How to Reverse the Continuing Housing Recession: "Tenants Anyone?

" Views by Steve Trowern, June 2011

For those who may think that the housing market has bottomed and there is a light at the end of the tunnel, think again. That isnt a light at the end and its not a train coming either. It might just be a blistering ray of solar radiation that could evaporate everything in its path, a wave of housing supply that will quickly overwhelm any hope for home price stabilization, much less an actual recovery. There is a shield, however, if politicians, policy makers and regulators can find the fortitude to redefine the American Dream. The few several months of 2011 offered a glimmer of hope to housing optimists that the worst was behind us. What many, however, failed to properly incorporate into their outlook are basic dynamics of supply and demand. Over the last 6 months, the nations housing supply has been artificially (and temporarily) held at bay by moratoriums imposed on the big servicers over foreclosure practices while buyer demand has remained relatively constant. Econ 101 would instruct us that, under this scenario, home prices should rise. Instead, during the same period home prices continued their decline, falling an additional 4-5% on an adjusted basis. According to an increasingly number of economists, including Robert Schiller, we should expect to see this trend continue another 20-25% over the next several years. Why? Because the supply of homes expected to hit the market is more than double all of the homes sold in 2010 and YTD 2011 combined. Large banks, private investors and the GSEs know this and are racing to the bottom to unload their existing homes before the tsunami hits. The GSEs alone have nearly 300,000 houses already owned and that figure grows by thousands every month. Recent CNNMoney headlines are telling. Walk Away from your Mortgage: Time to

Get Ruthless (June 7) highlights the driving force behind all of this supply: underwater homeowners. The number of strategic defaulters is accelerating as more people make a basic economic decision to walk away. In Squatter Nation: 5 years with no mortgage payment (June 9) savvy consumers are exploiting borrower-friendly courts and judges to remain in their homes for years (5 years or more is not uncommon without making a single payment in the northeast). When these borrowers finally do lose their homes, they will never join the ranks of buyers again. The same goes for most of the walk-away borrowers. In a recent Fannie Mae survey, 27% of homeowners would consider walking away from their mortgage if home prices keep falling, nearly double from a year ago, and more than 50% no longer believe owning a house is a good investment. The number of people who fit into these buckets is staggering: More than 4 million mortgage borrowers are either in foreclosure or are seriously delinquent. Most of their houses will end up on the market as short sales or foreclosure sales. Private estimates put the figure, often referred to as shadow inventory at more than 6 million. Consider that in light of a housing market that under normal conditions would clear about 4 million sales per year and currently has more than 2 million properties listed. Carrying costs for owners taxes, insurance, maintenance, financing exceed 10% annually so when the shadow inventory come on the market, creating a 2+ year inventory, sellers immediately drop prices by at least 10% just to stay in front of the competition. That would lead to further price erosion, more underwater home owners and more strategic defaulters. Supply will increase and demand will decrease, driving home prices down, which in turn will create a self-perpetuating cycle. So how do we stabilize home prices if there is limited homeowner demand? The answer, of course, is to reduce the supply through other means. We need to prevent the majority of the shadow inventory of homes from ever reaching the market in the first place and give the market time to absorb existing inventory. Modifications programs have largely been ineffective and foreclosure moratoriums, which reward bad actors (the squatters) as often as not while increasing costs and uncertainty, are perhaps the worst inhibitor to home price recovery. What are required are bold governmental initiatives to promote renting as a means to stabilize home prices. Start by accelerating the sale of entire GSE and FHA REO positions, which are worth on the order of $40-$50 billion, to private investors who could form large scale leasing portfolios. Divert what remain of federal and state funds from loan modification programs to rental-assistance programs. Rather than pay mortgage servicers to modify deeply delinquent borrowers who, after modification of the payment, are still underwater on their homes, reward servicers to convert them into tenants at reduced housing payments. Keeping people in homes and kids in schools while avoiding foreclosure signs on front lawns is almost always a good thing. Modifying borrowers to buy time without addressing negative equity is rarely an optimal outcome. And maybe, just maybe, adjust tax incentives to take into account all forms of housing payments, not just mortgage interest. From the 1970s through the 1990s, US homeownership levels were approximately 63.5%.

By 2005, that figure peaked at 69% before falling to about 67%, where it stands in 2011. This 3.5% delta between current and historical ownership levels represents approximately 4.5 million housing units or around the same number of borrowers in foreclosure or seriously delinquent. At the same time, rental vacancies have fallen steadily from 10.81% to around 7.5% (5% is considered zero vacancy due to normal turnover) while rents have increased just as dramatically, to the point where rent inflation is now a major worry for many economists. Perhaps owning a home is a less important part of the American Dream than living in a home that one can afford; we just have more houses in this country than can or should be owned by individuals. Weighing in how to address the housing crisis in the tumultuous days surrounding the collapse of Lehman Brothers, former Federal Reserve Chairman Alan Greenspan famously quipped, We should buy up all the vacant houses and burn them down. Maybe he was right. At least they wouldnt be for sale. Steve Trowern is a founding partner at MCM Capital Partners, LLC, a residential mortgage investor and advisor, based in Bethesda, Maryland.