This post first appeared on Minyanville.

As the debate rages about whether or not we’re finally approaching a floor in home prices, let’s examine the value of another asset: The mortgage.

When considering a home-buying transaction, buyers (and sellers) typically worry most about the value of the house. Lenders, on the other hand, are much more concerned with the value of the mortgage.

From a lender’s perspective, the economic value of a loan is its expected future cash flow in the form of interest payments. The key word in that phrase – and why a loan’s value isn’t purely derived from its rate – is “expected.”

To a bank, a loan is just a product, like an iPod is to Apple or a BlackBerry is to Research in Motion. The value of that product is just how much someone will pay for it. Loans with higher coupons, adjusting for risk, are worth more than those with lower coupons, because they fetch more on the open market.

Mortgages, or debt of any kind, are priced relative to their face value, or “par.” A $100,000 mortgage that’s worth par would cost $100,000. Prices are then expressed as a percentage of par. That is, a loan with a face value of $100,000 that’s worth 102.50 (percent) would cost $102,500.

Subprime loans are often considered “bad,” while prime loans are presumed to be “good.” Many assume, therefore, that high-quality prime loans are worth more than those lousy subprime ones. This isn’t entirely accurate.

“Good” loans are the ones where you’re appropriately paid for your risk, whereas “bad” ones are those in which you’re on taking too much risk relative to return. As Professor Sedacca often says, “If you aren’t being paid to take risk, don’t take risk.”

Consider the following 2 mortgage situations, ask yourself which one a lender is likely to value more highly:

Borrower A has impeccable credit, can make a sizable 30% down payment on her family’s first home, but will have to stretch to make the monthly payments because her husband just quit his job to stay home with their second child. The mortgage carries a low 6.00% rate, or coupon, because of Borrower A’s good credit and the low loan-to-value ratio (loan amount divided by sales price).

Borrower B has poor credit, stemming from medical problems that put him out of work for the past 12 months. Credit-card bills piled up, payments were missed and he had a hard time making ends meet. Healthy now, Borrower B is looking to refinance his existing mortgage on the home he’s lived in for 20 years. He needs some extra cash to finish paying off bills and get back on track, so he’s looking for a loan to value of 90%. The mortgage carries a high 9% coupon because of Borrower B’s bad credit and the loan’s high loan-to-value ratio.

I designed the examples to prove a point, but I would take Borrower B’s “subprime” mortgage over Borrower A’s every time. Even though Borrower A’s perceived risk (by the numbers) is less than Borrower B, Borrower A is probably more likely to default. Despite Borrower’s A big down payment, the low coupon may not cover the additional default risk.

Banks often write mortgages with the intent to sell them on the open market. Whether the loan is sold individually or packaged in a security, the higher the coupon, the higher the potential value for the ultimate owner (provided, of course, the risks are properly measured and evaluated).

Mortgage originators (both banks and brokers) and Wall Street firms used this concept to push bad loans onto borrowers. Whether Goldman Sachs (GS) wanted to issue a mortgage-backed security or Wells Fargo (WFC) planned to park the loan on its balance sheet, both earned more from higher coupon loans, so that’s what they asked for from their salespeople and brokers.

One of the most highly sought-after types of mortgages were those with a high loan-to-value ratio, written for speculative investment properties where borrowers didn’t have to state their income. These loans carried a very high coupon because of the high perceived risk of default.

However, since homeowners in areas experiencing rapid appreciation like Phoenix, Las Vegas, Florida and California could easily sell their way out of a problem during the boom, the actual risk on these loans remained low. Wall Street demanded precisely this kind of loan, and brokers wrote them. Whether the borrower could really afford the payments didn’t matter, since they could just sell the house at the first sign of trouble.

Of course, when appreciation stalled, actual risk shot up, and even high rates didn’t compensate banks for the risk these loans now carried.

Since Wall Street could earn far more packaging and securitizing these high-risk loans than they could on boring, low-coupon prime loans, they paid mortgage brokers and bankers higher commissions to write them. These originators, being good salespeople, aggressively marketed these loans to borrowers that fit these highly profitable criteria.

Homeowners, watching their neighbors get rich speculating on condos in Miami, had little to no financial incentive not to join in. That’s not to say there weren’t some who made responsible decisions - but enough people got caught up in the mania that, well, we are where we are right now.

So this brings us back to your mortgage. How much is it worth?

Remember to think about it from the bank’s perspective.

The next time you hear offers like “no closing costs!” or “low introductory rate!”, think about why the bank would do this. If it’s not charging fees to close the loan, you can be sure it’s making up that lost income with a higher rate. If it’s offering a teaser rate, the higher payments you’ll be making when the coupon adjusts upwards will more than make up for that low payment in the first few months.

The best way to get the best deal is to think about what loan will be worth the least to your lender. Low rate, low fees, low risk… Who wants that boring paper?

The answer: You do.

The S&P/Case-Shiller home price index is out today, showing a continuation of the downtrend in property values. Data from August — two full months before the financial crisis spun out of control — shows weakness across the country:

• Prices fell in August for the 25th consecutive month
• Prices in 10 major markets plunged a record 17.7% year over year
• The biggest declines in August were seen in San Francisco (-3.5%), Phoenix (-2.9%) and Las Vegas (-2.4%)
• The biggest declines year over year were seen in Phoenix (-30.7%), Las Vegas (-30.6%) and Miami (-28.1%)
• No metro area showed a price gain in the last 12 months.
• The best performing metro areas in the last 12 months were Dallas (-2.7%), Charlotte (-2.8%) and Boston (-4.7%).

Data continues to show that home prices are not approaching a bottom. Also, since contracts signed in the past month for home sales will not show up in the data until early next year (1-2 months escrow, 2 months lag in reporting), it’s pretty safe to assume data will be bleak for the foreseeable future. Calls for stabilization, especially after yesterday’s “better than expected” new home sales figures are premature.

The continued drop in home prices is further evidence that when considering buying a home in this market, one must be prepared to live there for at least five years. Trying to pick the bottom is a dicey proposition for everyone but the most savvy, well-capitalized investiors.

Most anyone who has bought a home in the past few months (or even years) has likely lost money on his or her investment. Add in the effect of leverage, and losses will be quite severe if homeowners are forced to sell.

It’s important to understand that the Case-Shiller index is not released by Realtors or Homebuilders, spinning data to try and persuade people it’s time to buy, or that Congress needs to increase handouts to prospective buyers. The data is simply produced to evidence the prevailing trends, in whichever direction they may be headed.

Finally, keep in mind that data from the “San Francisco” metro area, for example, includes data from the entire Bay Area. This means Oakland, Brentwood, Vallejo and other hard-hit cities are lumped together with Palo Alto, Hillsborough and other cities that have held up rather well. Attempts to make generalizations about homeowners in a particular area based on this data is misguided at best.

New Home Sales rose unexpectedly in September, but prices continue to fall. According to Bloomberg:

• Purchases increased 2.7 percent to an annual rate of 464,000
• Median sale price decreased to a four-year low
• The median price declined 9.1 percent from a year earlier to $218,400
• The supply of homes fell to 10.4 months from 11.4 months

Two quotes sparked our interest from two very different market participants.

First, we have Richard Dugas, the chief executive officer of Pulte Homes:

The industry continues to be plagued by tighter mortgage availability, a growing number of foreclosures, and a historically high supply of unsold homes.

Some of the biggest pieces of misinformation being spread by mortgage market participants are that tighter mortgage supply is (A) a bad thing for potential borrowers and (B) should be loosened to get us back to “normal” market conditions.

The fact of the matter is that people can get mortgages but they cannot get approved for high enough amounts to save the homebuilders. The reality is that there continues to be a huge demand for houses but market conditions are forcing them to be purchased at more affordable levels. This doesn’t bode well for homebuilders like Pulte, hence their lobbying efforts to increase tax credits for home purchases.

Second, we have Mark Zandi, chief economist at Moody’s Economy.com.

Builders are seeing the light … they are cutting prices more aggressively. They’re very nervous about all the foreclosures.

It is amazing that a quote like this one is newsworthy in October 2008. It is hard to imagine that the homebuilding industry is finally “seeing the light” in year 3 of the housing downturn. We continue to believe the new homes market will not reach any sort of bottom until there is meaningful of consolidation in the industry. Look at the investment and commercial banking sectors, which, although still in trouble, are at least starting work through their issues and fold weaker hands into the stronger ones.

Not only are the homebuilders competing against foreclosed homes, but they are also fighting against each other. It is time for this industry to start working together before they all end up in bankruptcy courts.

Finally, work began on the fewest single-family homes in 26 years and building permits also declined last month. While supply is falling, which is good for clearing out bloated inventories, less residential construction will deepen our recession.

The housing market led us into this mess, and while focus turns elsewhere as the problems spread throughout the economy, it’s not unreasonable to expect the housing market to eventually lead us out.

This post first appeared on Minyanville.

Despite the Armageddon-esque financial turmoil of recent weeks, one thing about America hasn’t changed: If you really want someone to do something, sue them.

They lined up in droves: Cities, counties and states sued the pants off Countrywide for its shady lending practices. California, Illinois and Florida all alleged the lender fleeced American homeowners, jamming them into loans they had no hopes of repaying.

Now, Bank of America (BAC), who purchased the troubled California-based lender earlier this year, is stuck cleaning up the mess. Earlier this month, the bank agreed to pay more than $8 billion to settle lawsuits filed against Countrywide. Friday, the Los Angeles Times ran through the details of its plan to help as many as 395,000 troubled borrowers:

• Only owner-occupiers (not investors) with subprime or option ARMs qualify for assistance
• Interest rates may be reset as low as 2.5%
• Prepayment penalties and late fees will be waived
• Upside-down borrowers may have principal reduced
• Borrowers who lost their homes (or don’t qualify for assistance) will receive an average of $2,000.

Notably, Bank of America managed to get most investors who bought Countrywide’s mortgage-backed securities to agree to the plan. Holders of these assets have previously balked at such sweeping plans, since modifications usually lower a loan’s cash flow and decrease the value of securities behind it.

Efforts to get lenders to work aggressively with borrowers to avoid foreclosure have been largely ineffective. To be sure, there has been progress, but it’s fallen mightily short of promises the Bush Administration made last year when it announced its pilot program, HOPE NOW.

The aggressive plan, which Congressman Barney Frank, capitalism’s new public enemy number-one, called “the first truly comprehensive plan we’ve seen from the private sector,” could set the stage for a deluge of lawsuits.

The precedent has now been set: The way to stop foreclosures is to start suing banks.

I remember sitting in a meeting in early 2006, when a German bank that had lent our mortgage finance firm a few hundred million dollars asked why we didn’t get into the lucrative option-ARM market. The response: “We don’t want to touch those things. They’re a class action lawsuit waiting to happen.”

Indeed.

Other than Countrywide, the biggest writers of option ARMs during the boom were Washington Mutual, Bear Stearns and Wachovia. Not a single one remains independent.

The proud new owners of these banks, JPMorgan (JPM) (WaMu and Bear) and Wells Fargo (WFC) (via Wachovia) would do well to beef up their legal departments.

This post first appeared on Minyanville.

Put on those Rose-Colored glasses, it’s time again for the Existing Home Sales data:

• September sales came in 5.5% higher than last month, at 5.18 million (annualized) compared to estimates of 4.95 million
• Sales were 1.4% higher than last year — the first year-over-year increase in 3 years
• Inventory shrank to 9.9 months worth, from 10.6 months
• Median home price dropped to $191,400, the lowest since April 2004
• Distressed sales made up 35-40% of sales, with 80% of those going to owner-occupiers (higher than the usual 75%)

Per normal, the National Association of Realtors chief economist Lawrence Yun is as optimistic as ever. He gets paid to obfuscate the truth.

Per normal, the National Association of Homebuilders chief economist David Seiders is as pessimistic as ever. The worse it is, the better chance his group gets on the government dole.

It’s messy out there in housing land, but that’s not exactly news. Keep in mind that the year-over-year numbers line up against this time last year, when credit markets first seized up and home buying all but evaporated for a couple months. Easy comparisons make for premature bottom call.

Of all the myths we were fed about the housing market and its implications for the broader economy, there is no greater one than the spin that housing couldn’t possibly drag the economy into recession. Since the downturn started in the context of economic strength, the argument went, we were better positioned to absorb the fall in home prices. This couldn’t have been more wrong.

Traditionally, housing slowdowns are caused by economic problems, not the other way around. If delinquencies starting running up when times were “good” what would happen when things got “bad?” We are now finding out.

Markets that haven’t seen forced sales in decades could soon find out what it’s like to watch housing wealth evaporate at an alarming pace. Everyone knows Detroit, Stockton, Miami, Phoenix — these areas are in bad shape. But what about upper-middle class suburbs where people haven’t faced layoffs in years? These are the neighborhoods that are more worrisome, since their inhabitants have been largely insulated from the downturn thus far. Prices ran up just as far, albeit for slightly more fundamental reasons, but home values were inflated by fraud and loose lending just like everywhere else.

It is, unfortunately, only a matter of time before reality comes back home.

This post first appeared on Minyanville.

Banning foreclosures is starting to gain momentum in Washington: This isn’t good.

Barak Obama, the current frontrunner in the race for the White House, recently floated a plan for a 90-day moratorium on foreclosures by certain banks, along with other initiatives to revive the economy.

While Obama’s heart may be in the right place with respect to homeowners, current efforts to stem foreclosures by making it harder for banks to take back houses are largely misguided. Preventing banks from exercising their rights as debt holders could have negative consequences for all homeowners. For the ones facing foreclosure, a moratorium is likely to delay in the inevitable.

Mortgage rates are kept low largely because banks can repossess a home if the borrower stops making payments. Even if a homeowner declares bankruptcy, the it can still take back the house. It may seem cruel, but it’s one of the primary reasons banks are willing to give out hundreds of thousands of dollars in support of home ownership.

By taking away their loss mitigation tool, or even by threatening to limit their ability to foreclose, banks will demand a higher return for the risk they undertake in lending. This means higher interest rates, tighter qualification requirements and home prices far lower than they are today.

We must find effective ways to limit the damage of the housing market’s collapse without endangering the eventual recovery of one of America’s most essential markets.

Case in point: California. The epicenter of the housing market’s implosion recently enacted legislation forcing lenders to jump through additional hoops before starting the foreclosure process. Aimed at finding common ground between lenders and troubled borrowers, the state saw a dramatic 62% drop in notice of default filings — which mark the start of the foreclosure process — a month after the new law took effect.

On the surface this may sound encouraging, but digging deeper, it appears the data simply reflect a brief interruption in the prevailing trend. Sean O’Toole, founder of research firm ForeclosureRadar, told Housing Wire:

Given the significant negative equity now occurring in most California foreclosures, modifying loans to affordable levels either requires large principal balance reductions, or extending the unsustainable teaser rates that created the foreclosure crisis in the first place.

Wide-scale adoption of large principal balance reductions also poses significant risks, as they are likely to encourage non-defaulting homeowners to default in the hopes of securing similar reductions. As such, either type of loan modification is likely to result in increased default, and/or foreclosure activity in the future, a consequence clearly not intended.

Foreclosures are a necessary, if painful, aspect of the housing cycle - and a requisite part of any sustainable market recovery. And while there are measures the government can take to prevent foreclosures without sacrificing the necessary price discovery the market so desperately needs, they must not be banned outright. Not even for a few months.

The guilty are being punished, albeit slowly.

Bank of America (BAC) recently had to fork over $8 billion to settle lawsuits filed against Countrywide, which it purchased earlier this year. Fannie Mae (FNM) and Freddie Mac (FRE) are being sued by angry shareholders who felt they were misled about the companies’ financial strength. Bear Stearns is gone, as are IndyMac and Lehman Brothers. And While this may offer little solace to upside-down homeowners, it’s evidence the free market is still functioning (however deep it may become buried under government intervention).

Significant increases in mortgage regulations are already in the works: A more restrictive set of rules is the only sure bet in today’s housing market.  However, in so doing, it’s important that we not block out an entire subsection of the population - those with poor or undeveloped credit, who are nonetheless worthy of and responsible enough to own a home.

These distinctions were badly blurred and blatantly exploited during the boom, but that’s not reason enough to preclude millions of deserving families from realizing the American dream of homeownership in the decades to come.

This post first appeared on Minyanville.

For anyone wondering where the billions of dollars in worthless mortgage-backed securities will wind up, look no further: The mirror.

Fannie Mae (FNM) and Freddie Mac (FRE), the formerly quasi-public, now taxpayer-owned mortgage behemoths, are stealthily sopping up the worst of the structured mortgage debt Wall Street churned out during the boom.

In a story that barely made the back pages of the nation’s newspapers, Bloomberg reports Fannie and Freddie will start purchasing $40 billion per month of “underperforming mortgage bonds.” For its part, the Federal Housing Finance Agency, which oversees the two firms, issued a statement saying it hasn’t set a specific dollar target for the initiative.

If this program is indicative of the care with which Washington plans to deploy taxpayer money to clean up the mortgage mess, we’re going to need a lot more than $700 billion.

In September, Treasury Secretary Hank Paulson rationalized the seizure of Fannie and Freddie by saying, “It’s very possible for not only the taxpayer not to be hurt or to make money, but for the shareholders to have some value restored to them.” It’s unclear how targeting the worst quality assets on the market will achieve this end.

The initiative — which is outside the scope of the recently announced bailout plan — intends to bring liquidity to the frozen mortgage markets. Regulators hope the effect will be lower rates on new mortgages, softening the blow of tumbling home prices.

Policy-makers are desperate to find ways to make buying a house easier, as banks continue to tighten lending requirements to shield themselves from further losses. From big banks like JPMorgan Chase (JPM) and Wells Fargo (WFC) to small, regional players like Gateway Bank in San Francisco, lenders are making it harder to take out mortgages, auto loans, credit cards and just about every other type of consumer debt.

The inevitable regulatory reaction in the coming years is likely to make getting a mortgage even harder.

Coupled with the growing belief in Washington that freezing the foreclosure process is necessary to stem the tide of repossessions decimating communities across the country, mortgage rates aren’t likely to fall any time soon.

This post first appeared on Minyanville.

Yesterday, I criticized Washington’s $700 billion financial bailout plan for missing the point. It fails to address the root of the problems facing the housing market and, by extension, the rest of the economy: Negative equity or a homeowner owing more on his house than it’s worth.

On The Exchange, several sharp-minded Minyans pressed for details on how the government could execute a program to “absorb negative equity” in a fair, equitable, efficient manner - and without bankrupting the entire country.

To be clear, I’m fundamentally opposed to government intervention into the free market beyond a requisite regulatory capacity. I’m also deeply skeptical that government can manage any program, large or small, with even the slightest degree of aptitude.

Unfortunately, the usefulness of ideological debate is growing fainter by the day. Practical solutions must be put forth and implemented immediately, lest we slip further toward a second Great Depression. Historians are welcome to argue semantics while we get down to fixing the problem. Only a mixture of public and private enterprise can repair the damage.

Negative equity creates a number of serious problems for the housing market, such as:

Foreclosures

Negative equity turns defaults into foreclosures. Delinquent borrowers can sell their way out of the problem if they can find a buyer at a level higher than their outstanding mortgage (plus closing costs and real estate agent commissions). But being underwater makes this impossible without coming up with the difference between the loan amount and the sale price.This is cash most struggling homeowners simply don’t have.

Oversupply

Negative equity exacerbates existing oversupply issues, pushing home prices down further. Sellers who haven’t yet missed a payment must list their house at least as high as their outstanding mortgage. But if a homeowner is upsidedown, the property gets listed too high and stays there. Borrowers must then choose to continue pouring money into a losing bet, while hoping someone buys their house at well above its market value. The alternative is to default and end up in foreclosure.

Bank losses

Once a mortgage becomes delinquent, banks must write down the asset and take a loss. Not only is the loan impaired because of the delinquency, but negative equity enhances the bank’s losses. As property values fall, balance sheets become even more impaired, mortgage-backed securities continue to lose value and the entire financial system becomes even more desperate for capital.

Banks are bleeding cash: JP Morgan (JPM), Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC) all recently announced reduced earnings and were forced to take equity injections from the Treasury. Lenders are reticent to accept short sales (allowing borrowers to accept a sale price lower than the loan amount without making up the difference) because they can’t handle the losses.

Now, for the solution(s).

There’s no magic bullet, no one solution that can, in one fell swoop, wipe the slate clean. As I’ve described it, “sopping up negative equity” is an immensely complicated task. The mortgage industry is massive, inefficient, disjointed, riddled with redundancy, buried in paperwork and plagued by bad regulation and misplaced incentives. In short, it’s a mess. Cleaning it up will take a very, very long time.

Still, I’d argue spending money on the programs below — without any hope of it being returned — is a better use of taxpayer funds than watching hundreds of billions of dollars simply disappear into the opaque balance sheets of what remains of the financial system.

There may be additional solutions, but this laser focus on earning taxpayers a return on their investment dilutes the effectiveness of many important initiatives.

Principal Forgiveness

Fannie Mae (FNM) and Freddie Mac (FRE) are already experimenting with a pilot program to give borrowers the amount of their negative equity as an unsecured loan. Based on the most recent appraisal (appraisals are, for all their faults, currently the most accurate way to value individual homes), Fannie and Freddie could pay down the negative equity — plus some cushion for future depreciation — and refinance the existing loan at, say, an 80% loan to value.

Even if the government-sponsored enterprises started with just their own portfolio, that would be a huge step in the right direction. For loans owned by banks and in securities, Fannie and Freddie could pay off the mortgage at the outstanding balance, forgive the necessary principal and write a new loan.

At this point, the homeowner is free to sell the house at the new, lower market price (price discovery) or go on making the now much-more-manageable mortgage payments.

Shared Equity

Banks could “sell” negative equity to Treasury, sharing any future upside based on each party’s pro rata share of the home’s current value (again, we’re forced to use appraisals because there just is not a better option - yet). When the home sells, the bank and Treasury would participate in any future appreciation. If the home’s value continues to slide, the bank is less exposed to the losses.

Bank’s could effectively choose the amount they write off: The more they receive from Treasury, the less upside exposure they retain. On the flip side, stronger banks would be able to write off just enough to stay afloat without losing future earnings potential.

The U.K. is already trying a version of this program.

Homeowners, out from underneath the negative equity and armed with lower mortgage payments could stay in their homes or sell at the current market price. Again, forced price discovery while keeping people in their homes.

Community Redevelopment

I believe the best way out of this mess is to set up a federal land bank system, where funds are distributed by the Treasury to local community development organizations and vetted real estate developers. I recognize the potential for bureaucratic abuses, but unfortunately the government is the only organization with the scope to handle the problem on a national scale.

Just as we now have a Bailout Czar, we need a Housing Bailout Czar to oversee such a program. I’m sure Goldman Sachs (GS) could send up another of its finest for the betterment of the country.

Groups like Habitat For Humanity, which have existing ties in the community and teams of professional and volunteer contractors, could dramatically help rebuild struggling communities with requisite resources from the federal government. These groups could either buy foreclosed properties, refurbish them and rent them out, write low cost mortgages through the land bank or offer up funds to enable banks to accept short sales.

If there’s a better use for taxpayer money than rebuilding communities after a tragedy, helping families put their lives back together - I’m not sure what it is.

Will some speculators be helped in the process? Probably. But the good news is the widespread economic implications of this crisis, which are now inevitable, will take care of much of the moral hazard we so fervently argue against.

Not every stock speculator was taught his lesson after the stock market crash of 1929, but the Great Depression did affect an entire generation, encouraging thrift and aversion to risk for decades. Now isn’t the time to take the moral high ground, only to watch our cities washed away by the rising flood of poverty.

This isn’t socialism, it’s being American.

This post first appeared on Minyanville.

Some say the definition of insanity is trying the same thing over and over again, expecting a different result. By that measure, voters should load up on straitjackets this November and drag everyone in Washington off to the nuthouse.

Despite overwhelming evidence that we’re in the middle of a debt crisis, regulators insist they’re wrestling a liquidity crunch. And all the while, a cancer continues to eat away at the guts of the economy: The housing market. Only when it stabilizes will the financial system and, by extension, the economy - recover.

And yet, despite this widely recognized fact, the recent $700 bailout package contains little support for struggling homeowners. Even the $250 billion being dumped into banks will have only a minor effect on property values.

Smothered under the weight of falling home prices and tight credit conditions, consumers are reining in spending, as evidenced by yesterday’s bleak retail sales data. The economy is following the housing market into the abyss.

Since last summer, Washington’s tactic has been to encourage loan modifications through HOPE NOW and Project Lifeline and to widen the scope of government-backed loan programs via the Federal Housing Administration, Fannie Mae (FNM) and Freddie Mac (FRE).

As noted in the Wall Street Journal and discussed ad nauseum here at Cirios, these measures are woefully inadequate to stem the continued decline in housing prices.

As property values fall, over-leveraged borrowers find themselves underwater, or owing more on a house than it’s worth. In order to sell, the homeowner must come up with the difference between the sales price and the balance of their mortgage. For most, this is cash that simply doesn’t exist.

As a result, homes sit on the market for months, further pressuring home values. Despite the insistence by some real-estate agents that this is a buyer’s market, it most certainly is not. Until bloated inventories fall, home prices will continue to slide, making buying a home a dangerous proposition in the vast majority of the country.

Meanwhile, politicians continue to bang their heads against the proverbial wall, backing programs simply that do not work with the scope and efficiency that’s needed. Loan modifications, opening up mortgage guidelines and providing tax breaks so homebuilders like Centex (CTX), Pulte Homes (PHM) and KB Homes (KBH) can sell more overpriced houses may help a select few, but they do little to address the root of the problem.

Until taxpayer funds are appropriated to absorb negative equity, price discovery in the housing market will be a long, agonizing process.

This post first appeared on Minyanville.

That glitzy McMansion you’ve always wanted may finally be within reach.

Or not.

If nearly 3 years of home price declines, historically low interest rates and a relentless media barrage of half-truths from the National Association of Realtors haven’t been able to stabilize home prices, it’s doubtful a gimmicky used-car-style sales event will do the trick.

Coldwell Banker, one of the nation’s largest real-estate brokerages, launched a nationwide campaign last Friday to boost the flagging housing market. The 10-day sales event aims to close the gap between buyers and sellers by offering up to a 10% discount on listed homes for, you guessed it, 10 days.

This selling bonanza was hatched in response to a recent survey of over 3000 of the firm’s real estate agents, which found that a majority feel listing prices are too high to attract buyers. The survey also showed almost 80% of the agents believe more appropriately priced homes are garnering more attention; apparently, you need a license to know people like to pay less for a house, not more.

Coldwell Banker’s president and CEO, Jim Gillespie, is confident the housing market may finally be nearing a bottom. He told our friends at Marketwatch: “Despite the difficult headlines regarding our overall economy, the residential real estate market has been showing several positive signs over recent months that could be signaling a tipping point.”

It’s unclear whether continuing price declines, historically high levels of inventory, tightening lending requirements or frozen credit markets are the “positive signs” he’s referring to.

Gillespie also believes the unprecedented sales event will encourage buyers to jump back into the market: “Because of higher inventory, buyers have more homes to choose from and they can take advantage of near historically low interest rates and affordability levels that are the best they have been in years.”

Yes, affordability levels are the best they have been in years: Much better than when the only way to get into a house was to lie about your income and take out an Option ARM with a 1% teaser rate.

About this time last year, homebuilder Hovnanian (HOV) tried a nationwide fire sale to flush out its bloated inventory. More recently, Lennar (LEN), Centex (CTX), and DR Horton (DHI) tried a similar approach with both land and homes - to no avail. The fundamental forces pushing housing prices down will persist, regardless of futile ploys aimed at tricking buyers into paying more than they should for homes.

To be clear: Being negative on the housing market isn’t exactly a contrarian position. Therefore, anyone claiming it’s a great time to buy – like Coldwell Banker and tens of thousands of real estate professionals around the country — clearly have their own reasons for doing so.

Real estate agents get paid to close transactions; whether their client receives (or pays) a fair price is a non-issue.

Commission expenses are borne by sellers, typically to the tune of 6% of the sale price. In California, where the median home price is still over $350,000, that’s $20,000 out of the pocket of someone who’s already seen his home’s value evaporate before his eyes.

The selling agent usually splits the commission with the buyer’s agent, a pay structure that gives both sides an incentive to not only focus exclusively on closing deals, but also to sell homes for as much as possible.

Coldwell Banker correctly asserts that many sellers have unrealistic expectations about their homes’ final selling price, and as a result keep asking for prices too high for too long. Their cute little sales event, however, is aimed more at earning commissions for their struggling agents than advancing true price discovery in the troubled housing market. If the firm truly had the best interests of homeowners in mind, agents would volunteer to take a pay cut to ease their troubled clients’ burden.

Gillespie, Coldwell’s CEO, claims the event will “help move the US real estate market in the right direction.” He’s right - home prices must continue to fall. Simple economics, the interplay between supply and demand, is driving most markets, as tens of homes sit on the market for every one qualified buyer. Until this overhead supply is worked through, prices will remain under pressure.

In some of the most depressed areas – Las Vegas, the California Central Valley, Florida and Phoenix – homes have reached or surpassed traditional levels of affordability. Unfortunately, there’s more to buying a home than just being able to make the monthly payments. With down payment requirements returning to pre-bubble levels, low interest rates are almost a moot point.

There just isn’t any economic rationale for buying if home values keep sliding.

Even if a borrower can afford the monthly payments, home price declines wipe out the tax benefits of writing off mortgage payments and risk putting the new homeowner in the paralyzing position of owing more than his home is worth. Buying a home today is almost like buying a new car: You’re upside-down as soon as you’re handed the keys.

Until there’s real, verifiable evidence that home prices have stabilized, buying a home remains a dangerous financial proposition. This is true in every market, not just the ones that make the headlines for mind-boggling foreclosure rates.

Renting is still the far more fiscally responsible option. Staring into the teeth of a recession, families should be making choices in the best interest of their financial security, not for bragging rights at cocktail parties.