughout all stages of the foreclosure process should be the best indicator of future reported house prices near and long-term. And it looks like reported prices are going up.
Detailed Charts Highlighting CA Present-Value Foreclosure-Related Mix-Shift
The following reports show average present values — based upon our enterprise AVM — of CA properties at specific foreclosure stages highlighting the REO stage as the most important. When the bank buys it back at the courthouse steps, which happens in 95% of cases, it goes into the REO resale pool and is sold through a Realtor. This counts as a comparable sale and effects similar house prices in the appraisal zone.
REO – Most Important Stage: The chart below shows the monthly aggregate average present value of all actual foreclosures that have become REO. Present values of props at this stage are still falling especially in the lower value tranches but at a much slower pace. From here these properties may go straight to the Realtor network and be only 1 – 6 months away from final resale. Properties in this foreclosure stage will have the most impact on house prices in the near-term. The clearly shows a near-term price stabilization on the exact inventory that will make up 50% to 60% of of the resales 1-5 months from now.
The following two charts cut all foreclosures above into multiple present value tranches in order to track more closely exactly what is happening with the mix-shift. The percentages on the left side of the chart clearly show the mix-change of property values entering the resale stream over time. With the sales cycle anywhere from 1-5 months, this gives a great forward indication of the direction of reported median house prices.
NOTICE-OF-DEFAULT – Leading Indicator Stage: The chart below shows the monthly aggregate average present value of all Notice-of-Defaults (NOD) – the first foreclosure stage. Prices are rising for the first time due to higher priced homes entering the stream.
This is significant and may be the earliest look available of ‘present value mix-shift’ as the average price here at the NOD stage is 10% higher than at the REO stage shown previously. But from here the properties are 5-7 months away from foreclosure and 8 months to a year away from being resold to a private party. Properties in this stage of foreclosure will not have any impact on house prices in the near-term but towards the end of summer could give house prices a good kicker.
The following chart cuts all Notice-of-Defaults into multiple present value tranches in order to track exactly what is happening within the mix-shift. At the NOD phase the mid-to-upper end present value tranches are now expanding. If this holds for 5-7 mo’s until the REO phase will have the effect of pushing up reported median and average house prices when resold.
Fast-Forward Five Months — DataQuick Recently Confirms False Bottom in Housing
Lastly, in their most recent Bay Area Housing Report DataQuick — a leading data provider — confirmed what was primarily responsible for the reported house price increases seen in much of CA this summer selling season. It is important to note that as organic sales drop sharply as they always do in the fall and winter, then foreclosure related resales will once again reclaim the mix likely bringing reported prices right back down.
Bay Area home sales hit 4-year high; median price up again
August 21, 2009
La Jolla, CA.—-Bay Area home sales rose last month to the highest level for a July in four years as deals above $500,000 continued to accelerate. The median sale price climbed above the prior month for the fourth consecutive month, lifted by the combination of more high-end transactions and fewer sales of lower-cost, lender-owned foreclosures (my emphasis), a real estate information service reported.
The median price paid for a home in the nine-county region rose to $395,000, up 12.2 percent from $352,000 in June, but down 16.0 percent from $470,000 in July 2008, according to MDA DataQuick of San Diego.
Although last month’s median was 36.2 percent higher than the current cycle’s low of $290,000 in March this year, it was still 40.6 percent below the peak $665,000 median reached in June and July of 2007.
The median’s $43,000 gain between June and July was mainly the result of a shift toward a greater portion of sales occurring in higher-priced neighborhoods. The trend has been fueled this summer by several factors, including: More distress in high-end areas, leading to more motivated sellers; more buyers sensing a bottom could be near; and increased availability of larger home loans, which had become more expensive and far more difficult to obtain after the credit crunch hit two years ago(my emphasis).
Best Regards,
Mark Hanson
This document is for your private information only. In publishing research, Mark Hanson and M Hanson Advisors are not soliciting any action based upon it. Mark Hanson and M Hanson Advisors publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Mark Hanson and M Hanson Advisors does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Mark Hanson and M Hanson Advisors publications only. Mark Hanson and M Hanson Advisors are not liable for any loss or damage resulting from the use of its product. Mark Hanson and M Hanson Advisors are Limited Liability Corp registered in CA.
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August, 26 2009 | Mark
Note to blog readers:
On Monday July 25th we released a report on reported median and average house prices and the Case-Shiller index and why nothing can be trusted in this unprecedented housing market.
We mistakenly entitled the report “Case-Shiller Confirms False Bottom in Housing’. The title was supposed to be ‘DataQuick Confirms False Bottom in Housing’ pointing to a press release within this post. We apologize for the confusion.
*This excerpt was first published as part of the
Mortgage Pages research series
on 8.25.09
There are three significant factors occurring that are influencing the outcome of the reported median and average house price indices. They have nothing to do with home price appreciation in the historical context and are absolutely unprecedented in nature.
Seasonality Mix-Shift – The Push-Pull Effect on Prices Creating a False Bottom
I discussed this effect in detail over the past 90-days. Essentially, foreclosure resales which are not seasonal by nature have remained relatively flat in count in CA and on a national level for months. But during the slow fall and winter seasons they made up the majority of sales because organic sales were so low due to typical seasonality.
Because foreclosure resales carry a lower price point than equivalent organic transactions the reported median and average house prices were pulled lower toward the distressed market price. However, as the busy spring and summer season came on and more organic and mid-to-high end sales occurred, the reported median and average prices were pulled back towards the higher organic market price. Boom – we have a ‘housing market bottom’.
The first chart highlights the seasonal organic sale vs not seasonal foreclosure resale mix shift and how prices pulled higher as organic sales reclaimed the mix for the summer selling season.
The chart below is another look at the sales mix-shift. Three years ago the market was healthy with most sales being organic (blue) in nature. Now with epidemic negative equity that prohibits at least half of homeowners in the bubble states from selling and re-buying, organic sales have plummeted and remain down nearly 60% from 2006 levels.
Apples to apples — assuming foreclosures and foreclosure resales never surged in the first place — the blue portion of the chart is the organic CA housing market. In addition to being down nearly 60%, organic sales are not up too much over last year underscoring how critically injured the market remains from negative equity and the loss of affordability through exotic finance.
Mid-to-High End Sales – Very Important. Not Representative of True Market
More mid-to-high end sales are occurring this year than last. Sales are not anywhere close to the bubble years due to the catastrophic loss of affordability through exotic finance but they have increased nevertheless. They are occurring at significant discounts to list prices and previous year’s sales as I have highlighted many times. At the same time, foreclosure-related resales are falling as demand from first-timers and investors who have carried the market for a year has peaked.
This seasonal mix-shift is almost exclusively responsible for the significant house price appreciation in many CA MSA’s over the past 90-days. Mid-to-high end sellers and buyers are the most seasonal of all. As soon as the summer warm months are over and kids are back to school these sales will drop considerably allowing foreclosure resales, which are not seasonal, to reclaim this mix. This will drop reported median and average house prices as early as September, which should be picked up in the October headlines. Because Case-Shiller lags several months, a fall beginning in Sept will not be picked up until Dec release at the earliest.
Who is the Mid-to-High end Seller & Buyer? Why Is This Important?
Now, think about those that are selling these mid-to-high priced houses. Other than short sales, the majority of sales are not from those who bought new and existing housing stock from 2005-2007 on a Pay Option ARM with 5% down because they can’t sell. They are from those who bought years ago or those who have enough equity to dump the price, sell, and have enough left over for the down payment on the house they plan to steal in the desert.
The primary buyer population in the mid-to-high end is a) that special buyer who can afford the down payment on a new house while renting their current residence b) the mid-to-upper end earner who has been renting either because they just never bought during the bubble years c) those whose earnings situation is actually improving d) young professionals who were not in the position to buy in the past that find today’s prices attractive.
But because of the supply/demand imbalance that exists in the mid-to-high end, it is absolutely a buyers market in contrast with the low end where we have a sellers market. Therefore, the majority of mid-to-high price band transactions are the best properties selling to the best buyers who may even pay a premium for their perfect home in some cases. These are not speculators by and large.
This is a complete departure from the bubble years when move-up buyers controlled the market and virtually every house sold to anyone that could complete a loan app. Back then a much wider variety of houses traded at a much greater frequency. Half the houses in the bubble states may not even trade for at least a decade given the epidemic negative-equity, excessive household debt levels, and lack of affordability through exotic financing that was responsible for the liquidity in the mid-to-upper end markets. In a nutshell, the more transactions across the greater number of price bands the more accurate prices indices will be.
But even with the price dumping at the mid-to-high end this season, a person who bought in 1999 for $450k — who saw their house price rise to $1.5 million by 2007 and subsequently drop to $700k — realizes a price gain. The mid-to-high end new house purchased for the first time just a few short years ago in a plowed over corn field for $1.25 million that is now worth $700k is transacting less frequently.
The bottom line is that house price indices such as Case-Shiller report what sold, period. It is my opinion that the real estate market is so thin and fragmented across all pricing bands, that what is selling today is not representative of the true real estate market. This is especially true at the mid-to-high end. And they likely are not accurately representing properties built and purchased during the bubble years — that have been hit especially hard — and are now worth a fraction of their purchase price because they are not transacting as frequently.
But one thing is for sure — the second derivative is that the homeowner who bought during the bubble is sure feeling the negative-equity pain from the comparable sale at $700k. So much so, he is at an exponentially greater risk of loan default and foreclosure.
DataQuick Confirms That Recent House Price Gains are Abnormal and Likely Temporary
Proof in point comes from DataQuick’s recent Bay Area House Sales report below. This is the first monthly report in which they cite many of the same premises that we have been waiving flags over for months as the reason for abnormal house price movement. An annualized appreciation rate of 146% will only lead to disappointment when foreclosure resales once again reclaim the majority when the summer busy season ends.
Bay Area home sales hit 4-year high; median price up again
August 21, 2009
La Jolla, CA.—-Bay Area home sales rose last month to the highest level for a July in four years as deals above $500,000 continued to accelerate. The median sale price climbed above the prior month for the fourth consecutive month, lifted by the combination of more high-end transactions and fewer sales of lower-cost, lender-owned foreclosures (my emphasis), a real estate information service reported.
The median price paid for a home in the nine-county region rose to $395,000, up 12.2 percent from $352,000 in June, but down 16.0 percent from $470,000 in July 2008, according to MDA DataQuick of San Diego.
Although last month’s median was 36.2 percent higher than the current cycle’s low of $290,000 in March this year, it was still 40.6 percent below the peak $665,000 median reached in June and July of 2007.
The median’s $43,000 gain between June and July was mainly the result of a shift toward a greater portion of sales occurring in higher-priced neighborhoods. The trend has been fueled this summer by several factors, including: More distress in high-end areas, leading to more motivated sellers; more buyers sensing a bottom could be near; and increased availability of larger home loans, which had become more expensive and far more difficult to obtain after the credit crunch hit two years ago (my emphasis).
Foreclosure Moratoria and Mortgage Mod Initiatives – Foreclosures Pushing Up Prices
A certain percentage of foreclosure resales are also artificially pushing up the reported median and average prices as of late. This has to do with the back log in foreclosures, servicers getting the houses back onto the open market in a timely manner, and the surge in investor interest.
For years, the foreclosure process was relatively smooth and consistent across servicers. When the property went to the courthouse for sale it was either bought by a third party or by the bank and placed in REO. The REO would then get listed with a Realtor and sell rather quickly. But there was so little of it, it was insignificant.
However, in these unprecedented times servicers all act independently of each other and inconsistently relative to past years. Houses can either come right back out the other side after foreclosure or be held for months. As of late, the time interval between the transfer back to the servicer and final resale to an individual buyer has been as lengthy process. Because of this, investors — that have become a significant presence in the foreclosure resale market segment — have significantly impacted the reported price outcome.
There are two primary investor types — buy and rent and buy and flip. Many flippers fix up the property and hope to resell for a higher price, which isn’t hard. If the house is flipped at least six months from the date of transfer back to the bank at Trustee Sale, then it counts as a pair sale in the Case Shiller unless the final sales price is completely out of scope and it is discarded.
Because Case Shiller gives more weight to houses that transfer within a shorter amount of time, these slightly greater than 6-month flips can carry a lot of weight. If they make it through to the index, foreclosure resales are given much more weight than ever before especially given they have ranged this year on a national basis from 31% in July to over 50% at the beginning of the year.
Foreclosure Resale Paired Sales Not Representative of True Market Appreciation
But as with the inconsistency in the mid-to-high end, a foreclosure flip — where the investor likely put lipstick on the pig before selling — is not representative of the overall market either. Very few low to low-mid price band sales from purchases made from 2004-2007 are occurring organically because the owners are too far underwater to sell. This increases the range of what is considered in scope and allows more of these types of transactions to make it to the index further skewing the results.
Giving an increased weighting to legitimate arms-length foreclosure resales flies directly in the face of the CS methodology. CS makes the assumption that the longer the time interval the more chance for property change or rehab thereby given them less weight. In this unprecedented market, many low to low-mid price band sales have indeed experienced the physical changes negatively mentioned in the CS methodology excerpt below.
The bottom line is that house sales in 2009 are keeping pace with last year, which happened to be the worse year on record in many aspects of the market. If not for massive temporary stimuli who knows where the market would be today.
Prices have likely stabilized at the low to low-mid end of the spectrum for now. In the mid-to-high end price bands, sales and prices are far from a bottom. The coming house price compression and record-high foreclosure pipeline supply will likely bring further pressure to the low end.
But even if the low end has bottomed with respect to sales, seasonality trends will pull prices back down when organic sales go away, as they always do in the fall and winter, and foreclosure-resales once again reclaim the mix. Even though we will not see the size of drop seen over the past two years, reported house prices rolling over will significantly impact sentiment.
When Will Housing Bottom?
We will not know it when the US housing market finally bottoms. It will not be foreseen in any of the typical indicators we presently watch. It will likely come when my Uncle Frank the plumber — who is out there every day trying to find a fixer upper — can’t stand the thought of real estate and buys a water purifier in a multi-level marketing scheme.
Best Regards,
Mark Hanson
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August, 23 2009 | Mark
Note to blog readers:
On Tuesday July 18th I released two detailed research notes warning clients of a potential miss coming Friday in the July m-o-m and y-o-y Western Region and national Existing Home Sales reports. Additionally, I highlighted Sept and Oct 2008 as months that will be nearly impossible to beat in 2009. On Friday following the release of the monthly existing sales data I released two additional notes — the second of which is reproduced below — that defend this call by highlighting the detail that was not reported in NAR’s official press release. Mark Hanson
*This note was first published as part of the Mortgage Pages research series on 8.21.09
Good Afternoon,
I love beating dead horses. I also love perspective because there is so little of it going around. This is an update to my previous report this morning on July Existing Home Sales.
Below are three additional charts I just threw together in order to provide further clarity. The first is of monthly Existing Home Sales from 2005 through 2009. The second is of Jan through July ytd sales going back 5-years. The third is June vs July sales going back 3-years.
These charts are of actual monthly sales and not annualized seasonally adjusted sales as NAR reports. How can NAR model seasonality when this is the first year in history — and the history of NAR — when distress sales made up so much of total sales and distress sales have not been proven to follow any trends other legislative and default?
Annualized seasonally adjusted figures have guess-work built in and have led to many bad calls over the last couple of years. There is no need to report house sales this way unless the reporting body needs flexibility of outcome each month.Why not just count the houses that sold each month and analyze — that is what we do.
In the first chart below look at the black oval. That red line (2009) slightly above the yellow (2008) represents 2009 beating 2008 by 45k sales in total for June and July. But from Jan to May, 2009 was the weakest year in years.
Ok, I get it — -after so many years, we finally have a beat. But look at what was thrown at it in order to get this rounding error. We have thrown in a trillion dollars to buy rates down, countless $8k tax credits, mortgage mods, foreclosure moratoriums plus hundreds of billions more, and it only bought 45k y-o-y additional sales over June & July combined.
After a 50% to 70% price hit in the hardest hit areas — that are also the busiest now — only 45k sales out of 2.8 million sold this year are responsible for the national consensus that housing has bottomed. This of course is leading to a renewed belief that the consumer will recovery quicker than previously thought.
Don’t forget that conditions were absolutely perfect in the first seven months of the year with respect to prices, rates and supply. And from March to July seasonality is always a significant factor.
But now as we move out of the summer selling season the seasonality goes away and rates are at least 1/2% higher across the board now than the average for Q1 – Q2. In addition, low cost foreclosure supply has rapidly evaporated due to the servicers keeping it off the market on purpose and the Admin’s mortgage mod initiatives & scare tactics that have kicked a million foreclosures down the road to whenever. This foreclosure pipeline supply reservoir is fuller than it ever has been and when the dam breaks, it poses a real threat.
The biggest problem for bottom callers in the chart below is second half sales. They remained elevated relative to the sharp seasonal decreases seen in previous years. They set 2009 second half sales up for the perfect national miss.
In July the Western Region missed badly. And as I discussed in detail in the first report, the July national monthly sales would have also missed if not for 16k extra mystery condos selling in the Northeast region. Most importantly, ex-condo Existing Home Sales, which make up the lion’s share were down m-o-m from 465k in 2008 to 460k in 2009. In my book, that is the housing market getting worse.
Today’s Existing Sales report was as close as it gets. The NAR’s annualized seasonally adjusted slight of hand made the beat appear bigger than it really was.
Last but never least, prices were down again. Always remember that for every person that get a great deal on house, orders of magnitude more are thrown into a negative-equity (or deeper negative-equity) position exponentially increasing their likelihood of loan default.
The chart below shows Jan through July monthly sales totals for the past five years. Once again, 2009 is the weakest.
The final chart shows June and July sales from 2007 – 2009. This is what the greatest amount of stimuli ever has purchased. In a nutshell, of 2.8 million houses sold ytd 2009, only 44k more houses sold in June and July 2009 vs the same time period last year. The takeaways are 1. July 2009 sales are down m-o-m 2. July 2009 sales are only up 24k units over the worst year for housing on record — 2008. June sales were up 20k y-o-y 3. Median prices are still falling.
Bottom Line: Be careful going forward — with strong consensus that housing trouble is in the rear view mirror a miss next month could produce an outsized reaction.
Best Regards,
Mark Hanson
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