No, not California, but everywhere that housing prices are falling. This article points out that banks buy their own foreclosed houses for what they’re owed, then carry them on the books at at least that value, if not a bit more. Welcome to the land of toxic assets.
A good local example of this is the recent foreclosure auction on Round Hill Road (414? I forget – the land and tear-down behind Round Hill Community Church, once owned by Robert Weiss). Seven indivisible acres with a house riddled with mold, the bank was owed $3.9 million and I believe that’s what they bid. I don’t think the land is worth anything like that – very nice property, but in this market, if I were a guessing man, I’d say somewhere between $2.7 and $3.3 ought to take it. If I’m right, there’s as asset on that bank’s books that’s being carried for at least $700,000 more than it’s worth. If I’m right. Here’s a portion of the article I link to – don’t miss the paragraph, “Dislocation Ideology” – it sums up what’s happening here, in my opinion.
Dropping Prices Mean Hidden Losses Mount. The bank’s purchase of the house may have put a floor on the immediate losses from the mortgage default but it doesn’t stop housing prices from dropping. If the housing market continues to deteriorate, the house now owned by the bank could be worth even less. The bank bought the house for $175K and booked it at $190K. But the market value of the house could be far less. If the value of the house drops to $150K, the bank is sitting on unrealized losses of 25% but has only booked a 5% loss.
How To Invent A Toxic Asset. Let’s conclude with the idea that this is exactly how a toxic asset is created. A bank buys something and books it at a value that winds up being far higher than the market value. It can’t sell the asset without realizing horrific losses. Investors and creditors of the bank know that it is holding these things at far above their real value, however, and discount the credit worthiness and profitability of the bank accordingly.
Dislocation Ideology. All of this is made possible by one thing: an ideological conviction that the national housing slump should have been impossible and therefore that housing prices are sure to recover shortly. That’s what we call the “Dislocation Ideology”–the idea that housing markets are temporarily dislocated and will soon find themselves back on the old path onward and upward.If a long term downturn were acknowledged, a conservative bank would avoid buying foreclosed houses and prefer to take the losses up-front, letting the outside buyers pick up the home and the downside risk of further price slides. But banks are still long housing, so they keep buying houses and booking them at inflated values.
No education in economics – just a lowly Realtor. Nevertheless, here is what I haven’t understood from the beginning of the downturn in real estate.
Wouldn’t it have made far more sense for those holding the original mortgages to somehow alter the contracts and keep people in homes rather than go through the foreclosure process? At least, in the cases that weren’t egregious?
In our community, it seems that the more foreclosures, the more the entire market is dragged down. While it would cost banks and shareholders a pretty penny to do the rewriting – as far as I can determine, it would be many pennies less than going through the foreclosure process – which in turn damages the entire market and lowers values even further.
I’m sure I must be missing something. I’ve been told that the lenders are unable to do this.
But – IF this is the case, no one has really explained to my satisfaction why it is.
Help.
Peg, I watched that phenomenon occur in the early 90′s when a family member was trying to sell a studio apt. in NYC’s Tudor City for, I think, the princely sum of $30,000 (unhappy homeowners, take note: that same studio would sell, even today, for at least 10X more, I think). A bank foreclosed on a developer who had 20 identical units in the same complex and dumped them on the market, all at once, for $20,000. It wiped out everyone who was trying to sell and certainly hurt the bank. So why’d they do it? I don’t know either, but perhaps a banker or lawyer reader can explain the appropriate regulations or business sense that forces such action.
Peg,
The answer is that there is no one to renegotiate with in most cases, as most mortgages have been sliced, diced, and packaged into mortgage-backed securities that have covenants holding the terms inviolate. There is no George Bailey to talk to at the Building and Loan anymore.
The other side to this discussion that everyone (including the politicians) refuses to focus on (understand) is affordability.
Even if we could wave a magic wand and every house on the market that is in foreclosure was suddenly saved, prices would still have to come down. And that is because buyers don’t have the income/assets to sustain high prices (no money down, stated income nonsense is gone). And this is without addressing the impact of job loss, which is an additional substantial downward force on prices.
All the machinations that our “leaders” are pursuing are about making the declines gradual so the financial system can handle the process of re-pricing overtime. They are hoping inflation will bail out the banking system. I personally do not think it will work. The markets are too big for even the US government to manipulate successfully over any length of time.
Unless we keep rates low forever (meaning for the next buyer and the next buyer ad infinitum), or we generate substantial wage inflation (but keep interest rates low (nice trick if the Fed can pull it off)), the price of real estate has to come down. All the rest is just noise…
For at least a few years, I kept on walking around my office and muttering “what WILL happen if interest rates go from 5.25% to 7% – or, God forbid – even higher?”
It never quite came to that. But, the simple fact is that for most folks, they purchase what they can afford with monthly payments. They don’t care if the price of a home is $350,000 or $900,000. “What’s my payment going to be?” is what I always hear. (Sorry Chris – this is true outside of la-la land.)
I saw people buying homes in early in our decade, paying twice what the current owners had paid for them – yet the new buyer’s loan payments were LESS than the previous owner had been paying. It always seemed like a prescription for disaster when the prices skyrocketed up, largely based on the very low interest rates.
Now we’re paying the piper. And, I realize that the loans have been sliced and diced. But – can’t some fund manager appreciate that taking a 30% hit or 40% hit is superior to a 50-70% hit when he has to foreclose on a house?
Answer: I guess not.