So Cal Real Estate News

I’ve been going back on forth on the bailout bill since it was introduced, but I just finished a phone call that’s got me jumping onto the pro-bailout bandwagon.

I just got off the phone with an efficient but polite collections representative folks at legendary sub-prime EMC Mortgage. We were discussing a “short sale,” which is anything but short. Basically, it’s the sale of an “upside down” (over encumbered) property where the lender takes a reduced or “short” payoff to enable the sale. The seller is a client of ours, and reflecting on her situation gave me a renewed desire to see at least the core parts of the bill passed.

This borrower is now upside down due to both market declines and negative amortization. A change in her family situation has created major challenges, and there’s no way she’ll be able to make her payment once massive scheduled payment reset kick in down the road.

When she first called me a few months back, I referred her to “Trouble making your mortgage payment? 7 ways to get back on track.” I suggested she review that post, then contact her lender to try to work out a waiver of the negative amortization and reduction of her interest rate. After about two months, EMC told her they weren’t interested.

It seemed like EMC was just too busy dealing with people whose loans had already reset. They didn’t want to deal with borrowers whose reset is still months away. They basically told her they’d talk to her then, but she felt that if they wouldn’t make a commitment to reduce the principal balance and interest rate now, she’d be better off biting the bullet sooner than later.

That’s when we started on the short sale. Despite another short sale listing across the street and a new REO listing a few houses away, we now have a buyer in escrow and are awaiting approval from EMC Mortgage’s loss mitigation department.

Were the Mortgage Relief Bill already in place, I’m pretty sure the owner would have been able to keep her home, we’d have one less listing in a saturated market, and EMC’s loss would be lessened, and the home owner’s equity increased. Pretty much a “win” all the way around.

Under the provisions of the Mortgage Relief Bill, as I understand them, if EMC accepted a write-down of the loan to 97% of current market value, FHA would insure a refinance with at least 3% equity if the borrower actually qualified, which I’m pretty sure would be the case in this situation.

Some people oppose the “bailout” bill because they feel like it rewards greedy lenders and imprudent borrowers. In this case, however, the lender would still have to write down at least $100,000. The homeowner, a hard-working, honest first-time buyer who trusted her lender too much, has lost her original equity and has certainly learned from her mistake.

However, the bigger issue isn’t helping undeserving borrowers & homeowners, but cutting back on the oncoming wave of foreclosures to help our economy by stabilizing home prices and keeping more banks solvent.

Some have suggested that private initiatives could do the same. They might to some extent, but they sure haven’t helped any of the upside down sellers I’ve worked with so far. The truth is, the bailout bill itself is significantly limited in how many homeowners it would help.

From where I sit, on the front lines of the market crash, it sure looks like it will take both private and government assistance to get us out of this hole, or at least keep us falling into one unseen since the Great Depression.

The increase in sales indicates prices have fallen to a reasonably affordable level. But the oncoming wave of foreclosures is apt to drive prices even lower, resulting in even more foreclosures and a spiral downward only compounded by energy, interest, inflation, and manufacturing woes.

We’re all in the same boat, & I’m not in favor of letting it sink just because someone else kicked a hole in the bottom. Sometimes even the “innocent” have to help bail out the boat! Private and government initiatives alike.

I’m not in favor of bailing out anyone who can’t qualify for the new loan. No more “liar loans,” please! If I understand this bailout bill correctly, the FHA would only loan to homeowners who could qualify.

In this specific case, what my seller was trying to negotiate with EMC was similar to what the bailout’s proposing. I’m sure she’d make it work if her principal balance was down to 3% below market instead of $100,000 over market and if she had a fixed FHA loan at say 6.25% instead of an adjustable about to adjust to 13%.

There’s plenty not to like about the govt. bail out, but the basic concept of the lender writing the loan down to a little below market value in return for FHA rewriting the loan if the buyer qualifies should reduce the foreclosure onslaught somewhat. I think the Senate tends to produce better law then the House, and they did some significant changes from Barney Frank’s original bill. They got more of it right than I expected.

We’ve seen a price correction around 25%, which is enough to bring buyers back even in such a negative environment. If it weren’t for all the additional REOs in the pipeline we’d probably be nearing a price bottom, based on current activity.

But the decline of an additional 25% that some people are predicting due to the REO problem would trigger a whole new round of foreclosures–a downward spiral of doom that could be worse than the Great Depression. That would cost FHA and taxpayers more than reducing the flood by guaranteeing some loans to stem the tide somewhat.

To me, it looks like a “pay me now, or pay me later” sort of thing, regardless of whose fault it is.  And there’s plenty of blame to go around, believe me! (see “How we got into this mess“)

In 35 years of tracking the Southern California real estate market, I’ve never seen anything remotely like the mess we’re in right now. . . but the basic causes are as old as humanity.

Greed, stupidity, and a lack of integrity got us into this mess. But we’re not talking your average, run-of-the-mill greed or stupidity. We’re talking greed and stupidity on a scale unseen since. . . the late 1920s?

Like the rest of our blog, this isn’t the researched opinion of some economist in New York, but the personal perspective of an agent who watched this whole mess unfold from the So Cal real estate trenches.

We could start all the way back with Moses, who laid down some pretty straightforward rules that would have avoided the whole mess (See “Moses’ 10 Rules for Success“) But for time’s sake we’ll start where the last boom went bust back in 1991, which eventually led to another boom, . . .

A Boom that Lasted Way too Long

We’d just finished another furious run-up in prices, fueled by multiple offers and overbidding after a rough downturn (sound familiar?) Then the end of the Cold War led to massive layoffs in our So Cal defense industries, which rippled into the construction business and then through the whole economy.

If you’re over 30, you probably remember the stories of all the U-Haul trucks leaving the state as homeowners and renters followed the jobs across the country. 1991 - 95 were four dramatic years of price and sales declines, a classic overcorrection fed by a massive local recession. In the real estate business, the cry was “stay alive ’til ‘95!” A few of us did. Barely.

In 1995 prices and sales finally started moving upwards again. By September 10, 2001, it looked like we were peaking & due for another correction. Things changed the next day.

Alan Greenspan took action to avert a post-9/11 depression, dramatically lowering short term rates. The long term bond markets, sensing a recession, cooperated & long term rates dropped too. Then the Fed dropped rates again. And again. And again. The real estate market cooperated & just kept moving up. And up. And up.

Late in 2002 Greenspan figured out things had gone too far, and belatedly began raising short-term rates. The long term bond markets, sensing that would cause a recession, failed to cooperate, and kept long-term rates low. Even lowered them a bit. Greenspan suddenly discovered the brakes on his economic sports car weren’t working!

So a correction that should have started in 2001 was put off even more. Eventually the brakes kicked in and real estate started slowing. Prices actually started dropping in the summer of 2004.

But then, for some unknown reason, prices began moving up dramatically in the spring of 2005. Every local economist except for Gary Watts was confounded. Cal State Fullerton’s annual negative Economics Forecast was beginning to look like a broken clock. (Just like a broken clock, it would eventually be right.) And more and more people forgot all about economic cycles and started believing that So Cal real estate really does only go up.

Insane New Mortgage Products

The unknown reason, it turned out, had a lot to do with creative new mortgage products. Creativity can be good, but creativity fueled by greed and aided by stupidity can–and did–create a monster.

Here are some of the parts that went into that monster:

No down: It used to be the only way to get 100% financing was to join the Armed Services or buy Robert Allen’s book, Nothing Down. Then someone figured out that a 13% mortgage for 20% of a home’s value could be “piggybacked” onto a more normal 80% mortgage to allow financing for a purchase with no down payment.

No mortgage insurance: These “piggyback” loans avoided loan review by those darned underwriters at the Private Mortgage Insurance companies by charging a higher interest rate and “self insuring.” But those PMI companies were the ones who kept everybody honest, because they were on the line if the loan went bad.
No documentation: It used to be you had to document your income to get a loan. If you were self employed, that meant tax returns. Which didn’t always tell the full story. So World Savings (I so miss all the old So Cal based S & Ls!!!!) (Pause for a moment of silence for World, Great Western, Cal Fed, Glendale Fed, Home Savings, & any others I forgot. If your old enough, picture those GW commercials with a cowboy riding past El Capitan as John Wayne intoned, “We’ll always be there.”)

Sob. OK, as I was saying, World Savings decided to allow self-employed borrowers with good credit scores and verifiable 20% down payments to get mortgages without documenting their income. “No doc” loans.

Lousy credit’s OK: Well, before you knew it, So Cal mortgage brokers like New Century and Argent were combining “no doc” loans with no down “piggybacks.” Then they decided you didn’t even need good credit scores if you would take a high enough interest rate, which won’t kick in for a year or two. All this after the market should have peaked.

Greedy rookie agents & brokers: At the same time two more trends appeared. The money was so good, everybody and her gardener went out and got a real estate license, which is way easier than getting a beautician’s license. (Some of them even got a broker’s license, because our beloved, “Blow Up the Boxes” governor vetoed a law that would have required real estate brokers to have two years experience as salespeople before getting a license.)

Disclosure about rookies: I don’t hate rookies. I was one once. Long ago, in a galaxy far away. . . .

Both new and experienced agents can be unethical and incompetent. But time does tend to weed out a lot of the worst agents. In a normal market, up to 90% of the newbies are out of the business within two years. In a booming market, they tend to hang around longer. And anyone who got into the business after 1995 did not experience the last big downturn. Some of them actually believed that “real estate never goes down.”

Agent/lenders: Lots of these brand new, do-anything-for-a-buck agents & brokers decided to double their money by acting as their buyers’ Realtor and mortgage broker. So the buyer didn’t have a Realtor looking over the lender’s shoulder, because the agent was the lender.

Bribes for selling bad loans: Interest rates were still low, and lots of people were excited to earn as much as 13% interest on these new “mortgage backed securites.” The investment banks like Bear Stearns that bundled and resold them couldn’t get enough of them. So they started giving bonuses to the brokers and agents for putting their clients into these loans–the higher the rate, the bigger the bonus. My boss says these Wall Street firms were the “pimps” of the whole operation.

Low “teaser” interest rates: Of course, those loans were advertised with their initial “teaser” rates as low as 1.9%. And the ad usually proclaimed “payment fixed for 3 years!” And nobody tried to undo the intended deception that confused fixed payments with fixed rates.

Ineffective or nonexistent disclosures: Of course, all this nonsense–even the negative amortization–was “clearly” explained someplace on the dozens of documents the buyer signed at closing. Whether the buyer spoke English or not. Oh, did I mention that it turns out that these newly minted agents often took the liberty of signing for their clients?

A culture of dishonesty. Unfortunately, lying is pretty much accepted as part of the business by many agents, lenders, sellers, and buyers. Actually, by our society as a whole. Nothing wrong with lying, as long as you don’t get caught, and the “good guys” don’t get hurt. Buyers lie to the lender about their income. Agents lie to the buyers about prices going up forever. Lenders lie to the buyers about the effects of the loan–or at least they neglect to tell the buyer. Investment buyers lie to their investors about the quality of the mortgage-backed security.

Actually, Moses told us not to do this. Over 3,000 years ago he laid down ten simple, straightforward rules for successful living. One of them was, “Don’t lie.” Of course, we’re such a smart, tolerant society that we stopped teaching that rule in public schools over 40 years ago. Too bad. A few moral absolutes would have prevented all this. Moses told us so.

Naive, trusting, desperate buyers: Not necessarily stupid, but unsophisticated. I think of Steve, an independent contractor for JPL who bought near the peak using 100%, no doc financing. We recently completed a “short sale” for him, where his lender absorbed a loss of over $100,000 so we could close the escrow. He simply couldn’t make the payments, which turned out to be $1,000 a month more than his lender/agent promised when he bought the home. “We just trusted her,” he told us.

Government Incompetance: Gee–who’da thunk! From Democrats who over-regulate to Republicans who under-regulate, to a Federal Reserve that drives the economy like my mom drove her car (slam on the accelerator–slam on the brake–slam on the accelerator. . .) nobody in D.C. seemed to be able to get anything right. For some excellent examples, check out SeekingAlfalfa’s excellent comment #1 below.

Let’s review: No down, no verification of income, bad credit, overvalued market, insane belief that real estate will never go down, desperate, naive buyers, brand new agents who got into it for the money acting as Realtor and lender both–and getting bonuses based on how bad the loan was for the borrower, non-English speaking buyers signing disclosure documents in English, everybody thinking it was OK to lie, incompetent government . . .

As my colleague and fellow Realtor Anthony Turner put it, “Any homeless bum could get a loan and buy a house.” And why wouldn’t he–especially if his 22-year-old Realtor cousin knew she’d make up to $20,000 if she sold him a loan & a home? Anybody see any problems with all this??

The Profitability of (Willful?) Ignorance

Jim T., a friend who’s been in the business even longer than me, did. At the time he was a wholesale rep for one of the big lenders. He tells me of pointing all this our to a rich young V.P. in his firm, who had no memory of the 1990’s crash because he was in 3rd grade then. “Relax, Jim,” Mr. V.P. said, “nobody’s ever lost a penny on any of these loans.”

He was right. Then. Because prices were going up faster than the negative amortization, so the houses were either sold for a profit or refinanced.

The biggest pyramid scheme since Social Security. another sad story that’s will eventually to unwind. (The N.Y. Times had an interesting page last year about mortgage backed securities, “Housing Busts and Hedge Fund Meltdowns: A Spectator’s Guide.”)

As long as everybody was making money, everybody had a financial incentive to be stupid. And ignorant.

And everybody in the food change was making money. The flipper or refinancing buyer. The real estate & mortgage salesperson(s). The real estate and mortgage brokers, who were supposed to supervise & train the salespersons. The loan underwriters. The Wall Street Bankers who packaged & sold the loans. Everyone who bought the 13% loans, from Deutschebank to little old ladies. Even the politicians, who bragged about the great increases in home ownership.

Conclusion

Greed, stupidity and dishonesty. A lethal combination. And, unfortunately, a natural product of our materialistic, me-first, live-for-today mentality.

There is a cure. Unfortunately, it’s often ignored. Even those who pay tribute to it often don’t practice it. (warning: the next paragraph could be construed as “religious”–feel free to skip it if you wish.)

Jesus expressed it as well as anyone: “Do unto others what you would have them do unto you.” “Love your neighbor as yourself.” Just treat others the way you’d want to be treated.

This is actually a real estate concept as well: The agent is supposed to be a fiduciary. That means she is to put the client’s interest above her own.

A little Golden Rule or fiduciary-mindedness at any step of the food chain might have kept us out of this mess. But right now we’re right in the middle of it.

For our thoughts on what’s ahead, check out our latest projections post, So Cal home price bottom near? as well as  what you might want to do about it.)

And, next time somebody wants ahead of you on the freeway, wave them in. Put them before your own needs. One small gesture for a man. One giant leap for mankind.