The United States is following the Japanese model of slow deflation using the amend-extend-pretend dance. Will it take the US 15 years to deflate its bubble? 

Irvine Home Address ... 26 SHADOWPLAY Irvine, CA 92620
Resale Home Price ...... $740,000

Are you still too blind to see
We're living in a fantasy
It's you and i who'll pay the cost
Where will we turn when all hope is lost 

Lionsheart -- Living in a Fantasy

Amend Extend Pretend

Banks are living in a fantasy, and you and I will end up paying the cost. They are refusing to write down the values on their bad loans. They amend the terms, extend the period of repayment, and pretend that delinquent borrowers will diligently make payments under the new terms. Lenders genuinely believe they will get their money back plus interest.

It isn't going to happen.

The reason banks amend, extend, and pretend is simple: lenders cannot afford to write down the loans to actual recovery values because they would be broke, either insolvent or bankrupt. Without factoring in the lowering of prices caused by the liquidation, if every bad property loan was written down to is realistic level of recovery in today's market, the losses would exceed the total capital in the banking system -- even now after three full years of mark-to-fantasy accounting at our major banks. Banks refuse to recognize HELOC and second mortgage losses; thus, our housing market sits in limbo while lenders and loan owners pray for prices to go back up.

The amend-extend-pretend policy has one intended consequence, and one unintended one: the intended consequence is that supply is restricted to the point that demand exceeds supply and prices are forced higher. Banks want higher prices to increase their loss recovery on each property and maintain the value of their portfolios. The unintended consequence is the moral hazard of indefinite squatting by delinquent mortgage holders.

As banks continue to pursue the amend-extend-pretend policy, delinquent borrowers are being given a free ride. Word travels quickly, and as some quit paying their mortgages and nothing happens, others who are struggling also quit making payments. What many term as strategic default (I call it accelerated default) is becoming more common. Why wouldn't it? Why does anyone keep paying their mortgage when not paying has no consequence? Squatting is becoming a way of life for many delinquent borrowers.  

The other unintended consequence is a huge buildup of loans where the borrower is not making payments, but the banks have done nothing about it: shadow inventory. Most delinquent mortgages are simply being ignored by the banks. Right now, if you are a loan owner, and if you quit paying your mortgage, there is a 60% chance your lender will do nothing, and your lender will likely choose to do nothing for a very long time.

60% of Delinquent Mortgages Not in Loss Mitigation

by JACOB GAFFNEY -- Tuesday, August 24th, 2010

According to a study from the State Foreclosure Prevention Working Group (SFPWG), 60% of borrowers with mortgages delinquent by 60 days or more are not being forwarded to the servicer's loss mitigation department.

That is shadow inventory: pure and simple. Those delinquent borrowers have not been served any notices, so they don't show up in the foreclosure statistics, and they have not signed up for a loan modification, so they don't show up in the government data. Sixty percent of delinquent borrowers are being allowed to squat in peace.

The SFPWG is a consortium of the Attorneys General of 12 states, three state bank regulators and the Conference of State Bank Supervisors. For the past two years, it collected delinquency and loss-mitigation data from the largest servicers of subprime mortgages in the country, totaling 4.6m loans as of March 2010.

While some serious delinquent loans remain ignored, foreclosures are outpacing modifications. Since October 2007, the servicers completed 2.3m foreclosures.

As HousingWire reported, HAMP cancelations number 616,839. Richard Neiman, superintendent of banks for New York State said such modifications are more likely to fail without principal reduction.

“We expect banks to take the performance of these modifications into account when deciding the best options for both consumers and investors," Neiman said.

Despite what Mr. Neiman may expect, banks are not going to write down principal outside of a foreclosure. That leads down a slippery slope where every borrower quits paying in order to get a principal reduction.

"Without improvements to foreclosure prevention efforts, the group anticipates that hundreds of thousands of these seriously delinquent homeowners could end in foreclosure," according to the SFPWG statement.

With cure rates under 10%, nearly all of those who are more than 60 days late will end as foreclosures.

The group said improvements in more recent loan modifications are yielding some positive results, such as lower rates of redefaults. According to the data SFPWG collected from nine mortgage servicers, loans modified in 2009 are 40% to 50% less likely to be seriously delinquent six months after modification than loans modified during the same period in 2008.

"As servicers have increased their use of payment reduction in making loan modifications, many more homeowners have succeeded in keeping their home," said Mark Pearce, North Carolina chief deputy commissioner of banks. 

In other words, as we have converted more loans into government-backed Option ARMs, people have been able to make the teaser payments. That should extend this crisis for a couple more years until the terms of the government's Option ARMs explode. This solution is simple a way to extend the pain over a longer period of time to prevent the insolvency of our banking system from becoming undeniable. Anyone who believes loan modifications are intended to keep owners in their homes is fooling themselves. This program is designed to keep banks solvent and keep loan owners in perpetual debt servitude.

780 days on the market

Evidence of the amend-extend-pretend is captured in the macro-economic data, but it isn't difficult to find specific properties that show just how ridiculous the lenders have become. Today's featured property is a short sale that has been on the market for 780 days!

The owners of today's featured property paid $814,000 on 11/29/2004. They used a $651,200 first mortgage and a $162,800 down payment. The obtained a $125,000 HELOC on 4/14/2006 and a $250,000 HELOC on 10/17/2006. It isn't clear wether or not they took this money. If they did, they got their down payment back and then some. If they didn't, they are out $162,800. It is likely they did take this money or it would not have been a short sale at $699,000 in July of 2008.

I first profiled this property not long after it was first listed.

When the property was first listed, they put a very low asking price to attract attention, then they raised it up to the level of bids they had at the time. Then they embarked on the amend-extend-pretend dance:

Foreclosure Record
Recording Date: 06/01/2010
Document Type: Notice of Sale 

Foreclosure Record
Recording Date: 03/30/2010
Document Type: Notice of Sale

Foreclosure Record
Recording Date: 08/11/2008
Document Type: Notice of Sale

Foreclosure Record
Recording Date: 05/05/2008
Document Type: Notice of Default

The current owners squatters have not made a consistent payment since 2007.

Why would banks permit this other than to avoid taking a write down? Now, with 4.5% interest rates, they may obtain a significant recovery; although, with two and half years of missed payments, they are probably no better off. 

The amend-extend-pretend dance must end. Of course, it won't end until the insolvent banks can afford the write downs. Until then, we are following the Japanese model of slow deflation until the market reaches fundamental values. It took the Japanese over 15 years. How long will it take the US?

Irvine Home Address ... 26 SHADOWPLAY Irvine, CA 92620

Resale Home Price ... $740,000

Home Purchase Price … $814,000
Home Purchase Date .... 11/29/2004

Net Gain (Loss) .......... $(118,400)
Percent Change .......... -14.5%
Annual Appreciation … -1.7%

Cost of Ownership
-------------------------------------------------
$740,000 .......... Asking Price
$148,000 .......... 20% Down Conventional
4.50% ............... Mortgage Interest Rate
$592,000 .......... 30-Year Mortgage
$144,622 .......... Income Requirement

$3,000 .......... Monthly Mortgage Payment

$641 .......... Property Tax
$250 .......... Special Taxes and Levies (Mello Roos)
$62 .......... Homeowners Insurance
$120 .......... Homeowners Association Fees
============================================
$4,073 .......... Monthly Cash Outlays

-$715 .......... Tax Savings (% of Interest and Property Tax)
-$780 .......... Equity Hidden in Payment
$247 .......... Lost Income to Down Payment (net of taxes)
$93 .......... Maintenance and Replacement Reserves
============================================
$2,917 .......... Monthly Cost of Ownership

Cash Acquisition Demands
------------------------------------------------------------------------------
$7,400 .......... Furnishing and Move In @1%
$7,400 .......... Closing Costs @1%
$5,920 ............ Interest Points @1% of Loan
$148,000 .......... Down Payment
============================================
$168,720 .......... Total Cash Costs
$44,700 ............ Emergency Cash Reserves
============================================
$213,420 .......... Total Savings Needed

Property Details for 26 SHADOWPLAY Irvine, CA 92620
------------------------------------------------------------------------------
Beds:: 4
Baths:: 4
Sq. Ft.:: 2492
$0,297
Lot Size:: -
Property Type:: Residential, Condominium
Style:: Contemporary
Year Built:: 2004
County:: Orange
MLS#:: 08-295511
Source:: TheMLS
Status:: ActiveThis listing is for sale and the sellers are accepting offers.
------------------------------------------------------------------------------
On Redfin:

Final approved!!!Elegant & luxurious 4 bedroom attached town home, very bright interior, spacious living space(2,492 sq. ft)built in2004,$120,000 upgraded option when purchased, This is a short sale property! Price & Commission are subject to lender approval. Commission will be 50:50.For showing, see private remark.

Final approved!!! Is that exclamation because the short sale if "finally approved" or because it has received its final approval?