Where is the money coming from?

[kent nickell]

http://seekingalpha.com/article/196979-are-strategic-defaults-fueling-consumer-spending

Are Strategic Defaults Fueling Consumer Spending

Zachary Scheidt April 04, 2010

The consumer is dead? Long live the consumer!

We?ve faced some very bipolar news on the US consumer over the last two years. With the unprecedented turmoil in the markets, a real estate market that remains depressed and illiquid, unemployment stubbornly high, and shaky financial ground to begin with ? most analysts (myself included) completely discounted the consumer?s ability to spend.

Since consumer spending is known to account for roughly 70% of GDP, this has not been good news.

But with all the headwinds, and with all the negative publicity? the consumer, it appears, is beginning to step up to the plate and once again spend us into recovery.

It should be considered good news, I guess. After all, numbers don?t lie and the statistics point to a relatively strong consumer with money in his pockets (or maybe plastic) and a list of wants akin to a seven-year-old at Christmas.

The strength is wide across the retail sector. Apparel stocks like Lululemon Athletica (LULU) and relatively new IPO Rue 21 Inc. (RUE) are only slightly off their all-time highs. Restaurants like growth stocks Chipotle Mexican Grill Inc. (CMG) and luxury Morton?s Restaurant Group Inc. (MRT) have staged impressive investment gains. Retailers from budget conscious Family Dollar Stores (FDO) to high-roller Tiffany & Co. (TIF) are all trading as if the consumer is healthy and spending once again.

And despite my reservations on this sector, I imagine that retail same-store-sales which will be reported on Thursday will show at least a stable pickup in consumer spending.

Where is the Money Coming From?

It?s been quite a mystery to me for some time now. Exactly where is all this pocket change coming from ? especially considering the difficulties we are seeing in other areas (savings rates are once again headed lower, consumer credit hasn?t expanded by any material amount, and despite positive payroll headlines, the underlying report is full of holes).

It wasn?t until this past week when a colleague mentioned the term strategic default did I realize what was likely occurring. Many consumers are spending their mortgage payments! It?s beginning to make sense in the most disturbing way. As homeowners face staggering payments on houses that have negative equity, a large number are simply deciding not to pay their mortgage bill, resigned to the fact that eventually they will lose their house.

And what happens with the money that would have been sent to the lenders? Well, an increasing mentality of ?eat drink and be merry ? for tomorrow we?re evicted? has set in.

It didn?t used to be this way. For decades, the US consumer placed priority on home ownership. We might miss a credit card payment, and we might put off that family vacation, but we were NOT going to default on our mortgage. After all, home ownership was a privilege, and a serious wealth-building opportunity. Heck, even today there are plenty of retired Americans who are living solely on the equity they built in their homes over a number of decades.

But a sense of hopelessness has emerged when it comes to residential real estate. The principal of home ownership as a tool for wealth building is being sharply disputed. As adjustable mortgages reset to higher rates and payments become more difficult to make, we are likely to see even more homeowners throw up their hands in disgust. If home prices are likely to be low for years (if not decades) then why sacrifice to pay the mortgage on a home where the mortgage is much higher than the value?

Many consumers are willing to turn in the keys and walk ? hoping maybe to get into a better deal once their credit is repaired.

On top of the negative equity issue, restrictions meant to help consumers are actually reinforcing this idea of strategic default. The past and current administration have both made it a priority to keep homeowners from being foreclosed upon whenever possible. Lenders are required to go through a series of bureaucratic steps before enforcing a foreclosure and many times this process takes several months to over a year to execute.

The good news is that homeowners who are truly struggling will be allowed to re-negotiate rates, possibly receive a write down on their principal owed, and participate in other federal and state programs aimed at giving them assistance.

But the dark side of this process is that many homeowners are purposefully not paying the mortgage in a strategic decision to allow the foreclosure process to happen and in the meantime to enjoy having the extra spending money. It is estimated that for every foreclosure on the market right now, there are five or six homes in strategic default.

How Long Can This Last?

The additional measures aimed at keeping homeowners in their houses and encouraging banks to write down loans may very well continue this process for some time. As with many other ?moral hazard? issues, the intentions of regulators may be noble, but allowing a broad portion of the population (whether they be financial institutions or individual consumers) to escape without taking responsibilities for their actions will inevitably cause irresponsible behavior.

It would not surprise me to see several more months (if not a few more quarters) of strong consumer spending in part due to strategic default capital. Also as the market climbs higher and employment statistics are spun to be perceived as positive, more healthy consumers will likely open their purse strings and begin to increase spending.

The momentum may very well continue and that is why the ZachStocks Newsletter portfolio actually holds a long position in Green Mountain Coffee Roasters (GMCR). It may surprise readers to see a long position in this name because I have been vocal about my expectation for the stock to decline. I still believe that at the end of the year GMCR will be significantly lower, but with the current investor capital flowing toward speculative retail issues, we are taking a short-term trade as the stock breaks to new highs.

Unfortunately, while the situation looks sanguine on the surface, the longer we inflate this speculative bubble, the more disturbing it will be when the situation begins to unravel. I expect regional banks and holders of mortgage debt to be the first firms hurt as strategic defaults cause them to write down the value of loans.

Foreclosing on mortgages and auctioning off these properties is an expensive process and banks are likely to take significant losses at some point this summer or fall. As strategic defaulters are finally evicted from houses and must pony up rent money, the growth in consumer spending will likely sputter. At this point many speculative retail stocks will become excellent short opportunities.

The timing is difficult to nail down. For now, speculation is being rewarded and irresponsible behavior has led to a better lifestyle for many consumers. Retail traders are likely to be rewarded by either taking a short-term positive positions or sitting on the sidelines. Once this bubble bursts we will be active on the short side, but until that happens it makes little sense to step in front of the strong positive momentum in speculative retail stocks.

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One of the comments on this article...

I have three friends involved in strategic defaults.
The first took 5 months(yep-you read that right) of non-payment for the bank to finally get back to him on his request to reduce his mortgage payment. His house is worth 40% of what he paid for it.
He had a great time in Vegas this past winter.

The second is planning her strategic default right now as the bank has so far not gotten back to her multiple requests to discuss her monthly payments. They were originally around 1.1k and 15 months later have ballooned to over 2k. This is a fixed loan mind you, but the bank(I believe) misled her into how high her payments could become because of raised taxes and so forth.
This has already boded VERY WELL for the Buckle and Olive Garden.

My third friend has been in her house for over 15 months since she paid her last mortgage payment since no one can find her title(I believe that is what is causing the holdup.) Her house is worth 66% of what she paid four years ago and since the bank and mortgage company can't produce a title, all is well. How can you throw her out when you can't prove you actually own the house?
LuLu Lemon, Sony and Tempur-Pedic are quite grateful for being the beneficiaries of such stupidity.

All three friends still have their original jobs before they purchased their homes.

Who in the world would I buy a house and pay a mortgage when so many people aren't paying theirs? You'll just end up paying more on HOA fees and/or property taxes to make up for the one's that aren't.
Bailing out the banks has created one huge moral hazard. These strategic defaults are the people's bailout and ends up being a massive stealth stimulus.

 

[sharon sanders]

Re: Where is the money coming from?

Interesting.

This part is not valid.

"...no one can find her title." Titles are recorded in the county where the property is located. No one needs to "find" a title. They are part of the public record.

I drove by our local mall last weekend and the parking lot was full.

 

[kent nickell]

Re: Where is the money coming from?

probably something more like this....

http://www.npr.org/templates/story/story.php?storyId=101665800

Missing Mortgage Notes Delay Some Foreclosures

by Greg Allen

March 10, 2009


Many mortgages are not held by banks, but by securitized trusts ? complicated arrangements that involve many investors and byzantine legal documents. Homeowner advocates say they're finding a surprising number of improper mortgage documents and ? in some cases ? fraud that can delay foreclosure.

For years, lawyers defending homeowners against foreclosure had just one option: Convince lenders to re-negotiate the terms of their mortgage. Now they're taking their cases to court.

The 'Rocket Docket'

In Fort Myers, Fla., it's been called the "rocket docket" ? a special court that hears ? and clears ? hundreds of foreclosures each day.

An average case takes just two to three minutes. State Circuit Judge James Thompson gets right to the point with homeowner Theresa Weber: "Miss Weber, it appears the bank has done what's necessary to get a judgment of foreclosure. Can you think of any legal reason why one should not take place?"

Like nearly all the other defendants, Weber answers, "No" and she gets what appears to be the standard judgment ? 60 days to vacate the premises.

There are few tears in this court, mostly resignation.

In Miami-Dade County, across the state, Ana Fernandez says she thought that would be her fate as well.

Fernandez says she made a big mistake a few years ago when she refinanced her home. The new mortgage started with monthly payments of $1,200, but soon ballooned to $2,600 per month. "There was no way that I could afford paying that mortgage," she says.

Fernandez's home is a modest but recently updated three-bedroom house in Miami Gardens. She's lived here for 24 years.

When Fernandez contacted her lender, Chevy Chase Bank, she says the bank was no help: "They told me the best I could do was [get my payments] up to date and then start paying again, which would still leave me with the $2,600 [monthly payment]."

Fernandez learned firsthand how difficult it can be to convince lenders to negotiate terms that allow borrowers to remain in their homes.

Negotiating To Stay In Homes

When Fernandez's lawyer, Ray Garcia, took the case, he found that Chevy Chase Bank had no proof that it, in fact, owned her loan.

In a hearing, a lawyer representing the bank conceded that he did not have the original mortgage note ? something that's required by law. What he did have was a copy.

Chevy Chase Bank bought Fernandez's loan from another institution. And, Garcia says, when he examined the copy, it showed ownership of the loan had never been assigned or transferred to Chevy Chase. In a recent interview in his office, he said: "As we sit here today, they haven't produced a note. They've produced absolutely no record evidence that Chevy Chase has a right to bring this action."

Chevy Chase was recently acquired by Capital One Bank. A Capital One spokeswoman maintains the company has filed the original note, but otherwise had no comment.

Producing The Mortgage Note

The demand that banks seeking foreclosure "produce the note" is a cry that's gotten attention from housing activists and real estate attorneys across the country.

For banks that own and service the loans they originate, finding the original paperwork is rarely a problem. But with loans that have been securitized ? parceled with other mortgages and sold to investors ? the original mortgage note can be elusive.

Lawyer April Charney, who works with Jacksonville Legal Services in Florida, has become well-known as an expert on defending homeowners against foreclosures. She says asking the bank to produce the paperwork is just the beginning.

She says lawyers who take the time to study the mortgage notes and the securitization agreements will almost always find deficiencies, and sometimes, fraud. "These loans are so tricked up by the Ponzi scheme that became the world of securitization and derivatives, that there is no owner to these loans," she says. "They just totally failed to comply with their contracts."

Charney has a full caseload and she's been working to train a small army of lawyers through seminars across the country.

The new world of securitized mortgages, she says, is layered and nuanced. Some courts, overwhelmed by a growing backlog of foreclosures, can even be hostile to attorneys who want to slow down the process.

But in some cases, it's the judges who are beginning to ask probing questions of plaintiffs seeking foreclosures. In California, federal bankruptcy judge Samuel Bufford has written about some of the new issues courts must consider in foreclosure cases. "One of the problems I see ? is I don't seem to have the right parties before the court," he says. "I've taken testimony ? and found out that the owner of the mortgage is somebody else who has not shown up in court at all."

A Changing Landscape

It's a still-developing area of law and it's one that could change abruptly with new federal legislation governing foreclosures.

Still, the growing number of legal challenges troubles Talcott Franklin, an attorney in Dallas and an expert on securitized mortgages.

He says mortgage-backed securities are an important part of a healthy housing market. If many of the legal challenges being mounted around the country are successful, he worries, that could undermine a vital financial tool.

"My big fear," Franklin says, "is that we'll get a series of decisions, based on not fully understood facts, which will prevent securitization from going forward in the future."

Franklin doesn't blame homeowners or their lawyers for bringing the challenges. He's more critical of lenders and their attorneys for not doing a better job understanding securitized mortgages and for not taking care of important legal matters before going to court to foreclose on a home.

 

[sharon sanders]

Re: Where is the money coming from?

Interesting. What a mess.

 

[kent nickell]

Re: Where is the money coming from?

The National Bureau of Economic Research

Joseph Stiglitz and Marcus Miller, Apr 05, 2010

Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?

https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=res2009&paper_id=726

excerpt:

We need bankruptcy reform allowing for homeowners to write down the value of their homes and stay in their houses, in addition to the help that the current legislation proposes. [In addition], the government could assume part of the mortgage, taking advantage of the lower interest rate at which it has access to funds and its greater ability to demand repayment. In return for the lower interest rate ? which would make housing more affordable ? it could demand from the homeowner the conversion of the loan into a recourse loan (reducing the likelihood of default), and from the original holders of the mortgage, a write down of the value of the mortgage to say 90% of the current market price. (Stiglitz (2008))

 

[mixin]

Re: Where is the money coming from?

What a mess.

That's a pretty good description of what's happening in my county. Our unemployment rate has gone down a little but it still has a long way to go.

I had a conversation with a bankruptcy attorney yesterday and her estimation was it will take about 20 years for our real estate values to return to where they were just a few years ago. Another person in the real estate business nationally said he thought we wouldn't hit bottom until at least the end of next year.

The foreclosure process is horrid. Some of the banks are starting the process, even putting them through the sheriff's sale; but then not bidding on them. Many of the owners move out and think the banks have taken the houses back; when in reality, the owners still have all the liabilities and maintenance they had when they lived there.

I know of houses here that have been in the foreclosure process for over 2 years.

In response to

eat drink and be merry – for tomorrow we’re evicted” has set in.

I haven't seen that from anyone I know. Some have lost everything they own trying to keep what they have; the smart ones are keeping the last few months of tenants' payments, which is pocket change compared to what they've lost.