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.

Mortgage guidelines have become increasingly strict — not to mention regimented — as the private secondary-mortgage market has all but disappeared in the past 24 months. But according to the Wall Street Journal, appraisals are increasingly becoming one of the biggest hurdles for new purchase and refinance transactions.

In the wake of the recent collapse in home prices, appraisers have come under fire for bowing to lender demands during the boom, offering up property values more aligned with lenders’ wishes than with reality. In 2007, the state of New York sued Washington Mutual — now owned by JPMorgan (JPM) — for colluding with a subsidiary of First American Corporation to overinflate home values.

Collusion between appraisers and mortgage brokers, real-estate agents, banks, and borrowers helped fuel runaway price appreciation. In response, Fannie Mae (FNM) and Freddie Mac (FRE) — the 2 government-owned giants that control around two-thirds of the mortgage market — issued new guidelines dictating how lenders can select and evaluate appraisals. The new policies went into effect May 1.

To help facilitate the new, tighter rules, lenders are using appraisal management companies, or AMCs, which employ networks of appraisers around the country to provide what purport to be unbiased value analysis. All this, of course, comes at a cost which is ultimately borne by borrowers.

And, in what could be considered ironic if it weren’t so repellent, appraisers are crying foul.

This from a group whose moral backbone during the housing boom most closely resembled that of a jellyfish – one seemingly incapable of preventing its members from being wooed by banks into committing fraud.

An appraisal is simply one person’s opinion of a home’s value on a given day. And although that person is licensed to provide such an opinion, the very nature of an appraisal renders its usefulness as a true risk management tool questionable at best.

The growing use of AMCs, opponents argue, reduces appraisal quality even as it increases costs. Appraisers are selected based on proprietary quality scoring mechanisms employed by each AMC, which may or may not be a good measure of reliability. And since AMCs take on average a 40% cut on the total appraisal fees and lenders demand quick turnaround, appraisers are working for less on a tighter timeline.

Sure, fraud may be reduced, but incompetence could more than make up for that as AMCs scramble to employ barely capable appraisers in order to ensure complete geographic coverage for their clients.

The real losers in all this — as is the case when poorly conceived regulation is aimed at making up for past mistakes without proper consideration for the root cause of those mistakes — are homeowners, who must now pay more for a property valuation mechanism that isn’t likely to be much better than the old one.

By ANDREW JEFFERY

This post first appeared on Minyanville.

The answer? An emphatic no. This is simply the latest example of legal plunder perpetrated by the federal government against law-abiding, tax-paying citizens.

The Obama administration’s scheme to help troubled borrowers centers on subsidizing interest payments, which would help borrowers make ends meet without angering those investors expecting full payments each month. This marks the first time the government is intervening directly with taxpayer funds to ease the burden of monthly mortgage payments.

Bloomberg reports the plan will be voluntary for lenders like Wells Fargo (WFC), Citigroup (C) and Bank of America (BAC), and will employ many of the tactics previous modification efforts have used (ineffectively), such as loan extensions and principal reductions. Modifications identified as having a net present value will be targeted, where foreclosing would be more expensive than changing the loan terms.

The program aims to establish a standard for loan modifications that can be used industry-wide. That’s an absurd claim, which demonstrates the extent to which lawmakers misunderstand the scope of the problem. It’s a bit like saying every American must cut their hair the same way: It would be laughable it weren’t so sad.

Each mortgage, each borrower, each lender, each home is unique; each situation is different. Individual banks can barely standardize the documents required to close a loan, so the notion that there can be one standard for approving a loan modification — an intensely complicated procedure involving countless interested parties — is ridiculous.

It would be one thing if the plan offered even the remotest possibility of stabilizing the housing market. It doesn’t. The few borrowers who may be helped will have little effect on a massive, disjointed housing market that remains determined to run its course despite government efforts to stop the bleeding.

The societal implications of this program are downright frightening.

Washington cutting checks to borrowers who can’t make their mortgage payments sounds like a benevolent act attempt to reach down to struggling families — and in some cases, it may certainly help. But it also fosters dependency on the federal government and incentivizes bad behavior.

It now appears we’ve reached a point in this crisis where differentiating between those worthy of help and those left to pick up the tab is determined primarily by how poorly one managed their personal finances. The worse the decision, the greater the federal assistance – and it’s true for government bailouts of bad choices on the part of individuals and institutions alike.

The message this sends to the rest of us – those who are still living up to their obligations and trying in good faith to eke out a living during tough times: Throw in the towel.

By ANDREW JEFFERY

This post first appeared on Minyanville.

Foreclosure: It’s not just for those “subprime” people anymore.

Besieged by collapsing home prices and frightened banks scrounging for cash, even the real-estate industry’s brightest stars are finding there’s no place to hide. According to the New York Times, small and mid-size homebuilders who thrived during the housing boom are seeing credit lines pulled even before they miss a payment.

Banks like JPMorgan (JPM) and GMAC, the financing arm of General Motors (GM), loaned builders hundreds of billions of dollars — even as the housing market began to falter — to buy up vacant land. Now that demand for new homes has plunged (and buyers in some areas can pick up previously constructed homes for less than it costs to build a new one), builders’ ability to turn a profit has been effectively eliminated.

It’s estimated that over 20% of the nation’s homebuilders have closed their doors, even as big builders like D.R. Horton (DHI), Lennar (LEN) and Toll Brothers (TOL) limp along, bleeding cash and fighting for survival.

Lenders, for their part, are scrambling to mitigate risk.

Collateral, the term used to describe the assets against which loans are given out, protects lenders in the event of borrower default. As the value of collateral rises, banks become better protected since their loans are now backed up by a more valuable asset. In a downturn, however, falling collateral values means risk increases with each passing day.

In response, banks may ask borrowers to send in cash to make up for the lost value of their investment. These margin calls, as they’re known, can quickly force small firms into insolvency.

Such was the case for Brown Family Communities, a well-known builder in the Phoenix area. The Times reports the firm’s lender, JPMorgan, demanded millions in cash for land on the outskirts of town that had fallen in value. Brown balked, since he was yet to miss a payment and had been a longstanding client of the bank with an impeccable record. Ultimately, Brown lost the property and closed his doors, complaining “The real estate market is gone.”

Other builders have suffered a similar fate, proving that despite extensive government-led efforts to minimize losses from investments gone awry, the fundamental tenets of capitalism remain intact.

Bad investments should yield losses, period. Savvy new buyers, able to handle the risk inherent in buying distressed properties, can make bets that have the potential to reap huge rewards. This cycle of profits and losses fuels economic expansion. By forestalling losses, intervention delays recovery.

The speculative buying of vacant desert land on the edges of the Phoenix city limits in 2005 and 2006 certainly qualifies as a poor use of borrowed money. That builders are being asked for cash to cover banks’ potential losses should be seen as nothing more than prudent lending – something builders and other real-estate investors spent the boom years conveniently forgetting.

By ANDREW JEFFERY

This post first appeared on Minyanville.

With millions of homeowners falling behind on their monthly payments, one in 6 underwater, and countless more struggling to keep up, politicians and banks alike are jumping on the loan modification bandwagon.

A modification – or “mod,” as it’s known in the industry — is simply the bank agreeing to change a borrower’s loan to make it more affordable. Mods usually result in a lower interest rate, principal forgiveness or some combination thereof.

For banks, adjusting loan terms is a way to keep cash coming in the door - even if it’s less than they’d been hoping for when they originally wrote the loan. For troubled borrowers, mods can provide an alternative to default and eventual foreclosure. It’s for these reasons that FDIC Chairman Sheila Bair and big banks like JPMorgan (JPM) and Bank of America (BAC) are aggressively promoting mods as the best way to fix the housing market.

The flood of troubled mortgages has also fostered a cottage industry that caters to distressed borrowers. Some are honest folks aiming to help struggling borrowers by using their mortgage expertise and contacts to negotiate better deals on behalf of their clients.

Others, however, are less upstanding.

According to Mandana Nejad, a real estate attorney and founder of Silver Lining Legal Group, a loan modification firm based in California, troubled borrowers have a lot to be wary of.

“Most loan modification companies are compromised of former lenders and brokers who put homeowners in these horrible loans in the first place,” says Nejad. ”Meanwhile, credit repair and debt consolidation firms are simply out to collect fees, regardless of whether or not they can actually successfully modify a loan.”

Last year, the Bush administration formed HOPE NOW, a government-led effort to get banks and the loan servicers who collect payments on their behalf to step up loan-modification efforts. By most accounts, results were underwhelming, as HOPE NOW counselors often asked for too much, and banks gave too little.

Data show that mods done at the outset of the mortgage crisis ended up in default, despite the lower payments. Without proper screening criteria, mods simply delay the inevitable.

For a mod to work, lenders and borrowers must be able to find common ground. Falling home prices, job losses and massive fraud at the time of origination have exacerbated the challenge of finding new loan terms that make sense for both parties. To complicate matters, if a loan has been packaged into a security, loan servicers are obligated to follow predetermined modification standards set by myriad third-party investors.

Borrowers looking to handle modifications on their own face a maze of legal and bureaucratic complications - not to mention the stress of negotiating to save one’s own home. Nejad tells her clients that anyone can attempt to modify their loan themselves, but doing so requires knowledge of the best strategies for success.

Banks treat mods almost like a fresh loan. In order to get the best deal, borrowers must submit a complete application, write a compelling hardship letter, include verification of income, and often support the home’s current value with an appraisal.

While this is no easy task, troubled borrowers shouldn’t run out and answer the first debt consolidation or mortgage relief advertisement they hear on the radio.

Upstanding modification firms should offer:

• Money back guarantees with no exclusions
• At least one experienced attorney assigned to each case
• Direct access to the borrower’s lender(s)
• No more than a 50% charge up front
• Verifiable success stories, not just web testimonials

Still, successful mods require lenders to take losses. Armed with billions in bailout money, banks are now in a better position to allow their borrowers more affordable loans, even if it means more writedowns and less interest income going forward.

Time will be the true arbiter for the success of Bank of America and JPMorgan’s recent plans, but as pressure mounts to seriously curtail foreclosures, more and more federal money will be thrown at the problem. Other banks are likely to follow suit.

Wells Fargo (WFC) has yet to announce a plan of its own, but – given its recent purchase of Wachovia (WB) and its inheritance of a massive portfolio of California option-ARMs – we shouldn’t have to wait too much longer.

While mods are by no means the magic bullet many are searching for to fix the housing mess, they do offer a way for lenders to retain a cash-generating loan – and borrowers to keep their homes.

This post first appeared on Minyanville.

I came upon an interesting report out from Deutsche Bank on the effect high gas prices are having on home prices. Below are some highlights:

• Gas prices are up 167% in the last five years, 32% in the last year.
• Monthly gas expenditure is up to $519 in June ’08 from $173 in June ’02.
• $54,000 in home price purchasing power has been lost in the last five years; $22,000 in the last year alone (Inland Empire, CA is the worst at 46% lost in the last five years).
• As measured by increased monthly expenses and translated into mortgage payment terms, the impact of rising gas prices is equivalent to a 2.47% increase in mortgage rates over the last five years; 0.98% in the last year (Inland Empire is again the worst at a 4.35% effective increase over five years).
• Deutsche sees non-bubble areas like Texas and the South more exposed to gas price increases than bubble states, due to long commute distances and low relative home prices.
• Homebuilders are being negatively effected by this trend, particularly in developments far away from the city center.
• Builders will likely switch strategies and focus on urban “infill” and closer-in townhome projects.
• According to Deutsche, Meritage Homes (MTH), Ryland (RYL) and Lennar (LEN) have the most exposure to highly impacted areas; MDC Holdings (MDC), NVR (NVR) and Toll Brothers (TOL) have the lowest exposure.

Below are some details on the Fed’s proposed new mortgage rules courtesy of Briefing.com:

• New final mortgage rules ban prepayment penalties if payment can rise in first 4 years.
• New rules create category of ‘higher-priced mortgages’ including virtually all subprime loans.
• Lenders must verify repayment ability from income, non-home assets for higher-priced mortgages.
• Lenders must assess repayment ability on highest scheduled payment in first 7 years of mortgage.
• Lenders must establish property tax, insurance escrow on higher-priced first-lien mortgages.
• Lenders may offer borrowers opportunity to cancel escrow account after one year.
• Creditors must provide estimate of mortgage costs, payment schedule,within 3 days of application

If mortgage regulators can enforce their new rules on “higher-priced mortgages,” at least as well as they do for “high-cost mortgages,” (which they actually do surprisingly well) this new category of home loan means one thing: don’t bother applying for a mortgage unless you have nearly spotless credit and money in the bank.

And while many would argue this is a much needed change in the mortgage market, it does raise a few questions:

• Won’t this further increase demand for rental units?
• Won’t this force people to save if they want to own a home?
• Isn’t money saved different than money spent?
• Where was this legislation in 2006, at the height of the boom, even when regulators knew what was going on?
• Why do regulators seem to focus so much on making new rules, rather than enforcing the old ones?
• If the mortgage market figured out how to get around the old, “high cost loan” limitations, won’t it eventually work its way around these as well?