Quelle Surprise! Fed Sees We Have a Big Mortgage Problem

It certainly is gratifying to see the Board of Governors of the Federal Reserve, via a paper released on Wednesday, “The U.S. Housing Market: Current Conditions and Policy Considerations,” (hat tip Calculated Risk) finally acknowledge that US has a mortgage/foreclosure mess that is not going to go away by virtue of QE or other efforts to goose financial asset prices. However, just as the Fed was late to see the global housing bubble (even the Economist was on to it in June 2005), so to is it behind the curve in its take on the housing problem. This paper at best constitutes a good start, when, pace Churchill, the Fed is at the end of the beginning when it really needs to be at the beginning of the end.

However, before we get to the housing/mortgage market issues, we wanted to focus on a political element of the paper which may be more important that its analytical content. The Fed is openly crossing swords with the FHFA.

The paper has four sections: background, a section on what to do about foreclosed properties that have not been resold (known as REO for “real estate owned”), borrower remediation efforts, and idea for improving mortgage servicing practices. The REO section is entirely about GSE REO.

Although the document is studiedly neutral in its tone, it makes clear in its coded way that it regards the GSE focus on short term loss minimization as destructive (note the Fed is hardly alone in this view). The Fed argues (with some supporting data) that in a lot of cases, converting REOs to rental would be a better policy, although it bizarrely fails to consider the “own to rent” option of keeping the current borrower in place. The paper is also a bit clueless about the realities of managing rental properties (it seems to fall for the economist’s default view that at some mythical market clearing price, demand will of course meet supply, when spread out properties, which is what you are likely to have in suburbs and low density areas of cities, does not make for an attractive property management opportunity on anything beyond a modest scale of operation).

This Fed paper happens to have been released just as Fannie and Freddie are about to embark on a program of bulk REO sales. Daily Real Estate News in October raised concerns (hat tip reader Mark P):

Will the Obama administration’s upcoming plans to sell REOs in bulk to mega-investors…be bad news for small-scale investors who no longer will be able to compete because entire chunks of the agencies’ portfolios will be stamped “for bulk only”? Won’t this further the impression that Washington favors the fats cats on Wall Street over Mom and Pop on Main Street?

The article also recounted how Fannie, Freddie and the FHA had accelerated their liquidation of properties in the first three quarters of the year, yet had recovery rates of over 90% of mortgage value. With those results, why the rush for bulk sales, which will clearly be at deeper discounts? Again to the article:

Current REO disposition techniques appear to be working well — lowering inventories, yielding significant recoveries for the government, putting owners into houses and yielding significant commission dollars to the brokers, agents and ancillary service providers around the country who help make this all happen.

Which raises the question: Why mess with success? This past Aug. 10, the Treasury Department, HUD and the Federal Housing Finance Agency — which oversees Fannie and Freddie in conservatorship — issued an unusual “request for information” on how they might sell REOs faster by offering homes in giant bulk sales of $50 million to $1 billion.

The main targets: hedge funds, large institutional investment groups, and real estate companies that have the capital and the national or regional scope and management teams to purchase and handle mass conversions of REOs into rentals, thereby getting REOs off the agencies’ books much faster than is possible today.

The request produced more than 4,000 responses, which the FHFA has been analyzing for the past two months. So how’s it going and what’s the timetable?

For starters, officials speaking on background made clear that they recognize the recent efforts of Fannie, Freddie and FHA to reduce their inventories. However, said one official, the three agencies face a tsunami-sized shadow inventory that is now heading their way — a combined 1.4 million delinquent loans on their books, at least half of which, they estimate, will end up in foreclosure. Even with heroic efforts, Fannie, Freddie and FHA won’t be able to handle that level of REO volume using their current systems of individual sales, directed at owner-occupants and small investors, via realty agent networks.

It’s that looming wave that is the real focus of the bulk-sale project, officials told me, not the relatively smaller numbers currently in portfolio. On the other hand, they also recognize that flooding local markets across the U.S. with rental conversions of REO would not be productive.

In a more recent article, Housing Wire notes that local groups urge that buyers be properly vetted, since negligent new owners could make matters worse:

Nonprofits and trade groups are stressing the importance of documenting any partnership with an investor to make sure these neighborhoods are maintained and begin recovery after the REO is sold. Most want documentation to ensure investors with poor management histories do not have access to bulk transactions.

And what about hedge funds with no management histories?

The REO section of this paper (without acknowledging the existence of the GSE bulk sales program)) is calling for more study before the GSEs embark on an REO disposition program, and recommends considering having “the REO holder rent the property directly” (ie, have the GSEs become landlords), selling to investors, or entering into JVs with investors (oddly, there was no consideration of having local governments become landlords, say in partnership with the GSEs, since many cities have low income housing and are thus already in the property management business).

The rest of the paper is good at points and provides some helpful data. It mentions a pet issue of mine early on: “economic losses remain and these losses ultimately must be allocated among homeowners, lenders, guaranators, investors, and taxpayers.” It also has some comparatively strong language about how bad servicers are, while refusing to acknowledge that they are engaging in large scale fraud (can’t have anyone in the officialdom admit that, now can we?).

However, the report is marred by nails-on-the-chalkboard omissions and biases. Consistent with commentary by bank regulators, the report gives short shrift to the interests of MBS investors, despite the fact that a lot of delinquent and defaulted loans sit in private label securitizations. It is almost as if the losses borne by ordinary Americans in their retirement accounts aren’t part of the equation.

Similarly, while it gives lip service to the idea that some reduction in mortgage credit availability is necessary and salutary, the article takes the position that lenders have become too stringent with mortgage credit, noting that half the banks aren’t offering products for borrowers with FICOs of 620 and 10% down payment. Yet it also repeats the policy mantra that the powers that be want the mortgage market off government life support. Investors like Bill Frey of Greenwich Capital, who advised Russia on the creation of its MBS market and did not blow up in the global crisis, argues that down payments of less than 20% should be rare. And in the early 1980s, downpayments of less than 20% were rare. Given how the labor market has deteriorated (much shorter job tenures, which means periods of no income are almost assured, low certainty of being able to find a new job at the same pay and benefits level of the old job), if anything, mortgage terms should be more conservative. The behavior that the Fed sees as an irrational overshoot is likely to be an uncomfortable adjustment to better risk pricing, particularly since we also now know that FICO scoring was a crappy approach but no one seems willing to go back to more costly but more information rich in person, local assessment.

The paper also dicusses principal mods. The Fed takes the peculiar position that since it isn’t sure principal mods will work, they probably aren’t such a hot idea. Notice the contortions the paper goes through to discount evidence that defaults are highly correlated with negative equity (and those findings make sense. Why should someone under stress struggle all that hard to hang on to a house with a guaranteed future loss?):

These potential benefits, however, are hard to quantify. Based on the evidence to date, the effect of negative equity on migration between labor markets appears to be fairly small. The effect of reducing negative equity on default is hard to estimate because borrowers with high LTV ratios tend to have other characteristics correlated with default. For example, high-LTV homeowners often made small initial down payments–perhaps due to a lack of financial resources–and tend to live in areas with greater declines in house prices, where unemployment and other economic conditions also tend to be relatively worse. Hence, principal reduction is likely to lower delinquency rates by less than the simple correlation between LTV and default rates would suggest.

This is completely silly. For every other type of credit, principal writedowns are standard and given without fuss and handwringing. It is normal creditor behavior, when a borrower gets in trouble, to consider whether the lender will come out ahead by liquidating the loan or modifying it.

The reason principal mods are a sound option for mortgages is bloomin’ obvious. In a lot of cases, lowering interest rates is not going to make enough of a difference in payment relief to the borrower to change outcomes. By contrast, even on prime mortgages, loss severities are 50% and rising as more borrowers contest foreclosures and housing prices continue to decline in most markets. There is a lot of room to do principal mods for qualified borrowers. If the Fed talked about operational difficulties, that would show they had thought about this issue seriously, but this is tantamount to a blow-off.

And the next bit implicitly sets up a straw man, that if you offer principal mods to borrowers that are under water, you are going to have to give them on a broad basis:

At the same time, the costs of large-scale principal reduction would be quite substantial. Currently, 12 million mortgages are underwater, with aggregate negative equity of $700 billion. Of these mortgages, about 8.6 million, representing roughly $425 billion in negative equity, are current on their payments.

This is spurious. The reason the Administration has created big unwieldy and not-very-successful mod programs (and those just payment mods) is that it is not willing to take tough measures that would create incentives for banks and servicers to give mods privately. In the old fashioned days of George Bailey’s bank, no one knew if his neighbor got a mod because it was handled privately. Make banks write down seconds (which is a big impediment to mods) and have examiners make banks explain why they are doing more mods for the loans they own rather than the ones they service, and encourage investors to pressure banks (investors are now terrified of bank retaliation; having regulators protect their backs would change the dynamics). The regulators have the tools. They lack the will.

There is also a pretty disappointing discussion of what to do about servicers. The Fed really does not get it. It chides servicers for not investing in more default services when times were good. Earth to base, the fee structure is all wrong for that (which the Fed acknowledges) and how can you expect a firm to hire people to sit around and do nothing waiting for a big increase in defaults? The problem is that what it takes to do routine servicing (highly automated, staffed with low skilled people) and default servicing (high touch, and ideally pretty high discretion, which takes high caliber and presumably much better paid staff) are so different that it is hard to accommodate them under the same roof (I can put on my consulting hat and give you a speech about core competencies, but I’ll spare you).

Another obstacle is that borrowers don’t trust their servicers, yet stressed homeowners need to make pretty complete disclosures about their personal finances for someone to see whether they can be salvaged and how much of a mod it will take. Some reports from mod programs like HAMP report that borrowers didn’t tell servicers about all their debts. Given how incompetent servicers were during HAMP (record losses were pervasive), I’m not sure how much was servicer error versus borrower malfeasance and borrower distrust. The Fed doesn’t know either, but the predisposition among regulators seems to be to assume the worst of borrowers.

Similarly, there is a discussion of servicer incentives which is woefully superficial; they should have just cited the early 2011 paper “Mortgage Servicing” from the Yale Journal on Regulations by Adam Levitin and Tara Twomey.

Despite its efforts to muster data, this Fed is badly blinkered by the fact that it operates inside a club. Anyone who has done research in areas where the data stinks (and it does in the housing arena) will tell you you have to do primary research, but economists are allergic to that (Nobel prize winner Wassily Leontief found that less than 0.5% of the articles published in top economics journals were based on data developed by the authors). The Fed is unduly influenced by the view of people who are part of the problem, and it shows in this paper.

In some ways, this failing does not matter. The Fed and the rest of the officialdom do not seem to realize that events have spun out of their control. Their denial of the elephant in the room, the extent and pervasiveness of the frauds perpetrated by servicers on borrowers and investors, means that the battlefront has moved into the courtroom, an arena in which the Fed has little sway. The only way to forestall that is to implement far more radical solutions than contemplated in this cautious paper. In the crisis, the Fed was behind the curve and then overreacted when the situation went critical. It appears to be on the same path once again.

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58 comments

  1. Harley Warren

    How about letting “The Market” decide.

    Come on, $700k+ for a 3b/1ba post-WW2 prefab in Culver City, CA that went for 250k (on a good day) BEFORE the bubble is still insanity!

    1. Art Eclectic

      Ultimately, the market will decide. In many ways, it already is. Despite all other intentions, there must be a buyer in correct financial solidity in order to purchase a home. The available pool of buyers will match up with the available pool of houses priced at a level the buyers can afford. If there are 200 houses priced at $700k and only 50 buyers that have the financial resources in which to pony up not only the down payment amount but be able to competently service the debt, then 150 of those houses are in for a price chop until the pricing reaches the next level of buyers with available funds and stability.

      With real wages stagnant and employment numbers still in the basement, that limits the pool of buyers. Sellers sit and complain about “lack of demand” but they fail to add the second part of the equation: “lack of demand at current pricing.” When prices drop to where buyers who are in the correct financial position to buy can afford the houses, then the buyers will be there. There is no lack of demand for housing, there is a lack of qualified buyers who are able to service the debt at current pricing. The pricing is the only link in the chain with any give, which is exactly what you are seeing in the market.

      Without jobs and rising real wages, the housing market will follow the natural course of declining home prices. Those prices will decline until homes are within range of those buyers with cash reserves and financial stability.

    2. Anonymous Jones

      But see, that price is not crazy. There’s a lot of people in west LA and not a lot of SFRs.

      If you were to put down 20% ($140k, which is easily possible for many people in LA, whether they be professionals or just got a gift from their relatives), and you get a 7/1 I/O ARM at 3.75% (I know someone who just did this), your monthly mortgage will be…wait for it…

      $1800 per month!!!

      So you can live in this house for a TAX-DEDUCTIBLE payment of $1800 per month (so a professional is paying about $1000 per month after taxes), locked in for SEVEN YEARS, as long as you put the $140k at risk as a down payment and you pay for property taxes and insurance.

      You’ve seen what PSF rents are in the area, right?

      So do you understand the ‘market’ now or is the ‘market’ still some delusional space in your head where everything is priced as you wish it were, not how it actually is?

      The market includes professionals making six figures a year, and lots of people who have inherited (or been given) money from their parents and grandparents. And interest rates are really low. That’s why you see the prices you do. That’s what drives the ‘market.’

      ‘Value’ is personal and subjective. The ‘market’ is created by the rules of the game dictated by the government and the people, but its output is objective.

  2. Lafayette

    The Fed argues (with some supporting data) that in a lot of cases, converting REOs to rental would be a better policy, although it bizarrely fails to consider the “own to rent” option of keeping the current borrower in place.

    This does make sense if the rent-level is placed far enough below the mortgage maintenance payment rate as to be affordable to tenants.

    Then, when housing prices finally bottom, with a happy conjuncture of low loan rates, perhaps refinancing could be envisioned?

    It’s a tricky situation because the banks (and other “owners” of the empty foreclosed property will not want to take a haircut on the property’s value. But have they any choice?

    They probably think they are better off to wait out the crisis until property prices improve and avoid a haircut on their prices.

    However by means of QE, is not the Fed now owner of at least some of those properties? And therefore can the Fed not task the GSEs to refinance loans – this time to qualified creditworthiness mortgage candidates?

    Thus it is the Fed that takes the haircut on housing prices and not the banks. And who should care that our hirsute friend, the Fed, takes a haircut?

    Not so …. ?

    1. Larry

      I agree totally with the rental price needing to drop. I live in suburban Boston, and I’m seeing an increase of homes to rent in the area. I rent a relatively smaller home and was hoping to get something a little bigger for the family. But most of the homes I’m seeing for rent are clearly at the level of the mortgage payment, which is too high. It makes me wonder who is renting the property given that the homeowner is out, but the rental rate is set up as what is obviously the mortgage rate.

    2. Yves Smith Post author

      The Fed does not own properties. The Fed owns RMBS. It is the trust that owns the properties.

      1. Lafayette

        The MBS stands for Mortgage Backed Securities.

        If the Fed does not own the Mortgage but only the “Security”, then what does it own?

        Hot air?

        Quelle surprise! ;^)

        1. Lafayette

          WikiP: A Mortgage Backed Security (MBS) is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.

          So, the Fed does not own the property, just the revenue from the property. Which, if foreclosed, the mortgage is non-performing and the revenue is tantamount to “hot air”.

          The Fed bought hot-air to refinance the banks?

          It is illogical to think that if a mortgage is non-performing (foreclosed and no tenant rent) then the “backing” must be obtained by means of the transfer of property rights. Otherwise, there was no backing whatsoever.

          In fact, to make the mortgage performing – and not transfer title – then the best option is to let the empty residence, the rents of which go to Fed.

          1. Lafayette

            Typo: It is illogical to think that if a mortgage is non-performing (foreclosed and no tenant rent) then the “backing” must be obtained by means of the transfer of property rights. Otherwise, there was no backing whatsoever.

            Should read: It seems logical that if a mortgage is non-performing (foreclosed and no tenant rent) then the “backing” must be exercised by means of the transfer of property rights. Otherwise, there was no backing whatsoever.

  3. Mark P.

    The last thing that our current financial overlords can afford to do is to let the market decide.

    That’s because these constantly repeated mantras assuming a resurrection of life as we knew it — or, anyway, of the mortgage-industrial complex and the FIRE sector as we had those before 2008 — are not only delusional now, but always were.

    And that’s because there always was a gigantic elephant in the room, aside from the credit ponzi and the unsustainability of financialized capitalism, that everybody wanted not to recognize. I read through the Fed paper, for example, and it’s nowhere in there.

    Very simply, there’s a vast demographic overhang. There are 83 million baby boomers. Conversely, 46 million Gen Xers exist, IIRC, if one takes that cohort as having been born 1964-1984.

    Sure, millenials (1984-2004) number about 81 million. But if we take as a indicative metric the average age of Gen X homebuyers — about forty — and then factor in that these poor kids in the subsequent generation are not just facing the worst job market for almost three-quarters of a century but also that the education-loan ponzi had loaded them with truly pernicious debt burdens, that means relatively few millenials will likely have the wherewithal to buy real estate for another couple of decades (i.e. before 2025-2030)

    And this may be the case even when home prices return to a sane relationship to first-time homebuyers’ annual incomes. As the Fed paper does note, history suggests that such a relationship means that a first home should cost about three times homebuyers’ annual incomes. Since U.S. median household income in 2010 was $49,440, that in turn suggests the average price of a home in the U.S. should be slightly less than $150,000.

    Given all that, you can see a big part of the reason why, firstly, the mortgage-industrial complex would have wanted to blow a sub-prime-based bubble when faced with the demographic overhang in the first place and, secondly, why they’re pushing strongly for government-supported, non-market scenarios now.

    As Yves says, however, at this point it’s all too late: the ultimate end is baked in.

    1. aet

      “….relatively few millenials will likely have the wherewithal to buy real estate for another couple of decades (i.e. before 2025-2030)”

      True: but many many boomers inherited fully-paid-for residential real estate from their parents – or at least, many of the “boomers” I know did so.

      Why won’t the parents of the millennials be simply passing on their bought-and-paid-for-long-long-ago houses when they die?

      There was ( and is, as I suppose that it may yet still be going on ) a massive inter-generational transfer of accumulated wealth to the “boomers” as the “greatest generation” shuffled off their mortal coils; why shouldn’t that happen again?

      1. ambrit

        Dear aet;
        Perhaps because the Millenials inherited Gen X standard of living expectations along with Depression Era wage scales.

      2. Larry

        Between longer life expectancies and reverse mortgages being used to finance long term care in later years, it’s pretty clear that younger generations are going to wait longer and longer for this inheritance to trickle down, if it does at all.

      3. JCC

        “Why won’t the parents of the millennials be simply passing on their bought-and-paid-for-long-long-ago houses when they die?”

        Many will, but…

        As an example, in my case and just a few months ago, a bought-and-paid-for house was passed on to 5 children. The house was in FL, the children are in NY, CA, OR, PA. None can quit their jobs and the house will be sold for far less than the purchase prise and the proceeds disbursed to the 5. The proceeds will not cover the down-payments based on 10% requirements for avg priced homes in their respective states for 3 of the 5 that rent (with the possible exception of the renter in rural PA). The other two will either put it in a savings acct. or use it to pay off some of their underwater mortgage.

        The “wealth” in all liklihood will end up in gas tanks and/or extremely low interest bearing savings accts.

        I would guess that this is a relatively common situation.

      4. drb48

        “Why won’t the parents of the millennials be simply passing on their bought-and-paid-for-long-long-ago houses when they die?”

        Because by the time they’ve both passed – in my case anyway – all their assets, inluding their home – had been spent spent on medical bills and nursing home care. And then some.

  4. indio007

    Oooh I wonder how large of a swath of land a billion gets you? Maybe half Maricopa County , Az? Of course … the 1% take the final step in returning to their birthright as Lord of the Manor. A sheriff is already in place to keep out the infidels…but.. How will these neo-feudal landlords treat the serfs ? Not well, I reckon. It only took 400 years to do it, they are finally getting back what they lost. Barely a blip on the pages of history. Future generations might not even know that feudalism disappeared for a spell.

    1. aet

      Stretching a metaphor until it snaps, huh? You ought to keep in mind that feudalism itself was an important advance in human political freedom over what had been in place prior to its arising.

      We could not go back onto the cages we’ve already broken out of even if we wanted to do so – but that’s the “conservative dream”, isn’t it? Going back to how they thought it “used to be”….well, it ain’t gonna happen.

      Geez…When did the right-wing become the dreamers?

      Conservatives should conserve, and I don’t see a lot of that on or from the right: I do see a lot of radicals around, though. Lately, it’s been the those the right calls “liberals” who sound most like they wish to conserve how things are, and to return to how things were….

      The right-wing is radical, not conservative.

      1. aet

        Damned typos…Couldn’t go back into those cages, either: but I suppose you could make someone believe that they are in a cage, even when they are not, provided that you completely control the information they can obtain.

        1. ambrit

          Oh, I get it. “Iron bars do not a prison make,” etc. etc.
          Perhaps a better allusion would be: “Better to rule on Wall Street than serve on Riverside Drive.”

      2. indio007

        The PTB’s solutions for the housing debacle is so damn predictable this shit just writes itself. Their machinations always lead right back to the social structure as it was 400-500 years past.
        I really don’t get how feudalism was an advance. Villeinage is slavery lite… half the beating and half the benefits.

      3. leapfrog

        “The way things used to be” phrase reminded me of a book I read, “The Way We Never Were; American Families and the Nostalgia Trap.” It was kind of dry reading, but dissected quite a few nostalgic myths.

          1. leapfrog

            Thanks for the new word. Had to look up the definition, as I’ve never seen it before. Pronouncing it will be a tongue-twister : )

        1. bulfinch

          Yes, a dull tome with some decent data. I think when people pine for ‘the way things used to be’ they’re probably not nostalgic for the days before civil rights/gender inequality issues/child abuse, etc. I’m guessing they’re talking about the days before the regulatory capture; before gamblers, speculators and arbitrageurs came to dominance and warped the playing field, turning the US into a FIRE economy.

          That, and the cool cars…

  5. Michael

    A deed in lieu combined with a simultaneous lease with option to purchase at a price near or at today’s value should be used as a tool for underwater homeowners facing foreclosure that meet certain criteria.

    There are existing resources that can be shaped, funded and built out to support such a program, such as nonprofit credit counseling associations. The housing counseling they do now is largely ineffective, but I suspect that is mainly due to the design and delivery set up to maintain the status quo:
    http://getoutofdebt.org/31299/nfcc-challenges-debt-relief-industry-to-think-bold-my-thoughts

    1. ambrit

      Dear Michael;
      The problem with your proposal is that the housing market is nowhere near the bottom yet. The number of people we see coming into the DIY Box Store I work in who say they are doing the very least they can get away with in the way of maintenance and repair even when they can afford better is way, way up. People are worried and anxious, even those with money.

      1. Lidia

        Wow, that’s another factor of *real* wealth destruction to add to those we already have: poorer-than-average maintenance of even occupied homes.

  6. TGS

    Hard to imagine hedge funds holding bulk REO very long in a rental portfolio. I could see several big players try beating the competition to flip their new bulk purchases, further flooding the market with properties for sale.

  7. Jim in SC

    There are a lot of moving parts in these proposals. Rental property is a mediocre investment unless property values are rising. If ‘own to rent’ becomes more common, it will hurt rental rates, and discourage private buyers, who mostly pay cash.

    1. ron

      In Calif rental home appreciation has been the difference between negative cash flow and a positive return over the past 40 years. In the Bay Area we used to have a large rental base but during the recent bubble property owners unloaded many of these aging rentals onto unsuspecting investors that were hoping for another bubble down the road but many of these new investors significantly overpaid and the negative cash flow combined with deflating home values have forced most to unloaded rentals back to the bank.These homes look exhausted requiring new everything as most are 70’s and 80’s tract built homes with poor materials and workmanship so even fresh paint and carpets don’t hid the chipped pressboard throughout the house.

      Bulk REO sales will work in very limited markets but most houses will require extensive repair and there new selling price as REO’s will lower the local neighborhood pricing down a notch or two making the resell market even worse.
      Our great financial central planners will discover that the world doesn’t reflect the model’s carefully crafted on their computer’s.

      The reality that the housing bubble will kill off the TBTF banks along with hundreds of local banks hasn’t reached the FED yet but sooner or later the reality of the situation will overcome the idea that they can create some new financial engineering formula to keep the banks out of BK.

    2. MB

      “Current REO disposition techniques appear to be working well — lowering inventories, yielding significant recoveries for the government, putting owners into houses and yielding significant commission dollars to the brokers, agents and ancillary service providers around the country who help make this all happen.”

      Yep, as one of those potential “pay cash” customers, I refuse to pay for an artificially propped up price for what Ron aptly describes. I have another name for many of the San Fran bay area housing..”throw-up” housing. They threw them together with no sense of substance or architecture, with a fairly definitive disposability quality. And now they unload it back onto the public at “fixed” prices. The problem is, the public is too busy and tired to read…just like they were when they signed their mortgages. I knew a wealthy man who did 1st and 2nd private mortgages. He always made his loan speech to his kneecap rate customers with the sentence…”I collect houses”. At least he was up front about it. He always told me that gain is always made purchasing at the right price, not selling. If the hedgies can steal it for their own profit, I guess the system is operating perfectly – as it was intended. Ah, the “free market”!

      1. ron

        MB- glad to see someone else has low opinion of the post 60’s tract homes in the Bay Area. The past two years I have been looking at the East Bay and not the Berkeley Hills!
        It appears that land prices are still in high bubble territory around the Bay, here is one example and I will give a link. This home is in Martinez in a decent neighborhood per Zillow in the low 200K range. Its currently an REO listed at 129K was 150K. I went out and looked it over besides the fact that the county has Red Tagged the house it clearly is a knockdown but at what price could one buy the lot and built even a cheap or modest home based on the general neighborhood values? This is common throughout the East Bay except in the most expensive areas it really impossible to build any type of new structure based on current land prices. It would seem that most properties will continue to decline from age & maintenance creating some nasty Detroit looking spots. I have to believe that land prices will decline significantly in the Bay Area including the most cherished locations today.

        the link:

        http://www.redfin.com/homes-for-sale#!market=sanfrancisco&min_listing_approx_size=1250&region_id=11767&region_type=6&sf=1,2&uipt=1&v=6

    3. curlydan

      “Rental property is a mediocre investment unless property values are rising.” Most investments within the past 10 years have been mediocre.

      Rental real estate seems like an area that needs long-term commitment where the returns in the beginning are fairly meager unless the buy price of the rental housing is really low. Hence, the need to package the houses up to the big boys and offer huge discounts. No self-respecting bankster is going to buy something that returns less than 5% or 10%. The Treasury Dept will make sure the business cases work :)

      To Yves’s point on the maintenance, though, I think it’s less of a problem because there are already a lot of companies out there competing in that business for the banks–any new investors can just shift it over to their side.

      1. Yves Smith Post author

        Re property management companies working for banks:

        1. By all accounts, they do a terrible job. I’ve had numerous reports from readers bidding on property as well as lawyers that they don’t even do the basics.

        2. Real live tenants have much higher needs and expectations. You got a leak or a boiler failure. they want it fixed NOW. And the smarter ones can and will escrow rent.

    4. Mark P.

      ‘Rental property is a mediocre investment unless property values are rising.’

      You’re thinking in terms of the old paradigm. We’ve entered the era of the’new normal’ and rental rates are rising.

      For instance, on Bloomberg yesterday —

      U.S. Apartment Vacancies Decline to a Decade Low of 5.2%, Rents Increase
      http://www.bloomberg.com/news/2012-01-05/u-s-apartment-vacancies-decline-to-a-decade-low-of-5-2-rents-increase.html

      ‘“The sector is benefiting from some of the lowest figures for new construction on record,” Calanog said. “By 2013, the influx of new units may begin eroding any benefit the sector derives from tight supply conditions.”

      ‘A total of 8,865 new units became available in the fourth quarter, the second-fewest for any three-month period in Reis records dating to 1999. The first quarter of 2011 had the fewest units, at 7,473.’

      Likewise, in yesteray’s WSJ —

      Apartment-Vacancy Rate Tumbles to 2001 Level
      http://online.wsj.com/article/SB10001424052970204331304577141130335463256.html

      ‘The nation’s apartment-vacancy rate in the fourth quarter fell to its lowest level since late 2001 … In the fourth quarter, the vacancy rate fell to 5.2% from 6.6% a year earlier and 5.6% at the end of the third quarter, according to Reis.

      ‘During the depths of the downturn, landlords had to offer incentives such as flat-screen TVs and months with no rent to attract tenants. But in the fourth quarter of 2011, landlords in 71 of the 82 of the markets that Reis follows were able to raise rents. … Nationwide, landlords raised asking rents an average of 0.4% in the fourth quarter, to $1,064 a month. That’s up from $1,026 in 2009.’

  8. Jim

    Unusual, giving up to the people that created the problem.
    No honest paperwork to show ownership, no rent to own, no price corrections they get to dump their excess money into a tax pit, write off the taxes, sell, claiming a loss, for their “business” or “fund”, and “save” the economy, after they dump their latest leader.
    Sounds like fun, get to lie all the way to the bank with their latest scam.

  9. liberal

    …it seems to fall for the economist’s default view that at some mythical market clearing price, demand will of course meet supply…

    Heh.

  10. Jesper

    This quote:
    “And the next bit implicitly sets up a straw man, that if you offer principal mods to borrowers that are under water, you are going to have to give them on a broad basis:”

    It might not be a straw man argument. Lets assume that executives have centralised a significant amount of power to themselves away from the employees closer to the situation. One centralised power might be that all modifications has to be approved on a very high level (executive). Suppose that there are too few executives to handle the large amount of possible modifications on a case by case basis. That would imply that if the power to authorise mods is at executive level, then it would, for practical reasons, be necessary to authorise mods on a broad basis.

    I suppose that it might be possible to delegate the authority to modify loans to lower level employees. That would of course mean that executives would be ok with losing power and that the lower level employees who’d get this power would be competent and honest. But executives giving up power would be executives giving up justifications to their huge salaries and perks.

    Also, big organisations seem to value social competence above other types of competence. The organisations involved in the US housing market seem big and therefore I suspect that social competence is common, at least among management. The performance of these organisations does seem to indicate that other competences are not as common.

    The way I see it; there are no good options left:
    -do what is currently being done
    -centrally authorise some broad loan modifications
    -delegate power to authorise loan modifications to people who might be as competent and honest as a Soviet bureaucrat (very socially competent, other competences might be questionable)
    -?

    1. ron

      One issue of mortgage loan mods is an item that gets little or no attention and that is the mortgage holders total DTI levels. My guess is that the media in general does not want to discuss consumer debt as it brings up the ugly subject of Americans living beyond there means combined with lower household incomes combined with lower employment expectations. Here is a bit from Mark Hanson and a link regarding DTI and Mods:

      “to those with a 65%, 75% or 80% % DTI — before taxes – default is a given eventually; the debt load is just too high at 100%+ of net earnings. This is regardless of the severity of the negative equity. Some with sky high DTI’s have greater savings or a moral compass that points to a mortgage as being the same as a promises to country, mom, or God. They can live in debtors prison longer than others, but eventually most will break.

      I think it’s safe to assume that the average earner with a DTI of over 50% DTI before taxes and all other monthly expenses not listed on a credit report (max DTI for Subprime full doc loan originations during the bubble years was only 55% by the way) needs relief. Stopping the mortgage payment is the easiest way to get that relief.

      “When you look at DTI as the real driver of loan default you get a much clearer picture of why loan mods don’t work — and why they will never work — and how insurmountable the problem really is…people need full debt portfolio mods not just ‘mortgage’ mods.”

      http://mhanson.com/archives/499

    2. Yves Smith Post author

      You are assuming lower level organizationally means lower level skill wise. We said in the post you’d need completely different staffing to do mods and that the differences in management approach (low discretion for routine servicing, high discretion for mods) was something most organizations can’t accommodate successfully under one roof.

      There are all sorts of places in banking where non-executives have tons of discretion: private bankers, traders, corporate lenders. And these are all functions where you are using the house’s money. Here you are an agent, not a principal, so the organizational risk is lower.

      1. Jesper

        It seems that I should improve my writing skills :-)

        I think we’re in agreement on:
        -loan modifications aren’t being done

        I believe we might be in agreement that the authority to modify loans has to be put on lower than on executive level.

        My post was intended to explain my belief on:
        -why the authority has not been delegated: Executives holding on to power to maintain their own importance.
        -if the power was delegated, then the current organisations seem to be filled with incompetent (except in the field of social competence) people in positions of authority who’d perform as they have in the past

        The task of doing the loan modifications is a huge task. The task is to minimise losses – any decision to modify a loan will by definition incur a loss. My experience is that many employees will rather risk a large loss to their employer than a small loss to their employer that comes with a threat to their career. The people who made their careers in the US finance industry does not strike me as people who’d chose small losses that threatens their careers over pretending everything is fine.

        It is a classical agent problem. Can the agent be trusted to perform? Given how they performed in their previous task of approving loans I’d say: No, they chose their (short-term?) careers (& monetary bonuses) over their duties. If they were asked to perform this task I’d be concerned about the risk that they’d accept bribes for overdoing loan-modifications.

        While there SHOULD be an organisation where skilled people with integrity are in positions where they can exercise discretion to approve loan modifications, I simply do not believe such an organisation exists in the US finance industry today.

        I have to say that it seems likely that either loan modifications will have to go through the courts or I suspect there will be huge amounts of malfeasance in the finance industry again.

  11. 2little2late

    1. Write millions of fraudulent mortgages.
    2. Make billions shorting #1.
    3. Sell trillions of worthless MBS based on #1.
    4. Foreclose on #1 en masse.
    5. Convert fraudulent #1 paper into rental agreements.
    6. De-legislate consumer protections.
    7. De-regulate governmental agencies.
    8. Allocate .01% to satisfy AG demands.
    9. Enact global austerity measures.
    10. Buy remaining utilities, resources and public lands.

    …..*Game over. Play again?

    1. Lafayette

      Convert fraudulent #1 paper into rental agreements

      Not so sure about that one.

      As I’ve said above, a “Mortgage Backed Security” that was Quantitatively Eased by the Fed, if non-performing or even under-performing, should be allowed to be “exercised”. That is what is meant by “backing”. (Banks cannot have their cake AND eat it, I should think.)

      That is, the mortgage becomes the property of the Fed in lieu of nonperforming payments. The Fed can then sell it off at whatever market rate and accept the loss (between mortgage and resale price). Or rent the property and securitize the rental revenues.

      Why not?

  12. LillithMc

    After switching to a global finance system based on mortgages that had been regulated within states, the “technocrats” never understood the basic nature of “home-ownership”. Homes need maintenance including expensive structural repairs. First the fat cats moved massive numbers of mortgages by robo-signing, ignoring state laws, not keeping records, selling them in tranches so the investor had no idea what they were buying and giving the tranches a fraudulent rating. Next they used the same system to foreclose, letting homes sit vacant for years while the home and neighborhood went downhill. In an under-water market, where is the incentive for the crushed home-owner or the renter to cooperate and maintain the home? Who trusts the housing market anymore? Selling these “destroyed” homes and neighborhoods in bulk to hedge funds completes the transition to what will be a new slum with absentee, arrogant, greedy owners who would never live in the homes they “own”. Perhaps the destruction is past the ability to change because of the mind-set of those in charge of the system. The next step will be to accuse those in the run-down neighborhoods of lacking “pride of ownership”.

  13. mk

    Re: Rent to own, page 13: “Rent-to-own provisions, which would give existing tenants the option to purchase their properties during their tenancies, might facilitate the
    transition of some renters back to the owner-occupied market. Such provisions may also reduce costs by encouraging renters to maintain their properties to a greater extent.”

    Re: “12 million mortgages are underwater, with aggregate negative equity of $700 billion” – $700 billion was what the banks got in the big bank bailout 2008. STOLEN!

    1. Yves Smith Post author

      The section you excerpted talks about “tenants”, not homeowners or borrowers. It is about the new renter.

      Rent to own does not = own to rent, which is what we were discussing (keeping current tenants in place). Rent to own is meant to give the investor in the rental a possible easy exit. Per the discussion earlier in the thread, most investors in rentals are looking for an exit, since a decent return depends on property appreciation. Having a rental where the tenant has a purchase option would presumably provide for more stable tenancies (ie, less turnover, turnover is costly, and they have more incentive to be nice to the property) and cheaper exit (saving brokerage fees, which is a big item, particularly on a levered transaction.

      Read the section again. This is just a strategy to goose the housing market by turning more renters back into homeowners. I forget where I saw it, but homeownership is now at low levels by recent norms, 60% (v. 69% on the eve of the crisis, IIRC in the early 2000s it was 64%). But with job tenures as uncertain as they are, lower levels of homeownership make sense. Who can commit to a 30 year mortgage when the longest you can expect to be in a job is 3 years at most?

  14. Brian Sierk

    I take exception to the characterization of the current system working well- It is working , but wit a wave of graft, backscratching and outright fraud. Much of the “local” realtors in the networks are small time operators who sell their name and license to larger capital groups who set up 4-5 different dummy offices in a market in order to get around the 50 property limit. THey are able to steer properties their direction by “Entertaining” Fannie Mae Asset Managers by meeting them at trade shows. Most of THe SAMS approved vendors for the work are dummy companies as well, buying up old licenses and creating companies out of thin air. Many of them are owned by the same groups that run the fake realties. When that happens you get rigged bidding and collusion for work that is bid out, and payment authorized for work not performed. It is bad out there, and while bulk sales will be nasty as well, They are not any more corrupt than what is happening now.

    1. Yves Smith Post author

      I did not say “working well” in any abstract manner. The article I cited did. It is working well enough by Fannie’s and Freddie’s apparent objectives (liquidating property pretty quickly and getting a decent recovery) to call into the question the need for a bulk sales program, which raises far greater issues re the potential for corruption.

  15. Crazy Horse

    One of the many distortions and delusions that Vampire Capitalism has bequeathed us is the notion that a house should be your primary (or sole) investment and security for the future. Even when Americans are evicted from their house and forced to live under a freeway overpass it is still hard for them to abandon this delusion.

    In reality the purpose of a home is to keep the rain and snow off your head and provide a place to raise your family. The sheetrock boxes and 10,000 sq. ft. fake castles that we have covered the countryside with over the last 40 years are widely unsuited to that task, but they are what we are stuck with. If they are to meet the needs of the future they must have their standards of energy efficiency drastically upgraded and the McMansions cut up into human sized units. There is no shortage of jobs that need to be done— what is lacking is the political will to construct an economic system that will allow us to get to work.

    But first we must put a roof over the heads of all the families that finance capital has rendered bankrupt, enslaved to the debt bubble created by Wall Street so they could construct fraudulent securities upon the slaves’ backs.

    Until we break the power of homeowner debt slavery, we will not begin the rebuilding process of our housing inventory. To that end I advocate a return to the principle of Homesteading. Any house that remains vacant regardless of which bankster claims fraudulent ownership should be placed in a pool of homes available for homesteading in the same way that the Western US was settled. The huge inventory of trash loans offloaded by the Vampire Capitalists onto the books of Freedie and Fannie should not be sold to hedge funds for pennies on the dollar. Far better that they be given to homesteaders who already live in them or are homeless, along with the opportunity to improve the properties to liveable condition and eventually upgrade them to the standards of the future.

  16. Dave Adelson

    This article seems to take the approach that the Fed’s approach is a bad and clumsy one because it does not lead to the greatest benefit to most people, i.e. the best resolution for public policy and government liability. The implicit assumption is that a lower total cost and a lesser burden to most homeowners is a desirable goal. While I agree with that goal, I am not at all sure that the Fed, and specifically Ben Bernanke, does. It seems hard for me to believe that Bernanke does not use the ability to print money (well, create reserves) to advance his vision of what is best for the economy. For example, if there were a greater financial burden to the government or to homeowners, but the result was a restructured system that fit better with Bernanke’s idea of what would be in the longterm best interest of the market, then would not Ben pursue such an outcome? It seems to me that this article is fairly decent evidence that that is what is happening. Then the question comes, what does Ben think is a good outcome. I would guess that this Ayn Rand devotee would think that the role of the government should be to facilitate the transfer of assets into private hands via market mechanisms.

    1. different clue

      Well , what do you know . . . my very last few minutes reveal to me that you did indeed already say a form of what I was going to say. I will just say that the Greenspanke Fed wants to deliver these houses into the hands of vulture investors and rentlords specifically, and prevent them from reaching the hands of individual private homeseekers.

  17. different clue

    My time at the workplace computers is limited to lunchtime and certain other little timebits. Forgive me if someone already said better what I am going to say very briefly.

    I remember hearing about a Greenspan speech some years ago to some financialists about how mortgage-seekers should be steered aWAY from fixed-term fixed-rate mortgages and steered inTO various variable rate types of mortgages. He also of course oversaw the emmission of as much credit as possible to keep “money” flowing into the growing housing bubble. I believe none of this was a mistake. He was doing it all on purpose to engineer the result we have now.

    The goal was to transfer many millions of houses from “middle” class homeowers to upper class vulture investors for as little money per house as possible. These vulture investors would then use these houses as rentals to
    “rentcrop” millions of ex-homeowers and never-will-be homeowers. The fact that arms of the Fed are hustling the emergency big-block sale of bunches of homes, as described in this article, suggests to me that I am exactly right. The current Fedsters are trying to force the result that Greenspan carefully and deliberately engineered the chain of events to lead to.

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