The Wall Street Journal
LOS BANOS, Calif. — In this California city, one of the hardest hit in the national housing crash, there’s good news: Homes are starting to sell again.
Investors and first-time home buyers are snapping up foreclosed houses here, with the number of local sales up almost fivefold from this time last year. While the volume of existing-home sales across the U.S. fell 10.7% in August from the previous year, according to the National Association of Realtors, there are signs that the most damaged of markets are starting to heal themselves. Across hard-hit California, sales volumes rose 65% in September compared with a year ago, said MDA DataQuick, a San Diego-based real-estate information service.
See some of the hardest-hit communities, plus more on Merced and Los Banos.
The bad news is that the latest round of sales is unleashing another round of pain in cities such as Los Banos, a commuter community in California’s Central Valley. With home prices already down 66% from their peak here, most homeowners owe more on their mortgages than their houses are worth. Successive deals bring new low prices, leaving remaining owners with little incentive to keep current on outsized mortgages.
Some stop paying, pocketing the money while they wait for their lenders to kick them out. A few lose their homes only to stay on as renters, paying hundreds of dollars less a month. Every fifth house in this onetime real-estate boomtown is in some state of the foreclosure process.
Until markets like this are sorted out, there’s little hope for calm in the global financial system. As banks and governments survey the wreckage of residential real-estate investments, the central mystery is how to value the trillions of dollars in securities that are tied to U.S. mortgages. These securities are so hard to value in part because no one knows when normalcy will return to places like Los Banos.
Economists and politicians offer two main prescriptions. Many say the government should buy these homeowners’ expensive mortgages and reduce the loan amounts to reflect current values, a taxpayer-funded effort to put a floor under the housing market. Others say such intervention would reward those who bought homes they couldn’t afford, and prolong the inevitable pain of a necessary housing contraction. These people say the market should continue its own path toward equilibrium.
Neither option would be pretty, judging by homeowners’ experience here.
Los Banos, a city of about 36,000 people, lies in Merced County near the center of the Central Valley, a fertile expanse that has long drawn opportunity seekers — Basque sheep farmers, dairy farmers from Portugal, migrants fleeing the Dust Bowl states during the Great Depression. Many of their descendants live here still.
This decade, Los Banos drew commuters from Silicon Valley, 80 miles to the northwest, and the construction workers who built their houses. Its housing market took off as builders, lenders and the government helped more people realize the dream of homeownership.
Dairy farms and fields of tomatoes gave way to cookie-cutter houses on the likes of Bentley Drive, Chianti Court and Riesling Street. Subprime lenders poured in, making cheap loans with few questions asked. Builders offered to pick up the tab for their customers’ closing costs.
Home prices soared. In 2005, one local builder was selling three-bedroom homes for $300,000 — more than three times what it asked for a similar design in 2000.
Many lenders catered to buyers with shoddy credit, who qualified for “affordability” loans with low payments that typically ramped up over time. In 2006, 45% of the home mortgages and refinance loans in Los Banos were high-rate loans, most of which would be considered subprime, compared with a national average of 29%, according to a Wall Street Journal analysis of federal mortgage data. The town’s top lenders included Countrywide Financial, New Century Financial and divisions of Golden West Financial and Washington Mutual — all former highfliers in the mortgage business whose holdings later turned toxic.
Sister Next Door
Claudia Pedroza and Veronica Banuelos were among the home buyers. In 2006, the sisters and their husbands bought new houses next door to each other in a subdivision surrounded by fields just outside Los Banos. Ms. Banuelos paid $350,000 and Ms. Pedroza paid $375,000 for similar four-bedroom homes with three bathrooms and cavernous living rooms.
Property records indicate that the Pedroza and Banuelos families took out loans for nearly 100% of the price from Bank of America Corp. In the Pedrozas’ case, the bank worked with the national nonprofit Acorn Housing Corp. as part of a program to help first time home buyers. The home builder, Hovnanian Enterprises Inc., funded $12,000 or more in closing costs for each home.
A California state housing agency also chipped in a $11,200 loan toward the Pedrozas’ purchase. Ms. Pedroza figured that with her husband bringing home $3,200 a month as a house painter, the family could afford the monthly mortgage payment of about $2,000. Ms. Banuelos, a college student, said the payments were affordable for her husband, who also had ample work as a house painter.
Indeed, the housing boom brought jobs to many local residents and attracted new businesses, with Starbucks and Target going up on the same street as a slaughterhouse and the local office of the Hay Growers Association.
But the market turned in 2007, and now the Merced metropolitan area leads the U.S. in many indexes of misery. By the third quarter of this year, 12.3% of home loans were delinquent in Merced County, the highest in the nation, according to Equifax and Moody’s Economy.com. Merced has also seen some of the country’s sharpest home-price declines. It has the highest share of owners who owe more on their houses than they’re currently worth.
Ms. Pedroza lost her home to foreclosure when her husband’s painting jobs vanished and the couple fell six months behind on their payments. The Pedrozas are now paying $750 a month to rent a two-bedroom apartment in downtown Los Banos, where their 10-year-old daughter and 11-year-old son share a room. Ms. Banuelos’s husband also took a cut in house-painting hours, and the couple stopped paying their mortgage four months ago.
Now, on the block where Ms. Pedroza and Ms. Banuelos bought homes, five of the 16 houses are empty with brown lawns, a typical sign of a foreclosed property. Both sisters are hoping that Bank of America will renegotiate their loan terms to allow them to become homeowners in good standing once again. “I’ve told the bank, ‘You won’t be giving me anything for free,'” Ms. Pedroza says. “Just make it so I can afford the payment.”
An Acorn official encouraged the Pedrozas, who have already lost their house, to call the group for help. A Bank of America spokesman said the bank’s servicing team would “reach out” to the Banuelos family.
Such dramas are repeated throughout California, where the U.S. housing market is arguably at its most troubled. Following years of big profits for bankers and home builders in this state, one-fifth of all outstanding U.S. mortgages by dollar value — and a higher percentage of risky loans — are written on homes here. Of the 25 metropolitan areas with the largest home-price declines in the past 12 months, 16 are in the state, according to Zillow.com, a real-estate research Web site.
Those woes weigh on the financial system. Though California represents about 12% of the nation’s population, its homes account for 34% of the loans in a typical mortgage-backed security, according to Fitch Ratings. “California doesn’t have a Wall Street problem. Wall Street has a California problem,” says Christopher Thornberg, principal at Los-Angeles based Beacon Economics and member of the California Controller’s Council of Economic Advisors.
People here talk a lot, and agree little, about what should be done to fix things. On a recent day in the Verona subdivision, an upscale development riddled with for-sale signs, Bill Knoff laid out pizza and beer for a half a dozen members of his van pool. The co-commuters, who drive nearly 80 miles from Los Banos to Silicon Valley each morning and then back each night, sparred over who’s to blame for local foreclosures and whether the government should bail out mortgage holders.
Mr. Knoff’s house has traveled the arc of the local market. Built on vacant land in 2002, it sold for $280,000. Its original owner unsuccessfully tried to sell it in 2006 for $450,000. Mr. Knoff bought it out of foreclosure in March of this year for $320,000. Today, based on local sales, he figures the house is worth about $220,000.
Mr. Knoff paid nearly half of the purchase price in cash, so most of his equity has been wiped out. But he said he believes in taking responsibility for such choices. “The government can buy up troubled mortgages. But it should kick the people out of their houses,” said the 61-year-old information technology manager. “Why should I pay for someone to buy their house?”
Darryl Williams blamed mortgage companies for granting the easy loans that fueled the boom. “I don’t like hearing that the people who got houses and couldn’t afford them are the bad guys,” said Mr. Williams, a 55-year-old warehouse-services manager. “These are families with children.”
Then Steve Sherman Sr. spoke. “I am one of those troubled borrowers not making any mortgage payments,” Mr. Sherman said. The 61-year-old shipping and warehouse supervisor refinanced his house in Los Banos two years ago for $365,000, spending much of the new loan on home renovations. Now, he figures, the house is worth $140,000.
Mr. Sherman said that while he can afford his payments, he had planned to sell the house in a year or so to supplement his retirement income. But now, he figures, he couldn’t afford to live there as a retiree. So four months ago he stopped writing mortgage checks, setting the cash aside in his retirement savings. He says he’s waiting for his lender to kick him out or to reduce his loan amount. He’d also be happy for the government to modify his loan.
“I don’t deserve a bailout,” Mr. Sherman said. “Will I take one? You are darned right I will.”
Such issues are at the heart of a debate among policy makers and economists about how to mend the nation’s housing market.
There’s growing momentum for the government to stem the slide in home prices. Federal Deposit Insurance Corp. Chairman Sheila Bair said last week the government should do more to help homeowners. Republican presidential candidate Sen. John McCain has proposed the Treasury spend $300 billion to buy up troubled mortgages and reduce the principal on the loans to reflect current values.
Others believe government intervention will derail the market mechanisms and postpone the eventual return to equilibrium. Sen. Barack Obama opposes using taxpayer money to intervene in the housing market, advocating instead that the government pressure lenders to alter mortgage terms and change bankruptcy codes to allow judges to do the same. Congress has already passed the Hope for Homeowners program, which aims to put 400,000 borrowers in more affordable loans.
Plus, some economists say the market is already correcting itself without federal intervention. The volume of home sales in California is rising even as the national average continues to fall. At the same time, median prices in the state fell in September, down 34% from the previous year, to $283,000, according to MDA DataQuick.
“The lower prices are getting people to buy, and that’s how you equilibrate a market,” says Gary Becker, a University of Chicago economics professor who won the 1992 Nobel Prize for research in microeconomics.
But the bottom still may not be in sight. Home prices in California could end down as much as 60% from peak values, according to recent research from both Barclay’s PLC and J.P. Morgan Chase & Co. Towns like Los Banos may have further to fall. According to the city and a local title office, roughly 2,000 of 10,000 homes in the town are in the foreclosure process. The city expects that number could grow before the crisis passes.
The bust is apparent throughout town. Storefronts in its older strip malls are empty. Citywide, sales-tax revenue is down 15% from initial projections and the city is also bracing for big declines in property-tax revenue. The free-meal program at the Los Banos Rescue Mission served 1,110 meals last month, more than triple the levels in July.
“People are in survival mode,” says Steve Hammond, the pastor of the nearby Bethel Community Church, which runs the mission. Mr. Hammond is also the chairman of the Los Banos Planning Commission. This month, Mr. Hammond missed his own mortgage payment for the first time, after his wife lost her secretarial job. “As Christians we believe in paying our debts,” Mr. Hammond said. “But we just can’t do it.”
Where many see ruin, some sense opportunity. Michael Arpaia, an officer with the California Highway Patrol, just bought a foreclosed four-bedroom house — valued at $400,000 two years ago — for $160,000. He spent $25,000 to replace linoleum floors, carpeting and landscaping. He’s renting the house to a local couple who lost their home in foreclosure.
With stocks falling, Mr. Arpaia is counting on the property’s cash flow and appreciation to supplement his retirement nest egg. “My financial adviser says residential real estate is the safest investment right now,” he says.
While local homeowners and world markets wait for resolution, Larry Frontella can’t believe his fortunes.
Mr. Frontella grew up on a dairy farm here and worked for three decades as a local deliveryman. In 1993, he bought a new house in the established part of town for $163,000. Two years ago, he refinanced with a $376,000 loan, property records show. His mortgage was written by a unit of Golden West Financial, which was later acquired by Wachovia Corp.
Mr. Frontella paid off credit cards, paid for his wife’s funeral and prepaid his own burial. He bought a $17,000 Harley Davidson. “I worked all those years, and felt like I had won the lottery and could take care of everything,” he said.
But several months ago, Mr. Frontella fell behind on the $1,800 payment on his interest-only loan. The bank also demanded back payments that pushed his total bill to $2,400 a month. The 68-year-old said he figured he wouldn’t live to pay off his home.
Foreclosure and eviction loomed on Sept. 30. But late last month, a local businessman stepped in and signed a contract to buy the four-bedroom house for $170,000. Wachovia will take the loss on the value of the original loan, according to people with knowledge of the home.
The buyer, who declined through his real-estate agent to be interviewed, let Mr. Frontella remain in the home. Mr. Frontella’s new monthly rent is $1,100, well below what he paid as an owner.
Speaking from the driveway of the home he once owned, Mr. Frontella says he feels lucky. “I’m not saying it’s not my fault,” he said. “Now I’m a renter. What the heck.”