Housing Update

Joe Nocera had a good housing piece in the New York Times yesterday. It led me to a research report written by Laurie Goodman of Amherst Securities titled "New Ideas to Address the Glut of Foreclosed Properties".

First, the backlog, or "shadow inventory":

The first column is Non-Performing Loans, more than 12 months delinquent, plus loans in some stage of foreclosure. The second column is Real Estate Owned, or Bank Owned Homes, i.e., those that did not sell at Foreclosure Auction. The third and fourth columns show quarterly and monthly loan or home sales out of this shadow inventory. As you can see, we had a tick down in 2011Q2, but we still have 32 months inventory.

Next, we have the problem of underwater mortgages, where a mortgage is valued at moire than or the same value as the house. Goodman works out probabilities about how many of these underwater homes will foreclose, computes a total estimated "new foreclosure rate", spreads those over 6 years, compares that to the expected rate of home sales, and concludes we have a big excess supply problem. Take a look:

NPL is a Non-Performing Loan. RPL is a Re-Performing Loan (was once non-performing, is now performing). APL is an Always Performing Loan with greater or lesser Mark to Market Loan to Value. Laurie then computes probabilities for new default in each of the categories, and gives a lower bound and a reasonable estimate: up to 10.4 million more homes will move into foreclosure over her estimate of 6 years, or up to 1.7 million per year.

Laurie adds in new home construction and estimates demand:

Goodman concludes that we will have up to 1.0 million plus homes per year over and above what our normal demand would be - 4.1-6.2 million homes excess over six years. And if we don't find a way to move them, the downward price spiral, somewhat steady for now, will take off again, restarting the killer wealth destruction cycle.

Goodman then shows how the GSEs' and the Banks have tightened their loan standards:

Then we see broad evidence that the home affordability index has moved way up, just when homeowners are seemingly trapped by underwater mortgages and the new, tighter loan standards:

She then presents statistics showing how rental vacancies are down and returns on rental investments have improved:

Goodman then develops a proposal for the GSEs' and the Banks, under a major new Home Rental Initiative, to sell geographically connected  groups of houses (blocks of 200 homes is proposed) to private investors with proved-up experience in managing real estate assets. The Government would provide financing and should consider joint venture arrangements.

The Administration has expressed interest in some form of rental program, but nothing of this scale has yet surfaced. Trying to do something for underwater borrowers is also very much on the radar screen, as evidenced by the recent Executive Order supporting the GSEs' in supporting home mortgage refinancing, allowing the Agencies to relax the loan to value ratios - i.e., a 125% loan to value would be allowed.

My take: This is a great idea. And it might be possible to combine Goodman's proposal with an earlier idea of mine,  where underwater and delinquent homeowners are given the option (before formal foreclosure) to enter a new rental program, with an option to buy back the home at the then appraised value, after 3 to 5 years of good performance as a renter.

A big-scale program like this (5-6 million homes in six years) would allow a lot of screwed up title to be reset, starting again with a clean slate (though I do not think the offending banks should be released from all liability). This would inject from $600 billion to $1 trillion into private household balance sheets, as the mortgages are taken off the family books. And when Mom and Dad are feeling wealthier, they will spend more, reigniting the US consumer, who always has been the key to our GDP growth. And moral hazard would be very limited, since the homeowners converting to renters are not getting something for nothing, since they will give up their homes.

Am convinced there is something important here for the country.