Comment: Is the housing tsunami receding?

Contrary to popular belief, a tsunami is not a single gigantic wave, but is a series of massive waves that can pummel shorelines thousands of miles from its origin, leaving a trail of devastation in its wake.

The current U.S. housing slump - the worst in 70 years - has been likened to a tsunami because of the carnage it has caused in financial markets worldwide, many of which were quite distant from the epicenter. The estimated damage in terms of market capitalization that has been vaporized over the past six months already exceeds hundreds of billions of dollars.

There are signs the worst is over and investors are cautiously picking up the pieces. But before you get too comfortable, realize that hazards remain.

Last week, Linens 'n Things became the latest casualty of the slowdown, as it filed for bankruptcy in the largest leveraged buyout failure since July.

The second-largest U.S. houseware retailer was unable to cope with competition and tight liquidity conditions as consumers cut back spending on home furnishings. Smaller rival Home Interiors & Gifts, a direct-marketer of home decorative products, also filed for bankruptcy last week.

Revenues and earnings at lumber producers have also taken a hit. Weyerhaeuser reported a loss of $148 million in its first quarter, and Canada's Canfor reported a loss of close to $84 million.

The slump has also slashed the market value of homebuilders in the S&P 500 by two-thirds from their peak in January 2006. The five companies in the S&P 500 Homebuilding index currently have a total market capitalization of $16 billion, compared with over $49 billion in the heady days of early 2006.

Nevertheless, judging by the performance of homebuilding stocks such as Pulte Homes and DR Horton, it appears as though investors believe the worst is behind them. The S&P 500 Homebuilding index was up 11 percent for the year as of Friday, led by Pulte with a 34 percent gain and DR Horton with 19 percent.

But the most telling indicator of improving sentiment is that top-rated securities backed by subprime loans rose - albeit modestly - in April, after falling over 9 percent in the preceding six months. As the implosion in U.S. subprime mortgage-backed securities was one of the major shocks that triggered the housing tsunami, any improvement in that asset class would be a positive factor for markets across the board.

For the moment, investors are willing to look beyond U.S. housing data, which continues on its dismal trend. Last week, real estate data company Radar Logic reported that home prices fell in 22 U.S. metropolitan areas in February, as foreclosures reached record levels. Prices per square foot in areas such as Sacramento plunged almost 30 percent from year earlier levels. Prices in Las Vegas fell 26 percent.

Markets may have stabilized in recent weeks as the leading wave of the housing tsunami recedes, but don't take your eyes off the water: there may be more waves on the horizon.

Bank's mail jingles as borrowers walk: James Saft

Increasing numbers of Americans are simply walking away from their houses and mortgages, increasing pressure on banks and the economy.

Rapid house price falls in many parts of the United States will soon leave as many as one in five borrowers owing more on their loan than the house will fetch, removing at a stroke the single most powerful incentive to keep up with payments.

The phenomenon of "walk aways" or "jingle mail," so called because of the noise the house keys make in the envelope mailed to the bank, is hard to measure but shows every sign of gathering pace and having a substantial impact.

Wachovia Corp went so far as to change its models on how quickly loans will go bad in the face of what it called "unprecedented" changes in consumer behavior.

"I don't know where the tipping point is, but somewhere when a borrower crosses the 100 percent loan to value, somewhere north of that their propensity to just default and stop paying their mortgage rises dramatically and really accelerates up. It's almost regardless of how they scored, say, on FICO or other kinds of credit characteristics," Wachovia chief risk officer Don Truslow told analysts on a conference call.

FICO, a credit score developed by Fair Isaac Corp., is one of many barometers of credit worthiness used in home lending to help predict the likelihood that a borrower will repay.

Wachovia this week announced that it would make a $2.8 billion provision for credit losses as it posted a first quarter loss, cut its dividend and sought to raise $7 billion in fresh capital.

While the law varies from state to state, in many parts of the United States mortgage lenders cannot go after defaulting borrowers' other assets. And even where they can, few lenders take the expensive and low-yielding option of chasing down borrowers who walk away from loans.

The scale of the potential problem is huge.

Mark Zandi of Moody's Economy.com estimates that 10.6 million homeowners will have zero or negative equity by the end of June, or 21 percent of first mortgage holders.

The impact of a new wave of defaults will also be potentially important. Banks and other investors in mortgages, as has been seen, will take further hits to their already weakened capital.

While few might shed tears for banks, this means a longer and deeper credit crunch. It will also mean a wave of new properties hitting the real estate market, driving prices lower still, as banks seize and seek to sell the houses homeowners have fled.

To give a flavor of the impact, Zandi has estimated that every foreclosure on a neighborhood block reduces the value of all homes on that block by almost 1.5 percent.

GROWING PHENOMENON

To be fair, not every loan default by someone whose house isn't worth as much as the loan is a walk away, but the two are closely linked. Wachovia is far from alone in feeling the impact from "walk aways."

Regions Financial Corp (RF.N: Quote, Profile, Research), a large U.S. bank active in the southeast, on Tuesday announced that nonperforming assets had nearly tripled to $1.2 billion, driven in part by deterioration in its home equity loan portfolio.

Regions chief executive C. Dowd Ritter gave analysts a similar picture of how borrowers react when confronted with steep drops in home valuations.

"As they started to sell it or refinance, they realized that valuation was 40 percent below what it was that 18-24 months ago and they are walking away from those homes in those markets," he said.

Data from real estate firm RealtyTrac not only shows a rapid rise in overall foreclosures, but also suggests a rising number of walk aways.

Home foreclosure filings surged 57 percent in the 12 months to March and bank repossessions soared 129 percent from a year ago, according to RealtyTrac.

In most of the United States, foreclosures follow a sequence of an initial notice of default, then notice of a scheduled auction, and finally a "REO" filing indicating repossession.

If borrowers walk away, lenders can skip the auction notice and accelerate repossession.

"On a year-over-year basis, default notices were up nearly 57 percent and bank repossessions were up nearly 129 percent, but auction notices were up only 32 percent, indicating that more defaulting homeowners are simply walking away and deeding their properties back to the foreclosing lender," said James J. Saccacio, chief executive officer of RealtyTrac.

While borrowers acting in their own best interests really shouldn't shock anyone, the costs associated will be just another unwelcome drag on the economy and finance until the value of U.S. houses stops falling.