I call it fraud, but they call it “stimulus.”
According to the Irvine Housing Blog last week, there are currently 650 homes officially listed in Irvine for sale on the MLS, the on-line homes-for-sale inventory listing used by realtors and potential buyers.
However, 826 homes are in pre-foreclosure or in the auction process and an estimated 2,700 homes are sitting in shadow inventory.
So out of 4,176 homes that should be for sale, only 650 are for sale.
As inventories rise, prices come down. As inventories decrease, prices go up. Abundance makes things cheaper and scarcity makes things more expensive. This is basic economics. But what happens when the abundance is hidden from you and the scarcity is faked?
This means the home prices you see in the market are intentionally being kept artificially high.
Historically, banks have always gone through the foreclosure and auction process as quickly as possible. But remember, before the bubble, the people who stopped making their mortgage payment had probably been paying for years, and bad luck or circumstance is making them unable to pay. They were probably sitting in a house that had gone up a little or a lot in value or the equity they had paid-in so far had covered any minor declines in value. It was in the banks best interest to flip that property over quickly to new owners, and the banks would lose nothing in the process. Times have changed.
Now, when someone stops making payments on a mortgage, they have most likely realized significant losses on the property value and paid little or nothing into it. Now if the bank forecloses, the next person to buy it will pay less than what it was sold for last time and the bank has to eat the difference as a direct loss. So…why would they ever sell it?
A way around this is to not foreclose on the property and let it sit on their financial statements at the original higher sales price. This makes their financial statements look a lot healthier than they are, which is why this is a fraud.
The reason they can’t do this is a GAAP rule in accounting that prevents all companies from playing this game. It is called the mark-to-market rule. It’s illegal to break this rule.
For example, if you buy a car for $30,000 and five years later you are asked by a bank to determine your net worth, as you would be if you were asking for a loan, you must add up all your assets. For most of us, that means adding up what’s in your checking accounts, savings account, 401(k)s and the value of other assets we have, like a car or a boat. So would you report that car as a $30,000 asset or what it’s worth now, let’s say you could sell it to someone for $18,000? Well, mark-to-market says you value it at $18,000 because that is what you will get for a five year old car. If you tried to sell it for $30,000 five years after you bought it, nobody would buy it.
All companies are required by law and GAAP to follow this rule. Common sense, right? Companies found violating this rule face fines, penalties and jail time for the participants in this kind of fraud.
Therefore, the banks are legally bound to revalue the homes they are sitting on to market value, which as you know would mean a home they sold for $700,000 in 2006 would probably fetch about $375,000 now. This is the law, and it would make sure all this shadow inventory was being sold, because the banks would want to sell as many homes as possible as quickly as possible and all of us would have lots and lots of homes to choose from all at extremely affordable prices.
Government Intervention #1
Our federal government stepped in and suspended the mark-to-market law for banks. Only for banks. Every other company you can think of still has to follow this law, just not banks.
This rule suspension by our friends in the Federal Government allows the banks to keep homes on their financial statements at the sale price, not the mark-to-market price. By doing this, the federal government has removed the only reason banks would have to try and sell foreclosed properties. Imagine if you could list that $30,000 car as worth $30,000 no matter how old it got or how many miles you put on it? This is what our government has allowed the banks to get away with.
Because of this, thousands of homes, just like the thousands in Irvine are simply ignored by the banks. The homeowners stop paying the mortgage and the banks lets them stay there for free, for years. Empty homes are left empty.
Our current example has 6 homes hidden in the shadow inventory for every 1 home up for sale. This 6:1 ratio will tick up to 10:1, 15:1, etc…but you can be sure the banks will only drip-feed a few homes into the market for sale at a time, hiding the rapidly inflating shadow market from any would-be buyers. You are being intentionally forced to pay more for a home than it is worth.
The only other check and balance that was helping to curtail this abuse was ironically, the banks themselves. They stopped loaning because most people would not meet the banks new stringent loan requirements. In many areas even the artificially inflated home price is still too high for most people to afford.
Our government, not in the mood to let us buy cheap houses, steps in yet again…
Government Intervention #2
Through the FHA, some 90% of home mortgages are now being passed over to the federal government, removing that last doorstop that would have let prices fall to affordable levels. Anyone can get a loan now, and if they default it will be up to the taxpayer to bail out the FHA, Fannie Mae and Freddie Mac. All of which have already asked for, and received, billions in taxpayer bailouts.
The only hope I hold out for is an increase in interest rates. That is the last thing I can think of that will force home prices to come down. Until then, the banks and the government can play this game for years and years…and years to come.
Everyone say, “Thank you Uncle Sam!”
Categories: Housing Market