Loss Given Default: From Madrid to Los Angeles Foreclosures Set to Crest in 2011-2012

I recently caused a fuss by predicting the default of the Golden State during a conversation with Henry Blodget.  The perspective which informed that outburst came partly from my experience watching both CA and NY, partly from the work on my book,
"Inflated: How Money and Debt Built the American Dream,"
which is now shipping from Amazon and other online outlets. In particular, the period of state debt defaults in the 1840s seems to be instructive, both for the actual examples of default and how that period effected attitudes toward taxes in many other states.

When people differ with my view of the forward outlook for state and municipal credit in CA, NY, IL, I start with the banks and real estate.  Most states and localities base their revenue on a combination of property, sales and other taxes and fees.  Unless you are fortunate enough to live in Alaska along with Sarah Palin and her fellow citizens, real estate and related services figure large in the equation that makes your community function financially.  We first talked about the ad avalorem tax base two years ago in
The Institutional Risk Analyst
thanks to a good friend in Laredo, TX, who worked for decades as a banker along the border with Mexico. 

Next year, IMHO, we are going to see a further sharp decline in residential home prices as the tide of foreclosures begun in the past year starts to clear the courts and move to market via involuntary sales.  The same thing is happening in Spain, by coincidence ("Foreclosed Homes May Flood Spanish Market as Banks Offload Unwanted Assets"). 

Like many of you, I was head faked in 2010 by the apparent stability in residential prices as measured by things like Case-Shiller.  I participate in the
Macro Markets
forward suvery of US housing pices and was way too bearish vs. this widely followed index. As I told Bob Shiller last week, the carnage in the loan servicing channel was not showing up in the retail index -- largely due to the lack of capacity to deal with the forclosures. 

So after being down 10% for 2010 earlier in the year, now down 5% for 2010 and -10% in 2011.  Hold on tight to your nappies, children.  The "resolution" of a lot of assets currently marked as "in transit" through the GI tract of the proverbial beast is going to reveal some currently hidden truths on the balance sheets of the banks.  The good news is that the industry's apparent performance is improving, but this is just one view of the world.  An "entry" valuation rather than exit, if you follow. 

Even as the Fed continues to manipulate the markets via QE, all of the assets and exposures not on Uncle Ben's menu are going to widen IMHO.  And the spreads in and around the homes of many of the homes of the readers of ZH are going to widen too as the number of involuntary sales grow and these far-below "market" transactions pull the comps down toward the cash price liquidation level.

When you factor in how the "shrinkage" of housing is already affecting the related sectors of the economy, the outlook for the other source of state and local revenue -- namely sales taxes -- does not look so rosy either.  Let's hope that flat to down just slightly is the rule.  Even then, automatic growth in public sector mandates in 2011-2012 forces even more cuts in public sector jobs and services.  And then you potentially create a feedback loop of deflation. 

To address this issue, I think we are going to need both public and private vehicles to take ownership of foreclosed properties and manage these assets.  As one of my mentors in the banking world told me last week, we first have to figure out whether any private investor will take the first loss position in any vehicle, then we should worry about whether it is an REIT or some other structure. 

In any event, we are going to need to apply leverage to this growing volume of foreclosures.  Otherwise we sit back and watch the largest asset liquidation in history, a process that may well take the pricing for residential properties down double digits next year.  If you think that this view is too pessimistic, ask yourself what the proportion of total homes sales will be involuntary this time next year, when Bank of America plans to have ramped its special servicing capacity.

-- Chris

Comments

[dizzyfingers]

Govment to scoop up all those empty units, use them to buy votes -- taxpayers continue to foot the bill forever?

[Bruce Krasting]

CW, RealtyTrac has 33 properties in Pre-foreclosure and 6 more marked REO in 10520.

Did you ever think that was possible a few years ago? I didn't. Blows my mind.

[Sudden Debt]

And now everybody is a BIG FAN OF BELGIUM! The land of Beer and Chocolat!

Our real estate is now officially 52% OVERPRICED!

[Fred Hayek]

There is no Belgium.

[tallystick]

Thanks for confirming my suspicions of your nationality. Prior statments by you in such context make more sense (not the statements themselves, but that you would make them).

[ZackAttack]

I've been telling people for several years now that they'd be absolutely insane to buy a house before 2012 at the earliest.

[masterinchancery]

Make that 2016, maybe later, based on housing prices during the Great Depression.

[Spalding_Smailes]

"In most of the cities and towns of this country, this Wall Street panic will have no effect."

- Paul Block, editorial, November 15, 1929

"There is no national housing market, so there can't be a national house-price bubble."

- Michael Youngblood, Managing Director, Friedman Billings Ramsey & Co

[Vampyroteuthis ...]

I had one coworker (Austin, TX) tell me that my reluctance to buy a house was just fear. She was going to sell the house for a killing and retire in a small town south of here. It has been a while since those comments were made. She can't sell the house and of course can not afford to build a new one on the empty lot she owns.

[Sudden Debt]

You forgot the add a -50% coupon code in you're post for you're book Chris...

[Ted K]

+5, I'm surprised he only plugged it once.  That's better than Yves Smith though, whining about it for months as she's writing it.  It is fascinating how these life changing events seem to happen around the same time we have a publication to sell on the details thereof.  That "Black Swan" dude sure is a sharpy eh??  Maybe the next guy will write a book about a comet that hits the earth, but you can only get the time it will hit earth by cross referencing 5 Amazon receipts.

[goldmiddelfinger]

A Home-Price Puzzle in Spain Some Question Accuracy of Government Data on Property Values; Further to Fall?

http://online.wsj.com/article/SB10001424052748703531504575624652193155966.html?mod=WSJ_World_MIDDLENews