sunny outlook

Consumer confidence is up. That had the markets all jazzed up and we saw another rally yesterday. Unfortunately, it won't last. Consumers may feel more confident now that the sun is out and the weather is getting warmer, but it won't lead to economic recovery. We are a long way away from that. Much more hardship is to come before we can start dreaming about recovery. 

The sunny mood was everywhere. Several newscasts did specials on Memorial Day sales and retailers tried to sound hopeful and upbeat. Even the real estate guys saw signs of a "turnaround" or a "reduction in inventory." Call it a calm before the storm. Rest assured that another round of foreclosures is coming our way. The first reason is quite simple: the moratorium imposed by the new administration is about to run out. The second reason is far less obvious but much more damaging.

The most onerous mortgages, the ones with negative amortization and pay-as-you-go schedules have yet to reset. Their 5 year grace periods will be ending soon. Starting this summer the first ones will hit their resets. When they do, a major wave of foreclosures is inevitable, even if the economy stays where it is (or improves). California will be especially hard hit as most of these "creative mortgages" were written in the golden state.

Foreclosure is inevitable is because people who bought houses with such mortgages were unable to pay their true mortgage rate 5 years ago when they acquired the house. They are even less likely to be able to pay it now. 

What will happen soon is that people who could not afford a 30 year mortgage of say $400K will now suddenly have to a pay a 25 year mortgage of $425K. With no equity in their homes and the residual values hovering around 50-60% (i.e. $250-300K in our example), these people will walk. They would be fools not to.

There is a third reason: the deteriorating job market. Everyone who have lost their jobs since the crisis started is also in trouble. That has added an additional pool of foreclosures in the prime mortgage category. People who have equity in their homes but who can no longer afford to pay the remainder of their loans.

All three factors are likely to exacerbate our problems starting this summer. Expect another big drop in housing prices. To be followed soon thereafter by another big wave of job losses and layoffs.