What You Need to Know About the Housing Mess

August 22, 2008

I've been talking about the housing meltdown for weeks now, and I wanted to follow up with a brief recap to make sure everyone is on the same page. It's important to understand what's going on in the homebuilding sector and financial companies, and what regulators are doing to help because it affects us as investors.

As an ex-banking analyst–I used to work for the federal agency that is now running IndyMac (IDMC)–I can tell you that we are only in the second to third inning of the credit crisis.

Some banks like Wells Fargo (WFC) and U.S. Bancorp (USB) are B-rated in my exclusive stock ranking tool PortfolioGrader Pro. Unlike most major banks and brokerages, WFC and USB have limited exposure to Auction Rate Securities, Collateralized Debt Obligations, Structured Investment Vehicles, sub-prime mortgages or leveraged loans.

But despite the oddball B-grade here or there, overall, the financial sector is burdened by legal settlements, write-downs and non-performing loans as delinquencies soar. With close to 4% of prime mortgages now delinquent, 20% of sub-prime mortgages delinquent and 7% of all mortgages in the U.S. now behind on their payments, we are in the worst credit crisis since the Great Depression.

As a result, foreclosures are soaring! One out of every 35 homes in Las Vegas is now in foreclosure, and that number is expected to rise. In my hometown of Reno, one out of 86 homes is now in foreclosure. Anywhere the big tract builders added too much inventory, like Southern California, Arizona and Florida, home prices have essentially collapsed. We've seen prices fall off 30% since they peaked in 2005, and due to the foreclosure rate, price declines of 40% to 55% are ever more commonplace.

Banks are doing everything they can to mitigate their losses. Programs called "cash for keys" are increasingly popular, where banks actually pay the occupants to hand in their keys within 30 days to avoid the hassle of evictions or paying for repairs and maintenance after angry owners trash their old homes.

Other programs look to refinance or partially forgive loans, since the projected mortgage loss is now more than 40% when a home is foreclosed. Basically, how this works is a homeowner pays the new renegotiated rate for six straight months. If the payments are made on time, then the loans are no longer considered delinquent. When banks do workouts and negotiate reduced payments, the projected mortgage loss falls to 12%.

These last ditch attempts, however, are as effective as putting a band-aid on an open wound. They merely mask non-performing loans, ultimately leaving the secondary mortgage market distressed.

Until the 6 million homes for sale in the U.S. declines, there is no end in sight to the housing meltdown and the accompanying pain in the financial sector. Most experts predict that home prices will drift sideways for a few years, since burnt home speculators are reluctant to jump back in. Additionally, mortgage lenders will avoid speculative loans again due to all the new regulations.

We've got a long way to go until this mess is over! Thankfully, my FREE stock ranking tool, PortfolioGrader Pro, has helped tens of thousands of investors avoid financial ruin by tipping them off to the problem in the financial sector. Is your portfolio safe? Check it in PortfolioGrader Pro today at no cost!