Curing The Foreclosure Market

We have seen the ads and we have become inured to them, a sporty car speeding through winding curves in the hills, a shiny truck bouncy across a creek, a mature man holding open the door for his equally stately spouse (we presume) in front of the club. Then the deep baritone voice of the announcer "Payments as low as x-hundred dollars with zero down."

Ah, zero down. Sometime ago the auto makers sat down with their finance and marketing wizards to answer the perpetual question, "how can we sell more cars?" And the answer to moving more cars out of the dealerships was not to sell them, but rather to lease them. Create financing that allowed Americans to drive off in a brand new car with no money down and an attractive payment. Nothing more than a long term rental contract on a depreciating asset, lease transactions create a sense of ownership and also because of the way they are structured are more often than not converted into another lease on another new car at the end of three or five years. Leases create a constant market for the auto makers.

When it comes to cars Americans are happy to continue making payments on an asset that is worth less in value than the balance of the obligation--most of the newer cars you see on the street are what is termed "upside down". To many Americans their vehicle is tied to their identity and the marketing departments feed on this. You spend a lot of time in your car, your neighbors see your car, your co-workers, your friends--your car says if you are rugged or sporty, if you are successful, it conveys your image. This is the marketing that too many buy into and as a result they auto leasing industry has done a great job of keeping these individuals in new cars every few years.

Evidently when it comes to our homes, where we raise our children, hold family holidays, establish roots in our community, we are much more concerned about when the asset depreciates. While as a nation we are more than happy to pay, or lease, for a $30,000 vehicle at the dealer only to have it worth $24,000 by the time we pull it into the garage, we seem to be extremely adverse to keeping a home purchased for $350,000 if it is now worth $280,000--even if the 20% loss is not out of our own pocket. After all only a fool would pay for an asset that has dropped in value---unless it says I have an urban-mountain chicness about me.

Most Americans aversion to paying for a house losing value is evidenced in the foreclosures happening across the country. While the early press and political statements where pointing fingers at my industry, to some extent justified, and to Wall Street greed, to some extent justified, no fingers were being pointed at others in the transaction: Fannie Mae and Freddie Mac, Congress which regulates Fannie and Freddie, and the borrowers who flooded the real estate markets from 2002 through 2007. Finding scapegoats is the primary focus of the media and politicians. Swarmy mortgage brokers had to be the cause of the housing crisis, forcing innocent Americans into "liar" loans, and loans that had adjustable rate bombs that were hidden in the documents they signed. Slick, greedy Wall Street financiers found exotic derivative investments to look like the risk would be spread thin across the globe to investors all the while piling billions of dollars from innocent American homeowners into their mansions and jets.

Very compelling stories, stories with legs and enough truth to find individual examples that could be splashed on the front page or before the first commercial break. But hardly truthful in telling the major cause for the pending and continuing decline in real estate prices that would affect the global economy.

In "New Evidence On The Foreclosure Crisis" (Wall Street Journal, 7/3/09, subscription may be required), Stan Liebowitz breaks down the numbers on over 800,000 foreclosures across 30 million loans for the second half of 2008. He categorized the foreclosure causation into five categories: negative equity, down payment of less than 3%, mortgage rate reset higher, subprime FICO score (less than 620) and unemployment increase in 2008. Far and away the largest foreclosure group, at 35% is the group with negative equity, combined with borrowers who put less than 3% down and the low to no equity group rises to over 51% of the total foreclosures in the second half of 2008. FICO score, stated income (or "liar") loans, adjustable rates and even unemployment as the cause of the foreclosure combined do not equal the number of foreclosures of those with no equity.

A huge factor in Liebowitz' data is what is not included: home equity lines of credit. His study was just on the foreclosures through the first trust deeds for primary mortgages. As I mentioned on Monday in "Congress Caps and Trades Homeownership" Fannie Mae and Freddie Mac lending guidelines allowed for, I would say encouraged, second trust deeds and mortgages covering 20% of the purchase price to allow for 100% financing--none of these transactions are accounted for in Liebowitz' analysis, so his numbers are very conservative as to the extent that no down payment at time of purchase is a primary cause of the foreclosures on the market. Because of the foreclosure process almost none of the foreclosures in the market were foreclosures made by the holder of the 2nd or equity line--they are at a total loss to the process.

Also not accounted for in Liebowitz' data is the loss to lenders and the markets due to short-sales where lenders take steep discounts in their loan payoffs to facilitate a sale, from my rather limited analysis of transactions at our company the vast majority of these transactions were low to no down and/or had 2nd trust deeds as part of the financing.

Why is this data important? Because as Liebowitz discusses, to this point the focus of policy from the White House, HUD, and Congress has been to prevent foreclosures by throwing various loan programs and modification policies into the market that do not address the fact that most foreclosures are the result of negative equity. Not interest adjustments. Not that income was inflated on loan applications. Not that the borrowers had subprime credit. No, most foreclosures to this point are happening because of the fall in real estate prices combined with the zero equity the borrowers had in their homes when they purchased them.

In California we have seen moratoriums on foreclosures for 90 day periods, all these moratoriums have done is hold off when the homes will be foreclosed on and then put back on the market. I have yet to hear of one home that was saved because of the moratorium--sure a few may have had time to go through a short sale process, but in the end is that not pretty much the same thing? The borrower is left without a home and the lender is left with a less than full balance pay off of their mortgage.

Left to its own devices with the financing currently available, as I addressed on Monday, first time buyers are flocking to market due to low prices and low interest rates. The mortgages our industry has been funding the past eighteen to twenty-four months are the strongest borrowers our industry has seen in decades. Tighter lending policies, down payment requirements and the absence of profit seekers purchasing homes for profit instead of for homeownership, have created a solid foundation for a recovering housing market. And as this continues we will see the credit driven foreclosures in America decline.

Instead of fiddling around with forcing cram downs for meeting arbitrary income to debt guidelines, increasing loan to value limits for refinancing mortgages to 125% of property values, forcing lenders to take losses on rates of return, Congress and President Obama would serve the nation's real estate markets best by letting the markets take care of the foreclosures through natural supply and demand. With the low prices and affordable rates Americans are buying homes, and they will continue to do so as long as they can afford to buy them.

What will impact future foreclosures and housing prices are two major factors: interest rates and unemployment. As job losses pile up many Americans will be forced to choose between paying their mortgages and feeding their kids. As Washington continues it spending of trillions of dollars at a time and the accompanying borrowing inflation in our economy is just a matter of time, and that will mean significantly higher interest rates that will reduce home affordability.

If Congress is truly concerned about homeownership and the foreclosure markets across America my advice is to a) leave it alone, let the markets cure the problem b) cut taxes for employers and investors to stimulate investment and capitalization of new endeavors, or if cuts are unpalatable then don't raise any taxes on any group c) quit spending money, no more stimulus bills, no health care reform, no new programs until the current economy rights itself and a solid foundation for future growth is established. Basically I am asking Congress to not pass any legislation that is supposed to "fix" the housing or mortgage markets, nor to redistribute any more tax payer dollars by taking it from those who create businesses to fund new programs that just add to government's size.

Too bad the housing industry has not done as good of a job promoting the chicness, the sportiness, the rugged manliness of homeownership as well as the auto industry, if it had perhaps more Americans would be willing to stay in their homes and make their payments as they raise their families in their own homes. Had more done so our foreclosure crisis would be significantly smaller than it has been.

Oh, and as always when the finger pointing starts take a look at the role of the one pointing the fingers--usually there is a good reason he is trying to show someone else to be at fault.

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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.