SHORTsense Blog

Mortgage Cram-downs will Cost Hard-Working Americans

It seems that some people in Washington are starting to realize what we in the mortgage business have known for a long time - loan modifications don't work.

Jim Puzzanghera reports in the LA Times this morning that:

Federal programs aimed at modifying loans to stem foreclosures aren't working, witnesses told a Senate Judiciary subcommittee, and some lawmakers called on Congress again to pass a bill allowing bankruptcy judges to modify home loans -- a procedure known as mortgage cram-downs.

But now that they are listening, what are they going to do about it? Sounds like Senator Sheldon Whitehouse (D:R.I.) would like to place an order for a full serving of working class votes:

"It is clear to me that Congress must do more to help struggling American homeowners.  If we fail to act, I fear that we put ourselves at risk -- that a vicious cycle of foreclosures, falling home values and declining tax revenues will keep us in recession for years to come."

Ah, yes.  Its the ol' "If we fail to act now, it will be financial Armageddon" play.  This play worked wonders for taxpayers last year when we pumped a trillion taxpayer dollars into the banks with no standards of accountability or accurate way to track the funds.  We, Senator Whitehouse, have acted, and we have failed.  Maybe its time stop acting Senator Whitehouse and let the most efficient and effective system of wealth creation known to mankind clean up this mess - it's called free market economics. 

A few months ago, I wrote a letter to Senator Feinstein outlining the factors that will lead to trillions of dollars in increased costs to average Americans if judges are allowed to modify loan contracts.  Unfortunately, Senator Feinstein didn't read it and sent me a spam letter in response to prove it.   Now that it looks like this issue is going to be up for a vote again, we need to email our senators and congressmen to vote it down.

Dear Senator Feinstein:

RE: Court-Approved Mortgage Modification

I am in the mortgage industry in Southern California and I rarely take the time to write my Senator, but in this case I feel that your vote on this issue is too important for me to sit on the sidelines. 

I have lived in California for 8 years.  I was trained as an economist in college and I, along with most credible economists, banks, the Mortgage Bankers Association and the overall investment community at large, believe strongly that allowing bankruptcy judges to modify loan contracts on primary residences will have dire unintended consequences in both the short and the long-run and will not have much immediate effect on solving the housing crisis for 4 main reasons:

1.  Moral Hazard.  This plan will actually work against the Treasury's "Make Home Affordable" initiative, as people will seek bankruptcy court as a first option vs. a last option (even with the 30 day modification clause).  I believe that the Treasury's plan has the potential to work and it is the best plan I have seen up to this point.  We need to give it a chance to work within the framework of a free market economy, where the rule of law stands.

2.  Investors.  The mortgage market works because investors like hedge funds, foreign investors, pension funds, etc. buy mortgage backed securities in a free market where the price reflects the risk they must take.  If the written word of a contract can be broken by a judge, then there is no rule of law and no predictive earning potential for the investor.  Without a predictive income stream, investors will have to increase the amount they charge (possibly double-digit interest rates) on the money they invest.  This will ultimately cost average Americans trillions of dollars in extra financing costs.  The cost will far outweigh any benefit to the few homeowners this legislation will help in bankruptcy court.

3.  Lawsuits.  Many of the investors mentioned above have already indicated that if their contracts are modified without their consent they will sue.  The amounts of these lawsuits will certainly be in the billions and possibly trillions.  Is the government (taxpayer) going to bear the cost of these suits?  And if so, what is the net benefit of helping a few thousand homeowners lower the principal on a home they couldn't afford in the first place?  The net benefit of this plan is nominal compared to the long-term costs of implementing it.

4.  Supply & Demand.  This legislation will increase the time it takes for the economy to begin to grow again.  Before banks can lend and before jobs can be created, the market must be cleared of the oversupply of houses on the market.  Just like any market from the farmer's market to the stock market, the housing market is based on supply and demand.  Market forces are stronger than government intervention programs.  What needs to happen to clear the housing market of oversupply is to actually lower the price of all of these homes further, not support the price.  The market is recovering from a hangover from a 5-year, "no money down" keg party.  These foreclosures are necessary and, ultimately, good for our economy.  They will get people that can afford these homes to buy them.  This will end the main problem of too much supply more quickly and get our economy back on track.  These new buyers will then buy goods at Home Depot and Lowe’s to fix the homes up.  They create orders for new products and create jobs and rental housing for people that are not yet financially capable of owning a home and paying the full mortgage.

I believe in the working class of this country.  I am from a poor family in a small town in northern Minnesota.  Hard working people where I am from understand that sometimes we need to simply admit that we made a mistake.  That maybe we bought more home than we could afford and we bought it at the wrong time and we need to figure out a way to get financially healthy and start fresh by getting out of the home ownership game for a few years.  Maybe the answer is to allow someone that can really afford our home to buy it, rather than suffer every day as a slave to the mortgage.  We will be back to fight another day and to buy another home that we can really afford.

I am hopeful that you will not vote in favor of granting bankruptcy judges the power to modify primary home mortgages.  

Thank you for taking time from your busy day to read my letter.

Best regards,

TJ Culbertson

Don't Believe the Hype on June Home Sales Increase

Today the NAR came out with a report showing that the volume of home sales in many parts of the country is up.  This has lead many in the media to declare that the housing market has hit a bottom and is now recovering.  Don't believe the hype.  Rising volume on lower pricing is not an indication of a bottom, it is an indication that you should not try to "catch a falling knife" in the parlance of a trader.

The housing market is just that - a market.  Though it is different than the stock market in many ways, price discovery occurs through the same process of supply and demand.  The main difference is that price discovery in the housing market takes much, much longer.  This is mainly due to the fact that stocks, generally, provide liquidity and similarity, i.e. there is no difference between one GE share and the next.  Each house is different, but areas can be grouped and viewed similar to different sectors of stocks, with each house in that sector being a different class of stock - common, preferred, convertible preferred, etc.  So the question is; just because there is a higher volume of trading on lower pricing, does this mean we are finding a bottom or simply overreacting to all of the hype in the media about the number of short sales and bank owned properties available at 50% off?

Another difference is that there is far more market manipulation in the housing market by government agencies than in the stock market.  Without Fannie and Freddie and FHA buying and insuring mortgages and Mr. Obama giving away $8K to every first time homebuyer to create a new wave of 100% financing, where do you think the real market price would be?  Im guessing it would be much lower. 

It will be interesting to see what happens to prices and volume once the $8000 first time buyer credit ends on November 30th. 

New Federal Home Loan Rules are too Much of a Good Thing

Starting on July 30th, lenders and brokers will have to begin providing borrowers with a whole slew of new disclosures - some good, most bad.  One of the worst of the new requirements, as reported by Ken Harney in the LA Times is the requirement to "redisclose" with regard to the APR:

Another significant change under the new rules: If the APR on the early truth-in-lending disclosure increases by more than one-eighth of a percentage point (0.125), the lender will now be required to "redisclose" -- that is, provide you with a corrected version and allow you an additional seven business days to consider the transaction before settlement.

What might cause the APR to increase after the initial disclosure? Lots of things: Say you left your initial rate on the loan to float with the market, but rates increase.

You'll need to get an amended truth-in-lending disclosure. Or perhaps the lender got inaccurate estimates of costs from third-party participants in the transaction, such as the settlement or escrow company. Or say that unexpected eleventh-hour junk fees materialize.

This is a perfect example of how some of the worst policies are put in place by government agencies.  It seems evident that whomever concocted this redisclose policy has never brokered a loan for a client.  The worst part is that it is also evident that they are thinking that this will benefit the consumer by forcing the broker or lender disclose more information - potentially unlimited useless information.

Why is this bad?  Rates fluctuate by the day, hour, minute and second.   If a borrower wants to "float" the rate instead of "lock" the rate, the lender will then have to send out another set of disclosures, continually, until the market trades relatively flat enough to where it is within one-eighth of a percentage point of the estimated rate.  This essentially asks the lenders and brokers to continually send out disclosures predicting something that they can't.  The net effect is that it will end up costing the consumer more because they won't be able to get the loan completed fast enough to coordinate with the closing of escrow on a new home purchase.  Then the lawsuits will come (lawyers around the country are likely staffing up for the slaughter as you read this).  Net, net;  consumers lose, lenders and brokers lose, construction workers lose, Home Depot employees lose, pool cleaners lose, window cleaners lose, gardeners lose, lawyers win.

Instead of forcing brokers and lenders to send out these ridiculous disclosures that will not serve the consumer in any meaningful way, the HUD and the Fed should be putting more resources into requiring more powerful self-regulatory action from the lending industry.  Take a page from the securities industry for example; the SEC oversees the self-regulatory organization, FINRA in the securities industry.  Imagine what would happen to volume on the NYSE if a stockbroker had to send out new disclosures predicting the stock price within one-eighth of a percentage point each time somebody wanted to buy a stock.  There wouldn't be any! 

The answer lies in the creation of a new regulatory organization like the SEC (or possibly a subdivision of the SEC) that would specifically regulate the mortgage industry's self-regulatory organizations.  This new agency would enact tough new standards on product suitability, licensing, and ethics.  Once this is done, it will free up the high-quality lenders, brokers and their agents to provide loan services to consumers in a manner that efficiently serves their needs, more specifically - allowing them to get the home they want with a fast loan approval (or denial) at the rate they need.  Throwing meaningless disclosures and paperwork at consumers is not the answer, it only complicates the problem.

Mortgages in Default Increase Sharply in California

According to First American CoreLogic, Inc., 9.5% of California mortgages in May were in default, up sharply from 5.8% in May 2008.  This will ultimately result in more foreclosures, short sales and bank owned properties coming on the market, assuming the Obama Administration allows market forces to work efficiently without the influence of moratoriums or other government pressures.

With the increase in NOD's (Notice of Defaults) and the banks holding back many REO properties from the market, the only place for these properties to go is on the books of the banks in sort of quarantine bay for sick homes to be nursed to health and released back into the wild once they are strong enough to survive.  But we all know that the banks are not in the business of managing properties for long periods of time and growing them to be profitable.  So the question is: What will happen to these properties?

One option is that the banks hold them until the market stabilizes enough to where they can start to steadily unload them onto the market without driving down prices.  When looking at the median home prices in Los Angeles, you might think that some stabilization is taking place on the lower-end, but as Peter Hong points out in his story in the LA Times this morning, the median is rising due mainly to lower priced sales happening on the higher-end of the market.

Although prices have firmed at the low end of the market, they are still falling in affluent communities, the home sales data released by MDA DataQuick on Wednesday show.

The high-end market did not suffer the rapid shock of subprime mortgage defaults and foreclosures that hammered the housing market's lower end. Sales stagnated as wealthier sellers held out for higher prices.

Now, however, some sellers "are realizing the market's not going to just bounce back" and are starting to sell homes for less than they had recently hoped to get, said T.J. Culbertson, a Beverly Hills real estate broker.

That has drawn buyers to the leafy suburbs, looking for deals.

The bottom line is that with record NODs being filed and banks holding properties back from the market, supply is still going to be outweighing demand for the foreseeable future.  Investors that are blindly putting in multiple offers on bank owned properties and short sales may find themselves slightly underwater a year from now, so do your due diligence and be prepared to stick it out for a few years before seeing any return on investment.

Jamie Dimon Throws the High Hard One at Uncle Sam

From Connie Madon at bloggingstocks.com: 

Imagine this:Your bank holds $81 trillion dollars worth of derivatives which is 40% of all the derivatives held by all the banks. Actually this is not a fairy tale. JP Morgan Chase (NYSE: JPM) does own this staggering pile of derivatives. What those derivatives contain in the way to toxic assets is a mystery because all of these transactions are "off the books."

Now enter the government that wants to regulate the derivatives market and force more transparency in reporting transactions, which heretofore have been kept secret. One of the proposals is to have each transaction go through a clearing house so that there would be a visible record of the securities and the players.

As you might well guess, this does not sit well with Jamie Dimon, CEO of JP Morgan. He has started playing hardball with the government saying that since the bank paid back the TARP monies that he should be left alone to wheel his deals like he always has. We must remind Mr. Dimon that it was reckless speculation and leverage in derivatives that brought down our financial system.

Can't we just leave Mr. Dimon alone to work his magic please?

Walking Away From Mortgage is a Strategic Decision for Many Homeowners

There was a report out last week, as reported by Kenneth Harney at the LA Times, that revealed some not-so-surprising information on why people walkout on their mortgage; about 26% see it as a strategic business decision. 

Among the study's sobering findings:

Moral precepts keep large numbers of financially struggling homeowners out of default, but only to a point. Fully 81% of household heads said they believed intentional defaults on mortgages to be "morally wrong." But that high percentage begins to crumble as negative equity grows increasingly larger.

When negative equity rose to $50,000, 7% of those who consider strategic defaults to be immoral said they'd walk away. At $100,000 negative equity, 22% would do so. At negative $200,000, 37% of those with moral objections would nonetheless default, and at $300,000, 38% said they would.

Among those who had no moral reservations, the percentages were much higher. At $50,000 negative equity, 20% said they'd walk away. At negative $100,000, 41% would do so, as would 59% at negative $200,000 and 63% at $300,000.

The researchers found that age, tenure of homeownership, the frequency of foreclosures in a person's ZIP Code and even politics influence an owner's willingness to bail out of a mortgage. Owners under age 35 are less likely to have moral problems with strategic defaults, as are self-described political independents, compared with Republicans and Democrats.

What is surprising in the report is that only 26% see it as a strategic business decision.

Why surprising?  Because once Barney Frank and his crew enabled Fannie Mae to buy loans up to 50% or more DTI (debt to income ratio), and once Mr. Greenspan and his crew looked the other way while Mozilo and the like started writing stated-income, zero-down option ARMs, people began to view their homes as a highly-leveraged speculative investment - and well they should have!  With a 15-20% annualized return and no risk, people were smart to take advantage of the American Dream.  "How can it be wrong if it feels so right?", as William Shatner says. 

photo courtesy of Priceline.com

Is a Short Sale the Answer for Lenny Dykstra?

CNBC reporter, Jane Wells sat down with "Nails" this week at his Sherwood Country Club estate to discuss his recent Chapter 11 bankruptcy filing.  Lenny bought the estate two years ago from "The Great One", Mr. Wayne Gretzky, with a loan financed by Washington Mutual. 

Lenny is not alone in this situation, as many good people got caught on the wrong side of the market when they bought at the height of the bubble.  But when you strap a $17.5 million loan on to your back at the top of the housing bubble, sooner or later you are "gonna need a bigger boat", as Chief Brody says. 

In addition to horribly timing the market on his home purchase, Dykstra is claiming Washington Mutual defrauded him on the mortgage:

He says when he bought Wayne Gretzky's estate two years ago, a broker from Washington Mutual promised him a single $17.5 million loan, but delivered only $12.5 million.

Dykstra says he was urged to go get a second $8 million mortgage, to complete the $17.5 million and allow him to have some extra cash, as the house, Dykstra says, appraised for $25 million.

Dykstra says the broker promised he could refinance both mortgages into one affordable payment after 60 days. But the baseball legend claims the mortgage broker disappeared.

There was no re-fi.

Meantime, he was paying close to $200,000 a month in mortgages, and his income was only $125,000, that money coming from a promissory note he received after selling his car wash business.

Unable to continue paying more than he was making, Dykstra says he was forced to sell the promissory note back to the owners of the car wash to pay off the second mortgage. That erased his nest egg, he says.

Dykstra refused to talk about Index Investors, which, as we reported yesterday, is the company actually moving to foreclose on his mansion, saying Dykstra owes $910,000. Dykstra is suing Index and its owner, Jeff Smith, for violating state usury laws, among other claims.

As was typical on these super jumbo loans at the time, the loan was split up into two loans:  The first loan would typically be sold off to an investor that was comfortable with the investment up to a certain loan to value ratio.  The second loan, or line of credit may have been done by the lender on the first loan or by another party.

Though many people will look at this situation and think that Lenny is grasping at straws in claiming mortgage fraud, I would not make that assumption immediately.  Back in the go-go days of stated income stated asset (SISA) loans, I would constantly hear stories from clients about the irresponsible verbal assurances some loan officers at these blue chip firms were making, just so they could close the deal and make the commission. 

In this situation, I would give Lenny the benefit of the doubt for this reason:  These banks were spending hundreds of millions of dollars on building brands that stood for trust and integrity.  While they were spending record amounts on advertising, they were making so much money on loans that they had to recruit more and more loan officers to service the demand.  Cubes were at full capacity.  Suffice it to say that shady loan officers were not just working for small independent brokers back in 2006 and 2007.

If the lawsuit doesn't work out for Lenny, completing a short sale - which has what appears to be three separate liens - would be like hitting a lead off home run in the World Series at Fenway Park (Lenny did this while playing for the Mets in the 1986 World Series against the Red Sox).  I wouldn't give up on "Nails" just yet.

Its Always Cloudy in Sun Valley

At investment bank Allen & Company's annual Sun Valley retreat, Rupert Murdoch sounded off on his feelings about the economy and where its headed after he spoke with some Silicon Valley and Wall Street insiders:

"I'm shocked at the business mood, which is talking about either that we're at the bottom or going lower," News Corp. Chairman and Chief Executive Rupert Murdoch said in an interview he gave during the conference to his Fox Business Network. He had just emerged from spending a morning with the most powerful people from Wall Street, Silicon Valley and Hollywood. What was the word from inside?  "It's going to take years and years, like five years at least before we see any real growth coming out of this," Murdoch said.

Its refreshing to get an insider's point of view from a scrappy billionaire like Mr. Murdoch.  Anybody listening over at the NAR?

Obama Calls for Loan Servicers to Beat the Dead Horse Harder

According to a report this morning by Ruth Simon at the WSJ, The Obama administration is urging loan servicers to up the ante on their loan modification efforts.  Treasury Secretary Geithner and HUD Secretary Donovan sent a letter out to 25 loan servicers urging them to "devote substantially more resources to this program".

More than 270,000 borrowers have received modification offers under the program.  But housing counselors complain many borrowers are waiting for help as mortgage-servicing companies get up to speed. The administration has said its program could help as many as four million homeowners.

The administration has "started to see a significant ramp-up" in modification activity, the letter said. But it added, "there appears to be substantial variation among servicers in performance and borrower experience." It called on mortgage-servicing companies to beef up staffing and training, and to provide "an escalation path for borrowers dissatisfied with the service they have received."  Freddie Mac, which serves as compliance agent for the program, will be developing a "second look" process in which it will audit a sample of rejected modification applications, the letter said.

This letter demonstrates the Keynesian mindset of the Obama administration in trying to deal with the so called "crisis" in the housing market.  The housing market is not in crisis.  The housing market is in perfect form as it cold-heartedly deleverages itself after 5 years of greed and risk-free speculation.  If this is a crisis, then the government should be setting up shelters for people that bought a home with no money down and claimed they made $20K a month as a "food services advisor".  Instead, they are enabling them to continue to live a life of making bad decisions with no consequences.

Sending warning letters to loan servicers won't fix the problem, it will only extend the problem and ensure a steady supply of short sales and bank-owned homes for a few more years.  The problem is that people are living in homes that they can't afford, even if their loans are modified to 0%. 

In order to fix the problem, we need to have government step out of the way and let the free market go to work to clear the inventory.  Yes, people will lose their homes.  Yes, there will be more pain.  But ultimately, it will be better for all Americans as the economy will recover faster and the people that lost their homes will have jobs to save up for a down payment on a home they can afford.

Are Banks Being Realistically Valued?

Cyrus Sanati wrote an article in The New York Times Deal Book this morning that some on Wall Street that are suggesting that TARP is masking some serious financial problems within some of the country's largest banks.  Daniel Alpert of Westwood Capital is quoted in the article:

The big concern for Mr. Alpert is that the banks are not being realistic in their valuation of those whole loans, and that all the government cash is masking the banks’ vulnerability to deteriorating loan values.

“The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,” Mr. Alpert said in his note. Later, he added: “It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.”

Consider the example of a person who bought a house in Phoenix in 2007 with a $400,000 mortgage from a bank. By 2009, the market value of the home may have fallen to $200,000. Instead of repaying a mortgage worth twice the house, the homeowner defaults on the loan and mails the keys back to the bank.

Up until the point the bank forecloses on the house, the bank can carry that whole loan on its books at $400,000. When the bank finally sells the house for, say, $180,000, then it will record the loss.

The net effect of the TARP money is that banks are holding back properties that would normally be on the market, either as a short sale or a foreclosure, were it not for the government trying to "fix" the problem.  Honestly, if you were a board member of one of these banks with a multi-billion dollar market cap it would seem logical to think that the share price will stay higher if you can just hold on to these loans until the market stabilizes or the Treasury buys the toxic assets from you at a higher value.  You would not want to take the write down at this point since you have the TARP money to cover up the real value of these loans.

Let's let the market decide the fate of these banks, not the bureaucrats in Washington.