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Wednesday, May 13, 2009

How Cities Should Manage the Next Foreclosure Wave

In February Governor Arnold Schwarzenegger signed into law a 90 day moratorium on foreclosures in the State of California. There were some loopholes, naturally, but the effect of the law was to keep tens of thousands of foreclosures from happening from the end of February through the end of this month, May 2009.

Since February we have seen an increase in the number of "short-sale" transactions (seller owes more in mortgages against the property than the sales price necessitating mortgagor(s) to discount principal owed to facilitate closing) as many homeowners have sold their properties ahead of filings of notices of default and foreclosure. As well California has seen a flattening of the median sales price through the first quarter of 2009, indicating a firming up of the housing markets through much of the state--particularly coastal counties and communities--from the bottom up. In some areas there has been an increase in median prices, particularly condominiums in some zip codes.

In part the flattening of the median prices and increase in the number of short sales versus bank owned foreclosures on the market in California are the result of the Governor's moratorium on foreclosures. With only a few weeks left before the moratorium expires what preparations have various California cities and counties and lenders undertaken for what will occur when that happens? My guess is nothing.

While the moratorium has allowed many lenders to off load poor performing mortgages through short sale transactions initiated by their borrowers, what the moratorium has not done is reduce the flow of borrowers into default on their mortgages. As a result lenders in California have a very significant number of mortgages on which they are about to initiate foreclosure proceedings. Three months of unpaid mortgages are going to start being processed by the banks and if not handled properly California housing markets will be hit with a flood of foreclosure sales due to the moratorium. The primary argument against the moratorium was what it would do to housing markets when the moratorium expires--we are about to find out.

Supply and demand function in any market, and left without interference will seek a market price for any good or service. Everyone with a basic concept of economics knows that scarcity of supply raises prices, scarcity of demand lowers prices, abundance of supply lowers prices and abundance of demand raises prices. For the past several months we have seen a growing abundance of demand in the lower price ranges and a flattening of supply, leading to stabilizing of home prices for the first time buyer markets. What happens to those markets when flooded with pent up supply due to banks being able to foreclosure again on delinquent borrowers? Abundant supply creates lower prices.

There is a possible solution to the flooding of the market with lender REO's (an industry acronym for Real Estate Owned, bank owned foreclosures) and the subsequent fallout in housing prices. Banks and local governments can work together to allow the banks to receive revenue from their REO properties while slowly placing their inventory on the market over period of a year or more and cities and counties can increase the supply of rental housing or moderate income housing for first time buyers.

Using Bank of America and the City of Long Beach as an example. Long Beach can approach Bank of America and determine how many properties they have in Long Beach that are REOs, in delinquency and about to be foreclosed upon. Understanding that BofA will need to remove the "toxic assets" off their books, BofA will continue with its normal foreclosure processes on delinquent borrowers. Understanding that the City of Long Beach is concerned with property values in its communities and the loss of tax revenues BofA will agree to work with the City to slowly sell its REO inventory over a period of twelve, eighteen or twenty-four months; slowly bleeding inventory on the market instead of dumping it all at once. For the properties that are not yet placed on the open market the City of Long Beach housing department can work with the BofA REO department to fill the properties with tenants paying fair market rent, perhaps subsidized (I cannot believe I wrote that word!) with funds from the housing department, to allow BofA to maintain funds for property taxes, insurance and general operating revenue (such as paying personnel in the REO department). Some of the properties can become eligible for funds from the housing department set aside for first time buyer programs that are currently not used due to inefficiency and requirements imposed on everyone involved.

Housing and government do not get along very well. Government imposition of requirements for low to moderate income families purchasing or renting housing creates hundreds of pages of restrictions and regulations and bottlenecks any funding to the point that no funding occurs. In the City of Long Beach there are millions of dollars in housing funds left unspent due to the requirements imposed on those funds being too stringent for the market to comply. If someone with sense in government, at the local, state and federal levels, were to look at the looming foreclosure flood about the hit the market in California he/she can see the problems that will occur. Yet under the guidelines imposed on housing funds there is nothing a city can do to manage the flood of inventory about to the open market in their communities. By re-negotiating the restrictions placed on housing funds from the state and federal governments cities can free up millions of dollars to use in working with banks so the inventory of REOs can be managed in a manner that helps both the banks and the communities where the properties are located.

From the bank's perspective the ability to forge a partnership with local governments to manage the removal of REOs from their balance sheets over time will add stability to their balance sheets, revenue to their income statements and groundwork for future partnerships that benefit both parties. Instead of having hundreds or thousands of properties on the market with declining values, they can have a few hundred properties at a time selling in a more stable market environment.

I do not expect this proposal to work as there is little chance the bureaucracy of the government housing departments can move nearly fast enough to free up the necessary funds from their current regulations that prevent their use. Cities across the country are flush with funds to promote home ownership and community development through rehabilitation of distressed properties--unfortunately the policies, procedures and regulations governing the funds make them useless. It is time for local governments to push back on Sacramento and Washington and renegotiate the terms under which those millions of dollars are being restricted.

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