Why the Mortgage Market Is an Impediment to Economic Growth - Bank of America (NYSE:BAC), American Intl Gr (NYSE:AIG)

By Robert Barone

The lack of clarity surrounding U.S. and worldwide economic growth certainly played a big role in the recent Wall Street sell-off. In part, it was precipitated by the “debt ceiling” prank that was played upon the country and the world, especially after the market dissected the deal and found that, through the use of smoke and mirrors, economic growth (and therefore tax revenues) was assumed to be 4% -- a growth rate that is hard to fathom, at least for the U.S. and Europe, given the financial landscapes in these two major consuming regions. Housing and GDP Housing is a case in point. The direct contribution of Residential Fixed Investment to GDP was 4.8% in 1990, 5.2% in 2000, and 6.1% during the housing boom of 2005. In this year's first half, it registered 2.2%, the lowest level since records have been kept. This measure of housing's impact on GDP significantly understates its importance. Ancillary to housing are such things as furniture and furnishings, appliances, demand for utilities, demand for other services such as landscape and repair, etc. Then there is the multiplier impact of the earnings of construction workers as they spend those incomes in the course of everyday living. It can be said with a high degree of certainty that U.S. economic growth will be weak until housing returns to some semblance of health. Historically, changes in housing construction have contributed significantly to the business cycle, both to pushing the economy into recession, and to lifting it out. In most post-World War II recessions, a housing turnaround usually starts before the recession ends. Given the state of housing today, is it any wonder why the U.S. economy is at stall speed?

(To read Atlantic Capital Management's piece on stocks that don't reflect that QE3 has been indefinitely postponed, click here.) The Swinging Pendulum In 2005 and 2006, if you could breathe, you could get a mortgage loan with little or nothing down and just your word on whether or not you could afford the payments. But today, just when the economy needs a growing housing sector, the pendulum has swung to the other extreme. Not only have most mortgage companies disappeared, but the criteria to qualify for those that are still in business are the strictest they have ever been. In addition, Congress and the states have now placed many obstacles into the mortgage lenders' paths including the promotion of legal actions against the largest mortgage lenders (or their successors) and the provision of legal aid, in the form of obstacles to the foreclosure process, to underwater homeowners who have quit making payments. (To see Gary Kaltbaum's piece on why everyone is bullish on the US, click here.) Bank of America (BAC) has tried to extract itself from the litigation cesspool resulting from its acquisition of Countrywide with an $8.5 billion global settlement, which still has to be approved by the court. (Just think – BAC purchased this garbage heap without any government assistance – does this say something about BAC management?) But, NY State's Attorney General has decided that $8.5 billion is completely inadequate, indicating that the settlement should be in the $22 to $27.5 billion range. At the same time, AIG (AIG) is planning to sue BAC for $10 billion on the grounds that the mortgages it purchased from Countrywide were misrepresented (whatever happened to due diligence or buyer beware, especially for “sophisticated” investors?). With all this going on, it isn't any wonder that Jamie Dimon has decided to remove JPMorganChase (JPM) entirely from the mortgage business. Dimon has proven over the years that he is an industry leader, so his withdrawal from the mortgage business may be an omen of things to come. Meanwhile, states are passing legislation aimed at “helping” consumers, but with vast unintended consequences for the mortgage markets. Don't misunderstand – I am not arguing in favor of the mega banks and Wall Street who have significant responsibility for the current state of housing in the U.S. But, litigation and legislation could have the unintended consequence of further slowing and postponing any housing rebound:

According to Mark Hanson of M Hanson Research, California recently passed legislation prohibiting second lien holders from filing deficiency judgments in short sales. Immediately JPM pulled all of their short sale second lien buyout acceptances, which forgive significant second lien deficiencies for a price of $3,000 to $5,000, and is now asking for 50% of the note amount. This will nullify the short sale and force the first lien holder to foreclose, now giving JPM the right to a deficiency judgment. Such legislation may have an adverse and unintended consequence of scuttling the short sale market in California, just when real progress was being made. Nevada leads the nation in underwater mortgages. Zillow (Z) reports those numbers are as high as 80% in Las Vegas and 70% in Reno. To deal with this, the last Nevada legislature passed legislation which prohibits a first lien holder from collecting a deficiency judgment on a primary residence short sale. This means that everyone underwater can walk away without significant consequences and presages even more short sales and foreclosures. In addition, another law prohibits note holders who purchased mortgage notes at a discount from collecting more than they paid for the note in a foreclosure process. The consequences of such interference can potentially be disastrous for the secondary mortgage market. Taken to its logical conclusion, no one would be willing to purchase troubled loans at a discount because the best return possible is just a return of capital.

(To see about the legend of turnaround tuesday, click here.)

To read the rest, head over to Minyanville.

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