Foreclosure Crisis Unveiled: Subprime isn’t the real story
Real Estate News & Commentary by Chris McLaughlin, July 3, 2009
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New insight into the foreclosure crisis
According to Stan Liebowitz, professor of economics at the University of Texas, popular explanations such as sub-prime lending and rise in unemployment and interest rates do not adequately explain the high rise in foreclosures since 2007. Liebowitz’s study of foreclosure data, pertaining to the period after the third quarter of 2006 when foreclosures started rising significantly, shows that 51% of all foreclosed homes had prime loans, not subprime. In addition, the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures. In today’s Wall Street Journal, Liebowitz says negative equity — the balance of the mortgage being greater than the value of the house — is the single most important factor driving foreclosures. While one may argue that negative equity does not mean a loss of homeowners’ ability to pay their mortgage, it does point to the possibility that homeowners may be more willing to walk away from their mortgages. Liebowitz argues that methods behind the government’s $2 trillion package for stabilizing house prices are poorly targeted. Liebowitz highlights the importance of underwriting standards, including a requirement of high down payments in mortgages. High down payments would have limited the growth of the housing bubble and the impact of negative equity would have been much smaller when home prices fell. If homeowners have positive equity, they would have lesser incentive to default on mortgages and the lenders’ salvage value, in the event of a default, would be much higher. Liebowitz exhorts politicians to “face up to the actual causes of the mortgage crisis, not fictitious causes that fit political agendas and election strategies.”
Mortgage rates fall; will they stay low?
According to Freddie Mac, rates for 30-year fixed home loan dropped this week to an average of 5.32% from an average of 5.42% last week. The rate was 6.35% this time last year. Rates on 30-year mortgage rose from a low of 4.78% earlier this year to 5.6% in June on account of rising yields on government securities. Analysts were worried about the rising mortgage rates hampering the recovery of the housing market. Yields on government securities have dropped in the recent past, leading to a drop in mortgage rates. “Lower mortgage rates are helping to support the housing market,” said Frank Nothaft, Freddie Mac’s chief economist. The average rate on a 15-year fixed-rate mortgage dropped to 4.77%, down from 4.87% last week, while rates on five-year, adjustable-rate mortgages averaged 4.88%, down from 4.99% last week. These rates do not include add-on fees.
Lies, damned lies, and statistics
Data drives everything in our economy. The government makes important decisions on the basis of data. But what if the data is incorrect? Robert Kleinhenz, Deputy Chief Economist for the California Association of Realtors (CAR), has said in an interview that the California home sales data for the current year had mistakes. Home sales data pertaining to San Diego county was incorrect on account of a computer error. The CAR had previously reported a 63% increase in April’s San Diego home sales from a year earlier and an 89% increase in May from a year earlier. Thomas Lawler, an independent economist, said last week the numbers reported by the CAR vastly exceeded those reported by other agencies. The CAR has now revised the gain in April to 20% and the gain in May to 6.5%. The mistake is confined to just San Diego data and the state-level data will not be impacted significantly by the downward revision. “It’s going to reduce the statewide number by a couple percentage points, but it’s not going to make a huge difference in the statewide,” said. Kleinhenz.
Seven more banks fail, taking the total to 52 this year
Six banks in Illinois and one in Texas, with total assets of $1.49 billion and deposits of $1.34 billion, were closed by regulators this week. Buyers have been identified for all the closed institutions. The failures will cost the insurance fund of the Federal Deposit Insurance Corporation (FDIC) a sum of $314.3 million. “The six failed Illinois banks are all controlled by one family and followed a similar business model that created concentrated exposure in each institution,” the FDIC said. All the failed banks had significant exposure to the real-estate sector. “The common denominator for most of the bank failures so far has been troubled construction loans,” said Matthew Anderson of Foresight Analytics. “There’s no easy way out with defaulted construction loans in today’s environment.” The number of failed banks this year has risen to 52, the most in a year since 1992. With the economy not showing any signs of sustained recovery, the FDIC’s insurance fund is likely to take more hits in the months to come.
Private equity players unhappy with takeover rules proposed by the FDIC
The Federal Deposit Insurance Corporation (FDIC) has proposed rules which would require firms buying out banks to put in more capital at risk. According to the FDIC’s “source of strength” rule, a bank’s owner should be a source of strength “for their subsidiary depository institutions.” The rule will force private equity firms interested in acquiring or investing in the assets and liabilities of failed banks to stay invested in the bank for at least three years and be capitalized at a Tier 1 leverage ratio of 15%. The FDIC believes that the new rule will prevent the acquired banks from being “flipped” for a short-term gain. The new rules are subject to a 30-day comment period. Not everyone inside the FDIC is convinced about the usefulness of the proposed rules. John Bowman, a member of the FDIC’s board, said the new rule could “choke off capital.” Douglas Lowenstein, president of the Private Equity Council, an industry group, said: “The FDIC’s proposed guidance would deter future private investments in banks that need fresh capital.”
Now on to our real estate investor education section…
The Fear Factor – Fight, Flight or…. Faint?
You have heard it a million times before; buy low and sell high. It sounds simple enough so why do so few people fail to heed this common sense approach to investing? Plain and simple – it’s the fear factor. Successful short sale investors have learned how to proactively invest with their intellect rather than react from an emotional response. Fortunately, once you realize how fear is responsible for the majority of short sale investing mistakes it’s easy to take action and get your investments back on track.
How do you respond to fear and uncertainty?
Fight. Some people are naturally motivated through fear. It provides just the right level of encouragement to get them moving and keep them alert to the potential opportunity afforded by short sales. No matter how bad the market has treated them they realize the need to not go down without a fight and fight they do. These are the people that take inventory, weigh the risk and reward then get busy informing themselves and working the program to begin rebuilding wealth.
Flight. These people are energized all right but they are unable to properly channel that energy into productive results. This is one of the worst situations to be in because it consumes all your time, energy and extra income while leaving you very little to show for it. Sadly, the majority of most self-proclaimed “investors” fall into this category – they believe the activity level makes them an investor…it doesn’t. The proof is in the PROFIT. Don’t trade a lot of activity for actual results – instead, go with a proven system that generates real returns.
Remember, your time and energy as well as hard earned dollars should show a very real profit. It’s okay to begin slow and learn as you go – but learn how to measure the results.
Faint. The fight or flight response is well known in nature but there is one other response less commonly mentioned…the tendency to faint. Have you ever met a person confronted with a perceived threat or something like blood that simply melts away rather than run or turn and confront the problem? Some investors are the same; they become immobilized by fear. Doubt, confusion and outright anxiety over-ride their normal senses. Without a clear plan of action they fall prey to unethical schemes or simply give-up on their hopes and dreams for the future…their own and often that of their family.
Recognize your tendency then take steps to restore your financial future with the help of a short sales system that has been proven to work. Get involved with others able to provide the information and tips you need to succeed until you have a proven track record of success under your belt. It’s one of the best reasons short sales remain such a popular investment vehicle; you can start at whatever level your tolerance for risk, level of energy and assets allow. There is literally something for everyone.
See you at the top!
Chris McLaughlin
http://www.shortsalesriches.com
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About the author:
Chris McLaughlin is widely known as America’s top
Real Estate Attorney and Investment Consultant.
* As the top Florida foreclosure and pre-
foreclosure expert, he oversees more than
100 short sale & REO closings each month
* Long-time authority on real estate investing
and rapid reselling of distressed homes. Owns
portfolio of nearly 100 high-value, high-profit
properties
* Owner of one of Florida’s largest Real Estate firms,
running 4 different offices, supporting nearly
450 agents, uniquely positioning him to help
thousands of investors make money in the
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* Highly sought-after speaker, consultant, and
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According to the National Association of Realtors, its Pending Home Sales Index, a forward-looking indicator based on contracts signed in May, rose 0.1% to 90.7 from a reading of 90.6 in April, and is 6.7% higher than May 2008 when it was 85.0. This incidentally is the fourth straight monthly gain; the last time there were 4 consecutive monthly gains was in October 2004. Lawrence Yun, NAR chief economist, cautions that there could be delays in closure of home contracts. “Closed existing-home sales have improved but are coming in lower than expected because some contracts are delayed or falling through from the application of new appraisal rules for many transactions,” said Yun. “The pronounced increase in April and the fact that May sustained this rise does indicate that actual existing home sales are poised to rise in the coming month or two,” said Joshua Shapiro, chief U.S. economist for MFR. On a regional basis, the pending home sales index rose 3.1% to 80.9 in the Northeast, increased 2.2% to 96.9 in the West, dropped 1.3% to 89.2 in the Midwest, and dropped 1.7% to 92.6 in the South.
The jobless rate jumped from 9.4% in May to 9.5% in June; the highest since August 1983. The Labor Department said employers cut 467,000 jobs in June. The total number of jobless people was 14.7 million in June. On a sectoral basis, professional and business services cut 118,000 jobs in June; manufacturers cut 136,000, and construction companies eliminated 79,000 jobs. Retailers eliminated 21,000 jobs, financial sector cut 27,000, and the government cut 52,000 jobs in June. Education and health services were among the few sectors which added jobs. Economists expect the unemployment rate to rise further, particularly in sectors such as automobiles. “Payrolls will be going down the rest of the year and the unemployment rate will be rising,” said John Silvia, chief economist at Wachovia. “The challenge for the Obama administration is that we’ll have positive economic growth but still no job growth. It’s going to be tough on them.”
General Motors (GM) proposes to sell its “worst” assets by way of auction in the bankruptcy court. The assets for sale include polluted factory sites, parking lots in Michigan, and a nine-hole golf course in New Jersey. GM has been criticized for its polluting factories. In a court filing, the state of New York has listed 11 GM sites that are contaminated or have “ongoing environmental compliance obligations.” New York Attorney General Andrew Cuomo has said that the carmaker should meet all its environmental obligations during its asset sale. A golf course is anything but strategic to a carmaker. “The new GM hardly needs to be in the golf course business,” said Tom Wilkinson, GM’s director of news relations. “The old GM will be selling a lot of potentially valuable but peripheral property the company accumulated over 100 years, kind of like a big garage sale. You will see some really good real estate deals come out of this for investors and communities.”
A large number of homeowners across the country are confronting defects in their homes largely on account of construction faults. As the housing sector expanded aggressively in the last couple of decades, the industry has been besieged with a shortage of skilled manpower and quality construction materials. In addition, tardiness of municipalities in inspecting and certifying homes contributed to the problem. Criterium Engineers, a building-inspection firm, has estimated that 17% of newly built houses in 2006 had at least two significant defects, up from 15% in 2003. Paul Amirata, vice president of claims at Axa Insurance, says construction-defect claims being filed are “pretty severe in terms of the total damage alleged.” The drop in real-estate values has exacerbated the problem. Those with faulty houses find that repairs often cost more than the value of the home. In addition, many do not have the equity to leverage in order to pay for repairs. In case of house defects what is the remedy for homeowners? The National Association of Home builders believes litigation is an inefficient way of resolving issue related to construction defects and says homebuyers should consider using “alternative dispute resolution including mandatory, binding arbitration in consumer contracts.”
According to a report released by the Office of the Comptroller of the Currency and the Office of Thrift Supervision, the number of loan modifications rose in the first quarter of this year. The report also said there was an increase in mortgage delinquencies and foreclosures in the first quarter. John Dugan, Comptroller of the Currency, said: “While I’m very concerned about the rise in delinquent mortgages and foreclosure actions, the shift in emphasis by servicers to more sustainable, payment-reducing modifications is a positive step that should show significant benefits in the coming months.” Servicers carried out 185,156 loan modifications in the first quarter; this is a rise of 55% from the previous quarter. Seriously delinquent mortgages – loans that are 60 days or more past due – rose 9% from the previous quarter. Delinquencies in prime loans increased by over 20% from the previous quarter and foreclosures stood at 2.5% of all serviced loans. Despite the bad news, analysts believe the loan modification program introduced by the Obama administration is gaining traction and will benefit a large number of homeowners in the coming months.
The Conference Board (TCB), an industry group, said consumer confidence dropped in June after rising in May. TCB’s index of consumer attitudes declined to 49.3 in June from a reading of 54.8 in May. The Present Situation Index, which measures overall consumer sentiments toward the present economic situation, dropped from 29.7 in May to 25.8 in June. Millan Mulraine, economics strategist with TD Securities, said: “On balance, this was a disappointing report as it has clearly bucked the trend of improving consumer sentiments in the past few months. Moreover, with the details of the report uniformly weak, we are left with the impression that this was an outright slump in consumer confidence.” Among the consumers who participated in the survey conducted to gather information on consumer sentiment in the current quarter, 4.6% said they had plans to buy an automobile within 6 months; in contrast to 5.7% in the previous quarter. Those with plans of buying a home dropped from 2.8% to 2.7% while those planning to buy a major appliance dropped to 26.5% from 29.2%. Inflation rate expectations for 12 months rose to 5.9% from 5.6% in May. “Consumers are making a more somber and accurate assessment of the economy and their own financial position,” said Mark Vitner, senior economist at Wachovia. “Consumers may be thinking less bad is not good enough.”
New York private-equity firm Quadrangle Group has offered a three-year sublease for 10,000 square feet at $85 a square foot, a discount of 32% to the 2006 rate. Taconic Capital Advisors has offered 50,000 square feet near Central Park at $80 a square foot, denoting a 22% discount to the rate being paid by Taconic. Hedge funds and other firms, when they sublet space, are likely to lose millions of dollars over the life of the building lease. Buyers looking for space are getting great bargains. Brian Rance, U.S. managing partner of law firm Freshfields Bruckhaus Deringer, says, “It’s a complete buyer’s market.”
The Standard & Poor’s/Case-Shiller index, which measures the movement of home prices in 20 major U.S. cities, dropped 18.1% in April from a year earlier. This follows an 18.7% drop in March. The price drop was largely on account of increasing foreclosures. “The market will likely remain out of balance for some time given the flood of foreclosures,” said Michelle Meyer, an economist at Barclays Capital. “Home prices are likely to continue to fall, albeit at a slowing pace, even after the economy technically emerges from the recession.” The decline in home prices is stabilizing the housing market. According to the National Association of Realtors, home
In an important judgment, the U.S. Supreme Court has ruled that New York’s attorney general can investigate whether banks discriminated against minorities while offering mortgage loans. In 2005, Eliot Spitzer, then the New York state attorney general, said data showed that loans to minorities carried higher interest than loans to non-minorities, and wished to start a probe. The Office of the Comptroller of the Currency (OCC), a federal agency that oversees banks, opposed the probe because it believed the probe fell outside state jurisdiction. The Supreme Court ruled in favor of the New York state attorney general. Andrew Cuomo, the current New York attorney general, said: “This is a huge win for consumers across the nation.” According to Cuomo, the ruling will help state attorneys to protect consumers from the “illegal and improper practices by our country’s biggest and most powerful banks.” James Cox, a securities law professor at Duke University, said the ruling gives state attorneys a “bully pulpit” and “even without subpoena power they can still hold press conferences and take steps to swing public opinion.” Michael Calhoun, president of the Center for Responsible Lending, said the ruling “is a victory for taxpayers, who have suffered enormously as a result of abusive business practices in all types of lending.”
The Obama administration’s financial reform plan, unveiled on June 17, is facing opposition from almost all constituents – banks, hedge funds, and industry associations such as the U.S. Chamber of Commerce. The “not in my backyard” (NIMBY) reaction is predictable as industry constituents begin to realize how the new regulations will impact their business. Scott Talbott, a lobbyist for the Financial Services Roundtable, which represents large financial companies, said: “I think the NIMBYism started once we had something to shoot at—before that, it wasn’t really real. Then once we have the legislative language, the real fights will begin.” While banks and other players say they have valid concerns on the impact of the new regulations, consumer advocates and groups supporting government proposals have criticized financial industry participants. “It’s a strategy to try to split people on Capitol Hill and try to confuse people,” says Ed Mierzwinski, consumer program director for the U.S. Public Interest Research Group, a consumer advocacy organization. “It’s an attempt to blame it on the other guy—they’re hoping to water down reform, deflect criticism of their industry.”
KB Home, a large homebuilder, has reported a lower loss for the quarter ended May 31 as compared to the earlier quarter. Analysts say this could be yet another sign of housing sector recovery. The company said new home orders, which totaled 2,910 units in the quarter, were up from the beginning of the year. In addition, the company’s cancellation rate improved. Net loss for the quarter was $78.4 million, or $1.03 a share, compared with a loss of $255.9 million, or $3.30, a year earlier, KB Home said in a statement. Michael Rehaut, an analyst at JP Morgan, said the result was worse than expected, and was “in sharp contrast” to the prior quarter’s order growth. Builders such as KB Home are competing with foreclosed homes up for sale. According to RealtyTrac, foreclosure filings, including default and auction notices as well as property seizures, rose 18% in May from a year earlier. Jeffrey Mezger, chief executive of KB Home, was cautiously optimistic. “Although key economic indicators remain mixed, we are beginning to see signs that some negative housing market trends may be moderating at both the local and national levels,” said Mezger.
Homebuyers are losing interest in McMansions – oversized homes with 3,000 to 5,000 square feet of living space – amid the recession, and are moving towards smaller sized homes. Smaller homes are cheaper to buy, furnish, and maintain, say homebuyers; particularly those buying a home for the first time. “Entry-level buyers are coming out of rentals and coming out of apartments, and they are not looking for 3,000 or 4,000 (square) feet,” said Steve Hilton, chief executive of Meritage Homes. Homebuilders, in order to cater to the change in customer preference, are going along with the trend. The median new-home size, which grew from less than 1,000 square feet in the 1950s to over 2400 square feet in 2004, has been falling in the last couple of years. In 2008, the median home size was 2,200 square feet. The current recession is bringing it down further. According to a survey conducted by the American Institute of Architects (AIA), Americans are increasingly looking at smaller homes and lower ceilings, in part because of energy costs. “Home sizes have been trending down recently,” said AIA chief economist Kermit Baker. “The era of the ‘McMansion’ could well be over.”
The Reuters/University of Michigan Surveys of Consumers are monthly surveys which provide a gauge of consumer anticipation of changes in the economic environment. According to the latest survey results, the Index of Consumer Sentiment (ICS) rose from a reading of 68.7 in May to a 70.8 in June; this equals the reading in February 2008. The Index of Consumer Expectations, which is a sub-index of ICS, moved lower to 69.2 in June from 69.4 in May. “Over the past four months, sentiment has improved moderately, suggesting that consumers’ attitudes about the economy are improving,” said Steven Wood, chief economist at Insight Economics. “However, they remain very cautious. Nevertheless, these data do suggest consumers are no longer shell shocked.” ICS has gained 15.5 points since a low of 55.3 last November. “Such a sizable gain has usually indicated that an end to the economic downturn is on the horizon, as consumers begin to increase their spending on houses, vehicles, and large household durables,” the Reuters/University of Michigan Surveys of Consumers said in a statement.