With the serious problems facing the housing market including high delinquency rates creating a massive shadow inventory, a weak economy, tepid demand from owner-occupants, excessive consumer debt, a depleted buyer pool due to credit impairment, and artificially low interest rates, it’s a wonder housing prices aren’t still heading straight down. The recent uptick in prices is largely due to a successful attempt by the lending cartel to restrict for-sale inventory on the MLS. Without this inventory restriction, prices would almost certainly be headed lower.
At some point, the shadow inventory of delinquent mortgage squatters will be cleared out. The liquidation will either lower prices or limit appreciation for a long time while these properties are processed. The big question is, when will this liquidation happen? Right now, the banks are in no hurry.
For lenders to be motivated to process their backlog of foreclosures, they need some reason to act. Ordinarily, the cost push of paying for capital would force them liquidate non-performing loans and put that money to productive uses. However, with the federal reserves zero interest rate program to steal from savers and the elderly, banks have no cost of capital. Banks can borrow all they want from depositors or the federal reserve for nothing.
Since the banks have little or no cost of capital, they can sit on their bad loans indefinitely — and they are. Right now, it’s in the best interest of the lending cartel to sit on their bad loans. The lack of inventory on the MLS is causing prices to go up — although it is simultaneously causing sales rates to plummet. Higher resale prices make for better capital recovery on the loans the banks do process. As long as they all agree to continue delaying their foreclosure processing, they all benefit from higher prices. Of course, this is still a cartel arrangement, and as prices rise, each member has a strong incentive to cheat, particularly the weakest members, but right now, the cartel is enjoying great success driving prices higher.
Until the federal reserve raises interest rates, lenders face no cost pressure to liquidate their bad loans. With no pressure to liquidate, lenders will continue to allow squatters free housing in hopes resale prices will continue to rise. So when will the federal reserve finally start to raise interest rates? Well, they said they will leave them at zero through the end of 2014, but it may leave rates along much longer. In fact, it is likely the federal reserve will leave interest rates near zero until house prices regain their peak, and with 3.5% interest rates, that will be much sooner than most think.
The federal reserve cannot raise interest rates as long as so many loanowners are so far underwater. The member banks of the federal reserve hold hundreds of billions of dollars in second mortgages and HELOCs on their books. If house prices don’t rise enough to put collateral value behind these mortgages, the resulting losses upon liquidation will bankrupt our banking system. This really leaves the federal reserve no choice but to push resale prices back up to peak levels as soon as possible by any means necessary.
As rising home values bring properties above water, lenders will liquidate, but not before. With no cost push, they can afford to wait. And with the threat of bankruptcy looming if they liquidate too early, they must wait. Based on those circumstances, inventory will likely remain in the shadows for quite some time. Prices will go up, transaction volumes will be way down, and prices will not flatten out until they approach the peak where lenders will finally begin their liquidations.
I guess that makes me bullish. I now believe that perhaps the bottom callers were right. I wish one of them would have identified the reasons I gave above. Perhaps I may have been convinced months ago, but now, based on what I believe the federal reserve and the member banks are going to do, and why they are going to do it, I think we may be at the bottom. So much for the capitulatory liquidation regulators would ordinarily require.
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Proprietary Irvine Housing News home purchase analysis
$939,000 …….. Asking Price
$755,000 ………. Purchase Price
9/3/2004 ………. Purchase Date
$184,000 ………. Gross Gain (Loss)
($60,400) ………… Commissions and Costs at 8%
$123,600 ………. Net Gain (Loss)
24.4% ………. Gross Percent Change
16.4% ………. Net Percent Change
2.7% ………… Annual Appreciation
Cost of Home Ownership
$939,000 …….. Asking Price
$187,800 ………… 20% Down Conventional
3.64% …………. Mortgage Interest Rate
30 ……………… Number of Years
$751,200 …….. Mortgage
$173,448 ………. Income Requirement
$3,432 ………… Monthly Mortgage Payment
$814 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$235 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$4,481 ………. Monthly Cash Outlays
($773) ………. Tax Savings
($1,154) ………. Equity Hidden in Payment
$223 ………….. Lost Income to Down Payment
$255 ………….. Maintenance and Replacement Reserves
$3,032 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$10,890 ………… Furnishing and Move In at 1% + $1,500
$10,890 ………… Closing Costs at 1% + $1,500
$7,512 ………… Interest Points
$187,800 ………… Down Payment
$217,092 ………. Total Cash Costs
$46,400 ………. Emergency Cash Reserves
$263,492 ………. Total Savings Needed
The property above is available for sale on the MLS.Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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