HOUSING MARKET AND THE REAL ESTATE BUBBLE

[nlightn]

The 'easy mortgage' era won't last
By Bill Fleckenstein
4/16/2010 5:30 PM ET


Along with easy money, the economy has gotten a boost from practices that let many homeowners stop paying their mortgages and use the 'extra' money elsewhere.

The real-estate market will soon see banks take a much more aggressive approach to foreclosures. It will be interesting to see how the economy is affected as rates are ratcheted up in earnest.

This story line, the focus of this week's column, draws its inception from the government's easy-money policies and the bank bailouts. To this point, the economy has gotten a substantial boost from homeowners who simply don't pay their mortgages and use the "extra" money for other things.

You needn't be a statistician to compile the evidence. Much work has been done for us, courtesy of an informal survey conducted by a reader of my daily column.

I have condensed his observations for Contrarian Chronicles:

Ignoring debt for fun and profit

Over the past six months, it has become more and more obvious to me (and others, I'm sure) that our government has a well-defined, unspoken policy (or plan, if you will) to increase consumer spending by reducing the debt of the very people with the highest propensity to spend.

As more and more people told me specific stories about others living rent-free, reducing credit card balances, walking away from $600k+ homes and then buying the same style house for $275k, I wanted to know more!

I started a little project to expand my sample size. Admittedly, it is nonscientific, and I wouldn't want to have to defend my methodology to a statistician, but I stand by the results. I asked people that I knew and that I could count on for accurate information. I then asked them to expand my horizon by doing their own research. We were looking for valid instances of debt repudiation, not anecdotal tales.

Almost everyone in my "survey" is aware of, or knows, someone living rent-free in their home for an extended period of time, having stopped paying their mortgage. Many of these free boarders are spending lavishly on non-essentials.

A friend owns a small manufacturing co. He tells me of one of his female employees who was saddled with a $450,000 home she purchased almost five years ago with no down payment. One year after her purchase, she pulled $75,000 home equity and purchased "fun stuff," including a boat. She recently walked away from the house (now saddled with $525K mortgage), purchased a new house for $200,000 (in her sister's name) and kept all the goodies purchased from the home equity withdrawal. With the much lower mortgage payment she just bought a new car.

My hard-working part-time assistant knows two different 35+ yr olds who have enjoyed over 9 months (one is up to month eleven) of rent-free living in very nice homes they purchased in 2004/2005! Both are employed and both enjoy a non-frugal lifestyle. My assistant wonders if he should do the same or have me pay him more so that he, too, can enjoy the "good life."

My sister is a nurse with 25+ years on the job. She told me of a young couple that she is good friends with that both work at her hospital making a decent joint income. They didn't like the fact that they grossly overpaid for their 3000 sq ft home in 2006. They stopped making hefty monthly payments six months ago and haven't yet been contacted by the bank. They have decided to wait until contacted and then walk away. In the meantime, they just returned from NYC from a week vacation in the Big Apple.

I can list numerous other, verified examples. And these are just from my tiny, tiny universe. I can't help but assume if I know of this many instances, there must be millions of similar stories across the country. And I am sure many of your readers have first- or secondhand knowledge of similar situations.

Continued: Forbearance and money printing

The net effect of all this: People who have stopped making home payments or those who are participating in short sales on homes they could actually afford -- in other words, the folks who have reneged on "underwater" mortgages because they can -- have extra money to spend.

I've seen recent estimates of as much as $2 trillion in extra money being available, which is a lot of juice for the economy. That helps explain some of the upside surprise that my good buddy Jim Grant of Grant's Interest Rate Observer has been looking for in the economy.
In essence, money printing has won, for now.

It's that money printing that allowed the government to absorb a lot of bad debt, especially through Fannie Mae (FNM, news, msgs), Freddie Mac (FRE, news, msgs) and the Federal Housing Administration, and which allowed the banks to mark assets to fantasy. The banks also make money on the backs of all the prudent savers in the world as they get their money for nothing (thanks to the Federal Reserve) and play the steep yield curve.

Think of the entire U.S. economy as a company. Though the balance sheet has become astronomically worse -- in the form of current (though postponed) debts, as well as future obligations -- the income statement has been boosted recently. Those folks who are upside down in real estate have been given a reprieve, and the real-estate market itself has been given a shot in the arm by tax credits (think: extend and pretend). So, the income statement -- for now -- looks OK, as does the economy.

In sum, company USA is "worth" a lot less than it used to be, but for the moment its operations are OK, at least on the surface.

Of course, none of this is fair -- as, to repeat, the prudent have been asked to bail out the reckless -- and it won't work over time. The do-over that the world was given during the financial crisis
, courtesy of the printing presses, will be paid for with higher inflation and ultimately higher interest rates.

At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column.

http://articles.moneycentral.msn.com/Investing/ContrarianChronicles/the-easy-mortgage-era-will-not-last.aspx