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 Deflation, Foreclosures and You

Five million households are behind on their mortgages. [24]. We were recently advised that the number is closer to {10,000,000} ten million homes. Banks repossessed almost 79,000 properties in February of 2010. “…fears remain about the hundreds of thousands of homeowners who are seeking help under loan modification programs. Many analysts say most of those borrowers will eventually lose their homes, sparking a new round of foreclosures later this year.”said Rick Sharga, a RealtyTrac Senior Vice President. [26] Foreclosures have spread from sub-prime borrowers to homeowners with good credit who applied for fixed term loans. “Nevada posted the country’s highest foreclosure rate…and Las Vegas was the metro area with the highest foreclosure rate in February of 2010 with one in every 90 homes receiving a foreclosure notice. Cape Coral-Fort Myers in Florida ranked second jamming in with a 31% increase from the prior month. Other hot spots were; Modesto, Stockton, Riverside-San Bernandino-Ontario all in California. [27]

We believe that Government programs may slow the decline and provide a corridor of escape for some people however as water seeks its own level it is not prudent to attempt to dam the river of degrading home values.  When the market descends to a level where an equal number of buyers and sellers can agree on price then and only then will the market clear and the carnage cease. Therefore some of the speculators bidding on properties in Las Vegas and elsewhere driving their old jeeps to the courthouse in raged attire while brandishing hundreds of thousands or millions in cash to bid on properties will be wiped out and many of their properties will drift back into foreclosure repeating the cycle over and over probably through 2016 when sufficient time has passed, personal balance sheets are repaired and previously bloated inventories have cleared the market  the price of stability, much lower bids.

 We appreciate that this strategy poses a real problem for banks committed to move certain loans off their books and balance sheets in the vain hope that “someday” their portfolio will recover. A more prudent approach may be to take as many write offs per quarter to show $1 of quarterly profit the stock price be dammed if necessary to purge the bad paper and destroy debt. Banks that continue to retain non performing assets over a fixed time period should be subjected to a real acid test including adding back all off balance sheet assets and liabilities published for the world to see subjecting these institutions to normal market reactions like a sell off or shorting of the stock to technical delisting and seizure of their deposits by the FDIC.

We must face the ugliness head on or risk a Japan style non recovery for decades to come. Remember a smart institution could unload all of its underperforming or nonperforming residential and commercial real estate tomorrow if the price was right. The first bank out the door is guaranteed to survive the next down leg. We must remember this is our new equilibrium and from here the economy has a 50-50 chance to improve or decline. They {the bank} make take a hit on their stock price and rightfully so but at the end of the day walking through the pain will enhance the prospects that the corporate design and signage a testimonial of their strength, character and deserving of our patronage. Years from now their night lit logo Symbolic of their purging of previous toxicity and reminding us that pain is mandatory but suffering optional.


Case study of a home retaining negative equity,

What’s the real cost?

Almost everyone in Las Vegas has seen or heard of local KTNV Darcy Spears whose claim to fame appears to be headlining the news as much as reporting it. Since she is a lightning rod of controversy and spends so much time prying into the lives of others we thought we would conduct some research on her. We visited the county recorders office online and learned of a home listed in the Darcy Spears Family Trust. We are not sure if this is her primary residence but it needn’t matter as the illustration of the costs of retaining any home with negative equity is basically the same.

M.1 Let’s help Darcy Spears [35]

Each of our assumptions is designed to convey maximum financial

benefit to Darcy Spears

2004 purchase price:                                         $600,000.00

2009 total taxable value:                                   $461,660.00

2010 total taxable value                                    $344,806.00

Gross loss to date:                                            {$255,194.00}

Assumption #1*                                               No money down

Assumption #2**                                             30 year note

Assumption #3***                                           4% fixed rate of interest

Mortgage Calculator:                                       $2864.49 monthly payment

30 year payout:                                                 $1,031,216.40


What is Darcy Spears to do?

The Good the Bad and the Ugly

Good: Ask the bank for a 25% cram down. The monthly payment declines to $2,148.37 from $2,864.49 a reduction of $727.62 per month and the total payoff declines to: $773,413.20 which is much more manageable depending on Darcy’s circumstances but again if her house triples in value over the life of the mortgage, her gross increase in value over the loan payout would equal $261,004.80 or a respectable 7% over 30 years.

Bad: refinance for 15 years at the same rate or simply escalate the monthly payment to $4,438.13 which has basically the same effect. Remember cash is King so we are breaking the iron clad rule of conserving cash but if one has really deep pockets then the savings would amount to $232,353.00 over the life of the loan costing $798,863.40 to retire the debt and maintain good credit. On a ten {10} year note the monthly payment escalates to $6,074.71 but the payoff drops to: $728,965.20 saving an additional $69,898.20 from the fifteen {15} year note.

Ugly: remain in the home and pay off the one million+ pay out over the next 30 years owning an asset free and clear and even if it tripled in value from its current taxable value would only appreciate $3,201.60 in 30 years or a paltry .003 or three thousands of one percent.

Best Buy: Strategic Default is not for everyone but is tailor made for Darcy Spears and family. Why? Darcy transfers a $255,194.00 paper loss to the bank, protects herself from further housing deflation by vacating the property, converts her monthly mortgage to a rent payment or cash purchase of a new home buying more home, rental space or upgrades with her new found and increased purchasing power compliments of a deflating economy using the same money she was previously throwing down a rat hole to service increasingly expensive debt.****

Deflation represents an additional burden to homeowners. Why? For several years we have witnessed declining housing values which is bad for homeowners as they have experienced for the first time in generations an asset that depreciates like a car and should be considered a long term liability. Since 1890 Home values have declined in value in fifty {50} of the last one hundred and twenty {120} years. [65]

When deflation affects the broader economy the homeowner suffers twice, once for the falling value of their home and again when they make their sacred house payment with a more valuable currency to pay off a fixed debt. The net effect is that the debt has increased in value as a liability to the debtor and as an asset to the creditor.

 In the illustration featuring Darcy Spears and with the latest data from the February 2010 consumer index prices decreased .6 or 7.2% on an annualized basis which had the effect of increasing her fixed mortgage debt by the same 7.2%. Remember the mortgage loan and her home represents two distinctly separate entities. The home decreases in value in real terms and the debt increases in value in real terms during a deflationary cycle. This situation represents the worst of both worlds to any homeowner and is not sustainable for anyone for any period of time especially when wages are adjusted to reflect the new economy and in this illustration Darcy’s paycheck or wages would technically decline by 7.2% reflecting both the surplus of other skilled investigative reporters willing to perform her job for less money and  since costs could theoretically mirror or equal declines in other pricing including the  discounting of advertising sold by ABC affiliate KTNV-13 accelerating further downward pressure on wages.

So if Darcy is making 7.2% less and paying 7.2% more to service her fixed debt on a depreciating home/asset or liability whichever you prefer representing an annualized purchasing power swing of -14.2%; a triple whammy that is not sustainable. The quadruple whammy on the horizon would be realized if the housing market is unable to absorb the estimated additional {6} million homes in some phase of foreclosure that may return to the market in the next few years [39], if and when government programs to help forestall foreclosures are withdrawn as deficit reduction conversations translate into action.

Some experts have called for an additional 10% decline in prices of homes [41] that would still value housing above the price before the last bubble commenced. We believe that in order to stimulate the return of cash buyers in mass willing to snatch up properties and accept limited downside risks the decline may be 20%-30%+ from the current values to effectively clear the market. We are confident that the floor would then be established and the quantity demanded and demand for housing would exceed supply. For Darcy Spears if we split the difference and applied a 15% further discount on the present value of her home would equal: $293,085.00 and if we’re right and the market bottoms at a full 30%+ from here then her home would be worth approx:  $249,122.00 or $350,000.00 less than she paid for it. Darcy Spears That’s quite a risk premium to remain in Summerlin, Nevada.


What if our forecast remains too positive?

Prices increased 104% and have declined 56%

Darcy Spears: Your home may recover what you paid for it 20 years from now!

81% of Las Vegas Homeowners retain negative equity in their homes. [42]

“Las Vegas remains ground zero for the markets historic boom and bust. Loose lending standards and speculative fervor helped send home prices surging more than 104 percent from 2002 to their 2006 peaks, according to Moody's Economy.com.” [43]

So what if prices decline to their pre boom levels? Then our predictions are much too rosy and in the case of Darcy Spears her home price could bottom at or around $151,714.64.  "If you bought a home in Las Vegas since 2004 up to about 2007, whatever you bought--I don't care if you bought a big house or a little house, in a great neighborhood or a crummy neighborhood--it's worth about half what you paid for it," [44] “and it may take 20 years for some of these home values to climb back to the levels they hit at the peak of the housing boom” according to Larry Murphy the President of Sales Trac [45]


*Why this assumption: If Darcy paid any money down that money is gone and is recorded as a total loss. Remember we are attempting to provide a conservative estimate for any gains and minimize all losses with all financial advantages accruing to Darcy Spears.

** Although a 30 year note represents the worst payback, other than a longer term, in a deflationary economy, the monthly payments are reduced by several hundred dollars allowing the homeowner to hemorrhage dead money more slowly.

*** probably not realistic but again for the purposes of this illustration benefits the homeowner. Mortgage Calculator compliments of www.bankrate.com Thank you!

**** In deflation the purchasing power of money increases as the currency strengthens and consumption weakens. Therefore any debtors owing credit card, mortgage, or other debt eventually realize and painfully so that in real terms their debts increase in value and against them even at a fixed rate of interest because the increased purchasing power of the currency has no effect on their fixed or increasing debt payments. The creditor benefits as more valuable dollars are being used to pay back the same fixed debt including interest.

              Life After Money Real Estates Economics:


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