Archive for July, 2010
In a really good mystery, the author can spin a set of circumstances to look like one thing has happened, and then unravel them to reveal a completely different — but equally plausible — sequence of events. I find myself asking if that’s what’s going on in the current mortgage-delinquency market.
Simply put, there are two disturbing trends — the number of mortgages that are entering the phase known as delinquency is rising, and the amount of those mortgages is rising. That is, a greater number of owners in more-expensive homes are falling behind on their payments.
Just for context, let me walk you through the process. A mortgage becomes delinquent when the owners are 30 days late with a payment. At this point, the lender traditionally sends a notice of delinquency. From this point forward, which is required under law if it wants to proceed with the foreclosure process, the lender files a notice of default. This notice must be served to the owners or posted on the property, and informs the owners that they have 90 days to make up all past-due payments and late fees to stop the process.
After this 90 day period, they have just 30 days to pay the entire loan balance in full, plus charges, penalties, and anything else the lender can legally throw in. If you’re keeping track, we’re up to five months here.
At the height of the housing crisis, lenders were so bogged down in defaults and foreclosures that it could be months before some owners received a notice of default. They could live in the house for a year or more without making payments.
Back to the explanation of what’s happening. One possibility is that wealthier people with more-expensive houses had more resources to fall back on. Those who were hit first may have been reaching to get into the housing market, and over-extended themselves. Wealthier people who were laid off from high-paying jobs still had home-equity lines, credit cards, stocks (though not as valuable as they once had been) to see them through. But the economy isn’t improving fast enough. These people may have been expecting that new job to come through, but it hasn’t, and now they’ve burned through those resources. They are now facing the same kind of stomach-churning fear that poorer people have been feeling. Hence, an increase in delinquencies for high-end properties.
Or is there a different explanation? It’s also possible that the lenders finally worked through their backlog and started the potentially four to five-month-long process earlier? Do they finally have the resources to start sending notices of delinquency and default earlier? It’s a mystery.
Either way, I find myself torn. This rising delinquency rate is bad for homeowners, but good for DBNR. When we started this business a year ago, most of what was on the market was substandard. We originally bought 33 houses for an average of $6,200 each. Now, we’re beginning to see more high-end property worth significantly more. That gives us a bigger pool of potential buyers, people looking for bargains in nicer neighborhoods. That’s capitalism — a system designed to help those with capital, as well as healthy chunks of luck and patience. But as a devotee of idealism as well as capitalism, I still feel for those caught up in these difficult times.
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When the housing crisis first hit, there was a chain reaction not unlike an actual train wreck. As foreclosures mounted, clogging up the tracks of lenders, homeowners in search of loan modifications started rolling in, hoping to avoid the debris up ahead but still piling up behind it. The homeowners’ requests were in many ways legitimate — they wanted to reduce the terms of their mortgage so that they would be less likely to become part of the overall wreckage.
I don’t want to express too much sympathy for banks, but they were completely unprepared for this. The same departments that traditionally handled foreclosures also handled loan mitigation, as loan modification is called in the industry. Load modification requires similar documents that an original loan does, such as income statements and credit statements, but also hardship letters. Homeowners would send these documents in, and they would disappear into a black hole. Three months later, they’d get a request that all the documents be resubmitted.
A catch-22 popped up in that, if homeowners lost their jobs in the meantime, they were no longer eligible for modification. Think about it — the people who needed it most were disqualified.
The situation got worse. As usually happens in such a crisis, third-party intermediaries step in and offer to guide dazed and confused homeowners through the process — for a fee. Now, some of these companies were legitimate. But as it happened, they were no more successful at navigating the rubble of the lenders’ loss mitigation departments than the homeowners were. Frequently, they just gave up — after they collected their fees, of course.
The situation has improved somewhat now, I’m happy to note. California has instituted some rather stringent guidelines regarding these loan modification agencies. The agency must be licensed by the California Department of Real Estate. It must comply with an 11-point checklist of items that must be taken care of before the agency is paid. Even better, the federal government is beginning to exert pressure on mortgage lenders regarding modification under the guise of consumer protection issues. To motivate the lenders, the federal government may allow the lenders to recover some of any losses attributable to the load modification. The government is also postponing for a year or two taxes that homeowners may owe as a result of obtaining debt relief.
We’ve recently come across a company called I’m Not Leaving, which has developed software that calculates figures showing bank officers how much they will benefit from load modification based on the Obama administrations’ tax credits. By doing a lot of the lenders’ own homework, it gets the process moving more quickly. According to I’m Not Leaving, it can generate a 97% approvable situation inside of 48 hours. You know what your costs are going to be before you sign a contract, and you don’t pay until the load modification goes through.
That’s what I call light at the end of the tunnel.
It’s never a good idea for someone in business to talk politics. But as I think about what’s going wrong with our mortgage system, it seems hard to avoid. I don’t mean to imply that banks and other financial services firms don’t deserve some of the blame for the housing crash. There’s really enough blame to go around. The federal government may not have been involved at the beginning, but it’s involved now.
Take Freddie Mac and Fannie Mae. According to Investopedia, they are government-sponsored enterprises. GSEs are defined as privately held corporations with public purposes created by the U.S. Congress to reduce the cost of capital for certain borrowing sectors of the economy. But in September of 2008, the federal government took over Freddie Mac and Fannie Mae, which together accounted for 50% of the mortgages in existence.
The other 50% of mortgages are done by financial institutions who create mortgage-backed security pools. These institutions fund the mortgages on credit lines, and then pool them together on the secondary mortgage market, where pension funds and insurance companies buy them. These are some of the mortgage-backed securities that went south early on, trigging the downturn. The federal government is now trying to create new rules to govern these securities, so they will basically have their fingerprints all over most of the mortgages written in the U.S.
What concerns me is that when government gets involved, the engines of commerce tend to slow down. If the U.S. economy is going to generate a recovery, housing is going to be a key part of it. When people buy homes, it triggers a multiplier effect. They remodel. They paint. They buy new furniture. They throw housewarming parties.
Approximately 90% of the population is still working, but the housing market is still in the doldrums. We could already be in a spiral that will decrease the value of housing. In the rest of the world, the mortgage business is already quite different than in the U.S. It has higher interest rates, shorter term mortgages, bigger down payments … and less expensive housing.
Americans believe that owning a home is one of their sacred rights. The public may have to face that fact that that may be changing. If there is a transition going on in which the percentage of homeowners in the U.S. decreases, it will increase the number of renters and increase the number of investment properties. But those properties may not be as profitable as they have been, so that will make them less desirable.
I don’t have the solution to this problem but I do believe the government is going to have to start extricating itself from the mortgage business — it’s simply not its core competency. And the private sector is going to have to figure out a way to step in and take over.
Last week we pontificated about the economy, and the mixed messages it’s sending. The topic is still on our minds this week, because there’s no end of conflicting signals.
Item: San Francisco Chronicle business columnist Kathleen Pender noted on July 1st that investors were turning to both gold and bonds, a confluence she’d never seen before.
Item: Interest rates are at historic lows, but according to my colleagues in that segment, there has not been a corresponding increase in mortgage inquiries. For my entire career in mortgage lending, when interest rates went down, the phones would ring like crazy.
Item: The stock market fell below 10,000 again, amid worries that the recession is going to be shaped like a W rather than a V. Unemployment remains high, so consumers are hanging onto their money.
I’m no more prescient than other investors. I see conflicting issues everywhere as well. On the one hand, I see the U.S. moving from a manufacturing economy to one based on technology. The latter not only needs fewer workers, but it can just as easily be replicated overseas with cheaper labor. Even if you factor in our superior intellectual property laws and transaction protections, that kind of paradigm shift always causes problems.
But on the other hand, I’ve also been talking to colleagues who are working with private hedge funds who need to invest somewhere in the neighborhood of $41 billion in order to fulfill their business plans. They want to get in, get out, and count their profits. It’s hard to do that these days (although my sense is that you could buy most of downtown San Francisco for $41 billion right about now).
That may be our current economic dilemma in a nutshell: People with money won’t do anything. People without money can’t do anything. We don’t have answers and we don’t know where to look for them.
I still believe the answer has to start with the housing market. I believe that low interest rates are going to do their part to entice buyers back in, and that may help trigger perhaps just the small avalanche necessary to get us rolling again. In the meantime, something I’m now considering is do we have a business un-friendly administration in power?
Economists like to use the term elasticity to refer to price sensitivity, but it’s equally appropriate now because the economy seems to be expanding and contracting like a rubber band held between a nervous child’s fingers.
Item: On June 16th, the U.S. Department of Housing and Urban Development announced that privately-owned housing starts in May were at a seasonally adjusted annual rate of 593,000, below April but above May of 2009.
Item: On June 23rd, the U.S. Department of Housing and Urban Development announced that sales of new single-family houses in May 2010 were at a seasonally adjusted annual rate of 300,000, below April and below May 2009.
Item: On June 16th, BusinessWeek said that economists polled by Thomson Reuters expected the Conference Board’s index of leading economic indicators would fall 0.5 percent in May; it had slipped 0.1 percent in April, the first decline since March 2009.
Item: The following day, the Conference Board announced that its index of leading economic indicators had actually risen 0.4% in May, following no growth in April.
Item: On Monday of this week, CNBC reported that that day’s stock market drop came from concerns about consumer spending, which supplies some 70% of the country’s GDP.
Interest rates are at historic lows. And the latest jobs report isn’t due until Friday. No wonder everyone’s confused about the economy.
This makes me wonder if all this confusion will pass, or are we heading into a time when uncertainty is normal?
I of course look at the economy through the lens of housing. Mortgage underwriting guidelines have undergone tremendous changes thanks to regulatory intervention. Lenders are interpreting the guidelines to protect themselves from violating the new rules. But at the same time, they’re trying to find a way in those guidelines that lets them generate profitability. The government is trying to protect consumers, and the lenders are trying to protect themselves from a recurrence of what we’ve all been through.
The problem is that the economy and the housing market are inextricably linked. When I was in real estate financing, we used to say that the sale of a piece of property pays the salary of some 10,000 people, once the transaction closes. It’s no wonder that consumer spending is dropping — what’s the most logical time to buy new furniture, appliances, and electronics but when you move into a new house?
If this isn’t the “new normal,” then what will trigger a shift back to the familiar? I believe it will be the result of American ingenuity and innovation. It’ll come from the private sector and investors who have no other place to put their money. When the adjustable rate mortgage was invented in the late 1970s, it was in response to astronomically high interest rates. It was a godsend, and nobody questioned the impact. It was an opportunity to sell something.
As we get accustomed to these circumstances, and as distressed properties dissipate and get assimilated back in the mainstream, we will begin to see changes in the way people finance houses. The changes will be small at first, but more and more people will begin to get financing, and they’ll do it in creative ways that don’t look like anything we have now. I’m voting that the confusion will pass.