Dr. Housing Bubble Blog

July 2nd, 2009

California Budget and Housing Financial Escapades: $26.3 Billion Budget Deficit with State Issuing Monopoly Money. Housing Still Collapsing. Comprehensive look at Mortgages.

The state has officially run out of money. The state government unable to govern themselves out of a paper bag missed the fiscal year deadline (again) and here we are starting the second half in a massive deficit. The crony bailout continues with absurd ideas but the second half recovery pundits are out in full force. Since this is the bottom, the Governator with no re-election and nothing to lose decided to give 200,000 state employees another day off formalizing a 14 percent wage cut. As I discussed in a previous article we are in the midst of deflation created by demand destruction. California has relied on two gigantic bubbles with technology and now real estate over the span of two decades to spend beyond its means. Now, with no other bubble in the foreseeable future time has run out.

Why has the state run out of money? First, a large portion of money is pulled from personal income taxes and another large portion comes from sales and use tax:

Over 83 percent of the states revenue comes from two extremely volatile sources. This week I happened to get the wonderful news that Los Angeles County now has a 9.75 percent sales tax! So not only do you get taxed on your income, now you will get taxed when you go buy goods. And look at what kind of great government we have in Sacramento for this high tax rate. The best that IOU money can buy!

Here is a problem with the current system. No one has the ability to tell people in the state that we are flat broke! I’ve noticed the pundits are out in full force again with horrible ideas about buying toxic mortgages and bottom callers are out in mass again preaching to their housing gods.

Dumb and Dumber - I.O.U.

In another smart move worthy of a Noble Prize, the state has decided to offer IOUs:

“SACRAMENTO - In a move certain to draw national ridicule and exact financial hardship on business owners and taxpayers across the state, California is slated today to begin paying billions of dollars in bills with IOUs instead of cash.

Nearly 30,000 IOUs totaling more than $53 million are expected to be sent out by state Controller John Chiang this afternoon, the day after Gov. Arnold Schwarzenegger declared a fiscal emergency in the face of a staggering $24.3 billion deficit. The state Legislature remained in its familiar state of gridlock, raising the prospect of an extended standoff that further damages the state’s financial reputation.”

If you have noticed unlike the early 1990s not many banks have come out and stated publicly that they’ll honor these IOUs. It is likely that many will honor the IOUs but the banks are flat out broke too! We are going to give people monopoly money so they can go and deposit their funds into a bank that is broke so it can then lend it out to people with no money! This is the solution to the $26.3 billion shortfall.

But wasn’t it $24.3 billion on Tuesday night? Yes it was. So buy the end of the month people in jail will be getting legit get out of jail cards.

“CHICAGO, June 29 (Reuters) - Michigan has to close prisons to save money. California’s are bursting at the seams.

Both states are struggling with huge budget gaps.

Now, Michigan Governor Jennifer Granholm has offered California some of the state’s prisons that are slated to close at a yet-to-be-determined cost.”

Well I guess we’ve found one export we can depend on. The budget is in shambles because each year, we go through this song and dance and eventually, a budget does pass but it is basically a patchwork of delaying reality for another day. That day has come. Asking the Federal government to bail us out would be a nice form of beggar thy neighbor. Even though Bernard Madoff is getting 150 years in prison, there are far more corrupt things going on right now.

Two of those things involve California and National Housing.

OCC and OTS Show Country insane like State

Earlier this week the OCC and OTS released their first quarter results on the health of the mortgage market. As you may have guessed, lenders across the country are as blind as those in California. Some have thrown out the idea that the government should simply buy up all the toxic debt. When they say the government, they mean you and every other taxpayer. The public-private investment program, which ironically is anything but an investment and does not resemble a partnership, is one of these crony banking ideas. Yet that doesn’t resolve the fact that if you are unemployed or have a mega-mortgage then any housing payment is a burden that isn’t within your budget! These programs are to aid Wall Street and all lenders that are still living in their delusional crony world of housing bubble economics.

Yet some of the public are taking notice. During the Great Depression the word banker took on a negative connotation and I don’t see how it is avoided during our Great Recession. But let us look at those OCC and OTS stats:

This is important information so let us spend some time here. This data covers approximately 64 percent of all first lien mortgages. In the data covered by the report, we have a sample of 34 million mortgages. Of these 34 million mortgages, we can say that 11.8 million loans (the Alt-A, subprime, and other) are questionable. Essentially 34 percent of the entire portfolio is made up of junk! Here is the breakdown of the loan categories:

This is junk! In fact, that “other” category is a mix of Alt-A, subprime, and prime but these are loans made with no credit scores or low documentation! Who in the world knows what this crap is. We have a better chance of guessing what is floating in the Los Angeles River. And those in the housing industry are eagerly waiting to unload this crap to the public. Let us just assume that the entire portfolio has mortgages with the same balance. 34 percent of $6 trillion is $2.04 trillion! As you all know 634,000 of those Alt-A loans are here in California with an average balance of $420,000+. According to data from the OCC and OTS, there are still 3.5 million Alt-A loans floating out there. But fear not, loan modifications are way up. Let us look at that data:

The crap California is doing is nationwide. That is, with loan modifications and workouts the main strategy is to convert loans into option ARM, low teaser rate, 40-year mortgages. Take a look at those principal reductions! Bwahahaha! Now you know why they ripped out all that cram-down legislation. With bankruptcies skyrocketing many of these loan modifications and workouts are basically converting people to renters and locking in the bubble price of the home.

Think of a situation in our current market. You buy a home at the peak for $500,000 and the home is now worth $300,000. Their idea of a workout is turning your loan into a 40-year mortgage with a teaser rate. But what happens when you want to sell? You can’t! Homeowners are now being swindled once again by the same banks that issued this toxic waste under the guise of “helping” you. Sort of like how Bernard Madoff helped all his investors; things look good until you read the fine print or dig deeper. The Alt-A and option ARM wave is going to hit California like a tsunami especially in the more so-called prime areas. Some of these people think they are insulated from the rest of the state economy in silos. They are going to find out the hard way in the next few months.

What the OCC and OTS data tells us is this problem goes beyond California. You can look at Florida, Nevada, and Arizona and these states are loaded as well with these toxic mortgages. Yet you will find the toxic waste in every state. And to show you how much a waste of time this is look at the re-default rates:

If we extend this out to another year and break the data out by Alt-A, subprime, and prime I bet you would see in some categories a 90 percent plus re-default rate. The data is telling us this is a waste of time. It seems like people are hell bound to repeat the lessons from Japan.

Some people have told me, “but California housing is now affordable. It is a good time to buy.” I have decided to compile a list of median household income and median home prices for all California counties to show you that we are still over priced in many regions:

The above chart sums up the California situation. What you have is the lower-end being pummeled and now having more modest price to income metrics. Yet those higher priced areas, those areas with the 643,000 Alt-A mortgages with a nice average sum of $420,000+ are going to take it on the chin next. These numbers are simply unsupportable. Bottom callers are drinking the Kool-Aid once again. Ironically, we may see the median price stabilize but this does not show the real story. The mid to upper range of the market will fall, creating more sales, and thus creating volume to shift the median price up. For example, say a place like Culver City has a $600,000 home that sits on the market for ages. The place has a nice Alt-A, the borrower walks away and the bank is forced to unload it. It goes for $400,000. The median price for L.A. County is $300,000 so this gives fuel to a higher median price but the place took a $200,000 hit. This will happen.

The state has an 11.5 percent unemployment rate (the highest in record keeping history), the state is slashing the wages of 200,000 employees, more layoffs are in the pipeline, the Alt-A and option ARM problem is not being addressed by delusional loan mods and workouts, and yet this is the bottom. What high paying industry is being created to give birth to the new era of suckers that will over pay for housing in those so-called prime areas? Maybe we can start buying homes with IOUs.

Orange County had a median price of $258,000 in 2000 and Los Angeles County had a median price of $192,000. Just think of that when you see the current median price for Orange County of $411,000 and $300,000 for Los Angeles. To describe the problem takes much analysis. Solution? Let these homes foreclose as quickly as possible and let banks fail. But too many people believe in the Angelo Mozilo school of, “homeownership is not a privilege but a right!”

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The Continued Crony Banking and Housing Industry Bailout: Foreclosure Scams, Japan Subprime Loans Coming Back, and Generally Bad Advice for American Consumers.

It is amazing that those who have been wrong predicting the housing collapse are now the folks guiding policy. As I discussed in the last article regarding Alt-A loans and the California Foreclosure Prevention Act, all that is being done is the state is institutionalizing option ARMs which is flat out insanity and would make anyone feel like they took crazy pills. Why is this nuts? The so-called modifications include freezing the interest rate, negative amortization, 40-year terms, and gimmicky teaser rates. However, you can forget about lenders knocking down the principal balance since this will actually eat into their delusional profits (and would most likely make them explode like a piñata).

I love how some people to fit their own agenda (i.e., those in the real estate industry or deeply connected to it) have now taken it on their behalf to use our argument about the coming Alt-A tsunami for further government bailouts! Dear readers, as I warned you back before TARP became the utter monstrosity that it is for the crony bankers, this kind of thinking will lead to more taxpayer waste. I recently saw this argument floated but want to address it as quickly as possible:

“(LA Times) One proposal for a debt-forgiveness program was floated this month by the Milken Institute in Santa Monica. The plan, authored by institute President Michael Klowden and regional-economics director Ross DeVol, would refinance existing mortgages of underwater homeowners with new loans from the government.

Klowden and DeVol call it the “homeowner principal forgiveness vesting plan.” Here’s how it would work:

Say an owner’s mortgage is worth $400,000 but his house is valued at $300,000. The government would refinance the $400,000 loan with two new loans. Fannie Mae, the mortgage financier now under government control, would provide a first loan for the market value of the house, in this case $300,000. The Treasury would issue the second loan, in this case for $100,000.”

This is a bad idea. Since some people are misconstruing what many of us who have been warning about with the Alt-A and option ARM tsunami let me be clear about my position:

These homes should be taken back in foreclosure. Banks must eat their losses. If it is game over for them, so be it. We have a healthy rental market. People won’t be out on the streets. To take a loan from an irresponsible gambler (aka lender) and convert it to a government loan is absolute insanity. It is a scam. A swindle. I bet many of you are seething and probably have the desire to punch your monitor now that you know how this housing casino works. But guess what? This plan is much more of a crony bailout:

“They estimate that the cost to Treasury (and thus to taxpayers) of saving 1.5 million homes from foreclosure or abandonment with this plan would be between $75 billion and $100 billion. That assumes the government wouldn’t jeopardize the original lenders’ balance sheets by forcing them to share in the cost via haircuts on their loans.”

Oh really?! We wouldn’t want to jeopardize all those crony banks and Wall Street right? So let me get this straight. The purpose of this plan is to:

(1) Bailout lenders who made irresponsible loans?

(2) Give over leveraged homeowners and speculators an easy way out?

(3) Put the toxic waste onto the taxpayers’ bill?

(4) Expect lenders to walk away with no serious repercussions?

I know many of you are against the prospect of nationalization when I tossed it out many months ago. These kind of “plans” and additional workouts are actually going to cost us more than simply going in with a strong arm and gutting the system. That ship alas has sailed politically so fear not. But take a look at those banking and Wall Street stocks. Guess who won? It wasn’t the average American. However, these are the consequences of allowing the corrupt banking system to guide bailout policy. Seriously folks, here in California many people should lose their homes and become renters. Enough with the renting stigma and the notion that everyone should own a home. If you make your payment and are prudent then you have nothing to worry about. Yet if you over leveraged yourself and took a HELOC to put in a pool with faux rocks and a waterfall or bought at the peak then why should the government bail you and your lender out?

Some people are making the comparison to the S&L crisis and the Home Owners’ Loan Corporations during the Great Depression. Here are some facts about the HOLC:

-At the peak it was massive employing some 20,000 people

-HOLC received 1.9 million applications for home loans with 1 million being approved

Even with favorable terms and conditions, 20 percent of these loans failed! With that kind of rate most banks would sink. And by the way, the HOLC did file 200,000 foreclosure auctions and this experiment never revived mortgage lending which remained anemic for another decade. Why? Because the nation was in something called the Great Depression! Our housing obsession started nearly a century ago. If you have a weak economy chances are, you are going to see problems with housing. The solution isn’t to give more loans to people who can’t afford them. The solution is to focus on creating a sustainable economy with a laser focus on job creation.

By the way, as crazy as the housing market was during the Great Depression and the S&L crisis, we have never seen the amount of toxic garbage like Alt-A and subprime loans like we have in this market. So those that use those past experiences have no reference because we have never scorched the Earth with so much toxic waste that we once called “creative financing.”

The ideas being proposed are as bad as the loans that got us here in the first place. If you want an idea of how this is going to play out you should really examine what Japan went through with their double bubbles just like we did. In fact, Japan has a tsunami of their own giving us a Scrooge like glimpse into our Ghost of Christmas Yet to Come if we don’t change course:

“(UK Times) A housing loan default problem is looming and likely to begin in the next few weeks. It amounts to the detonation of a ten-year time bomb that, researchers at the Tokyo Foundation say, started ticking around 1999 in the immediate aftermath of the Asian financial meltdown. This is the result of flawed government policy, whereby the state housing loan agency offered mortgages to families that they knew were unable to pay. According to the think-tank, those loans were made on the assumption that the traditional staples of Japanese corporate life - seniority-based pay increases, constantly rising bonuses and lifetime employment - would remain as fixtures.

The impending meltdown, which the Tokyo Foundation believes could affect some hundreds of thousands of households, will be focused initially on the country’s industrial heartlands, where corporate bankruptcy rates are rising. The residential zones around Toyota’s home territory of Nagoya could become ghost towns, Kazuo Ishikawa, the think-tank’s senior research fellow, said.”

Can things get any clearer? With Americans losing some $13.87 trillion in household wealth, we have seen our own lost decade yet people keep refusing to examine the lessons of Japan. Now Japan is seeing their own horrific policies of propping up a failed banking system. No bank should be too big to fail. And foreclosures are necessary to reach a bottom quicker. The CFPA for example is merely a kicking of the can down the road policy. Don’t you find it ironic that whenever cram-down legislation is introduced into Congress the banking industry shoots it down but once the government is involved in sucking up those toxic loans, the lenders come out of the woodwork? Cram-downs don’t work when lenders need to eat the principal but when they use the taxpayers’ dime, then they are all for it. The banking industry is still operating under similar terms that caused the bubble and we keep funneling money into this sector. Are people not outraged anymore? I remember back only in September of 2008 people were calling up their representatives and mounting quixotic battles for a few billion dollars in proposals. Now, we are days away from the worthless public-private investment program and the public seems in a daze.

There is now an industry leaching on those in financial trouble:

“(LA Times) David Berenbaum, vice president of the National Community Reinvestment Coalition, called on newspapers to stop running ads by “for-profit racketeers who charge on average $2,900 to consumers for poor advice.” Examples he cited included counsel to not pay the mortgage or contact the service provider. HUD-approved counselors will help consumers for free.”

This is another problem with running programs like the CFPA or any government sponsored help. You will have these shady operators pop up to scam folks and take any money left from those who really need a call that goes something like, “unfortunately, you are insolvent. Here is what is needed to file for foreclosure.” It is that simple financially but I know emotionally, it is difficult. But don’t you think it will make it harder when you prolong the suffering with gimmicks and scams? If we kept a simple message and didn’t compound this problem further, we’d have a tough couple of years but now we are risking the fiscal sanity of our country because the banking system has our government in some form of deep capture.

Think for a few minutes. At the end of the day, someone is going to have to realize those losses on all these toxic mortgages. The only question is who is going to take the brunt of the fall? Many borrowers are losing their homes yet somehow, the big banking centers are still up and running and supposedly turned a first quarter profit thanks to the taxpayer bailout.

These bailouts have compounded the mess. In fact, it has clouded sound judgment. I think most Americans would have been even okay with say a bailout that went like, “the median home price in America is roughly $150,000. If you have a mortgage below that, we can take a look. Anything above that and sorry.” Instead, we are trying to game the system to unload the gambling happy California and mega-mortgages to the rest of the country. Need I remind you that the state has 643,000 Alt-A mortgages with an average balance of $420,000+? Sound policy involves foreclosure but you’ll never hear that from the pundits since they have their hand too deep in the bailout cookie jar.

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