Double-Dip Recession in Housing? How to Profit From Foreclosures

When it comes to home prices, my first stop on the web is www.zillow.com. You can type in any home address in the U.S. and it will provide you with a “zestimate” of what that home is worth. Unfortunately, when I type in my address, the zestimate seems to be falling again after having risen for a quite a few months last year. Dang, I thought the housing recession was over!  

Get Ready For a Housing Double-Dip Recession!

It turns out that I am not alone. A new report by Zillow says that 12 metropolitan markets have officially entered a double-dip recession for home prices, with 10 more markets on the verge of double dipping. Zillow defines a double dip as having three components: (1) an initial thrust down where 10 of 12 months show negative month-to-month price declines; (2) a rebound where at least five consecutive months show price increases; and (3) a second thrust down of at least five consecutive months of price declines.

Last month, Zillow chief economist Stan Humphries said that one in five U.S. housing markets run the risk of a double dip recession and “there are clear signs that home prices will turn more negative in the near-term.” To find the signs, all one has to do is look at the most recent existing and new home sale figures reported last week. According the National Association of Realtors, existing home sales (more than 90% of the total) fell for the third consecutive month in February and the U.S. Commerce Department reported that new home sales in February fell for the fourth consecutive month.  New home sales fell to an annualized number of 308,000, which is the lowest number since . . . well since the Commerce Department starting reporting the number 47 years ago in 1963. 

The good news according to Zillow is that home prices should bottom sometime this year.  The bad news is that a bottom does not mean a rebound:

Home values are likely to bounce along the bottom with real appreciation remaining negligible for some time.

What does “some time” mean?  This month’s Zillow report defines it as “several years before values begin to show substantial increases again.” Looking at a chart of the Case-Shiller Home Price Index, one can clearly see that the price rebound in 2009 is over and a new decline has begun:

Drowning From Underwater Mortgages

The reason a price rebound is not in the cards is because of one startling fact: nearly one in four U.S. mortgages is “under water.” An underwater mortgage means that the homeowner owes more money on the mortgage than the house is worth.  How much more? According to FirstAmerican CoreLogic, more than 10% of homeowners owe at least 25% more. The worst state is Nevada. I enjoy visiting Las Vegas, but I wouldn’t want to own a house out there: a whopping 70% of home mortgages in Nevada are under water!

People with underwater mortgages are much more likely to default and walk away from their monthly payments, resulting in foreclosures.  Call such people deadbeats all you want, but walking away (i.e., a “strategic default”) is the rational thing to do, especially in the 11 states that are non-recourse and don’t let lenders go after one’s non-house assets to pay off the debt (Alaska, Arizona, California, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington, and Wisconsin).

How come nobody calls Morgan Stanley (NYSE: MS) and BlackRock (NYSE: BLK) “deadbeats” for doing strategic defaults in San Francisco and New York? I hate it when wealthy corporations get to play by different rules than the average Joe.

Home Foreclosures Will Explode

According to the Center for Responsible Lending, banks have foreclosed on 6.6 million homes since 2007 and another 10-12 million foreclosures could occur in the next few years!  Just think about that: the U.S. has gone through the worst housing crisis in history over the past four years and yet the greatest wave of foreclosures has not even hit yet!  Foreclosures are bad for home prices because banks are motivated sellers that are willing to sell at a discount to fair value to clean up their books.  As Greg McBride, chief economist at Bankrate.com, stated recently:

There are still a lot of foreclosures in the pipeline. Who knows what will happen when that inventory hits the market. It will more than likely hurt housing prices even more.”

And it doesn’t help that two federal programs aimed at supporting the housing market are coming to an end. First, on March 31^st, the Federal Reserve has announced that it will stop purchasing mortgage-backed securities (MBS). Since mortgage rates are based off of MBS rates, the Fed’s MBS purchases have kept mortgage rates low; without them rates will rise and make home ownership less affordable. Second, on April 30^th, the $8,000 first-time homebuyer tax credit is ending. Without this credit, fewer potential buyers will be able to bid on homes. A Deutsche Bank analyst published a report last fall predicting that nearly half of all U.S. mortgages will be underwater by the end of 2011. Yikes!

Mortgage Modification, Obama Style

It was precisely this fear of increased foreclosures stemming from underwater mortgages that prompted the Obama administration last week to revamp its mortgage modification program to include principal forgiveness as a core component.  Oh, another impetus to the program’s revamp was a scathing report from Troubled Asset Relief Program (TARP) Special Inspector General Neil Barofsky calling the program a failure.  Among Barofsky’s criticisms:

• Pressuring lenders to rush homeowners into mortgage modifications before collecting the documentation needed to prove that the homeowner had the income needed to actually pay off the mortgage;

• Providing stingy modifications that did not take into account a homeowner’s non-mortgage debts and which left many borrowers still owing at least 70 percent of their monthly income in debt payments;

• Offering principal forgiveness to only two percent of those receiving mortgage modifications; and

• Achieving only 169,000 permanent mortgage modification out of 1.3 million trial modifications initiated.

Under the revamped program, the Obama administration is spending $14 billion from the TARP program to provide financial incentives to lenders to provide underwater homeowners that owe more than 115% of their home’s worth with debt forgiveness of the amount above 115%. The program will not require debt forgiveness but will only require that lenders consider it.  Consequently, many analysts are skeptical that the program revamp will actually result in a significant decrease in foreclosures.

Even White House economic advisor Diana Farrell admitted that the new program is not capable of “tackling what may be 10 to 12 million foreclosures over the course of the next three years.” With cheerleaders like that, who needs critics?

Profiting From Foreclosures

Faced with all this evidence that home foreclosures are going to skyrocket over the next few years, you may be asking if there is a way to profit from foreclosures. I know, you feel a little guilty profiting from events that throw people out of their homes, don’t you? Well, don’t worry about it. Somebody is going to profit from these tragedies, so it might as well be you.  The following table lists five companies that make money on troubled home mortgage loans:

Source: Bloomberg

This is just a list to get you started, not recommendations. Further research is required.

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