Lenders are bringing back 100% financing. Do you believe they can do it effectively? I have my doubts.

Irvine Home Address … 25 LAURELWOOD Irvine, CA 92620

Resale Home Price …… $899,000

Things just couldn't be the same

'Cause I'm as free as a bird now

And this bird you cannot change

Lynyrd Skynyrd — Freebird

Zero down mortgages were a big factor in the inflation of the housing bubble. The debate now is whether or not this form of financing is inherently bad or if that bird can change. This is one Phoenix that probably shouldn't rise from the ashes.

I wrote about the evils of 100% financing in The Great Housing Bubble:

100% Financing is a path to destruction

Once 100% financing became widely available, it was enthusiastically embraced by all parties: the lenders suddenly had a huge source of new customers to generate high fees, the realtors and builders now had plenty of new customers to buy more homes, and many potential buyers who did not have savings were able to enter the market. It seemed like a panacea; for two or three years, it was. There was a problem with 100% financing (which was masked by the rampant appreciation brought about by its introduction): high default rates. The more money people had to put in to the transaction, the less likely they were to default. It was that simple. The borrowers probably intended to repay the loan when they got it, however they did not feel much of a sense of responsibility to the loan when the going got tough. High loan-to-value loans had high default rates causing 100% financing to all but disappear, and it made other high LTV loans much more expensive, so much so as to render them practically useless. It was all part of the credit tightening cycle.

Besides stopping people from saving for downpayments, 100% financing harmed the market by depleting the buyer pool. In a normal real estate market, first-time buyers are saving their money waiting until they can make their first purchase. This usually results in a steady stream of first-time buyers that enter the market each year. When 100% financing eliminated the downpayment requirement, it also eliminated any need to wait. Those who ordinarily would have bought 2-5 years in the future were able to buy immediately. This emptied the queue. This type of financing appears periodically in the auto industry, especially in downturns when it is necessary to liquidate inventory. The term for this is “pulling demand forward,” because it reduces demand for new cars in the next few years. This might not have been a problem if 100% financing would have been made available to everyone forever; however, once downpayment requirements came back those who would have been saving were already homeowners, so there were few new buyers available, and any potential new buyers had to start over saving for the downpayment they thought would never be required. The situation was made worse because those late buyers who were “pulled forward” from the future buyer pool overpaid, and many lost their homes. This eliminated them from the buyer pool for several years due to poor credit and newly tightened credit underwriting standards. Thus, most who thought 100% financing was a dream come true found it to be a nightmare instead.

Mortgages as Options

An option contract provides the contract holder the option to force the contract writer to either buy or sell a particular asset at a given price. A typical option contract has an expiration date, and if the contract holder does not exercise his contract rights by a given date, he loses his contractual right to do so. An option giving the holder the right to buy is a “call” option, and the option giving the holder the right to sell is a “put” option. Writers of option contracts typically obtain a price premium for taking on the risk that prices may move against their position and the contract holder may exercise his right. The holder of an options contract willingly pays this premium to limit his losses to the premium paid if the investment does not go as planned. Most options expire worthless.

Mortgages took on the characteristics of options contracts in the Great Housing Bubble. Speculators utilized 100% financing and Option ARMs with low teaser rates to minimize the acquisition and holding costs of a particular property. The small amount they were paying was the “call premium” they were providing the lender. If prices went up, the speculator got to keep all the gains from appreciation, and if prices went down, the speculator could simply walk away from the mortgage and only lose the cost of the payments made, particularly when this debt was a non-recourse, purchase-money mortgage. Another method speculators and homeowners alike used was the “put” option refinance. [viii] Late in the bubble when prices were near their peak, many homeowners refinanced their properties and took out 100% of the equity in their homes. In the process, they were buying a “put” from the lender: if prices went down (which they did,) they already had the sales proceeds as if they had actually sold the property at the peak; if prices went up, they got to keep those profits as well. The only price for this “put” option was the small increase in monthly payments they had to make on the large sum they refinanced. In fact, on a relative cost basis, the premium charged to these speculators and homeowners was a small fraction of the premiums similar options cost on stocks. Of course, mortgages are not option contracts, and lenders did not view themselves as selling option premiums to profit from the premium payments; however, speculators certainly did view mortgages in this manner and treated them accordingly.

The "put" and "call" option features of mortgages during the bubble are the direct result of 100% financing. Speculators and homeowners have too little to lose to behave responsibly when 100% financing is available. Without increasing the cost to speculators through downpayments or a loan-to-value limit on refinances, speculators are going to utilize these mortgage products in ways they were not intended. There are many expensive lessons learned by lenders concerning 100% financing during the Great Housing Bubble.

With the problems of 100% financing, it is a legitimate worry that we may not want to let that genie out of the bottle.

New Program for Buyers, With No Money Down

By JOHN LELAND

Published: September 4, 2010

MILWAUKEE — When the housing bubble burst, one of the culprits, economists agreed, was exotic mortgages, including those that required little or no money down.

But on a recent evening, Matthew and Hannah Middlebrooke stood in their new $115,000 three-bedroom ranch house here, which Mr. Middlebrooke bought in June with just $1,000 down.

Because he also received a grant to cover closing costs and insurance, the check he wrote at the closing was for 67 cents.

“I thought I’d be stuck renting for years,” said Mr. Middlebrooke, 26, who earns $32,000 a year as a producer for a Christian television ministry.

The guy is only 26. Perhaps he could save money for a while like everyone else his age that wants to buy a house. Is a no money down house the new entitlement for twenty somethings?

As long as the borrowers are Christian ministers, I guess 100% financing is okay, right? Is this borrower more moral than the strategic defaulters who walked away from zero-down mortgages?

Although home foreclosures are again expected to top two million this year, Fannie Mae, the lending giant that required a government takeover, is creeping back into the market for mortgages with no down payment.

Mr. Middlebrooke’s mortgage came from a new program called Affordable Advantage, available to first-time home buyers in four states and created in conjunction with the states’ housing finance agencies. The program is expected to stay small, said Janis Smith, a spokeswoman for Fannie Mae.

Option ARMs were expected to stay small when they were rolled out too. A niche product with high appeal inevitably is made more widely available, and as these programs expand, buyers enter the market, prices go up, and the problems are masked by another housing bubble.

Some experts are concerned about the revival of such mortgages.

“Loans that have zero down payment perform worse than loans with down payments,” said Mathew Scire, a director of the Government Accountability Office’s financial markets and community investment team. “And loans with down payment assistance” — like Mr. Middlebrooke’s — “perform worse than those that do not.”

The evidence is clear: zero down loan programs have high default rates. Why should we pay the bad debts of the many who default to help the few that don't?

But the surprise is the support these loans have received, even from critics of exotic mortgages, who say low down payments themselves were not the problem, except when combined with other risk factors like adjustable rates or lax underwriting.

Moreover, they say, the housing market needs such nontraditional lending, as long as it is done prudently.

Again, the Option ARM is not a bad loan when given to the right people. The problem is that these loan programs are never contained to only the right people.

“This is subprime lending done right,” said John Taylor, president of the National Community Reinvestment Coalition, an umbrella group for 600 community organizations, and a staunch critic of the lending industry. “If they had done subprime this way in the first place, we wouldn’t have these problems.”

At Harvard’s Joint Center for Housing Studies, Eric Belsky, the director, said the loans might be the type of step necessary to restart the housing market, because down payment requirements are keeping first-time home buyers out.

I mentioned that problem above. This is a problem the housing market is going to have to get past. You can't give out 100% loans without having problems. The default rates will be high, and the programs will lose money. Do we really want to replace all the bad loan programs that inflated the bubble with government-run programs of the same ilk?

“If you look at where the market may get strength from, it may very well be from first-time buyers,” he said. “And a very significant constraint to first-time buyers is the wealth constraint.”

First-time buyers are really the only game in town. There is no move-up market while prices decline or stagnate.

The loans are the idea of state housing finance agencies, or H.F.A.’s, quasi-government entities created to help moderate-income people buy their first homes.

Throughout the foreclosure crisis, the state agencies continued to make loans with low down payments, often to borrowers with tarnished credit, with much lower default rates than comparable mortgages from commercial lenders or the Federal Housing Administration. The reason: the agencies did not offer adjustable rates, and they continued to document buyers’ income and assets, which many commercial lenders did not do. In 2009, the agencies’ sources of revenue dried up, and they had to curtail most lending.

Then they created Affordable Advantage. The loans are 30-year fixed mortgages, with mandatory homeownership counseling, available to people with credit scores of 680 and above (720 in Massachusetts). The buyers have to put in $1,000 and must live in the homes.

They keep out conventional investors with these requirements, but the specuvestor homeowner is strongly encouraged to buy a property with the government covering their downside risk. No risk loans are a bad idea.

All of these requirements ease the risk, said William Fitzpatrick, vice president and senior credit officer of Moody’s Investors Service. “These aren’t the loans that led us into the mortgage crisis,” he said.

So far Idaho, Massachusetts, Minnesota and Wisconsin are offering the loans. The Wisconsin Housing and Economic Development Authority has issued 500 loans since March, making it the first state to act. After six months, there are no delinquencies so far, said Kate Venne, a spokeswoman for the agency.

The agencies buy the loans from lenders, then sell them as securities to Fannie Mae. Because the government now owns 80 percent of Fannie Mae, taxpayers are on the hook if the loans go bad.

The US taxpayer is covering the losses of a new breed of speculator-homeowners.

The state agencies oversee the servicing of the loans and work with buyers if they fall behind — a mitigating factor, said Mr. Fitzpatrick of Moody’s.

“They have a mission to put people in homes and keep them in homes,” not to foreclose unless other options are exhausted, he said. The loans have interest rates about one-half of a percentage point above comparable loans that require down payments.

Ms. Smith, the spokeswoman for Fannie Mae, distinguished the program from loans of the boom years that “layered risk on top of risk.”

With the new loans, she said, “income is fully documented, monthly payments are fixed, credit score requirements are generally higher, and borrowers must be thoroughly counseled on the home-buying process and managing their mortgage debt.”

That probably does help.

For Porfiria Gonzalez and her son, Eric, the loan allowed them to move out of a rental house in a neighborhood with a high crime rate to a quiet street where her neighbors are retirees and police officers.

So this mortgage saved her and her son from the evils of drug dealers, gangs, and random violence. Pity the poor renters who have to continue to live in those crappy neighborhoods with pimps and prostitutes.

Ms. Gonzalez, 30, processes claims in the foreclosure unit at Wells Fargo Home Mortgage; she has seen the many ways a mortgage holder can fail.

On a recent afternoon in her three-bedroom ranch house here, Ms. Gonzalez said she did not see herself as repeating the risks of the homeowners whose claims she processed.

“I learned to stay away from ARM loans,” or adjustable rate mortgages, she said. “That’s the No. 1 thing. And always have some emergency money.”

When she first started shopping, she looked at houses priced around $140,000. But the homeownership counselor said she should keep the purchase price closer to $100,000.

A 40% reduction in price must have reduced the quality of the property she obtained a great deal. There is a tradeoff when deciding to purchase less.

“They explained to me that I don’t need a $1,200-a-month payment,” she said.

The counselor worked with her real estate agent and attended her closing. On May 28, Ms. Gonzalez bought her home for $90,500, with monthly payments of $834. After moving expenses, she has kept her savings close to $5,000 to shield her from emergencies.

“If I had to make a down payment, it would have wiped out my savings,” she said. “I would have started with nothing.”

Good thing she had some money to go shopping for furniture, right? How much of that emergency fund do you think she spent? If she didn't, I give her credit for great self-discipline. Most people would blow it on crap for the new house.

Now, she said, she is in a home she can afford in a neighborhood where her son can play in the yard. A neighbor brought her a metal pink flamingo with a welcome sign to place by her side door.

“My favorite part is the big backyard,” said Eric, 10. “And that’s pretty much it.”

“You don’t like it that it’s a quiet, safe neighborhood?” his mother asked.

“Yeah, I do.”

“He didn’t go out much with kids in the old neighborhood,” she said.

“Because they were bad kids,” he said.

Ms. Gonzalez said that owning a house was much more work than renting, and that when the basement flooded during a heavy rain, her heart sank.

“But I look at it as an investment,” she said, adding that a similar house in the neighborhood was on the market for $120,000.

That's a great attitude for zero-down buyers to have. Not. What would she be saying if comps were selling for $85,000?

Prentiss Cox, a professor at the University of Minnesota Law School who has been deeply critical of the mortgage industry, said the program met an important need and highlighted the track record of state housing agencies, which never engaged in exotic loans.

“It’s not a story people want to hear, because it won’t bring back the big profits,” Mr. Cox said. “The H.F.A.’s have shown how the problems of the last 10 years were about having sound and prudent regulation of lending, not just whether the loans were prime or subprime.”

He added, “One of the great and unsung tragedies of the whole crisis was the end of the subprime market.”

What? One of the great virtues of the crash has been the elimination of the subprime market. Why is it a good idea to loan money to people who have proven they cannot save money or make a consistent payment? Subprime borrowers are not stuck in poverty. Subprime borrowers suffer from the consequences of their own life's choices. Unless they prove they can make different choices, they cannot sustain home ownership, and loaning them money is only going to result in losses to the lender.

What do you think? Can no money down mortgages be underwritten prudently?

It's all an illusion

Sometimes I feel a bit sorry for the poor Ponzis in Irvine. There are thousands of Ponzis in communities all over California, but only the ones in Irvine have me looking through their dirty laundry. The illusion in Irvine is that a mob of high-income buyers live the good life. The reality is that many of them are pretending Ponzis that only made it by spending their home appreciation as soon as it appeared. Today's featured property is a Ponzi short sale.

• The owners paid $750,000 on 8/22/2003. They used a $600,000 first mortgage, a $74,900 second mortgage, and a $75,100 down payment.
• On 8/5/2004 they refinanced with a $700,000 first mortgage.
• On 4/26/2005 they obtained a stand-alone second for $44,250.
• On 11/9/2005 they refinanced with a $738,000 Option ARM and obtained a $220,000 HELOC.
• On 9/6/2007 they got another Option ARM for $837,615 and a $170,385 HELOC.
• Total property debt is $1,008,000.
• Total mortgage equity withdrawal is $333,100.
• Total squatting time is 10 months so far.

Foreclosure Record

Recording Date: 06/15/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 02/10/2010

Document Type: Notice of Default

Look at what these people spent, and look at the property they are going to lose because of that behavior. It's sad really.

Irvine Home Address … 25 LAURELWOOD Irvine, CA 92620

Resale Home Price … $899,000

Home Purchase Price … $750,000

Home Purchase Date …. 8/22/2003

Net Gain (Loss) ………. $95,060

Percent Change ………. 12.7%

Annual Appreciation … 2.3%

Cost of Ownership

————————————————-

$899,000 ………. Asking Price

$179,800 ………. 20% Down Conventional

4.36% …………… Mortgage Interest Rate

$719,200 ………. 30-Year Mortgage

$172,824 ………. Income Requirement

$3,584 ………. Monthly Mortgage Payment

$779 ………. Property Tax

$167 ………. Special Taxes and Levies (Mello Roos)

$75 ………. Homeowners Insurance

$170 ………. Homeowners Association Fees

============================================

$4,775 ………. Monthly Cash Outlays

-$848 ………. Tax Savings (% of Interest and Property Tax)

-$971 ………. Equity Hidden in Payment

$286 ………. Lost Income to Down Payment (net of taxes)

$112 ………. Maintenance and Replacement Reserves

============================================

$3,354 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$8,990 ………. Furnishing and Move In @1%

$8,990 ………. Closing Costs @1%

$7,192 ………… Interest Points @1% of Loan

$179,800 ………. Down Payment

============================================

$204,972 ………. Total Cash Costs

$51,400 ………… Emergency Cash Reserves

============================================

$256,372 ………. Total Savings Needed

Property Details for 25 LAURELWOOD Irvine, CA 92620

——————————————————————————

Beds: 5

Baths: 3 full 1 part baths

Home size: 2,588 sq ft

($347 / sq ft)

Lot Size: 4,510 sq ft

Year Built: 1997

Days on Market: 82

Listing Updated: 40355

MLS Number: S622100

Property Type: Single Family, Residential

Community: Northwood

Tract: Oakh

——————————————————————————

According to the listing agent, this listing may be a pre-foreclosure or short sale.

This property is in backup or contingent offer status.

Guard Gated Northwood Pointe. Desirable Oakhurst plan with main floor bedroom and bathroom. Beautiful entry with custom double door and tasteful hardscape. Formal living and dining with vaulted ceilings. Light and bright kitchen with granite counters and breakfast nook opens to family room with fireplace and built in entertainment center. Nice size yard with built in bbq. Walk to Canyonview Elementary and Northwood High School.

Currently, lenders control the housing market. How they go about disposing their supply will determine the fate of prices.

Irvine Home Address … 4 STAR THISTLE Irvine, CA 92604

Resale Home Price …… $640,000

Sometimes you think your playing the fool

he's runaround braking all the rules

some how that don't seem fair.

There's got to be a better way

you know what I'm trying to say

When It's Over! — Loverboy

Many people believe the crash is over because removing the supply stabilized prices. Most people who carefully watch housing markets agree that a cartel of lenders controls the market through its ability to control supply. Since lenders are being permitted to hold non-performing loans on their books — and allow delinquent borrowers to squat — they control the flow of properties through the foreclosure process. Also, they control the approval of short sales; therefore, they control the flow of properties through the short sale process. Since distressed sales of foreclosure properties and short sales make up a significant percentage of market sales, lenders control the bulk of the supply on the market.

I believe this cartel will fall apart (The Upcoming Collapse of the Banking Cartel) partly because all cartels are inherently unstable, and partly because the Government Expedites Foreclosures, Threatens Banking Cartel. The article below from the Wall Street Journal is one of the better descriptions of the problem I have read in the mainstream media.

Banks' Plans for Foreclosed Homes Will Drive Market

By NICK TIMIRAOS — SEPTEMBER 13, 2010

The speed at which house prices fall over the next few months could depend less on mortgage rates and Americans' appetite for home buying than on how banks decide to manage the huge number of foreclosed homes they own or may take from delinquent borrowers in the near future.

Unlike home owners, banks often are much quicker to slash prices to unload properties quickly.

This has certainly been true in the past, but lenders seem much more willing to emulate homeowner denial this time around. Loan owners are quick to lapse into denial on the false belief that prices will quickly rebound. We explored that phenomenon in Contrarian Investing and the Psychology of Deflation. Lenders are usually pressured by regulators and investors to process their non-performing loans and dispose of their REO. Because this inventory problem is so large, the groups that usually pressure disposition are embracing a hold-and-hope strategy largely doomed to fail.

The upshot is that, the more homes being sold by lenders, the faster prices tend to fall. That pattern was clear over the past two years: Price declines that began four years ago accelerated rapidly in 2008 as banks dumped foreclosed properties at fire-sale prices. By January 2009, the share of distressed sales had soared to 45% of all sales nationally; it was even higher in hard-hit markets such as Phoenix, according to analysts at Barclays Capital.

Even though mortgage defaults kept mounting, housing markets began to stabilize early last year as low prices and government interventions broke the downward spiral. Policy makers spurred demand for homes by holding down mortgage rates, offering tax credits for buyers, and extending low-down-payment loans through the Federal Housing Administration.

This is the squatting problem. We didn't have much squatting prior to 2008 because lenders processed their foreclosures in a timely manner. When they saw what this did to markets like Las Vegas, they stopped processing these foreclosures. Since subprime defaulted first, they were foreclosed on, and since the alt-A and prime mortgages defaulted later, and since those mortgages are much larger, lenders have opted to let those delinquent owners squat.

The government also attacked the supply problem. Regulators relaxed mark-to-market accounting rules, giving banks more flexibility in valuing certain real-estate assets and removing some of the impetus for banks to quickly foreclose.

This is mark-to-fantasy accounting, otherwise known as Amend-Extend-Pretend: 780 Day Short Sales, 60% of Delinquent Loans Remaining.

Meanwhile, the Obama administration put in place an ambitious program to modify mortgages.

The Home Affordable Modification Program has fallen short of its goals. So far, fewer than 500,000 loans have been modified, below the target of three million to four million. Yet the program served as a "closet moratorium" on foreclosures that stanched the flow of bank-owned homes to the market, said Ronald Temple, portfolio manager at Lazard Asset Management.

The result: The share of distressed sales fell by November to 25% of home sales, and prices stabilized. After rising in the winter, the distressed share fell to 22% in June, before bouncing to 30% in July.

The loan modifications programs have all failed, and they will continue to fail. They have provided some political cover for the amend-extend-pretend policy exercised by nearly every bank.

The problem is that these measures are wearing off. Demand plunged this summer after tax credits expired, and unsold homes are piling up. More foreclosures could move onto the market as borrowers fall out of the loan-modification program.

"We see the perfect storm brewing with rising supply and falling demand," said Ivy Zelman, chief executive of research firm Zelman & Associates and one of the first to warn of trouble five years ago. She estimated that distressed sales could account for half of the market by year-end if traditional sales didn't rebound.

Does anyone think the traditional sales market is going to rebound this fall and winter? I don't either. Ivy Zelman is usually correct. Her analysis has been some of the best of the housing bubble.

The market does have some tailwinds: Housing starts are at all-time lows. Banks have hired more staff to manage problem loans and government entities such as Fannie Mae and Freddie Mac that own a growing share of foreclosures are less likely to deluge the market.

Actually, the GSEs are processing their foreclosures: Government Expedites Foreclosures, Threatens Banking Cartel.

The next leg down in prices "isn't going to be the foreclosure-induced freefall where you just had inventory coming out the wazoo, and it was going to be sold one way or the other," said Glenn Kelman, chief executive of Redfin Corp., a real-estate brokerage.

He is probably right that we will not have a mass forced auction that pounds prices back to the stone ages, but we will have significant pricing pressure until this supply is cleared from the market.

Prices also have come down so much already they have less distance to fall. During the housing boom, prices inflated much faster than incomes rose, thanks to speculation and lax lending. The ratio of home prices to annual incomes reached 1.6 at the end of June, which is below the ratio of 1.88 from 1989 to 2003, according to Moody's Analytics.

By those metrics, prices are actually undervalued in markets that have already seen huge declines, such as Las Vegas, Phoenix and Los Angeles. But Moody's data show that prices remain "significantly overvalued" elsewhere, including Boston; New York; Seattle; Orange County, Calif., and Charlotte, N.C. Markets in both camps face supply imbalances that will pressure prices for years.

Moody's is right on. Las Vegas is too low relative to incomes, and Orange County is much too high.

The fastest cure for housing would be job creation because it would boost demand for homes while putting delinquent borrowers back on solid footing.

But if that doesn't materialize, policy makers face a thorny question: whether to intervene if price declines accelerate beyond the 5% to 10% that most economists expect. In recent weeks, the White House has been surveying industry analysts on how to manage the inventory overhang.

I believe the government will intervene if prices fall too fast, particularly if interest rates go up too fast: The Bernanke Put: The Implied Protection of Mortgage Interest Rates.

Analysts at Barclays Capital estimate that some four million loans are in some stage of foreclosure or are at least 90 days past due, down slightly from a January peak.

While more tax credits aren't likely, policy makers could still attack the supply problem by, for example, taking foreclosed homes off the market and renting them out.

An idea I endorse: From Squatting to Renting: Another Solution to Stabilize Housing.

Ultimately, market fundamentals will prevail "and any attempt to get around that will only be short-term," said Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School. But officials should be prepared to intervene anyway, she said, if psychology spurs a downward spiral "where price declines are feeding further price declines."

You mean if deflation psychology takes over? Good luck combating that one: Contrarian Investing and the Psychology of Deflation.

That leaves few attractive options. Prolonged intervention could backfire by creating uncertainty that keeps buyers on the sidelines. Extending foreclosure timelines also risks inducing more borrowers to default and live rent-free.

The amend-extend-pretend policy has been a fiasco: Thinking About Accelerated Default? The Average Squatting Time Is Up to 449 Days.

Letting the market take its medicine sounds more appealing than it did 18 months ago. But it risks saddling taxpayers and the banking system with billions more in losses and trapping more borrowers in homes on which they owe more than the house is worth.

Write to Nick Timiraos at nick.timiraos@wsj.com

Kudos to Nick Tamiraos for such a lucid description of the problem, and of the problems associated with all the bad solutions that have been implemented to solve the problem to date.

Knife catcher gets sliced

One thing all knife catchers have in common is their belief that they got a good deal when they bought. They are all mistaken.

If we go back two owners, we find a major HELOC abuser:

• This property was purchased on 3/4/2005 for $611,000. The owner used a $488,800 first mortgage, a $61,100 second mortgage, and a $61,100 down payment.
• On 6/27/2005 he obtained a $102,500 HELOC.
• On 1/5/2006 he refinanced with a $742,500 first mortgage.
• On 11/14/2006 he refinanced again with a $655,200 Option ARM and a $81,900 stand-alone second.
• The total property debt was $737,100 plus negative amortization and missed payments.

The property was sold to the current owner for $820,000 on 3/3/2007. The previous HELOC abuser got away with the abuse plus obtained some extra cash. Not a bad deal for him.

• The current owner paid $820,000. The original mortgage data is not in my records. However…
• On 5/3/2007 he obtained a $656,000 first mortgage and a $123,000 HELOC.
• On 7/31/2007 he increased his HELOC to $160,000. If he maxed it out, he got most of his down payment back.
• Total property debt is $816,000.

It's currently listed as a short sale, so we can assume he is no longer making payments.

Irvine Home Address … 4 STAR THISTLE Irvine, CA 92604

Resale Home Price … $640,000

Home Purchase Price … $820,000

Home Purchase Date …. 3/3/2007

Net Gain (Loss) ………. $(218,400)

Percent Change ………. -26.6%

Annual Appreciation … -6.6%

Cost of Ownership

————————————————-

$640,000 ………. Asking Price

$128,000 ………. 20% Down Conventional

4.34% …………… Mortgage Interest Rate

$512,000 ………. 30-Year Mortgage

$122,743 ………. Income Requirement

$2,546 ………. Monthly Mortgage Payment

$555 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$53 ………. Homeowners Insurance

$30 ………. Homeowners Association Fees

============================================

$3,184 ………. Monthly Cash Outlays

-$421 ………. Tax Savings (% of Interest and Property Tax)

-$694 ………. Equity Hidden in Payment

$202 ………. Lost Income to Down Payment (net of taxes)

$80 ………. Maintenance and Replacement Reserves

============================================

$2,351 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$6,400 ………. Furnishing and Move In @1%

$6,400 ………. Closing Costs @1%

$5,120 ………… Interest Points @1% of Loan

$128,000 ………. Down Payment

============================================

$145,920 ………. Total Cash Costs

$36,000 ………… Emergency Cash Reserves

============================================

$181,920 ………. Total Savings Needed

Property Details for 4 STAR THISTLE Irvine, CA 92604

——————————————————————————

Beds: 4

Baths: 3 baths

Home size: 2,474 sq ft

($259 / sq ft)

Lot Size: 4,275 sq ft

Year Built: 1974

Days on Market: 111

Listing Updated: 40365

MLS Number: P735477

Property Type: Single Family, Residential

Community: El Camino Real

Tract: Di

——————————————————————————

According to the listing agent, this listing may be a pre-foreclosure or short sale.

Great Schools!!! 4 bedrooms + den. This great house offers thousands in upgrades!! State of the art gourmet kitchen. All bathrooms remodeled. Two bedrooms down three up. Spacious family room. Flat TV and Pool table and bar could be included. Wood floor through out the first floor. Inside laundry room. Built in barbeque. Central air. Close to park.Walking distance to great schools & shopping center, NO Mello roos and low low HOA dues. This home must be seen to be appreciated. Directions Culver & Irvine Center

Great exclamations!!!

Judging by the disheveled appearance, I have to assume this property belongs to a bachelor. You have to admire a guy that has a bar in his bedroom. If he gets his dates drunk, he doesn't have to pursuade them to go far. Those horseshoes are great: Get Lucky!

I hope you have enjoyed this week, and thank you for reading the Irvine Housing Blog: astutely observing the Irvine home market and combating California Kool-Aid since 2006.

Have a great weekend,

Irvine Renter

Contrarian Investing requires the ability to ignore the prevailing mood of the market and buy when the herd is selling and sell when the herd is buying.

Irvine Home Address … 59 BAMBOO Irvine, CA 92620

Resale Home Price …… $800,000

Some of it's habitual

Some of it's predictable

sometimes the change is not enough

And in the lost empathy

memories of better days

Lagwagon — Change Despair

Bubble Blogs and Deflation Psychology

The IHB has never been a bubble blog, but it is often labeled as such because I have been bearish on housing for so long. I am still bearish on Orange County (and I am not alone), but I am very bullish on Las Vegas and many other beaten down markets. Someday, I may even be bullish on Orange County — probably after all the bulls give up.

Bubble blogs resonated with many people because they spoke a truth about greed and stupidity during a period of mass financial insanity. Prices were insane, and bubble bloggers said so. Once prices started to fall, bubble bloggers were heard by a wider audience and they fed into the cycle of deteriorating buyer confidence. Falling prices makes buyers understandably cautious, and it is this caution that creates deflation psychology that often causes markets to overshoot their fundamental valuations during the deflation of a financial bubble.

The article below is one of the finest explanations of deflation psychology I have read.

The Psychology Of Deflation Explains Why House Prices Will Continue To Fall

Edward Harrison, Credit Writedowns | Sep. 8, 2010, 12:22 PM

A great article in this past weekend’s Washington Post highlighted many of the major issues affecting the US housing market and most of those issues point to lower house prices. In particular, the self-reinforcing psychology of price deflation has already set in. And that means prices will continue to fall.

While the government is doing its best to prop up the housing sector and maintain credit growth, most common metrics suggest house prices are still elevated. This artificial prop buys banks time by preventing banks from taking losses and depleting capital while the yield curve is still steep. Yet, investors are coming to the realization that short-term rates will stay near zero percent for a very "extended period" indeed. Perpetual zero (PZ) is having the perverse effect of flattening the yield curve and reducing the carry trade that is benefiting banks. If banks are unable to restore adequate capital to deal with the loan losses that removing the government prop would induce, the next recession will be very painful.

The psychology of deflation in Japan

I first talked about the behavioural psychology of deflation in 2008 when writing about Japan’s housing bust. The post "A cautionary tale: story from 1994 Japan" relied on Michael Nystrom’s 2006 tale about a Japanese man buying a house amid the mid-1990s Japanese house price deflation to bring the psychology to life.

Michael wrote:

In spite of the booming economy, my uncle, like many Americans today, was shut out of the housing market. Prices always seemed too high, but a pullback never materialized, so he waited until the right time to buy. While he waited, prices spiraled up and away until at last they were hopelessly out of reach. By the time I arrived in 1990, his family was living in a government-owned, rent controlled flat that was, by any standards, small: Two rooms that were each about 12 feet square, a small kitchen and a tiny bath to serve three adults (including his mother) and his two kids…

My uncle thought that he would never ever be able to afford a house in Japan, and that he would live out his dying days in that little rented flat. In his experience, housing prices went only in one direction: up. But by 1992, two years after the Nikkei peaked, something strange began to happen – housing prices started drifting down…

By 1994, housing prices continued to drift lower until some units started to become, with considerable stretching and creative financing, affordable. So that year, by taking out a two generation, 60-year mortgage — with his 16-year old son on the hook for the remaining years that he might not be able to pay — my uncle bought his first home. The family had to scrimp, and both he and my aunt had to work more hours, but they were finally, proud homeowners. And it was a nice house – larger than their old house (but not much), in a nicer neighborhood, and on a higher floor with a view of the treetops. I even helped them move in. It was a happy day. I don’t recall the exact price he paid, but I remember thinking that it sure was a lot! Somewhere north of half a million dollars. Those were the kinds of details were lost on me at that age.

I left Japan in 1994, and didn’t return again for a visit until late 1998. In the intervening 4 years, housing prices had continued to fall, and fall, and fall to the point where my uncle’s house was worth only half of what he had paid for it four years earlier: A couple hundred thousand, up in smoke, just as Japan’s economy was mired in a 13-year slump. But he stuck with his loan, hoping the value will come back. And one day, it just might. So he makes his payments each month faithfully, and when he can no longer make them, his son will take over and pay off the remaining balance. And sometime, in the remaining 48 years on the mortgage, the house may once again be worth more than what is owed on it.

The psychology of deflation hits America

What happened? The psychology of deflation happened. But rather than go into some diatribe of how this works, I will use excerpts of the Washington Post article In struggling housing market, buyers and sellers are out of sync to paint the picture. While reading this, remember that the DC area has been relatively buoyant economically during this crisis compared to other American cities due to federal government largesse. I have highlighted the parts that pertain to deflation psychology.

Jack Donnelly put off selling his Capitol Hill rowhouse for three years until he thought he saw glimmers of life in the housing market this past spring. At $950,000, he said, the red brick Victorian is a "solid deal."

Jackie Wright sees it differently. The row house is one of many homes competing for her attention in uncertain economic times. She’s been looking to buy a home in the District since April but is in no rush to commit, partly because she thinks mortgage interest rates – and prices – could sink even lower.

As with many prospective sellers, Donnelly’s hopes for his rowhouse were forged in the past, before the housing bust, when homeowners assumed that real estate prices would inexorably rise. They expected to reap vast windfalls when their houses sold. But Wright’s eyes are turned to the future. She’s anxious about whether the coming months will bring more gloomy economic news and reluctant to gamble on a major purchase, especially if a flagging market might actually mean better deals ahead.

Notice the disconnect between Donnelly and Wright’s psychology. That’s the interesting thing about this story. The house was bought for $645,000 in 2004. Renovations of $150,000 (excluding labour) put the all-in cost at $850,000. So, why is Donnelly trying to sell the house for nearly a million dollars? In behavioural economics, this is called anchoring. Donnelly’s price point is anchored to the $1 million he expected to receive during the halcyon days of the housing bubble. See Michael Mauboussin on investor psychology for more on this.

Back in 2004, when Donnelly and his new bride, Roxanne, bought the home, they’d paid $645,000. It was a fixer-upper in a transitional neighborhood. And the finances had been a stretch. But with a child on the way, they had been ecstatic to find a place they could afford.

They converted the space from apartments into a single-family home and installed central air conditioning. The renovations totaled more than $150,000, not including labor costs, Donnelly said. Three years later, after the tremendous run-up in U.S. housing prices, he decided he wanted to sell it for $1 million.

By then, however, the housing market had begun to sour, and he figured the home couldn’t fetch what he thought it was worth.

"I decided to do the conservative thing, collect rent on this place and wait a couple of years for the housing market to improve," Donnelly said.

See, Donnelly bought another house and moved in there. He could have sold his old house. But he was anchored to the prices of a few years back and so decided to rent it out – that isn’t the conservative thing. The thing is house prices are lower today – even in DC. And this presents a classic negotiating problem. H. Raiifa’s "The art and science of negotiation" sets out a framework based on three sets of data (as quoted by Max Bazerman’s "Judgement in Managerial Decision Making"):

1. Each party’s alternative to a negotiated agreement (BATNA – Best alternative to a negotiated agreement)
2. Each party’s set of interests
3. The relative importance of each party’s interests

In a period of falling house prices, a home buyer’s BATNA is to simply wait. She can rent or stay in her present home. Here’s how the Post puts the conflict.

Hart, the real estate agent, insisted that Donnelly’s house is properly priced. She said five other comparable homes within short walking distance are for sale at similar prices – $900,000 to $974,000. She said others have sold within that range recently.

Donnelly has his doubts.

"Frankly, I don’t know what number makes sense anymore," he said. "It’s not a normal market. . . . Some houses are gone, and some in the same price range are not going. I can’t gauge what’s real and what’s not."

He acknowledged that he’d been thinking of reducing his asking price, lowering his goal for a second time.

In fact, by Saturday he’d dropped the price to $895,000.

And while that may narrow the expectations gap with prospective buyers, it might not be enough. If he fails to attract a buyer soon, Donnelly said, he would take the house off the market, possibly refinance it at lower rates and keep on renting it out.

That would be one more sale that never took place.

Lower home sales presage lower prices

This last sentence is the crux of the article.

In any negotiation, the two parties have a "reservation point" beyond which they will refuse to negotiate and will simply walk away and accept their BATNA. The art of negotiating is finding a price higher than the seller’s reservation price that is also lower than the buyer’s. In a market panic, sellers reduce price quickly because markets are more transparent, the assets transacted assets are fungible, transaction costs are low and volume is high. All of this means a bottom comes more quickly because a seller’s reservation price becomes unanchored very quickly as market prices fall.

In a housing market selloff, markets are more byzantine, properties are unique, transaction costs are high, and sales are infrequent. This means that, in assessing one’s set of interests and their relative importance, many sellers decide not to transact because their reservation prices are still anchored to in bubble psychology.

So the first thing to give way in a housing bust is volume. Lower transaction volume is prelude to lower prices. If volume is falling, you can be sure it has done so because sellers have not lowered their reservation prices and are waiting for prices to rise again. But, of course, if the psychology of deflation has set in for buyers, they are not going to pay more. And that means prices and sales volumes drift lower as forced sellers dominate the marketplace.

Moreover, the psychology of price deflation is also the reason markets tend to overshoot to the downside. Buyers are saying, "wow, those prices sure have come down. Maybe they will come down even more. I think I will hold off on buying and see." This type of psychology is self-reinforcing and almost always takes markets below fair value when value players snap up bargains and change the psychology. In my view, the government can slow but simply will not be able to overcome this dynamic. That means a slow and inexorable decline for house prices.

And since housing usually leads recoveries, that spells a weak recovery and perpetual "extended period" language from the Fed. Eventually, the U.S. yield curve will flatten as it did in Japan if PZ takes hold. PZ is toxic for banks because when the next recession hits, the central bank cannot lower rates to induce a steep yield curve and bail them out. Therefore, loan losses will have to be taken without the benefit of the carry trade and that spells bankruptcy for the weakest. This is what happened in Japan and what is likely to happen in the U.S.

I agree with everything that author has written. Well done.

Notice that it is the value players that snap up bargains and form a durable bottom. Who are the value players? Cashflow investors. That is why I am so enthusiastic about Las Vegas. The market is in despair. Deflation psychology is in full force, but as individual buyers do a own versus rent analysis (at least the ones who understand how) they quickly see that ownership saves them a huge amount compared to renting, and they buy. Further, cashflow investors see the same disparity, and they buy. It is these buyers that stabilize prices and change deflation psychology.

Understanding deflation psychology gives cashflow investors an edge. They can see the true value of a property when others are afraid to buy. If there are any enduring lessons the bubble blogs have taught readers, it is how to identify bubble psychology, and hopefully, how to identify the opposite: deflation psychology. Smart money is not buying in safe havens. Smart money is taking advantage of deflation psychology and obtaining undervalued cashflow properties in markets like Las Vegas.

Now is a safe time to quit paying your mortgage

Obviously, I watch the trustee sale market closely. Over the last two months, lenders have slowed the rate at which they allow properties to go to auction. I can only speculate as to their reasons, but a burgeoning MLS inventory is likely the cause. Of the few properties that have gone to auction, almost none of them have been priced over $500,000. That isn't likely to change considering we are still in a recession, there is too much inventory, and few buyers are stepping up to buy overpriced local properties. Any struggling property owner considering accelerating their default should do so now. There is little or no change a lender is going to begin foreclosure proceedings over the next 6 months or more. For anyone already squatting, they too will likely get through to next spring.

• Today's featured property belongs to a Northwood II squatter. The property was purchased on 11/10/2004 for $924,000. The owners used a $738,940 first mortgage, a $92,300 second mortgage, and a $92,760 down payment.
• On 7/19/2005 they refinanced with a $801,000 Option ARM with a 1% teaser rate and obtained a $53,400 HELOC.
• On 8/15/2005 they obtained a $146,850 HELOC.
• On 2/8/2006 they got a larger HELOC for $279,000.
• Total property debt is $1,080,000.
• Total mortgage equity withdrawal is $248,760.
• Total squatting time is about 30 months (off and on).

Foreclosure Record

Recording Date: 05/01/2008

Document Type: Notice of Default

The received a loan modification on 5/20/2008, but they received a NOT shortly thereafter.

Foreclosure Record

Recording Date: 05/21/2010

Document Type: Notice of Sale (aka Notice of Trustee's Sale)

Click here to get Foreclosure Report.

Foreclosure Record

Recording Date: 05/04/2010

Document Type: Notice of Sale (aka Notice of Trustee's Sale)

Click here to get Foreclosure Report.

Foreclosure Record

Recording Date: 08/11/2008

Document Type: Notice of Sale (aka Notice of Trustee's Sale)

It looks as if they are still in the property wating for the bank to accept a short sale. $250,000 in free money and 30 months of squatting. Not bad… for them.

Irvine Home Address … 59 BAMBOO Irvine, CA 92620

Resale Home Price … $800,000

Home Purchase Price … $924,000

Home Purchase Date …. 11/10/2004

Net Gain (Loss) ………. $(172,000)

Percent Change ………. -18.6%

Annual Appreciation … -2.4%

Cost of Ownership

————————————————-

$800,000 ………. Asking Price

$160,000 ………. 20% Down Conventional

4.36% …………… Mortgage Interest Rate

$640,000 ………. 30-Year Mortgage

$153,792 ………. Income Requirement

$3,190 ………. Monthly Mortgage Payment

$693 ………. Property Tax

$267 ………. Special Taxes and Levies (Mello Roos)

$67 ………. Homeowners Insurance

$142 ………. Homeowners Association Fees

============================================

$4,358 ………. Monthly Cash Outlays

-$755 ………. Tax Savings (% of Interest and Property Tax)

-$864 ………. Equity Hidden in Payment

$254 ………. Lost Income to Down Payment (net of taxes)

$100 ………. Maintenance and Replacement Reserves

============================================

$3,094 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$8,000 ………. Furnishing and Move In @1%

$8,000 ………. Closing Costs @1%

$6,400 ………… Interest Points @1% of Loan

$160,000 ………. Down Payment

============================================

$182,400 ………. Total Cash Costs

$47,400 ………… Emergency Cash Reserves

============================================

$229,800 ………. Total Savings Needed

Property Details for 59 BAMBOO Irvine, CA 92620

——————————————————————————

Beds: 4

Baths: 2 full 1 part baths

Home size: 2,460 sq ft

($325 / sq ft)

Lot Size: 3,799 sq ft

Year Built: 2004

Days on Market: 33

Listing Updated: 40423

MLS Number: S629433

Property Type: Single Family, Residential

Community: Northwood

Tract: Came

——————————————————————————

According to the listing agent, this listing may be a pre-foreclosure or short sale.

Almost Brand New Home in Northwood II. Beautiful hardwood floors throughout downstairs.Upgraded carpet in great room and upstairs. Gourmet kitchen w/ stainless steel appliances, incl. extra convection oven, white Euro Cabinets,custom Caesarstone Countertops incl. butler pantry w/ full back splash and center island. Built in desk and addt'l cabinets in study alcove. Custom two tone paint & wood blinds/shutters throughout. Central vacuum & much more!

Apparently, in realtorspeak, a six year old property is "almost brand new."