Can Demolition Boost the US Housing Market?

By David C Nelson  AUG 29, 2011 12:45 PM

Bank of America, JP Morgan, Fannie Mae, and Wells Fargo are all experimenting with home demolition as a way to reduce their foreclosed home inventory -- as Warren Buffett suggested over a year ago.

 


"Blow up a lot of houses."

No those weren’t the words of a terrorist. They came straight from the lips of perhaps the world’s greatest investor, Warren Buffett. When asked more than a year ago how to fix the housing crisis Warren said, “Blow up a lot of houses.” Perhaps he wasn’t serious and recently has made statements suggesting that we are about to turn the corner in housing.

I don’t think we can see the corner, much less turn it. Despite Warren’s bullishness on housing, Wall Street seems focused on his earlier call.

Bank of America (BAC), JP Morgan (JPM), Fannie Mae, and Wells Fargo (WFC) are all experimenting with home demolition as a way to reduce their foreclosed home inventory. They haven’t been passing out sticks of dynamite yet, but the bulldozers are running and demolitions are proceeding. According to RealtyTrac Inc., a research firm in Irvine California, there are nearly 1.7 million homes in foreclosure in the US.





Rather than put homes on the open market banks have started to bulldoze some into the ground and donate the property. This helps reduce their tax burden, eliminate maintenance costs, and maybe even get a tax-deduction.

Understanding the laws of supply and demand is Economy 101. We are drowning in a sea of houses coming to market and as a result home values around the country continue to plummet. Underwater homeowners who owe far more than their homes are worth are increasingly making the decision to walk away. Rather than send in this month’s mortgage payment many are sending in the keys -- what lenders refer to as Jingle Mail (the sound made when the keys fall out of the envelope).

Even Fed Chairman Bernanke commented on the importance of housing and the failure of current efforts as a drag on the US recovery in his recent speech at Jackson Hole. Home construction is unlikely to increase as long as the current supply demand dynamic remains in place.

Currently solutions like this are focused on homes in disrepair and are too small to really make a difference in their present form. Why not make this program larger? Even with record low interest rates demand is tepid as most buyers remain on the sidelines, concerned that they might be buying into a falling market. Other attempts to stimulate demand just haven’t worked and remain very unpopular. Loan modification has had little success and creates the moral hazard of rewarding those who overextended themselves, leaving homeowners who lived within their means to pick up the tab.

A scorched earth policy has other parallels. Firefighters understand the need to cut down healthy trees when fighting a raging forest fire. While it is unfortunate that a solution like this needs to be considered in a country where many are homeless, nevertheless we must consider it. Conventional solutions just aren’t working and we continue to kick the can down the road.

The charts above point out that in some areas of our country, foreclosure rates are relatively benign. In Vermont the numbers came in at 1 in 28,000 units while Nevada is at an epidemic level of 1 in 115 and California isn't far behind with 1 in 239. This map looks vaguely familiar to a Bio-Warfare Map showing the potential spread of a fatal disease. Every day a house remains empty decreases its likelihood of future sale. Inventory will continue to build with prices likely to fall further.

The alternative to the bulldozer has been loan modification. Even though these programs have been stepped up in the last few years, many applicants complain they don’t get an offer after going through all the necessary steps. Bank of America responded with a Customer Outreach event for those more than 60 days delinquent on their mortgages. Homeowners faced with foreclosure got the opportunity to meet with loan officers and apply for loan modification. Even with efforts like these many still complain they aren’t getting the desired relief.

Meanwhile, the number of empty homes grows larger and pressure on our economy continues to rise. Faced with the option of another empty house on the block or a stick of dynamite, your next door neighbor just might light the fuse.

Editor's Note: This article was originally published on Belpointe.
No positions in stocks mentioned.

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