The fundamental problems have not gone away…

http://housingcorrection.com/misc/MVm.png

Note how the money multiplier (1/Reserves) has so far directly offset the massive increase in the monetary base. So what’s left is velocity has been declining, thus pushing GDP down. IOW, in order for inflation to hit, the banks must loan, and people must spend. As AMS has alluded, if the Fed gets this wrong, we will pay a hefty price for having undergone such extreme manipulation. If you stop and think about it, that is a very abnormal and scary chart.

FHA is broke: http://www.washingtonpost.com/wp-dyn/content/article/2009/09/18/AR2009091803578.html?hpid=topnews

FDIC is broke: http://online.wsj.com/article/SB125328162000123101.html?mod=googlenews_wsj

Fannie, Freddie, and Ginnie are broke.

The entire system is a house of cards.

The stock market continues to soar pricing in a massive V-shaped recovery.

” We have three main problems leading to this dramatic rise in FHA defaults:

1. Pressure from government to use FHA for purposes of taking toxic loans off the bank’s balance sheets;
2. Lack of education, training, and mentoring of new underwriters during the recent, dramatic rise in FHA originations; and,
3. Lack of a large enough down payment from the homeowner to insure against falling home prices.”

IMO, it’s all part of the bag of extraordinarily risky tricks to prop up the paper mache economy in a sly attempt to rescue society’s most elite class of criminals.

We are in a pickle.

Re your question in #44, what I mean by “fha approved lender” this would mean a bank, consumer loan company, credit union, or other non-depository lender that have the ability to fund their own loans. By definition a broker is not a lender so we’re talking lenders only. The vast majority of brand new underwriters I met in 2008 were working for federally chartered banks.

You have really put a point to the discussion here and on the Open Thread. These are investor dollars that I am calling a market manipulation. Dumping money into the stock market makes every one feel good, mortgages are being churned, refinance, new purchase mortgages, and it appears as though we are doing business, creating commerce, having an economy.

As money retreats back to the reserves, or any safe haven, it will suck the life back out of the economy. This time the consequences will be less sever. There are other things to do. We can make money doing other things than trading paper.

One more question:

Where is the critical point at which the United States must inflate the dollar to pay back debt? Of course this could be based on GDP, debt holders switching to consumption, level of debt, and so on. But there must be a critical point where the US will have a problem paying back its debt. It’s not a question of if, but rather, how much.

Overheating too far leads straight to inflation, but I am not suggesting that is what is going to happen. In my opinion the problems in the economy are very deep. For example, it’s tough to drop interest rates when the FED target is essentially zero. What’s next, negative 2%?

Then we have a problem with the total education of the workforce. While Seattle is one of the more educated areas, which is one of the justifications for inflated prices, the total workforce is not in such good shape. So turning up the heat might not put much in the economy.

Then there is debt–how do you turn up the heat when you have a bunch of boomers trying to consume in retirement? The promise must come from generations below?

Oh, and I do agree we are in a very risky position. Volatility isn’t something that I view as bad, but some do.

Nobody knows for certain where we are headed, but I think most people agree we are still amidst a high degree of risk and volatility.

I am afraid that with TARP and how much in debt the banks are to the government…the government is now working for them. (As if they weren’t bought all ready).

“The question is can we inflate the dollar so that money becomes worth less but people aren’t technically underwater?”

Basically this is the question of “Can the FED get inflation to be such that it is positive, yet not too high, and at the same time stimulate a strained economy?” I find this very problematic. It is going to be a surgical maneuver to heat up the economy, but not overheat it. Very tricky given our situation.

One thing is for sure, the mass psychological forces have a much lower discount rate than just about each and every one. It reminds me of how long it took the Catholic Church to forgive Galileo. Does it do much good to be forgiven some 400 years later? Maybe his soul has been transferred to a much happier place.

Not like it used to be where HUD issued your number.

Amazing is the word…but hey….the govt is picking up the tab so this TARP receiving company could care LESS.

actually Kary – analyzing my bank’s losses….those we approved above 700 FICO so far
I only have one foreclosure….I feel that FICO socres should be a PART of the underwritng process, more importantly is a HARD stop at 43% DTI. Anything above gets declined.

But I agree with you it is so easy to get a high FICO and have no business getting a home loan.

So far most of the foreclosures I see are all due to lying about owner occupancy….almost all were flips.

Sorry, my notation is sucky. That should be M2=MB/R. The point is FHA defaults will rise if home prices continue down. The question is can we inflate the dollar so that money becomes worth less but people aren’t technically underwater?

Most people believe inflationary pressure currently outweighs deflationary pressure. But if that’s true, why won’t the Fed up the short-term rate? If the Fed knew inflation was about to take off, it would be highly irresponsible not to raise the rate.

IMO, we are not in danger of inflation until banks start lending and people start spending. As long as the banks hold money in excess reserves, the increase in the money supply is negated (M2=MB/R). Increasing the monetary base does not automatically mean hyperinflation will hit. First that new money has to circulate and chase goods. So how much money is currently chasing Seattle houses compared to 2005? It seems to me, that’s what matters to whether prices will go down, stay flat, or rise from the current 2005-ish levels. If the answer is, there is less money chasing houses now than then, most likely FHA defaults will rise from current levels.

“Propensity to spend, save, taxation rates, and so on must change just perfectly if the velocity is to remain constant with a changing money supply. Possible, yes. Probable, no.”

True, but people spend less when unemployed. I agree we will most likely experience high inflation when the money catches up to us, but I don’t see it happening in the near term.

This is true: “That is only true if the increased money circulates through the economy with flat to rising velocity. If the money is kept as reserves, it loses its inflationary effect (i.e. M2=m/R).”

Similarly, as long as the velocity does not change, the money supply can contract without deflationary effect.

Propensity to spend, save, taxation rates, and so on must change just perfectly if the velocity is to remain constant with a changing money supply. Possible, yes. Probable, no.

That is only true if the increased money circulates through the economy with flat to rising velocity. If the money is kept as reserves, it loses its inflationary effect (i.e. M2=m/R).

“For some reason a “trade deficit” with my local Starbucks is just fine, but a “trade deficit” with China is a bad thing.”

You are not borrowing money from Starbucks to buy the coffee. If you were, what would happen if you walked into Starbucks and tell them you are going to pay them back with money that is only worth half as much as they loaned you? They would cut you off the crack, and once all the other dealers learne about it, you’re days with the glass pipe are finished. It can be viewed as the best thing that ever happened to you, but the pain you experience during the transition won”t be much fun. As for Starbucks, it learns a lesson it won’t repeat.

It is not a good thing to live beyond your means by using borrowed money. If you continue to do it long enough, as mentioned above, you reach the saturation point.

We always feel good when we first take out a loan and are partying with the money. The problems start when our debtors start to question our ability to pay back the money.

I’d like to know what you define as an FHA approved lender… “Today, FHA allows the FHA-approved lenders to appoint and train their own underwriters!”

It’s not very easy to become an FHA/HUD Direct Endorsed approved lender (not sure what level you’re talking about which is why I’m asking for clarification).

I would disagree with the “haven’t done it” statement when referring to inflating away part of our debt to the Chinese. It’s true that the Fed hadn’t bought long term treasuries in years up until last March. But since the Fed announced that it would buy up to 300 billion in long term treasuries last March, the Dollar Index has dropped from about 88 to it’s current level of about 76. Meanwhile, China continues to buy short and medium term treasuries along with all the other investments they make with what was once our money.

Unless the dollar index rises, It’s too late for the Chinese to avoid losing that 14% on their current portfolio of dollar denominated assets because Ben already sent it swirling down the drain. And you thought Ben was’t all that sharp. Arguably, the Chinese have already taken most of the inflation hit on their present and perhaps their future dollar denominated investments in which case, helicopter Ben would be more appropriately referred to as “quick draw Bernanke.” The gun fight was over before the Chinese got their gun out of their holster. Of course this analysis assumes that the decrease in the dollar index is to a large degree a market discount for predicted inflation in the dollar and that the dollar index won’t quickly reverse. You’re certainly free to debate those assumption. But I think they have a certain amount of merit.

http://topnews.us/content/24517-federal-reserve-intends-buying-300-billion-worth-long-term-treasury

http://www.traderslog.com/stock-charts.htm?page=chart&sym=DX*1&data=W

We might still end up with deflation in the future, but unless you consider bringing the CPI increase down to a low positive number, or slowing the growth rate of the money supply to be deflation, we haven’t had much, if any, deflation in the general economy yet. And before you tell me that the CPI was “down” in the last 12 months, take a look at the numbers after eliminating the huge decrease in energy prices. According to the BLS August press release, not only did the CPI go up month over month:

“The index for all items less food and energy increased 1.4 percent over the last 12 months, the smallest 12-month increase in the index since February 2004.”

So what’s this got to do with FHA? The cost to taxpayers to fund losses by FHA is just another small piece of the insurance premium the taxpayer will pay to insure against the risk that the financial sector might implode and the economy might collapse as inflated real estate prices slowly fall to fundamentally reasonable levels and banks slowly absorb otherwise potentially fatal loan losses. I wouldn’t look for real estate prices to rise because of the FHA, but the FHA will slow the rate of the fall and move some of the losses to the government balance sheet to buy time for the banks to heal their balance sheets. Yes it costs money, but the end cost will probably be far less than the trillion plus dollars spent to fight wars in the middle east and probably won’t take nearly as long as it will to find Osama.

Conversation Continued.

See Reply in Open Thread.

“So how do we keep inflation low when we do not have sufficient production?”

I’m not sure I said that we didn’t have sufficient production. We have a trade imbalance with China. I’m also not sure how that in itself will lead to inflation? Can you expand on that train of thought? Perhaps move the answer to the open thread since this is an FHA thread that The Tim gracefully have allowed some expansion on but it’s getting rather polluted from the core of the thread.

This is in reply to both posts, combined.

On the one hand you have the claim that we will not inflate our way out.

On the other hand you have the claim that, “if you just consume and don’t produce you will endup in trouble.”

It is no secret that manufacturing in the US has gone down. I have not checked the farming numbers recently, but I doubt that’s gone up enough to make a significant impact.

So how do we keep inflation low when we do not have sufficient production?

If China uses too much economic force, then that could inflate the dollar even more.

I can hear the US saying, “Here, we will pay you back with these dollars that are not worth as much…” Of course we will fire up the printing presses to pay back our debt (monetary inflation).

I do not think we will experience hyperinflation, and let me repeat: I cannot find a good example of a major economy that has had reductions in home values while the currency experienced inflation. In my opinion, as long as we continue this trend, there is no threat of inflation.

For the record, unless stated otherwise I measure inflation using the purchasing power of a unit of currency method. Others use measures such as the supply of money. If the supply of dollars grows while the goods and population stays constant, then the dollar value of the goods erodes, and thus the price of goods grows. Ultimately there is no single good way to measure inflation, as every method has some weakness.

This is a good point to talk about trade.

For some reason many consider a “trade imbalance” to be bad. We send China green sheets of paper, and they send boat loads of goods.

Yesterday I went to Starbucks and said to the friendly Barista that I have noticed that we have been involved in a trade imbalance. It seems that every time I come to Starbucks I walk in with cash and walk out with coffee. This is not very balanced. To balance the deficit, I should walk in with coffee and out with cash. For some reason a “trade deficit” with my local Starbucks is just fine, but a “trade deficit” with China is a bad thing.

First let’s separate deflation, which is the rising value of the dollar, from falling home prices. Home price might fall yet the dollar could be experiencing inflation. I do not think this is the case.

I have not found a single historic example of wide-spread falling home prices and inflation at the same time.

There is another problem that I didn’t mention during a period of deflation, and that is the desired point of consumption. Most people seek a known level of inflation to keep an incentive to buy today. During a period of deflation there is an incentive to continue to put off buying, as prices just keep going down. As a consumption based society that we are, we need a certain level of inflation. Also known inflation does not adversely impact cash holders, as they know what to expect. On the extreme, Weimar style inflation leads to and might be the cause of the collapse of society.

The problem that I cannot resolve is how to return to inflation, yet not high levels of inflation, while balancing employment (cost-push/demand-pull could both be a problem).

With the high levels of national debt, I think there will be a period of high inflation, but like the housing collapse, when is the bigger question.

And I agree with your general intents.

Affordability is being swept under the rug the last 5-10 years because otherwise, there’d be no housing market at today’s insane prices.

The answer is what they did during the 1990s housing bubble, no loans to exceed 30% of real net pay after car, college, credit card, etc loans are removed from net pay. Its that simple. 20% down minimums too, especially since price degradation appears to have no end.

http://www.realtytrac.com/ContentManagement/RealtyTracLibrary.aspx?channelid=8&ItemID=6783

The noise issues are sort of crazy. No approval if within 1000 feet of a freeway, so if you have a view condo overlooking I-5, no more FHA. No approval if within 5 miles of a military airport. You would think they would use different lengths for beside the airport as opposed to under the approach path.

The big thing though is no more spot approval. That will really hurt some.

:) well, thank YOU for the great insights in the article – and for playing along with the picky geek in me.

After some more deflation, do you think this is what they will decide to do: Inflate our way out of the housing mess?

Inflation always hurts those with cash savings, and generally helps those with hard assets.
Investors generally look for above-average returns, on a risk-adjusted basis, no matter what the inflation rate is.

If a person knew we were going to experience high levels of inflation, then he would want to take leveraged positions in housing (or some other physical asset). The problem is that if the lenders expect high inflation, then there will be a premium charged, and thus the attractiveness of housing is tempered by the inflation premium.

If we independently inflate the dollar, then all debt goes away, if the inflation is sufficient. But all savings also goes away, including the value debentures.

It is tough to separate inflation from investment in physical assets.

It should be noted, however, that during a period of deflation that a person seeks to be paid back later rather than sooner.

(There are other good investments during a period of high inflation.)

Hi Kary,

Back in the 1980s we did not look at a person’s credit score. We looked at their entire credit history, however the scoring system was not a factor..

Thank you for the response. As I’ve said before, I think that’s what they need to get back to (real underwriting). Credit scores are lousy tools for determining mortgage qualifications.

Yes. We are stuck in a feedback loop and it’s going to take quite a while to reverse the direction. I’m with Ray all the way back at comment 1. I believe home values will slow continue to decline for many years, unless something like what AMS is describing happens and we end up inflating our way out of it.

Well, this sounds like a typical FHA borrower with one change: FHA doesn’t do high debt to income ratio loans.

Ratios should be right around 31/43.

I like your analysis in comment 11.

Question. What happens when we experience both numbers 1 and 2?

Standard FHA ratios are: 31/43.

For those who need the long answer:

First ratio:

principal, interest, taxes, insurance (PITI) divided by total gross monthly income

Second ratio:

PITI plus all other monthly debt divided by gross monthly income.

Patient,

Downpayment for a purchase money loan is 3.5%

Recall that all of the downpayment can be in the form of a gift from a relative.

“FHA doesn’t make subprime loans. They will allow loans to people with less than perfect credit but this is definitely not subprime territory. ”

While some of the FHA loans might qualify as “Prime” due to the credit, capacaity, collateral, etc of the borrower, many do not. If they aren’t prime, what are they if not subprime?

How would you categorize FHA loans to borrowers with middling credit scores, high debt to income ratios and little in the way of assets?

The key takeaway I got from the class was that if you have a credit score of 620 or above then there is a good chance that there is a loan out there for you, and if your credit score isn’t quite there, they talk about the steps you can take to repair it. I also decided that going with a Mortgage Banker actually provided me with a lot more available options for loans. I was also able to decide on the right type of loan for me which was a FHA Loan.

In the end I not only was able to get an FHA Loan, but I also qualified for the House Key State Bond 1st Mortgage Loan that helped me come up with the 3.5% down payment that is required. So my expenses at closing were less than $2,000.

Before I took this class I always felt like buying a home was out of my reach. This class helped me make educated decision and understand my different options, and now I have my 1st home and a mortgage that I feel is right for me.
————————————————

Really? No comment.

Regarding FHA Streamlines, this is only for refinancing one FHA loan into another FHA loan.

Once again, FHA is slow on the uptick to change these guidelines. Why not start NOW?

HOWEVER, recall that although FHA sets minimum guidelines, banks and lenders can be tougher than FHA’s underwriting guidelines.

Here’s a great story from 2008. Mortgage Loan Originator student says he’s been selling FHA ARMs like mad because he can qualify people at the teaser rate. I ask him to analyze that decision from an ethical standpoint knowing what we know now about ARMs. He says, “no problem, I can just refinance them to a fixed rate loan using an FHA streamline.” I asked, “What if the underwriting guidelines change?” He says, “Well I can be expected to see that far out into the future.”

This was spring of 2008.

“If collapsing home values are the only reason FHA defaults are rising then that would mean in a rising home value market we would have zero defaults and we know the latter is not true.”

There will always be situations here and there that cause foreclosures, but that’s not to say that the lender takes a loss on the foreclosure. There will be a certain level of those borrowers who never make a payment.

There are some situations where a foreclosure isn’t so bad. For example, a death can be a situation that a foreclosure is a good solution for the lender. Natural disasters can cause situations where foreclosures will be required. While there will always be some background noise, but the losses to the FHA fund, as well as owners in general, are minimized during a period of rising prices.

I hope it is obvious that falling market values only adds to the lender’s losses, no matter what the reason for foreclosure. Also I hope it is obvious that falling prices only increases the number of foreclosures. In other words, we start with some background noise number in a rising home price market, and then we add for falling market values.

Back in the 1980s we did not look at a person’s credit score. We looked at their entire credit history, however the scoring system was not a factor.

Everyone received the same interest rate on their FHA or Conventional loan whether or not their credit score was 800 or 500.

Yes, private mtg insurance has been around since at least 1957 so we’re talking over 50 years. I believe the 80/20 loans went mainstream right around 1999, 2000 when it was considered smart to go 80/20 to avoid PMI!

Declining values is a huge problem when a homebuyer or refinancing homeowner is going there at almost 100% LTV. It’s also important to pan out and see it from a wider angle. The defaults happening today were because of underwriting decisions made last year. Let’s pretend that values stabilized in 08 and started to rise in 09. I believe we would still have high FHA defaults due to poor underwriting as well as the minor problem of the government encouraging the banks to refi problem loans into FHA loans in 08 and 09.

It’s like tasting a delicious chocolate cake and saying the reason it’s delicious is the chocolate. Well the quality of the chocolate is a big part of the taste but there are other ingredients that enhance the flavor. Sorry for using such a girlie metaphor.

We could think of it like this: If collapsing home values are the only reason FHA defaults are rising then that would mean in a rising home value market we would have zero defaults and we know the latter is not true.

I know a retired guy who put what I will call “putting his eggs all in one basket.” He personally underwrote mortgages, and he felt it was a sure way to get an above average return. The theory was simple: Underwrite housing, and if the debt is not repaid, simply foreclose. In general there would be close to enough equity to cover the foreclosure costs on an undiscounted basis, so the losses would contained and relatively low, or so the theory went.

After many years of shunning me about the risk, recently he called up asking me for advice. I knew things were bad. He’s taking heavy losses, and he wants to sell at today’s prices, but he cannot push the foreclosure process along fast enough to do so. Yes, he did have the mentality that housing prices only go up.

If you want to make sure there is never a black swan to be found, then you must avoid uncharted grounds, of which the future is full.

Looking at the macro level, there seems to be very few options to prop housing prices back up: Change the mass psychology so as to put home prices back on a solid foundation. (Ultimately all solutions involve some use of this.)

1. Inflate the dollar. (This is a cost-push argument–if housing costs too much, then the dollar isn’t worth as much, at least within the bounds of the US. Inflating the dollar gets to be problematic when looking at international trade.)
2. Attract more investors into the market. The problem with this is that eventually it will collapse, but the collapse could be much slower. For example, if housing prices remained constant for ten years, then that would be ten lost years on an investment, or less with some inflation. In this case, however, the loss is so gradual that it is spread out so very few notice the impact. If nothing else, the biggest risk is the transactional costs. (Yes, I understand that there is a problem with the condition of the various homes, and this does not reflect that some areas will increase in desirability, and other problems.)

Right now what we have is both falling prices and falling volume, as measured by total dollars transacted. The basic economic theory is that there is a greater quantity demanded when prices are lower. In this market lower prices have not increased the volume of total dollars transacted. Certainly I do recognize that total dollars transacted is a function of both the number of homes sold and the average price. If one or the other goes to zero, then there will be no dollars transacted. It should also be clear that if all homes are over-priced, then the the number of homes sold will go to zero. With some nice assumptions, it should be clear that there is a single maximization point between a price of zero and a clearly over-priced market. Yet we have falling volume as prices drop…