Litigation Nightmare & Heartbreak Hotel

I RECENTLY CALLED Jack McCabe of McCabe Research & Consulting for an update on Florida housing. McCabe told me he is now bracing for a “litigation nightmare” over the next several years in the wake of the housing bust. Following are some of the items we discussed:

1. Buyers suing developers for nonperformance.

2. Developers suing speculators for flipping properties in violation of contracts.

3. Subcontractors suing developers for nonpayment.

4. Subcontractors suing general contractors for non-payment.

5. Class action lawsuits against single-family homebuilders and condo developers for faulty roofing, HVAC, electrical, and plumbing systems.

6. Lawsuits against inspectors for not catching code violations.

7. Condo boards and individual homeowners suing developers for shoddy work.

8. Lawsuits against appraisers for inflated values.

9. Lawsuits against banks when project fundings are halted.

10. Lawsuits over completed condo units being substantially different in size, interior finishings, and quality from how they were represented pre-construction.

11. Lawsuits by anyone and everyone against anyone and everyone over various fraud allegations.

12. Of course, we can’t forget countersuits by anyone and everyone against anyone and everyone over anything and everything.

I think those 12 points pretty much sum it all up.

McCabe is telling me that speculators have totally vanished from the market, which, of course, means there has been an enormous shift in the supply-versus-demand ratio. To make matters worse, there are “approximately 25,000 condo units currently under construction in Miami-Dade County alone. Another 25,000 condo units have received building permits, and about 50,000 more units have been announced.”

Financing has now dried up, but those 25,000 units under construction will likely be completed along with 75-80% of the units with valid building permits. The vast majority of unapproved but announced projects will be canceled. Even so, “the completion of 75,000 units or so could make for a 5-10 year supply of condos at normal sales rates, and sales rates are far below normal.”

In addition, McCabe is expecting to see a “sharp increase” in prosecutions for mortgage and real estate fraud as well. Indeed, bubbles have a way of exposing all kinds of fraud that people happily ignored as long as prices were rising. When the party ends, the lawsuits begin (and you can quote me on that one). We saw the same thing when the dot-com bubble burst. We will see it again over housing. “We are going to find a tremendous amount of abuses associated with this boom, and the fallout will not be in the millions of dollars, either. It will be in the billions.”

It’s Not Just Florida

“What is happening in Florida, can and will happen in other markets, such as Washington, D.C., Las Vegas, San Diego, Phoenix, and many other bubble markets with rising inventory,” said McCabe.

I am sure of that, and I am sure McCabe is correct about the “litigation nightmare” as well.

Foreclosures Jump

In another nightmare of sorts, The Associated Press is reporting, “Foreclosures May Jump as ARMs Reset.” As more hybrid adjustable-rate mortgages adjust upward and housing prices dip, many Americans can’t refinance out of this squeeze. They are finding themselves trapped in too high monthly payments, and some face foreclosures:

“In the last several years, millions of Americans took equity out of their houses and refinanced when interest rates were at historical lows and housing prices were at record highs.

“Many of them chose to refinance into hybrid ARMs that lenders were aggressively pushing. ARMs, which featured a low introductory interest rate that resets upward after a set period of time, were easier to qualify for than traditional fixed-rate loans.

“ARMs are now starting to fall by the wayside as the difference in interest rates narrows. The average rate on a 30-year fixed rate loan in May was 6.60%, compared to 5.63% on a one-year ARM, according to Freddie Mac. In 2003, rates on a 30-year fixed were at 6.54%, while ARMs carried a 3.76% rate.

“This year, more than $300 billion worth of hybrid ARMs will readjust for the first time. That number will jump to approximately $1 trillion in 2007, according to the Mortgage Bankers Association. Monthly payments will leap too, many beyond what homeowners can afford…

“‘ARMs are a ticking time bomb,’ said Brad Geisen, president and chief executive of property tracker ‘Through 2006 and 2007, I’m pretty sure we’ll see a high volume of foreclosures.’

“Last year, foreclosures hit a historical low nationwide at about 50,000. But that number has more than doubled since then, according to

“And delinquency rates appear to be rising as well. While delinquency rates fell for most types of loans from the fourth quarter of 2005 because of a stronger economy, delinquencies for both prime and subprime ARM loans increased year over year in the first quarter, according to the MBA.”

A Mish Singalong

Notice that the ARM time bomb is just now going off. The explosion will be over three times as big in 2007, with over $1 trillion in loans resetting to much higher rates. Yet merrily we roll along with more and more rate hikes. On that note, please sing along with Ben:

NAHB Sales Data

The National Association of Home Builders released new data for 2006 on June 19. Following are two charts from that release with colored highlights in red added by me:

Those charts show we are clearly rolling downhill, as opposed to merrily o’er the deep blue sea, but don’t blame me — I am just singing along with Bernanke.

Homebuilder Sentiment

Speaking on homebuilder sentiment, NAHB President David Pressly had this to say: “Looking at today’s numbers, it’s important to keep one thing in perspective. [The National Association of Home Builders/Wells Fargo Housing Market Index]is a measure of builder sentiment — and attitudes may vary by a greater degree than actual market activity.”

Clearly, David Pressly is singing a different tune. Sales are falling off a cliff and traffic is back to 1990 levels. Talk about “Denial”!

Hmmm. That title sounds right, but let’s face it: Those lyrics totally suck.

With traffic crashing, inventories soaring, holding costs jumping, Bernanke hiking, rates resetting, and an economy slowing, it is very unlikely that stubborn sellers can hold on for their price much longer. Indeed, some unfortunate KBH renters have had to return their “hotel keys” much sooner than expected. We now switch from David Pressly to Elvis Presley. What a difference in quality.

Heartbreak Hotel

The Denver Post is reporting, “Heartbreak Along Mockingbird Lane”:

“Margie Ibarra worried about paying $160,500 for half a duplex. She knew she was buying it with no money down and a pair of home loans, one carrying a double-digit interest rate.

“But she dreamed of spending her life on a peaceful street at the edge of Brighton — and of owning 710 Mockingbird Lane free and clear when she retired.

“Instead, two years after she moved in, she lost the first home she ever bought to a foreclosure.

“‘I took the keys with me. I made sure the door was locked and the windows were shut. I cried when I was leaving. I loved my little townhouse,’ she said.

“These are troubled times on Mockingbird Lane…

“Mockingbird Lane curls beside a flood plain on the eastern bank of the South Platte River, land Brighton initially zoned for manufactured housing. Then a national builder, KB Home, showed up with a grander vision in the late 1990s: a community of 556 affordable homes along streets named for songbirds and waterfowl.

“On Mockingbird Lane, many who moved into homes designed for first-time buyers put little or no money down. KB offered easy financing. So did other lenders…

“Jim Spray, a Colorado mortgage broker who battled predatory lending practices, and his wife, Linda, a REALTOR, reviewed foreclosures on Mockingbird Lane and Street at the request of The Denver Post.

“They say they saw minimal down payments, and also refinancing loans, that left homeowners owing more than their homes were worth.

“At foreclosure, some buyers owed $20,000-30,000 more than their original purchase price. ‘That’s a killer,’ Linda Spray said.

“Gov. Bill Owens this month signed a law that will require mortgage brokers to submit to criminal background checks, post a $25,000 surety bond, and register with the state as of Jan. 1. Previously, Colorado was one of only two states — Alaska being the other — that did not regulate mortgage brokers.

“Jim Spray hopes the new law will help.

“But he worries what will happen when existing loans, especially ‘these 80-20s with no money down,’ kick into their adjustable-rate phases.

“‘We could well see another spike in foreclosures,’ he said. ‘It’s nowhere near over’…

“In six years, lenders have foreclosed on 59 homes at Welby Hill, a condominium complex near Thornton, and 50 homes at View Point Condominiums in Thornton. On Mockingbird Lane and nearby streets where foreclosures are rampant, the homes are duplexes.

“Since 1995, Adams County foreclosures have grown nearly eightfold, reaching a record 3,281 last year. This year, the county is on pace to exceed 4,000.

“Every one lands on the desk of Jeannie Reeser, the Adams County public trustee, who spends her days signing foreclosure papers.

“‘I want to be No. 1 in something different,’ she said. ‘There’s a tragedy in every one of these files. I’ve had grown men cry on my shoulders, and there’s nothing I can do’…

“On Mockingbird Lane and Mockingbird Street, records of 23 foreclosures — all of which were half a duplex — around a two-block loop show Ibarra’s financing terms were not so unusual…

“‘I ended up getting a divorce, and I couldn’t afford my house anymore,’ said Danielle Williams, who had two boys, a girl, and no income after her husband moved out. She lost her home at 785 Mockingbird St. one year after they bought it.

“Marilyn Sisti, the first of two homeowners foreclosed at 727 Mockingbird St., said she had a high-interest mortgage loan and lost her job. Her variable interest rate started at 10.4% and could have surpassed 16%.

“Ernesto Rodriguez, who lost the house at 722 Mockingbird Lane, said he simply couldn’t keep up with $1,400-a-month payments. He realized, too late, what a high price he paid: $161,900 for a house auctioned at $130,000 and later sold for $145,000…

“KB Home representatives talked of a fishing lake ‘and a little swim beach,’ [Gayle] Langan recalled. They promised to fix any problems she found. They made borrowing easy. The builder had its own mortgage branch.

“‘So you don’t even have to find a lender,’ she said they told her. ‘We’ll take care of that.’

“She bought half a duplex in 2000 for $136,000. She said she put $6,000 down for the home, at 801 Mockingbird St., and borrowed the rest from KB Home’s mortgage arm, which later sold the loan.

“From the day she moved in, she said, her brand-new home had problems. Windows leaked. A drain spout laid a sheet of ice on her sidewalk. In her bedroom, she could hear the couple on the other side using the bathroom. They told her they could hear her snore.

“‘It was like living together,’ she said. ‘I could hear more than I ever wanted to hear.’ …

“Tom Dory, another resident who may sell, shares their concern.

“‘It’s not going to be easy to dump,’ he said of the home he bought six years ago. ‘My son’s a real estate agent. He even told me that. These things don’t move very well.'”

The big question now on my mind is this: Is the above situation more like “Heartbreak Hotel” or “Hotel California”? I am discarding “Mockingbird Hill” for obvious reasons.

Please vote. And before voting, please consider the following: In “Hotel California,” “You can check out anytime you like, but you can never leave.” In Hotel KBH on Mockingbird Lane, “You can check in anytime you like, but you can never stay.”

While singing along with Big Ben’s Band, please cast your ballots.

Write-ins are allowed.

June 21, 2006