The California housing market is slowly entering phase two with the Alt-A and option ARM train quickly barreling down the tracks. Attorney General Jerry Brown should be hearing back from some of the top option ARM lenders soon since he put a November 23rd deadline on his request for additional information. This information should give us deeper insight in to what option ARM lenders have been doing to remedy the approaching tsunami. It is likely that not much has been done. Wells Fargo is attempting to remedy the issue by converting Pick-a-Pay loans to interest only loans. It is yet to be seen how well this is going to workout or what other lenders are doing.

For all the recovery talk, housing is still seeing massive amounts of foreclosures. On Thursday we saw the 8th consecutive month of 300,000+ foreclosure filings:

In other words, homeowners are still losing homes at a record pace. The stock market might like this but the vast majority of Americans must be wondering why a stock market is up 60 percent when foreclosures are sky high, unemployment is still increasing, and the U.S. dollar is on a progressive state downward. The stock market is defying all rules of logic with high price to earnings ratios and ignoring market fundamentals. Yet in the last two decades, economic fundamentals were after thoughts with two enormous bubbles in technology and housing.

FHA Going Broke

FHA loans were never intended to become a giant part of the mortgage market. Don’t tell that to California. Take for example last month’s data that shows for Southern California, 36 percent of all homes purchased were financed with FHA insured loans. Since FHA only requires 3.5 percent down, FHA insured loans have replaced the Alt-A and option ARMs as the new leverage product for those with miniscule down payments. Surely this move has done wonders for the FHA right?

“(WaPo) As of Sept. 30, those reserves had an estimated value of $3.6 billion, a sharp drop from the $12.9 billion available a year earlier, the audit found. The current total represents 0.53 percent of all outstanding single-family-home loans insured by the FHA, well below the 2 percent portion set by law. This is the first time reserves have fallen under that threshold since 1994.

A year ago, the agency’s reserves equaled 3 percent of those loans.”

Whoops. It must be stunning to find out that making low down payment loans in a recession is resulting in higher defaults. The only other examples we have of this are interest only loans, subprime, Alt-A, and option ARMs. FHA was supposed to be different because they actually looked at W-2s? Of course the FHA doesn’t envision a scenario that we all now find to be obvious:

“Under the audit’s base scenario, the FHA can cover projected losses over 30 years and have $3.6 billion left in its reserves if home prices stabilize by the second half of 2010 and start rising about three years later. The agency’s reserves could even bounce back to the required 2 percent level by the end of fiscal 2012, the audit said.

But under the audit’s most pessimistic assumptions, the reserves would run dry in fiscal 2011, requiring a $1.6 billion cash infusion from the Treasury. This case assumes that home mortgage interest rates would plummet to about 2 percent and trigger a significant wave of refinancing. It also assumes that most of those borrowers would refinance out of FHA-backed loans, depriving the agency of insurance premiums. FHA officials said that scenario is unlikely.”

The new strategy is more housing speculation! Wells Fargo is speculating that all those interest only loans will be in the green in a few years and the FHA is thinking that things will turn around by the middle of next year. I’m so glad that now instead of toxic mortgage lenders speculating on low down payment mortgages, we have the FHA playing this game. I described in detail why housing will be in a long winter and much of it goes beyond short-term tweaks to the system.

Another bust for the housing market is the home equity machine phenomenon. Never in our history have we seen so much money extracted from homes to fuel consumption. People forget that many of the options ARMs have 2nd mortgages attached to the home. Some people did not buy during the bubble yet put themselves in financial danger by refinancing their home like a piggybank. Today’s home is one of those examples.

Today we salute you Irvine with our Real Home of Genius Award.

The Irvine Home Equity Machine

Orange County has seen the median home price stabilize in 2009 yet this is based on higher priced homes selling at lower prices and the shift in home sales volume. In fact, foreclosures are at an all time record high:

Source: Matthew Padilla at the O.C. Register

Clearly the above isn’t good news. Yet if look into the data we see that 1st time homebuyers spurred by the tax credit and investors looking for quick gains are a large part of the current market. Today’s home takes us to the city of Irvine. This home is the perfect example of a home equity machine:

The above is a nice 3 bedroom and 2 baths home that is listed at 1,116 square feet. This is what you would consider a starter home for a working professional couple. The home is currently listed for sale at $420,000. If we look at sales history we see the last recorded sale back in 2000 for $265,000:

Sale History:

9/22/2000: $265,000

So this is a happy ending here right? We have someone that bought the home for $265,000 and is looking to sell for $420,000. They missed selling at the peak but that is okay. Not a bad profit of $155,000 without factoring in sales commission or any additional costs. But that is where the conventional side of the story ends. California was home to the HELOC ATM machine. This home was anything but conventional:

Welcome to the OC folks. So a home purchased in 2000 for $265,000 by 2004 had:

First mortgage: $315,000

Second mortgage: $381,500

Yes, a second bigger than a first. But the story didn’t end there. In 2006 they took out a third mortgage with the Orange County Teachers Federal Credit Union for $119,100. So in total by August of 2006 this home had $815,600 in loans! And not once during the decade did this home sell aside from the 2000 purchase which makes this even more incredible.

And get this. The Case-Shiller data when this home sells (if it sells above $265,000) will register a nice price gain. Yet the reality is some lenders are going to eat some major losses here. That is why it is important to look at all the factors involved here.

When talking to people that didn’t grow up in the U.S. about home equity refinancing they cannot believe something like this would happen. It doesn’t compute that people were able to use their home finance vacations, cars, granite countertops, or gold plated toilets. This was a very unique domestic issue. Sure, many countries had major housing bubbles but very few have examples of home equity withdrawal machines like the above case in California. And this is only one example of thousands.

Today we salute you Irvine with our Real Home of Genius Award.

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