Are We Headed for Another Housing Bubble?
By Vena Jones-Cox

I was attending a note-buying conference this weekend where, with the whooshing of the fountain at the Bellagio for background, I had a very interesting conversation with a couple of southern California investors.

It seems that these fellows had, for the past few years, been in the business of buying starter homes at the trustee auction, renovating them, and reselling them to homeowners. They completed 150 such transactions from 2009-2011, and had built a construction company, real estate agency, and investment fund around this successful business.

So why, you may ask, were they at a note-buying conference?

Because, in the last 6 months, their business has completely dried up. They went from more than 4 properties per month to less than 1, more or less overnight.

The problem isn’t lack of retail buyers or of money or of qualified contractors. It’s lack of deals. It seems that properties that they were able to buy at 70% of the after-repaired value in 2010 had risen to 75%, then 80%, then 85% in 2012—at which point they wisely decided to pull out of a high-risk business which now, apparently, also has a low margin of profit in their area.

I’m hearing complaints like this from all over the country: fixer-upper inventory is down, what’s there is being bid up to prices that are too high to justify for an investor who actually cares about making a profit in line with the work required to renovate and resell a property.

This has been going on for long enough now—since early spring, by most estimates—that it’s even showing up in the homebuyer market. In some areas, it is again becoming possible to choose among multiple offers on starter homes in great shape. Some nicer starter homes are being bid up above asking price. Days on market in many parts of the country is down significantly. It sort of looks like the market is recovering. Finally.

But things are not as they seem, and it would behoove us all to tread carefully over the next year or so. This apparent “firming up” of the housing market is not being driven by demand, as it would in a healthy market, but by supply. And the supply isn’t being driven by market forces, as it should be, but rather by political ones.

The reason that there’s less housing inventory, particularly in the starter home market, is NOT that fewer people are selling their homes. It’s that the banks—especially the big 5—are withholding inventory from the market for reasons that have nothing to do with whether or not it can or should be sold, and everything to do with governmental interference in the housing market.

This “withholding from the market” takes a number of forms, including:

Holding an unknown number—but certainly in the tens or hundreds of thousands—of defaulted mortgages against which the lenders have taken no legal action whatsoever, thus delaying the eventual foreclosure (and thus availability) of these properties indefinitely
Holding a number of properties already owned by the lenders—estimated between 1.5 million and 2.5 million—off the market. These properties are owned by the banks (or FNMA or HUD), but are not, and have never been, listed for sale
“Bulking out” both defaulted notes and REO properties, and placing restrictions on the buyers that effectively keep THEM from placing the properties on the market. For instance, when FNMA sells bulk packages of millions of dollars worth of REOs, the buyers are not permitted to resell them other than to homeowners for a full year after the purchase, thus removing most properties in any such package from the market for an additional 12 months.
By restricting the supply of houses on the market, banks are manipulating the supply/demand ratio and causing a temporary shortage that is making the housing market look healthier than it actually is.

So what’s the problem? Why shouldn’t the banks just keep right on doing this forever, thus reversing the downturn permanently?

The problem is that it can’t go on. The current size of this “shadow inventory” of properties that are bank-owned but not on the market, and of loans that are delinquent but not on track to foreclosure, is the subject of much secrecy and much debate. Estimates range from 6 million to around 11 million total “distressed assets”, which can’t be held off the market forever, and here’s why:

You’ve probably heard that banking regulators require lenders to retain a certain amount of cash for every dollar they hold in bad assets. For instance, a bank with $100,000 in bad debt has to keep $700,000 in reserves until that bad debt is disposed of. That’s $700,000 it can’t loan to buyers or businesses or credit card holders until it sells that REO or defaulted note. That’s $700,000 that isn’t generating any real returns for the lender.

So all of these “distressed assets” are building up like water behind a dam. Eventually, large banks and the various government-owned entities are going to HAVE to shed assets, both to raise cash (as in the case of FHA’s recent announcement that it would be selling 750,000 defaulted mortgages starting this fall) and to free up reserve capital for lending, which is what the banks did for income back before the government started giving them money at 0% interest.

The question is, will the damn break all at once? Because if it does, our little housing “recovery” will end fairly brutally. Or will it overspill and leak through the cracks, but not burst, in which case we’ll see 5-7 more years of depressed prices, but probably not get our collective legs kicked out from under us again?

The answer to this SHOULD be simple and predictable, but it’s not, because it’s all about politics. Banks are waiting to see who’s elected, and more importantly, whether the “bailout” (which allows the participating lenders to get back up to 80% of their losses when participating in short sales and the first look program) will be extended past 2013.

If it is, we can expect a loosening up in inventory, but not a flood of properties on the market, since it matters less to a lender whether they lose $100,000 or $110,000 on a property when they’re getting back most of that loss anyway. Want proof? In the years since the first bailout, which was intended to allow the banks to dispose of their toxic assets without major loss to the banks, they’ve only managed to dispose of 40% of what they had on day 1. In other words, through lack of action and new bad loans and REOs, they still have 60% of the inventory they had back in 2008-2009.

If it isn’t extended—and my guess is that it won’t be, since voting for additional money to the banks would represent political suicide for those who agreed to it—there’s going to be a huge problem. Lenders have huge numbers of toxic assets already, and a huge backlog of foreclosures that will need to be processed over the next few years. And if they have to go back to making money by lending money (rather than borrowing from the government at 0% and investing that money in treasury bonds at 3%), they’ll need to raise cash, and that means selling off those assets at what they can get.

In parts of the country where no “recovery” has occurred, this will have minimal effect on house prices. But in those areas where people have been feeling confident about the firming up of prices and reduction of inventory, and have been spending accordingly, I think we can expect another, smaller “bursting” of the housing bubble.

Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at www.TheRealEstateGoddess.com