The Toxic Asset Base May Have Little Future Value

Between 2000 and 2006, it is estimated that Americans borrowed between $5 and $7 trillion against their homes. This is money that fueled the fantasy economy of the last eight years, leading to our current and likely-to-be-ongoing economic catastrophe (with a lot of help, of course, from a whole lot of banking crooks, Congressional enablers and the NAR).

So now one of the big ongoing debates is whether we should, and if so to what extent we should, bail out distressed homeowners. Discussions on this topic weigh such factors as how a homeowner bailout would be costly for taxpayers or how massive foreclosures could ruin the nation. I personally believe all loans that can be modified to a fixed, 30-year mortgage at an acceptable (not give-away) rate of interest should be so modified. Beyond that, however, any homeowner who can’t make payments at this modified rate of interest should walk away, and the banks should suffer the loss, not the taxpayers. Keeping people in a home they can’t afford does not help them.

There are instances in which I’m willing to give some benefit of doubt to many of those who got into some of the bad mortgages through lender fraud. Take my own personal experience: In 2002 my wife and I refinanced our original mortgage. Our goal was to take advantage of ultra-low interest rates and to combine our 30-year mortgage and small home equity loan (used for home repairs) into a 15-year fixed rate loan. We did not want to cash out any money. Our credit rating was excellent. Still, each of the three financial institutions and the one independent mortgage broker we contacted tried to cheat us. Each one pushed us to take out an ARM and to cash out a large amount of money. The closing costs they quoted were outrageous. Every loan officer said the same thing: “Don’t worry about the closing costs; we’ll just roll them into the loan.” It took months to finally get an acceptable deal, and even that one ended with the closing agent presenting us with closing papers listing costs that were twice what we had been quoted! After we instructed the loan closer to leave, it turned out that the bank discovered a “mistake,” and the closing costs, amazingly, were cut in half within 5 minutes, saving us thousands. Note that I am a building contractor, and my wife is a lawyer.

In fact, I am a 49-year-old building contractor with over 30 years of experience. I have had my own painting and then construction company since I went off to college in 1977. I have been hired as an expert witness in cases involving construction issues. I frequently consult for other contractors on how to complete difficult or complicated projects. As a hands-on contractor, I am competent at pouring concrete foundations to installing multi-piece crown moldings and most things in between. I know how to do my job. In over 2,000 jobs over my career, I have never had to repair a workmanship failure on my jobs. In addition to my own work, I also worked as a paid project manager for 10 years for a large corporate Habitat for Humanity sponsor, where I managed thousands of employee volunteers on many homes and housing projects each fall.

One thing I have noticed in my contracting experience is that, particularly over the past decade or so, new homes, from the basic to the high-end, have been ever more poorly built, and most of the remodels haven’t been much better. I believe that is a result of housing changing into more of a commodity in the late 1990’s. This became especially so once banks, as a rule, stopped carrying their own loans. Lenders no longer cared about quality construction, the expected life of the home or the ability of the borrower to pay the loan. Why would they? They were selling the loans off as fast as they could. Home buyers became real estate investors, in which the property was no longer a place to live but a place to occupy for a year or two and then sell for a killing. The largest mortgage bankers switched to loan originators and servicers with no skin in the game after 120 days. Suddenly people with no construction knowledge at all became home builders and remodelers, or worse, flippers. Indeed, classes were offered everywhere where the believers in the “new housing paradigm” were taught that, as a building contractor, you deserve to make over $150 per hour. Many fellow contractors who were my friends and acquaintances attended these classes and based their businesses on what they learned there. Now, I do not believe all contractors and builders are bad. There truly are some exceptionally talented and honest contractors and tradespeople out there, but unfortunately they are increasingly hard to find. If you have found a great honest contractor, you should be buying lottery tickets; you are a lucky person.

Over the years I have been asked many housing questions. At one time in my life, I wasted a lot of my time trying to explain home issues to home owners and friends who really didn’t care to hear what I had to say. What they really wanted from me was reassurance that they were right about conclusions they had already come to or decisions they had already made. One example of a common question I got was, should I replace my windows? My opinion on windows is and was that, if your old windows are rotted, get new ones, preferably wood ones. Otherwise, if your present windows are working fine, new windows really won’t save you much in energy costs because most of your heat goes through your roof. Usually less than 15% of your wall space is windows. Only 1/3 of your heat is lost through your walls (including windows). An empty wall (drywall, studs, no insulation, sheathing, and siding) has on average over two times the insulating value of the average new window. So just multiply 1/3 of your winter heating bill by 15% and that should approximate your new savings (not perfect but close enough). In Minneapolis where I currently live, most quality window replacements cost $800 to $1,000 per window making for a very slow pay back (25 years or longer). Contrast that with a high efficiency furnace with a programmable thermostat that would usually pay for itself in 5 to 10 years with its energy cost savings.

I usually never actually get into this much detail—the person asking had already decided he or she was going to get the new windows or whatever, so they didn’t want to hear any of this.

So back to the problems with many new homes and remodels. It is my opinion from looking at more failed construction than I ever wanted to that the current generation of housing will not last nearly as long as previously built housing. I specialized in older homes, and many of the homes I have worked on were 80+ years old. These homes have little in common with newer homes in both their construction methods and materials. The expectation of a lasting, durable home has all but disappeared. Major home builders know what home buyers want. Quality has been replaced with “house bling”: kitchen islands, master bath with custom tile, granite or granite-looking countertops, crown moldings, multiple roof planes, 3,000 to 4,000 square feet consisting of many useless vaults and irregular spaces, and 20-foot high foyers with a faux chandeliers (how do you change the light bulbs in that?).

Home buyers, even the ones who say they care, don’t usually give much thought to things that really impact quality or cost of ownership, like furnace or air conditioning efficiency, quality building methods, proper insulation, or quality soil around and under their home. And if the buyers aren’t asking for these things, builders, who are in the business to sell homes and make money, don’t build those features into the homes. If buyers cared about better quality and/or energy efficiency, and indicated so in their home buying purchasing behavior, the builders would too. But, as I said earlier most home buyers in the past 10 years or so have not seen themselves living in the home for that long. Just long enough to make a killing and continue “moving up”.

Taking into consideration what purchasers do buy or remodel homes for, builders often cut costs on things that are very expensive to upgrade of replace later on. Electrical and plumbing work usually goes to the lowest bidder. It is not unusual to have half the electrical circuits in a house that it should have. The cabinets look pretty, but they are not really high quality. Flooring looks good for as long as the warranty period lasts, but not much longer—the hardwood floors are beautiful until they are horribly scratched in three to four years, and only then does the owner discover that there isn’t enough real wood veneer to sand. Other problems I have seen a lot of include:

• Bad foundations built on bad soil
• Roof and floor trusses engineered to the bare minimum required
• Improper fasteners in new ACQ treated lumber
• Improper nailing of sheathing or almost no nailing
• Nails missing studs or trusses
• Poor quality roof and floor trusses
• Window inserts that don’t deal with problem of old window trim
• House wrap or tar paper not installed properly
• Vinyl siding poorly installed (often trapping water in the j-channels)
• Wood, fiber and stucco sidings not being properly detailed
• Excessive soaking of framing or sheathing during construction
• Poorly installed insulation and failure to seal bypasses
• Framed corners (insulation) getting soaked
• Poorly installed roofing
• Bad window installation detail

What does all this poor construction mean? Well, it means that the majority of new homes and new remodels are going to require serious repair way before the homes are paid for or even worth what they were originally sold for. As I have said, I don’t believe many new homes are going to last nearly as long as previous generation homes. Upgrading energy efficiency will be way too costly, but the utility bills will also become increasingly more burdensome. Many homes are going to just fail and become unlivable.

News stories around the country have been featuring the suburban ghost towns. Developments half sold and now abandoned. The one catastrophic detail they don’t mention in these news reports, but is often apparent from the video footage, is how damaged many of these homes are, often after only a year or so since completion of construction: siding falling off or missing, shingles blowing off, doors and windows rotting. These homes are badly damaged, difficult to repair and soon to be valueless. I believe that many of the new sprawl homes and bad remodels will experience catastrophic failure after between 10 and 15 years, leaving them more expensive to fix than they are worth or their owners can afford.

An example to illustrate my point: A typical new $400,000 move-up house has vinyl siding and an attached garage which butts into the side wall of the house. The last piece of step flashing on the garage roof is tucked under the vinyl siding of the house (a very common error). Even if this piece is caulked, it will begin to leak. The water shedding off the garage roof will slowly start to find its way behind the house siding. If the house wrap was installed improperly, or worse, not installed at all as many municipal authorities have been allowing, the sheathing is now getting wet, and it will soon start to rot. The water will work its way behind the sheathing and soak the framing and insulation. Windows in the trail of the water will also become damaged. Eventually, the water will soak the bottom plate of the wall framing, damaging the subfloor and floor joists underneath it.

All this can easily happen in just a couple of years, and no one knows it’s happening because it is happening behind the siding. Eventually, though, there are clues, like a mildewy smell in that part of the house. Once the damage is discovered, it is likely the case that the statute of limitations for recovering from the builder has expired. It might also be the case that the homeowner’s insurance doesn’t cover damage from an ongoing problem or caused by a construction defect. Even though permits were issued and government inspections done during construction, they failed to protect the homeowner from the failed construction.

So what are we looking at in terms of repairs for this problem? Siding will need to be removed and replaced along with the damaged sheathing, the damaged framing, the flooring and the damaged subfloor. Drywall may need to be removed from the wall and part of the ceiling and replaced. All wall repairs will require repainting. Damaged floor joists will require repair or replacement. An electrician will need to remove the old wiring in the damaged wall and run new wire. The damaged window will need to be replaced. Repairs like these could easily run into the tens of thousands of dollars, depending on where you live. They could be a lot worse too. If the water damage happens in a way that mold and mildew form in the heating ducts, it can be a lot worse. Let’s say this home was bought at the peak of the inflated market in 2005. In 2015, based on historical averages, it will probably be selling for little more than its purchase price in 2005.

Moreover, if the homeowners by then will typically have little or no equity. The economy is still stumbling along much like Japan’s did for 20 years. Even if they have decent jobs, the household still likely makes only $50,000/year. By 2015, the homeowners’ taxes will likely be even higher than they are today. (Someone is going to have to pay for the bailout sooner or later.) To make matters worse, it is likely that by 2015, the furnace originally installed in this house broke after only eight years, and the water heater probably broke after only seven years. The stainless steel-faced dishwasher probably broke after three years and even has rust in spots (not all “stainless steel” is the same). It is likely the homeowners still haven’t fixed the broken dishwasher. So where in the world are the homeowners going to find $15,000, let alone $50,000, to fix the house? Keep in mind that, if the water damage isn’t fixed, the damage will keep getting worse.

Damage or no damage, well built or poorly built, nationally, the typical existing home was worth roughly the same in 2000 as it was in 1950 after adjusting for inflation, according to Yale University economist Robert Shiller as reported in USA Today. So in reality the actual value of current housing hasn’t changed in real value since 2000. Everything homebuyers have spent over that amount was just bad judgment. The value only exists as inflated valued loans and for a short time in the minds of unrealistic buyers … oh, and one other place, on the bottom line asset base to all mortgage backed securities (SIVs, CDOs, CDSs, etc).

The sucker’s bet that is currently being made by the current administration and Wall Street with our tax money is that that bottom line asset base (i.e., all those over-leveraged homes) will return to its former value if the homes are not forced to market too quickly. This upside-down pyramid of our financial system is resting completely on the housing stock. All current proposals to save the banks as well as the distressed homeowners are based on the belief that the toxic assets have value because those homes have long term value. So extending mortgage terms to keep people in homes they currently can’t afford, or by holding foreclosed properties from the market is the fool’s solution. It hasn’t even occurred to the “fixers” that the asset base may degrade making all the projections just fantasy. But the sad fact is that the asset base, the homes that the mortgages were originally attached to, were really never worth what they sold for in the first place, and very likely at least half will fail to less than salvage value long before the loans against them, restructured or not, have any value. It leaves a very depressing financial scenario in the not-too-distant future. What happens then, when the entire bailout fails?

Comments are closed.