This post first appeared on Minyanville.

There’s a good amount of buzz surrounding the Wall Street Journal’s piece on the staggering number of homeowners underwater on their mortgages. This, on the same day the Case-Shiller Home Price Index posted its fourth consecutive month-over-month increase.

Mixed signals? Possibly. But in reality, these two seemingly disparate data points suggest that even as foreclosure moratoria continue to keep bank-owned properties off the market — which is artificially limiting supply and creating the illusion of a tight housing market (the supply of existing homes is back to historical norms) — behind the scenes, more and more borrowers are falling behind, and staying that way.

The number of mortgages in the “90+ delinquency but not yet foreclosed” bucket is still growing and the rate of change is yet to slow. The looming backlog of foreclosures not yet completed is growing much faster than banks can (or are allowed to) push them through the system. Lender Processing Services (LPS), a spinoff of Fidelity National Information Services Inc. (FIS) estimates that 710,000 mortgages are more than six months delinquent but not yet in foreclosure. A year ago, that number was “just” 203,000.

So what does all this mean?

While another leg down in housing is certainly in the cards, another cliff-dive isn’t the likely scenario. Rather, a continued slow bleed, with increasing localization as certain markets recover while others languish. Second home and jumbo markets are still under pressure, even as investors feast on low-priced homes in some of the country’s seedier neighborhoods. But as long as the US government dominates the secondary market for mortgages (FHA/Fannie Mae (FNM)/Freddie Mac (FRE)/VA, etc), mortgages will be available to qualified (and unqualified, in the case of the FHA) buyers.

Betting on another all-out collapse in residential housing prices is akin to betting on the bankruptcy of the US government. Could it happen? Sure, but that certainly isn’t the base case.

A much more interesting (and profitable) bet is to find areas that have fundamental (ie, demographic) drivers for demand, and looking for affordable submarkets where demand is strong and not driven by the FHA. Are there a ton of these neighborhoods around? Nope, but they’re out there if you know how and where to look.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Despite Herculean efforts, the Federal Reserve is losing its battle to keep mortgage rates at all-time lows.

As fear that we’re headed for imminent collapse slowly wanes, investors’ appetite for risk is coming back. This renewed confidence has helped buoy stocks, and the major equity indices have rallied more than 30% from their March lows. The shift, however, has come at the expense of the Treasury market, which has been in a 7-week slump.

According to Bloomberg, big money managers like Blackrock (BLK) are betting the Fed will step in to support the Treasury market (again), as regulators hope renewed Treasury purchases will push down mortgage rates (again).

Bond prices and yields move in opposite directions. When investor demand falls, so do prices, pushing up yields. And as investors shun the safety — but relatively low return — of government-backed debt, the impacts are felt throughout the credit markets. Of concern to the Fed, and what has led Chairman Ben Bernanke to increase Treasury purchases in the past, is the effect this dynamic has on mortgage rates.

A mortgage is nothing more than a long term bond, given to a borrower to purchase a home. So when lenders get fearful they’re not being compensated for tying up money for as long as 30 years, they increase rates. Further, as the specter of inflation rises, lenders demand bigger interest payments to keep up with higher prices. In other words, when dollars in the future are worth less than dollars today, banks demand higher payments to make up the difference.

Keeping mortgage rates low has been a cornerstone of Washington’s efforts to jump start the flagging housing market. But with rates at the highest level since April, the “smart money” is betting the Fed may return to the Treasury market en masse.

Paradoxically, even as the Fed tries to keep interest rates low — which are rising in part due to the expectation that higher prices loom in the years ahead — its actions increase the likelihood of future inflation. Running its printing presses around the clock has consequences, even if Fed officials are loathe to admit it.

Minyanville’s Mr. Practical often discusses the fallacy that credit markets are improving. As he points out, only in corners of the market where the government has stepped in to support lending is any so-called “normalcy” returning.

So too in the mortgage market.

Loans backed by Fannie Mae (FNM), Freddie Mac (FRE) and the Federal Housing Administration account for the lion share of mortgages currently being issued in this country. Aside from the occasional jumbo loan written by banks like JPMorgan (JPM) or Wells Fargo (WFC), government mortgages are the only game in town. Coupled with the Troubled Asset Lending Facility (or TALF), which funnels money into the market for mortgage-backed securities, the home-loan market remains completely dependent on government support.

This is one reason recent “strength” in the housing market will provide transitory. There’s a limit on how much government can control markets, as evidenced by mortgage rates that move persistently higher every time the Fed eases its aggressive intervention. Fundamentals, not subsidies, will provide a true floor in prices.

And as banks prepare to unleash a firestorm of foreclosure inventory into the market, fundamentals will remain pointed south, thereby pushing down prices. And as foreclosures continue to infect higher end real-estate markets, these price declines will be felt by a growing — and more prosperous — segment of the population.

Mortgage rates, left to their own devices, would be far, far higher without government support. This is the message of the market – one bureaucrats in Washington seem unwilling to learn.

No, we’re not talking about the upper class neighborhood in Santa Monica. We are talking about a city 52 miles northeast of San Francisco, a farming town that epitomized the housing boom and bust. Of late, sales activity has leapt in Brentwood, almost exclusively due to the prevalence of the FHA loan program. (NOTE: in the days it took us to produce this edition of Cirios Trends, this home went under contract).

Neighborhood Overview: Brentwood, CA had a population of 7,600 in 1990, when its economy was based almost exclusively on agriculture. Many farmers discovered a new source of income in the mid-90s: Selling their land to homebuilders to create large subdivisions. Brentwood’s population ballooned to over 50,000 in 2008, fueled largely by the white hot housing market. As prices fell back to levels that are within FHA loan limits (typically around $417,000 for this type of community), buyers returned to the market in droves. The FHA requires down payments as low as 3%, a credit score not much higher than 600, a stable job and a house that’s in reasonably good condition. Sales in Brentwood spiked more than 200% from last year’s levels and supply is way down. The question we keep asking: Is this trend sustainable, or is it driven by loan programs that don’t require buyers to put down a substantial down payment (sound familiar?)? Only time will tell.

2640 Torrey Pines Dr, Brentwood, CA 94513

Original List Price: $384,000
List Date: 4/22/2009
Current List Price: $384,000
Previous Sale: $529,000
Previous Sale Date: 2/11/2004
Estimated Down Payment: $11,520*
Estimated Monthly Payment: $2,479.55*
Bedrooms: 4; Bathrooms: 3
Liv. Area: 2,951 sqft; Lot Size: 10,000 sqft

Positives:
+ Near a golf course
+ Interior condition is very good with high end appliances
+ Located on a very quiet street

Negatives:
- Backyard and side yard are in need of maintenance
- Corner lot, yards poorly laid out
- No golf course view

Cirios Valuation Approach:

Step 1: Location

First, we review the subject’s location on Google Earth to see if there are any negative obsolescences. The major detractor is that despite the large lot, the yard wraps around the house creating 3 small yards, rather than one large one.

Second, we look for positive factors: Based on examining Google Earth and likely traffic patterns, the road does not appear to be heavily traveled. Since Torrey Pines Dr. starts and ends on St. Andrews Dr., there is no reason for cars to go down this street unless their final destination is a home on the street. There is a good chance the street is safe for children to play in.

Step 2: Data Analysis

% of Zip Distressed: 10.2% (Very High)
% of Zip For Sale: 1.8% (High)
% of Zip Sold Over Last 3 Months (year-over-year): +39.6%
Elementary School API: 796 (above average)
AHA (Affordable Home Amount): $482,451

The number of distressed properties in Brentwood remains very high relative to the listed homes, which leads us to believe there is a significant amount of inventory due to flood the market in coming months. (See this month’s Doing Your Real Estate Homework: RealtyTrac, for more on this subject). We fear the amount of qualified and willing buyers in this area is starting to diminish, based on sales activity that is already beginning to slow. However, the affordability number is encouraging and we find the subject to be a very desirable home for the area. The distressed properties coming on the market may not negatively affect its sale price for a few months.

Step 3: Comparable Properties

Please visit www.ciriosre.com and click on “Market Commentary” for our CLEAR valuation with a full list of comparable listings and sales.

Step 4: Value Analysis

As noted above, the subject went under contract from the time we performed our initial analysis to the time Cirios Trends went to print. There is another home under contract nearby, 2771 La Costa which was listed at $349,000 with similar characteristics. The listing does not contain interior photos, which typically indicates a home that is less than ideal on the interior. Based on the subject’s superiority to this comparable, the sale price for 2640 Torrey Pines Dr. should be at or close to the list price.

Cirios Value: $384,000
Over-Listed Amount: Well-listed.

By ANDREW JEFFERY

This post first appeared on Minyanville.

This week, 2 data points led optimistic market-watchers to declare the bottom in the housing is nigh: Indeed, one widely read trader-writer proclaimed, “The oversupply of housing that so plagues the market at present will be a figment of our memory a few months hence.”

The first: On Monday, the National Association of Realtors said existing home sales jumped 5.1% in February compared to the previous month, largely due to the high number of foreclosures being dumped onto the market by big banks like JPMorgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC).

While indicative of buyers gingerly dipping their toes back into the market, existing home sales are still down 13.4% from a year ago.

The second: On Wednesday, the Commerce Department released data on February new home sales which showed a similar trend: Transactions bounced 4.7% from January, but remain a whopping 41% below sales this time last year. Nevertheless, shares of beleaguered homebuilders like Centex (CTX) and Lennar (LEN) had stellar performances this week, capping a nearly 100% gain since the beginning of the month.

Prices, however, continue to slide for both existing and new homes. And while median (and average, for that matter) price data is skewed to the downside due to the mix of homes sold in a given period — in this case, more cheap houses than expensive ones — property values remain in a decidedly downward trend.

But since transactions typically find a bottom prior to prices, the number of people who believe prices should stabilize in the near future is growing.

Examining the data, unfortunately, tells a different story. Below is a chart produced by my firm, Cirios Real Estate, showing home prices and sales transactions in for the eastern part of the San Francisco Bay Area. The East Bay is a fairly representative sample of California housing markets: A little high-end, a little middle-class and a little low-rent all mixed in.

Click to enlarge

The red line shows average home prices, while the blue line shows sales transactions, as measured by their change from a year ago. Notice how, even as sales have spiked from the previous year, prices continue to plunge.

Two things jump out at me on this graph (aside from the massive increase in transactions and precipitous decline in prices):

First, transactions began to ramp up as prices moved down toward levels where borrowers could get government-backed loans to buy homes. That means Fannie Mae (FNM), Freddie Mac (FRE) and the FHA have financed a whole swath of homes in the past 18 months that are now severely underwater.

Second, transactions bottomed in September 2007, not long after the market peaked. 18 months have passed and prices have dropped more than 50% since that time.

With that in mind, the current “euphoria” over housing data — after a single month-over-month increase in sales, when year-over-year measures remain well behind even last year’s weak totals — seems a bit premature.

This is not to say prices will never stabilize, or that increased sales are a bad thing. In fact, the more sales we have, the quicker price discovery happens and the faster a true bottom can be found. Nor is this some proclamation that this part of California is a perfect proxy for home prices nationwide.

But given the backlog of foreclosed homes sitting on the books of the major American banks, continued price declines across the country and tight mortgage market conditions, calls for the devouring of supply by voracious home buyers causing an imminent housing bottom is downright premature.

To be sure, we may be one step closer to a housing bottom, but that’s one step on a very, very long path.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Americans finally get it: Home prices are falling.

This may seem like a preposterous statement, what with the entire global financial system in disarray after the collapse of the US housing market, but we Americans are stubbornly optimistic people, content to ignore calamity as long as we possibly can.

A study released this week by Zillow, a real estate information website best known for its wildly inaccurate estimates of property valies, shows Americans have finally succumbed to the notion that home prices aren’t going up anymore. 57% of homeowners polled believe their own home lost value during 2008, up from 38% who felt that way just 6 months earlier.

Interestingly, when asked about the future, respondents were upbeat: Only 30% estimate the value of their house will decrease in the next 6 months. Of course, their neighbors aren’t so lucky: Forty-seven percent believe home values in their local markets will fall during the same time period.

Zillow has become something of a cult phenomenon in the past few years, as it  allows homeowners to go online and see how much their house is “worth.” By its own admission, Zillow’s values are merely estimates based on amalgamating sales data from nearby homes, comparing bedroom counts, living area, lot size and other salient characteristics.

What few people realize, however, is that Zillow’s valuation algorithm isn’t just used by John Q. Homeowner: Every big lender in the country uses a similarly opaque formula to price real estate.

Wells Fargo (WFC) – now the biggest US home lender in the country after its acquisition of Wachovia – holds tens of thousands of mortgages on its books, each backed by a unique house. It’s impractical to regularly review each home for a fresh value, so Wells and other big banks like Citigroup (C), JP Morgan (JPM) and Bank of America (BAC) rely on analytics firms to provide property values churned out by what are called Automated Valuation Models, or AVMs.

AVMs rely heavily on recent sales data to drive their valuation estimates. This works reasonably well in a vanilla market, one where home prices move uniformly in a single direction – namely up. Even rapidly rising prices are well accounted for, since liquid markets provide reliable, normal data sets upon which calculations can be made.

AVMs are a bit behind the curve in an appreciating market, offering a conservative estimation of a home’s value. But in a declining, choppy, illiquid market like the one we’re in now, AVMs fall apart.

As sales volume dries up and prices gap down, transactions that are even 3 months old become woefully out of date. Even in distressed markets that are now seeing frenetic buying activity, active listings — and therefore true market prices — are well below all but the most recent sales.

By using AVMs to value housing assets, banks are constantly underestimating losses in a declining market. Unfortunately, there isn’t much of an alternative.

Small, independent valuation firms offer the most reliable estimations of value, but they specialize in local markets by definition, which limits the scale with which huge lenders can effectively use their results to evaluate nationwide portfolios of loans.

Next time you laugh at Zillow’s estimation that a home that just sold for $250,000 is really “worth” between $315,000 and $375,000, remember that your bank is looking at the same data. No wonder they keep asking Uncle Sam for so much money.

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.