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Will 2012 Be Another 'Groundhog Day' for REO?

JAN 11, 2012 1:38pm ET
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The number of words written about the REO industry in 2011 makes ‘War and Peace' seem like a Reader's Digest short story. So what's new for 2012? Good question ... tough answer. 

Opinions about the future for REOs are as wide and divergent as the span of the Grand Canyon.  CNBC's Jim ‘Mad Money' Cramer called the ‘housing bottom' in July 2009.  Mr. Cramer probably doesn't want to be reminded of that prognostication.  In retrospect, 2009 might wind up looking like a short term ‘top.' On the other side of the spectrum is Nassim Nicholas Taleb's opinion.  In his 2007 book ‘The Black Swan', Taleb wrote:

“The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.  But not to worry: their large staff of scientists deem these events 'unlikely.”

Taleb's comments were certainly prescient, especially considering how the GSEs have fared in the years since his prediction.  The point is that despite the depth of the housing crisis, and the state of the U.S. economy in general, there is little consensus as to just how bad the situation really is. An August 2011 L.A. Times article headline heralded that foreclosure numbers had actually dropped in August 2011. The ‘fine print' revealed, however, that even though the number of new foreclosure actions had declined, the number of homes acquired by the banks had actually increased. 

Rick Sharga, then Senior Vice President at Realty Trac, Inc., was quoted in the October 2011 issue of Mortgage Servicing News that “We are still not selling enough of this inventory to make a dent,” while in a December 2011 interview on CNBC, Dundee Wealth Management's Noah Blackstein called the ‘Shadow Inventory' of REOs overestimated. Jamie Dimon, Chairman and CEO of J.P. Morgan Chase insists the U.S. is in a ‘broad recovery, but in the same January 9th, 2012 interview with CNBC's Maria Bartiromo, he said that the 20% drop in home prices is “a catastrophe.”  So which is it? Whom or what are we to believe?

Some aspects of this crisis are clear; residential foreclosures are at the highest levels seen in decades, perhaps since the Great Depression. One in four homes with mortgages are ‘upside down,' and one in 200 homes in the U.S. is in some stage of foreclosure. The recent reported drop in the official unemployment rate from 9.1% to 8.5% appears to have conveniently omitted nearly 300,000 workers who have simply left the workplace altogether. The old adage that 'Figures don't lie, but liars can figure' comes to mind.

The actual number of REOs held by lenders and servicers is difficult to know. Fannie Mae, Freddie Mac, FHA and VA are required to disclose the number of properties they own, while the major banks do not make these numbers public. 

No one knows what the future holds, but sadly I'm convinced that things will get worse before they get better. Maybe much worse. The underlying dynamics of the housing market are creating a ‘Perfect Storm.' Lenders and servicers are taking back more REOs than they are selling, real unemployment is far higher than the ‘official' number of 8.5%, more homeowners go ‘underwater' every day, and property values nationwide are still falling. The original strategy of U.S. banks may have been to hold their REOs off the market until market conditions improved and property values started stabilizing, if not increasing. This is a failed strategy as evidenced by the huge shadow inventory, estimated at between 1.6 to 1.9 million units. Falling home prices generate more delinquencies, foreclosures and so-called 'strategic defaults.' The impact of home modification programs has been negligible at best. And with a re-default rate on modifications between 60-70%, the net benefit of loan modifications is little more than a drop in the proverbial ‘bucket.'

The Federal Reserve has recently indicated its support for a proposal to ‘bulk-sale' REOs owned by Fannie Mae, Freddie Mac and FHA. The Fed noted that approximately 60 local markets in the U.S. each have 250 or more GSE-owned properties, with Atlanta leading that list with roughly 5,000 government-owned properties. The Fed's ‘White Paper' report also says that the number of properties in foreclosure is four times larger than those in REO inventory, leading to the conclusion that the GSEs' inventory will almost certainly increase. Given the virtual 'gridlock' in Congress, however, even bulk sales of REOs might be a long way down the road, as the FHFA reviews thousands of proposals received in response to their public ‘Request for Information' last summer.

And what if the GSEs do conduct bulk sales to help clear their bloated inventories?  What impact will that have on the REOs held by U.S. Banks and property values in general? Successful ‘purging' of large numbers of REOs by the GSEs might provide some financial relief for them, but that would almost surely come at the expense of even greater losses for lenders and servicers as they liquidate their own portfolios of REOs. Will the government essentially ‘shoot itself in the foot' with bulk sales at ‘bargain basement' prices only to find they must provide more financial assistance to the 'too big to fail' banks? Will government TARP programs continue to spawn like the 'Rocky' film franchise?

The answer to that question and others in future columns.

Comments (3)
Back in scohol, I'm doing so much learning.
Posted by | Sunday, January 15 2012 at 2:55AM ET
That's the perfect inishgt in a thread like this.
Posted by | Friday, January 20 2012 at 10:00PM ET
Articles like this are an emxalpe of quick, helpful answers.
Posted by | Monday, January 23 2012 at 11:27PM ET
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