To see Part 1 of this article, please click here.
Yesterday's column, "QE3 Isn't Working," struck a nerve with many subscribers, for various and sometimes conflicting reasons. So in this column, I am going to look at the issue from a different slant.
There are about 130 million residential dwellings in the U.S. Of these, 30 million are in multifamily structures clustered in urban centers. The other 100 million are the houses that are predominantly in the suburban areas around the cities.
The majority of the nonperforming residential mortgages are concentrated in the 100 million suburban properties. The equity position that homeowners have in these properties can be broken into three areas: all equity, no equity and negative equity.
About a third of these homes are unencumbered by a mortgage and are owned free and clear. About another third have between 0% and 10% equity. Because it costs about 10% to sell a home, for practical purposes this group has no equity. The last third consists of the homeowners who are in a negative equity situation -- they owe more than the property is worth.
Of the roughly 65 million homeowners who have no equity or negative equity, about 13 million are in default on their mortgages. That means that they are more than 90 days late, and their loans are no longer accruing interest. These loans are essentially in a holding pattern, awaiting either the mortgagor's (homeowner) request to be allowed to do a short sale or the mortgagee's (lender) decision to foreclose. The probability than any of these loans will be brought current and that the borrowers will be allowed to stay in their homes is essentially zero. These homes will be sold short or foreclosed on at some point.
Although the bank call reports for the fourth quarter of 2012 show that this issue is slowly being resolved, it is a massive problem overshadowing the banking industry, and promoting the acceleration of this resolution is one of the major goals of the Federal Reserve's third round of quantitative easing.
The idea is to drive down mortgage rates and hold them down in order to attract homebuyer demand. This would give banks the opportunity to accelerate the resolution of their nonperforming loans, either by granting short-sale approval for mortgagors who are in a negative equity position or by foreclosing on delinquent borrowers and sending the properties through the usual recovery process.
There has been some activity in this regard, as I discussed last week in the column "Excellent Fourth Quarter for Banks." Nonperforming loans declined from 9.87% of all mortgages in the third quarter, before QE3, to 9.50% in the fourth quarter, which was the first quarter after the Fed started buying $40 billion per month in mortgage-backed securities.
To put this in perspective, the value of nonperforming mortgages held by the banks and non-banks in the U.S. declined by about $40 billion during the fourth quarter, while the Fed purchased $120 billion of agency mortgage-backed securities.
The banks met the Fed's demand by selling their existing holdings of mortgaged-backed securities to the Fed and passing through their origination of new loans to the MBS market rather than retaining them.
The result has been that the demand by homebuyers has been greater than the number of existing properties made available to the market for sale.
Since two-thirds of homes are ineligible for sale unless their lender approves them for a short sale or forecloses on them, buyers have been forced to compete for the limited supply of housing being made available by the third of homeowners who have equity and can sell or by builders of new homes.
This manipulation of increasing demand for mortgages by the Fed and a not-commensurate increase in supply of homes by the banks is providing the illusion that housing is rebounding, as it forces up the price at which homes transfer.
From the perspective of gaming confidence into the market, that's great, but the banks still have to bring those 13 million properties with nonperforming mortgages to the market.
At the current rate of home sales, assuming no more mortgages become nonperforming and builders stop building and everyone who owns a home refuses to sell, and the only properties allowed to be sold are those encumbered by nonperforming loans or already foreclosed on, it would take three years for these properties to be sold.