By A. Cassandra, found at EWI 3/30/2007 

subprime mortgage foreclosures in your neighborhood

Our new feature, "Vox Populi Asks," kicked off last week in the Weekly Select with this two-pronged question:

Do you see foreclosures in your own neighborhood? How do you think troubles in the subprime mortgage market will play out in your community and the economy at large?

Here are answers that came in from various readers. Thanks to them all. I did have to prune some of the longer answers, but I'm glad to hear from everyone at any length. If you would like to add your own two cents, please send a response to contact us and put the word Foreclosure in the subject line. I will be tossing out a new question for discussion in mid-April 2007.

From David W.

As for foreclosures themselves, I can’t say as they are indistinguishable from a house for sale in the short run. However, there are many houses on the market, with an increase in the last 6 months or so. There are virtually no sales to speak of according to the MLS system. 

It has been proved repeatedly that a huge increase in the number of foreclosures in any community will result in a significant price decline and market liquidity (Sunbelt and Midwest states in the late 1980s – early 1990s). The difference this time is that unlike Houston, Denver or Detroit in the past where the problem was localized and to a large extent caused by the local economy, this is much more of a nationwide happening that will depress prices and real estate liquidity everywhere (some more than others). The looming real estate problem is more one of bad lending policies on a massive scale that lead to economic deterioration rather than economic deterioration leading to real estate problems.

The real test for the mortgage market meltdown will be when some of the mortgage backed securities are downgraded (below investment grade), forcing institutional investors to sell. I find it hard to believe that anyone associated with the issuance of mortgage-backed securities ever envisioned a default rate of 13% and even then not all at once. Most securities are underwritten with a 2-3% (at worst) default rate, and again it is assumed the defaults will happen throughout the life of the security not all in a 3-6 month period. 

The Rating Agencies periodically review the ratings issued on mortgage-backed securities, and I have trouble believing that they will be able to Affirm the current ratings given the tidal wave of defaults and pending foreclosures. This will lead to an inevitable tidal wave of Rating Agency downgrades of mortgage-backed securities, institutional investor sell-offs and a price collapse in the asset class. This is exactly what happened to regulated institutions when regulators forced the sell-off of junk bonds and other non-investment grade securities in the early 1990s.

I have not looked into Rating Agency review period of some of the more suspect mortgage backed securities but anticipate that given the recent press and concern over this topic, reviews will be done sooner rather than later. The originators of sub-prime and “Alt-A” are to a large extent irrelevant in the context of the overall economy. However, the estimated $4 trillion of outstanding securities that fit this description are anything but irrelevant and so far have been virtually overlooked with respect to their potential impact on the economy and even their existence. Assuming a 10% default rate on this class of securities, the resulting $400 billion dwarfs the S&L crisis that held the real estate markets hostage for years during the RTC period (1989-1995). 

From Chuck B.

A main driver in this 'innovative' economy is the job black market in home building/service labor. The hinges have been broken off the border door, and the available cheap (cash/ under the table) labor has been a boon for the whole industry. Everyone involved is on the take and ignoring fed., state, local laws, and reaping the savings. Wall Street productivity stats have to be skewed because there are so many non- census (illegal) participants creating more, per capita. Anyway, the point is that the party is going to end. When it does, illegals are going to be displaced to a certain level of strife. Thievery and disobedience has proved to follow. America has been sold down the river, and our national problems are going to compound once housing &/or credit is crushed. The socionomic implication and consequences are immanent because of the short sightedness of the infusion of a failed policy. It's surely not sustainable. Something is going to give.

From Curt H.

In my part of the country (Northern Kentucky and Cincinnati), real estate prices really didn't go up as much as the rest of the country. There are a few pockets that are inflated, but most of the prices have been flat for six years now! It's not like a real estate crash is about tohappen, it's like there has always been one here. The reason is that growth in this part of the country is very, very slow. So it's very easy for new construction to get ahead of itself, but it rapidly corrects.

Consequently, wise people from coastal areas sold some of their outrageously priced properties and moved here and have no mortgage and a ton of cash in the bank. There are a high number of foreclosures in this area, and the inventory of homes for sale is slightly above average.  However, I don't foresee this situation worsening very much, because this market doesn't have as far to retrace….

I purchased my own home for $263,000 seven years ago. I live in a subdivision in which there are about 75 to 80 homes. It broke ground 14 years ago, and the last home was built 5 years ago. A house was foreclosed at the very beginning of my street last year and sat vacant most of the year. Someone bought it, and it's occupied now. However, there are now 5 homes for sale, 2 of them just across the street from me. I live just before the beginning of a cul-de-sac on a wooded lot.

The homes across from me do not have as much woods backing them, and are slightly smaller, but their asking price is approximately $200K. So rather than foreclosures at the immediate time, what I'm seeing is a significant price depreciation below reconstruction cost.  My home is taxed at $300,000 and is insured for $333,000 for the main structure.     I estimate that the homes that aren't selling directly across from me for $200K are only worth about 20% less than my property. This means that rather than my property value keeping pace with inflation, it now has a market value of something like 10% less than I paid for it 7 years ago. I can see how this situation could very easily lead to foreclosures even for people who have dual incomes and are not big spenders. Real estate deflation is a much more serious threat than terrorists, wars, trade deficits, government deficit spending, etc….

I feel that the collapse of subprime lenders is a mixed bag -

1) They made loans they shouldn't have, and there needs to be a correction for that.  

2) It does help the very large lenders get bigger, which reduces competition, which long term is not a good thing.  

Ultimately, I'm afraid it's either a combination of the [Federal Reserve] lowering rates (too little too late as usual), which could keep some people from losing their homes and perhaps keeping some brokers and lenders afloat, or an all-out government bailout. The government bailout funded at taxpayers expense is the most disgusting scenario, but if history is any guide, it's also a very likely scenario. And most likely people losing their homes won't benefit much, just "certain" investors in sub-prime paper.    

But the effect on the real estate market of course is more foreclosures and more RE inventory which results in price deflation, which is a self-fulfilling downward spiral. I don't expect it, but it's not inconceivable that mortgages would hit all-time-record-low rates in that environment just to stabilize prices. RE deflation in the US is the last shoe to drop, isn't it?  

From David W.

Here's something to make a true "Waver's" jaw drop open. Here in the UK, our real estate bubble is still inflating. A banker told me yesterday that foreclosures here will start about a year after America's.  "Ours will be much worse," he said, "because our bubble's bigger."

From Ishaq U.

1)    I think sub-primes will snowball other mortgages sooner or later, and eventually  affect the whole national housing market. The crash point will be when one (or a few) cases of the synthetic product, like CDO/MBS, goes really, really bad, and money  managers start worrying about their jobs, if they have these products in their portfolio.

2)   Currently, things are going great in Austin. The home prices are actually going up, and houses are being snapped up like crazy in my neighborhood. No sign of distress around here in the north-west Austin. There was some distress in the 2001-2005 time-frame, there is none right now. The south-east Austin is always under stress due to lack of good jobs, but even it is showing much less stress than normal. All bets are off if Dell starts laying off people.

From Derek B.

This isn't about foreclosures per se, but a related detrimental effect. There was an article in the San Jose paper about a mortgage lender that is going to close down and lay off 350 people:
http://www.mercurynews.com/breakingnews/ci_5490326
This is not even a subprime lender.  However they did a lot of high LTV (99% - 100%) and low documentation loans. Their lenders tightened the standard they use to fund them, and they couldn't keep up. So this is definitely a ripple effect, and shows that it is not just the subprime market that is affected. And people are losing their jobs, which is never a good thing.

From Larry C.

I see  foreclosures in many different socioeconomic strata of my city (Louisville, Kentucky). They are now affecting lower and middle class and the marking down of real estate is beginning to catch fire. The economics of the city are very good here but it is getting nastier according to the realtors I know along with the mortgage brokers who are crying a little now but are getting louder.

From Anita V.

I live in Italy, and I don't know if what I'm reporting is useful to you, but still..

In Italy we are used to following other countries at least two steps back. We get into a mania when in other countries everyone is stepping out. I live in a very small village in the Western Alps, 70 Km from Torino (the site of 2006 Winter Olympic Games).

During the last 4-5 years, a process of re-building has been carried out both from Regional and State Administration, encouraging the renewal of old houses and the construction of new residential  and manufacturing sites, all over the country. Who is expected to inhabit those sites I can't really imagine. Perhaps a new Barbaric Invasion is on. But from where? Do you see any UFO approaching? I don't know. We have to suppose so, as the demographic reports indicate a constant fall of births.

What I see is the [real estate] advertising posters increasingly dusty, everywhere.  A clear sign that demand and offer aren't matching. The posters are exposed to pollution for too long time, as vacant new houses will be.

The politicians are careful to avoid the word recession, they are glorifying "the silent boom of economy" and forecasting a GDP growth of 2-3% in 2007. That's not the opinion of "vox populi" in my own village. Things aren't going well since 2000. But I live in the mountains, and people living in the mountains are bearish by definition. That's why we fought (peacefully) the project of the High Speed Train Torino - Lyon. But that's another story, that I will tell you another time.

From R.R.

I live in a wonderful neighborhood in San Francisco.  We went around it a week ago & have not seen much "For Sale" signs yet. The city government (the government at large) has no clue what will hit them in the coming months ahead. Still business as usual. I'll update you next quarter on this topic.

From Glenn H.

My area of Nassau County, Long Island, has escaped the foreclosure problem so far.  But the real estate unwinding is just beginning. Over the last 5 years, many people (close to 40%) in my area have either moved up to a bigger house or expanded the size of their homes, in some cases doubled them!  All on easy credit, of course.

As it hits the fan worse and worse, while I don't think there will be many foreclosures in my area (I hope not), I can see massive belt tightening. Many Starbucks, dance studios and gyms for kids will go out of business, and all those big soccer mom SUVs will sit around while everyone crams into a Kia.

From William M.

I don't see [foreclosures] in my neighborhood yet, but what I do see for the first time in a long time is job listings for REO departments at banks.  [Editor's note: REO is real estate owned by a financial institution after a borrower defaults and the financial institution forecloses on the property.] I once worked in this area and looking through job boards, I now see these types of positions advertised here in Southern California. It has been since the mid-90s that you saw these positions so in demand that there are actual job adverts for them.

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related: Prime time Mortgage Mess: Now It's Prime Time