Rick Sharga, Cont.

Watching "Strategic Defaults"

A couple other points from Rick Sharga's excellent presentation yesterday, including a much-needed "silver lining":

The "X" factor in everyone's foreclosure projections is what happens with "strategic defaults."

Typically, people don't pay their mortgages because they can't. A strategic default is when someone doesn't pay their mortgage because they've decided not to.

Basically, the borrower decides that the "cost" of wrecked credit -- at least for a few years -- is less than the "benefit" of preserving what cash flow they have, and being freed of making payments on a house that will never be worth what they bought it for (if by "buying" you mean putting next-to-nothing down, and making nominal payments for a few years -- the case for millions of "Buyers" at the peak of the housing boom).

The odds of strategic default increase as homes become more deeply "underwater" -- that is, worth less than the mortgage against it.

Nationally, Sharga estimates that more than 20% of all mortgages now meet that description.

A sea change in how otherwise solvent borrowers regard their mortgage obligations would obviously wreak havoc with the experts' current default predictions.

One Solution: Equity Sharing

Precisely because of the risk of strategic defaults, many experts are calling for some sort of "equity-sharing" feature in new mortgages, and in restructuring existing ones (I'm one of them).

For existing, "underwater" mortgages, the bank reduces the mortgage balance in exchange for an ownership stake in the collateral (the home that secures the mortgage). That's pretty much what happens now with creditors and corporations that file for bankruptcy protection.

Prospectively, new mortgages would provide that banks share in both a percentage of the upside and downside in the home's future value. In exchange, borrowers would have to forfeit the "non-recourse" nature of mortgage debt, as it's currently defined.

Oh, yes, the silver lining?

As bad as the foreclosure numbers are nationally, and despite signs of "metastasis" (discussed in my previous post), for now the pain is still geographically concentrated in places like Southern California, Arizona, Las Vegas, and Florida.

Banks & Foreclosures: Rational Actors or . . .

. . . Foot-Dragging Ostriches?

Just a heard a very thorough -- and harrowing -- overview of the foreclosure picture nationally from Rick Sharga, a senior executive at RealtyTrac.

His company compiles one of the most complete databases tracking foreclosures, so he's speaking from authority.

What does he see?

--The housing mess is going to persist longer than is currently projected, because rising unemployment is exacerbating the problems with dubious mortgages -- especially Option-ARM's -- originated when the housing market was flying high.

Think of it as two rivers merging into a mega-river.

So when does he expect to sound the "all-clear," signifying a return to "normal" housing market conditions?

Not before 2012, and perhaps 2013 (no, not a typo).

--Peel back all the confusing statistics, short-term noise, etc. and the current foreclosure numbers are staggering.

According to Sharga, prior to 2009, there's never been a month where the number of foreclosure notices exceeded 300,000. Just so far in 2009, there have already been seven such months.

--Conventional wisdom is that every 6-10 job losses result in one foreclosure. However, because there's typically a 3-6 month lag, there are lots more foreclosures in the "pipeline."

Foreclosure Pain: 4 More Years

More gloomy news:

--Foreclosure pain has metastasized, spreading from places like Southern California, Florida and Arizona to previously unaffected places like Portland, Boise, and the northern Virginia suburbs.

--A combination of logistical delays, federal intervention, and the banks' self-interest are keeping many would-be foreclosures off the market -- for now.

According to Sharga, a bank that forecloses on a home can expect to incur $100 a day managing it, paying the utilities, taxes, etc. That comes to about $36k a year.

Now assume that the bank originally lent the homeowner $600k, and that the home is currently only worth $300k. When the home sells in foreclosure, the bank stands to lose more than 8x its annual carrying charge.

What initially looks like ostrich-like behavior on the banks' part suddenly seem quite rational!