Mortage regulators now plan to start regulating!

It may be a few years too late, but federal regulators are finalizing some new rules for mortgage lenders that would largely eliminate some of the loopholes with qualifying borrowers for adjustable rate mortgages as well as make it easier for them to refi into loans less onerous. From an L.A. Times story:

On Monday, the Federal Reserve is expected to require lenders to document borrowers' incomes and verify that they can afford their mortgage payments -- including the higher payments that come when adjustable-rate loans reset...

First proposed in December, the measures have been revised in recent months in response to public comment. Fed officials declined to describe the changes, but the regulations also are expected to limit bonuses paid to brokers for making subprime loans and restrict prepayment penalties for borrowers who want to refinance...

Some of those new rules also may include restrictions on the use of the word "fixed" to describe the rate of a loan that may adjust in the future and prohibitions on brokers influencing the appraised value of homes.

Lenders also may be required to give borrowers at least 60 days before their loan rates reset, a period during which they can refinance without penalty.

Paul Leonard, director of the California office of the Center for Responsible Lending, said that many of the federal rules, as originally proposed, were too weak. For instance, he noted that some of the practices proposed by the Fed would apply only to subprime loans but not to other nontraditional mortgages, including so-called no doc and interest-only loans that also have high rates of default...

On the other hand, the Mortgage Bankers Assn. has expressed concern that the new rules could impose burdensome requirements on lenders that would result in higher costs for borrowers...

Also Tuesday, California Gov. Arnold Schwarzenegger signed into law a bill that represents the Legislature's first stab at trying to stem the tide of foreclosures.

The bill, which took effect immediately, requires lenders to give homeowners an early warning that their mortgages are heading toward default. The measure also gives renters an extra 30 days' notice to find a new place to live if their landlord is losing the property.

"Foreclosures not only devastate families, they hurt neighborhoods and depress our economy and our budget," Schwarzenegger said.

The bill by Senate President Pro Tem Don Perata (D-Oakland) also provides communities with a new weapon to combat blight created when homes are allowed to run down after being vacated. Local governments can now fine property owners who fail to maintain empty homes.

How bad is it for builders? Worse than you thought.

One of the main reasons that the NAHB is pressuring Congress for tax credits to first-time homebuyers and extending the tax loss carryback is because many smaller, private builders are simply on the ropes. Whereas it's the large, public builders who have been told "go sell stock or raise money from the capital markets," for smaller builders it's just not that simple. From a BuilderOnline.com story:

While many builders have been quoted in newspapers saying the media has overblown the severity of the housing downturn, some home building consultants are saying the picture is far bleaker than even the media is portraying... Why are things so bad? Declining land values combined with banks worrying ­about their real estate–related loans has caused a number of banks to call on countless builders and land developers to either pay lump sum amounts to get their loan-to-value ratios back in order, to sell the land, or even to give it up to the bank...

Evan Smiley, a partner specializing in bankruptcy law at the firm Weiland, Golden, Smiley, Wang Ekvall & Strok in Costa Mesa, Calif., and coauthor of Bankruptcy for Businesses, pegs the problems that banks and builders are having on declining land values.

A bank’s reaction, mainly out of fear for its own financial health, is to declare default or send the builder notice that the bank doesn’t intend to renew the loan. Or the bank may tell the builder it needs to pay down the loan, often through personal guarantees, to somehow re-leverage the transaction and decrease the bank’s risk, Smiley says.

How a bank or banker will handle any given situation will vary from bank to bank and person to person within each bank, but Smiley offers three strategies for a builder facing tough times.

A builder must maintain good communication with its lenders, he says. Lenders are unlikely to want a builders’ land, especially if they are dealing with many builders and facing the proposition of owning huge amounts of land, and will therefore try to be cooperative. Smiley says banks are doing a better job of working with builders than they did in the 1990s housing bust in California...

Market conditions for new-home builders are deteriorating day by day, say the building consultants Builder spoke with.

Builders must seek expert advice; their human resources departments do not have the experience to adequately guide them through this crisis. Solving the complex problems that builders are facing requires specialists, say the consultants Builder interviewed...

Builders need their own advocates, because their creditors will have a team of lawyers at their disposal and the issues that need dealing with are not simple—tax issues, life insurance policies, land, debt, possible cash infusions from private equity, and so on.

But before builders get to the stage of hiring experts, they must admit they have a problem, says Tarabulski.

“One of the problems is that builders are can-do guys. They’re the heroes by nature,” she says. “This is very psychologically hard for anybody, and they are having a really hard time saying, ‘I can’t fix this,’ admitting they can’t. And by delaying this, their chance of surviving this catastrophe and coming out the other side diminishes day by day. By day.”

Finding the next President for anxious times

Now that we've whittled down the presumptive nominees to Barack Obama and John McCain, it will be very interesting to see their plans not just for the real estate market, but the overall economy, a real energy policy and what we can expect from their respective administrations.

Friends, family and colleagues get very irritated with me when I tell them I've not yet decided who will get my vote in November (the building industry tends to lean conservative and my friends are a mixed bag), but that's because I simply don't know enough about either man to make an informed choice, so for me the debates will be crucial.

As a 'decline to state' for many years (also known as an Independent), I don't vote party lines and think it's irresponsible and lazy to do so -- what's next, "I like the sound of his name?" (don't joke, that's how some people vote for local judges). For those people who decided months ago who would get their vote -- well before we've seen the two candidates argue the issues -- I would argue that the choice is not one of intellectual honesty, but of emotion. And, according to an op-ed piece by Thomas Friedman in the New York Times, that's exactly what we do NOT need. Amen to that. Let's ask people to THINK this time:

Just a few months ago, the consensus view was that Barack Obama would need to choose a hard-core national-security type as his vice presidential running mate to compensate for his lack of foreign policy experience and that John McCain would need a running mate who was young and sprightly to compensate for his age. Come August, though, I predict both men will be looking for a financial wizard as their running mates to help them steer America out of what could become a serious economic tailspin...

My fellow Americans: We are a country in debt and in decline — not terminal, not irreversible, but in decline. Our political system seems incapable of producing long-range answers to big problems or big opportunities. We are the ones who need a better-functioning democracy — more than the Iraqis and Afghans. We are the ones in need of nation-building. It is our political system that is not working...

We used to try harder and do better. After Sputnik, we came together as a nation and responded with a technology, infrastructure and education surge, notes Robert Hormats, vice chairman of Goldman Sachs International. After the 1973 oil crisis, we came together and made dramatic improvements in energy efficiency. After Social Security became imperiled in the early 1980s, we came together and fixed it for that moment. “But today,” added Hormats, “the political system seems incapable of producing a critical mass to support any kind of serious long-term reform.”..

We need nation-building at home, and we cannot wait another year to get started. Vote for the candidate who you think will do that best. Nothing else matters.

UCLA Anderson Forecast still says no recession

Claiming that he's still holding onto a "shaky view," Ed Leamer, Director of the UCLA Anderson Forecast says California and the U.S. will still avoid a technical recession (two consecutive quarters of negative growth) but that it still won't be an enjoyable time. From an L.A. Times story:

Under pressure from falling home values, high oil prices and rising unemployment, the economy in California and the nation will perform anemically in the coming months -- but there still won't be an actual recession, UCLA forecasters say.

"I am holding on to what is now a shaky view: no recession this year," said economist Edward Leamer, director of the quarterly UCLA Anderson Forecast, which is being released today.

The predictions, however, call for somewhat more pain in the months ahead than previously forecast, with little improvement this year or next.

Not good, but not a recession, which is commonly defined as two consecutive quarters of negative growth in gross domestic product...

The drag on the economy from the buckling housing industry may become the most severe since the Great Depression, the report said. There will be little or no growth in gross domestic product this quarter, and GDP will probably slip into negative territory in future months before finishing next year with a tepid average improvement of 1.2%.

A key factor in favor of the economy, the forecast says, is that so far the pounding of the housing market has not badly damaged the job market.

In the 1990s, Southern California home values fell after many workers -- particularly in the aerospace and defense industries -- lost their jobs and couldn't keep up mortgage payments. Foreclosures peaked in 1997, when employment already had recovered, because many homeowners had struggled for months to hang on.

"This time, what happens in housing stays in housing," Leamer said, as many employers worried about the economy hold off on new hires but decline to cut staff.

Many homeowners are choosing to sell their houses at a loss and move -- not because they lost their jobs, he said, but because they owe their lenders more money than their houses are worth.

Bailing out makes financial sense to them. "The lenders have provided an option to walk away if things go bad -- you might as well exercise that option," Leamer said.

Distress sales will continue to wreak havoc on home valuations for the rest of the year, the forecasters said...

"The unprecedented speed of the price adjustment means that instead of several years of slow bleeding [like the 1990s] we have compressed the necessary adjustment into two years of intense housing pain," wrote UCLA economist Ryan Ratcliff. "Mom always said it's better just to rip the Band-Aid off."...

Housing woes now impacting community banks

Local community banks have long been an important source of financing for various homebuilders from those building custom homes to subdivisions. And, although these banks shied away from the sub-prime mortgages that have been decimating large, national banks, the housing slowdown is increasingly impacting community banks as builders short on cash are defaulting on construction loans. From the L.A. Times:

Home-mortgage specialists may have been the first lenders to suffer for their roles in financing the housing bubble. But, as foreclosures rise and home prices fall, many smaller banks and thrifts that backed residential developers and home builders are watching black ink turn red and are spending uncomfortable amounts of time with regulators. The financial institutions also are enduring jabs from critics who say they tossed lending standards out the window...

Residential construction loans, which generate big fees, were especially profitable for smaller banks -- until housing collapsed in places like the Inland Empire, where prices are down more than 30% from their highs, and the Central Valley, where some former boom markets are off more than 40%. Raw land on which Ontario-based Empire Land installed roads, sewers and utilities, expecting to then sell it to builders, has declined even more.

"In the Inland Empire, we're hearing land is going for 20 or 30 cents on the dollar" of its appraised value when the loans were made, said RBC Capital Markets analyst Joe Morford.

According to data tracker Foresight Analytics of Oakland, 15.8% of single-family home construction loans were at least 30 days delinquent in Riverside and San Bernardino counties last quarter, up from just 1.7% a year earlier. The delinquency rate was 14.7% in Los Angeles County, 14.9% in Orange County and 15.4% in Ventura County. It was 30.4% in Merced County, near Sacramento...

Regulators are now aggressively requiring banks to write down the value of questionable loans and to raise more capital to make up for those write-offs. That creates a pinch for banks, one that is apparent in their regulatory filings.

Security Pacific Bancorp of West L.A. -- which resembles in name only the former L.A.-based banking giant acquired in 1992 by what is now Bank of America Corp. -- has written off millions in dud Inland Empire housing loans. In a recent order, the Federal Deposit Insurance Corp. and state regulators required Security Pacific, with $585 million in assets, to diversify its operations, cut off deadbeat clients and "determine that the lending staff has the expertise necessary to properly supervise construction loans."

Other Inland Empire-based construction loan specialists also are feeling the pain.

Corona-based Vineyard National Bancorp, with $2.3 billion in assets, lost $70 million in its last two quarters, and its stock is down 82% from a year ago. It has blamed inland housing loans, though it also specializes in another tricky business, financing builders of expensive custom homes in West L.A., the South Bay and coastal Orange County. Its executives declined to be interviewed...

Home builder troubles haunted even City National Corp. of Beverly Hills, the Southland's largest commercial bank with more than $15 billion in assets. City National avoided the riskier segments of home-mortgage lending and suffered none of the losses on mortgages and bonds backed by home loans that have plagued larger competitors.

But City National's clients have always included home builders, and the bank paid the price as losses on builder loans contributed to a 22% drop in first-quarter earnings. That was despite the fact that such loans made up only 5% of the company's $11.8-billion loan portfolio, and few of them were made in the Inland Empire or Central Valley, CEO Russell Goldsmith said.

How the housing bust was merely the symptom of a culture of debt

A few years ago, a friend with whom I grew up was talking about how most people we knew were in the same financial boat: middle class. Sure, some lived better than others, but we didn't hear much about the rich about the poor like we do today, and I've often chatted with my parents about the values they taught me and how they've changed over the years.

In his latest opinion piece for the New York Times, David Brooks puts in words what we were discussing: that the cultural change which should worry us is not related to Hollywood movies or rap music, but the simple seduction of debt, with the banks and credit card issuers being the drug dealers who made it happen:

The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth. For centuries, it remained industrious, ambitious and frugal.

Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. The country’s moral guardians are forever looking for decadence out of Hollywood and reality TV. But the most rampant decadence today is financial decadence, the trampling of decent norms about how to use and harness money.

Sixty-two scholars have signed on to a report by the Institute for American Values and other think tanks called, “For a New Thrift: Confronting the Debt Culture,” examining the results of all this. This may be damning with faint praise, but it’s one of the most important think-tank reports you’ll read this year.

The deterioration of financial mores has meant two things. First, it’s meant an explosion of debt that inhibits social mobility and ruins lives. Between 1989 and 2001, credit-card debt nearly tripled, soaring from $238 billion to $692 billion. By last year, it was up to $937 billion, the report said.

Second, the transformation has led to a stark financial polarization. On the one hand, there is what the report calls the investor class. It has tax-deferred savings plans, as well as an army of financial advisers. On the other hand, there is the lottery class, people with little access to 401(k)’s or financial planning but plenty of access to payday lenders, credit cards and lottery agents...

The agents of destruction are many. State governments have played a role. They aggressively hawk their lottery products, which some people call a tax on stupidity. Twenty percent of Americans are frequent players, spending about $60 billion a year. The spending is starkly regressive. A household with income under $13,000 spends, on average, $645 a year on lottery tickets, about 9 percent of all income. Aside from the financial toll, the moral toll is comprehensive. Here is the government, the guardian of order, telling people that they don’t have to work to build for the future. They can strike it rich for nothing.

Payday lenders have also played a role. They seductively offer fast cash — at absurd interest rates — to 15 million people every month.

Credit card companies have played a role. Instead of targeting the financially astute, who pay off their debts, they’ve found that they can make money off the young and vulnerable. Fifty-six percent of students in their final year of college carry four or more credit cards.

Congress and the White House have played a role. The nation’s leaders have always had an incentive to shove costs for current promises onto the backs of future generations. It’s only now become respectable to do so.

Wall Street has played a role. Bill Gates built a socially useful product to make his fortune. But what message do the compensation packages that hedge fund managers get send across the country?..

Foundations and churches could issue short-term loans to cut into the payday lenders’ business. Public and private programs could give the poor and middle class access to financial planners. Usury laws could be enforced and strengthened. Colleges could reduce credit card advertising on campus. KidSave accounts would encourage savings from a young age. The tax code should tax consumption, not income, and in the meantime, it should do more to encourage savings up and down the income ladder.

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

Do builders need to re-learn PR 101?

A couple of months ago, I had what I thought was a great idea for a story for the real estate section of the Los Angeles Times: helping their readers negotiate the maze of builder incentives being offered at new home communities including upgrades at design centers, payment of closing costs, interest rate buy-downs or even pricing discounts. There's even a website, BuilderIncentives.com, that helps consumers pick their homes based on incentives (not a great idea, in my opinion, since that could mean buyers buy a home they hate but loved the incentive).

Having written a few book reviews and articles for the paper since January, the Times editor was already comfortable with my writing style and agreed that my background in the building industry would be an asset. She even assigned me a homebuyer to interview, who had recently used incentives to buy two new homes at communities in Orange County built by two large builders in Southern California.

"Great!" I thought. "Good, solid companies -- they'll love the chance to tell their side to someone from the industry who wants to write a balanced article."

The buyer told me his story (which ultimately turned out to be positive since he got what he wanted), and afterwards I contacted both homebuilders to comment, thinking I'd get to someone right away or at least a return phone call within a day or two.

I told them that if the story, once published, is re-purposed to other Tribune-owned properties such as the Chicago Tribune, Baltimore Sun and Newsday, that the story could ultimately be seen by up to 3.5 million readers, so this would be a great opportunity for them to explain to potential buyers how and why they use incentives, including sometimes tying incentives to using in-house lenders, how they figure out the total value of a home, what kind of mark-ups are typical at a design center, how a buyer's agent can participate in the process and get a commission, if the incentives make a new home a better deal than a resale, etc. -- in other words, all the things that I'd want to know when shopping for a new home and what questions to ask.

And what have they said so far?

NOTHING.

First, I got shuffled to one person, and then another, and then another. I'm still waiting for a call from a Division President -- perhaps he's busy, but c'mon, THAT busy?

So far, no returned phone calls, no returned emails, and I've been going at this for two weeks.

I can't imagine ever just ignoring a phone call from a reporter for a major daily or a business publication -- while giving a speech a couple of weeks ago, I forgot to shut my cellphone off, and it was a reporter from the Financial Times asking about -- surprise -- builder incentives, and I called him back as soon as I was done. Even if I can't answer the question, I still return the call in order to build the relationship so they'll call me in the future and view me as a reliable source.

My editor says builders are notoriously difficult about commenting to the press about anything (something that's been verified by reporters at other papers). That, of course, reminded me of the PR debacles of WorldCom and Enron, when refusing to comment ultimately meant that they were hiding something, such as billions in write-downs and falsified revenue statements.

While that's certainly not the case for this story, it does beg a question: do builders need to re-learn PR 101? Many of them hire PR agencies on retainer -- but isn't that simply wasted money if they ignore opportunities such as this? I feel sorry for PR people who are ordered to ignore phone calls, because I'm sure that's not what they thought their days would be like when they chose the vocation.

So, until I hear back from either of these large builders, the next time one complains to me about media coverage of new home sales, I think I'm going to tell them this story and ask them to consider just much of the PR damage has been self-inflicted due to simple lapses of common sense -- you know, the same kind that led to purchases of hyper-inflated land.

If I do hear back from either of them soon, I thank them in advance for helping me to write a well-rounded article. Either way, look for it to be published on Sunday, July 6th!

Why walking away hurts everyone else, too

A recent story in the Wall Street Journal profiles a woman who intends to buy a new home and then stop making payments on her old one, forcing it into foreclosure. She's taking advantage of an underwriting loophole that allows her to tap 75% of what she expects to get in rent to qualify for the new home. But now, with this type of mortgage fraud rising -- which is what it is -- FNMA is changing their guidelines, forcing borrowers to prove they can make both payments in order to clamp down on this most unethical of behaviors.

So why does this hurt everyone else? Because one of the best ways to slowly add new properties to a real estate portfolio is to (a) buy a home; (b) rent it out; and (c) use the rent to qualify for a new home while keeping the second as an income property. How do I know? Because I've done this before, and had intended to continue doing so as long as the investments cash flow.

But now, because of people like Michelle Augustine of Sacramento, that plan could now be history, and many others will be paying the price of her own -- and others whose brains misfire like hers -- poor planning and selfishness. I think people like her -- and her enablers in the real estate industry -- belong in jail, so I really hope that the DA for her county prosecutes her -- and her agent Linda Caoili -- for mortgage fraud. If he/she doesn't, what's the point of having a DA in the first place? What's the point of having a Department of Real Estate that is supposed to regulate such behavior? From the story:

Next month, Michelle Augustine plans to walk away from her four-bedroom house in a Sacramento, Calif., subdivision and let the property fall into foreclosure. But before doing so, she hopes to lock in the purchase of another home nearby.

"I can find the same exact house as what I live in right now for half the price," says Ms. Augustine, 44 years old, who runs a child-care service out of her home. She says she soon will be unable to afford her monthly payments, which will jump to $4,000 from $3,300 in August, and she doesn't want to continue to own a home that is now worth $200,000 less than what she paid for it two years ago.

In markets hit hardest by falling home prices and rising foreclosures, lenders and brokers are discovering a new phenomenon: the "buy and bail," in which borrowers with good credit buy a new home -- often at a much lower price -- then bail out of the "upside down" mortgage on their first home.

Homeowners are able to pull off this gambit -- which some lenders and real-estate agents call mortgage fraud -- by taking advantage of mortgage-lending practices that allow them to buy a new primary residence before their existing residence has been sold. And with the lending industry in disarray as it tries to restructure millions of mortgages, some boast they are able to pull off the strategy with ease.

In some cases, homeowners are coached through the buy-and-bail process by real-estate agents and brokers who see nothing wrong with it. Some blame the phenomenon in part on lenders' unwillingness to cut deals or restructure loans made when home prices were inflated. "It's just a business decision," says Linda Caoili, a Sacramento real-estate agent who is working with Ms. Augustine and others who are considering walking away from their mortgages. "If you're upside-down $250,000, why would you keep it? It just doesn't make sense."...

While buy-and-bail is on the rise, the practice doesn't appear to be widespread. Credit is much tighter now than it was during the real-estate boom, and most families with an upside-down mortgage likely will hold on to their homes and hope the market improves in the future -- even though many of them could lose their properties.

Still, with home prices falling rapidly in some parts of the country, a growing number of frustrated consumers are willing to take the risk -- especially in so-called nondeficiency states such as California and Arizona, where it is more difficult for a lender to sue consumers who walk away from their mortgages. Borrowers who bought or refinanced their home with a personal line of credit, however, instead of a home-purchase loan -- a common practice during the housing boom -- could be sued by a lender in those states. Borrowers also could be on the hook if lenders can show that homeowners committed fraud by misrepresenting themselves on their loan application.

Yet even in cases in which a lender could attach a lien on the new home, some homeowners simply assume that lenders are too swamped. "So many people are foreclosing, is it cost effective for lenders to go after all of these people?" says Steve Hawks, a Las Vegas real-estate agent who handles lender-owned properties...

Ms. Augustine, the Sacramento day-care provider, became a first-time homeowner in November 2006 by taking out two loans with nothing down to cover the $426,000 home purchase. With her home valued at about $220,000 now, she is actively looking in nearby communities for another one to buy before the bank forecloses on her current home.

The mortgage industry is starting to wise up to the practice and is scrambling to fight back. Buy-and-bail is "certainly fraudulent and unfortunately on an uptick," says Gwen Muse-Evans, vice president for credit policy and controls at Fannie Mae. Although she doesn't have data to quantify the size and scope of the trend, Ms. Muse-Evans says overwhelming anecdotal reports have prompted the agency to draft tougher regulations aimed at closing one big loophole that allows underwater homeowners to qualify for new home loans.

That loophole currently works like this: Homeowners provide a rental agreement showing that they will rent out their first home, and underwriters allow rental income to cover as much as 75% of the mortgage payments on the first home when determining whether the borrower can make payments on two homes. This allows homeowners to secure a second mortgage that they might not otherwise afford.

Under revised Fannie Mae guidelines, which could take effect next week, loan applicants who claim they will rent out their first home will have to produce supporting evidence, including an executed lease agreement. Borrowers also will have to prove that they can pay the mortgage, property taxes and insurance for both residences. The guidelines will make an exception only for borrowers who have at least 30% equity in their current home...

Some private lenders aren't waiting for Fannie's lead. In April, underwriters handling bank-owned properties at IndyMac Bancorp Inc. told brokers they would require borrowers purchasing new homes while retaining their existing home as a rental to prove that they could make full payments on both homes to qualify for a loan. A memo sent to a Southern California broker said the policy change was prompted by "losses from individuals walking away from properties after the acquisition of a new home."...

Meanwhile, Mr. Hawks, the Las Vegas broker, says he receives one to two dozen inquiries every week from individuals inquiring about a buy-and-bail. "People are starting to ask how much their good credit is worth," particularly when their home is underwater by hundreds of thousands of dollars.

The tactic doesn't appeal to people such as John Ristuccia, a 48-year-old Buckeye, Ariz., paper-company sales director whose job was moved to Houston in August. He is trying to complete a "short sale" for $425,000 on his five-bedroom, 4,000-square-foot home, which was appraised for $800,000 last year. In a short sale, a lender allows the sale of property for less than the amount due on the outstanding loan and often forgives the remaining debt.

Even though he might be able to qualify for a second home loan, Mr. Ristuccia says he wouldn't consider sticking his bank with his suburban Phoenix property. "Just personally I've got a problem with that," he says. "I really can't put it in terms other than it feels wrong."

It's too bad that Mr. Ristuccia is such a rare person in the U.S. these days -- someone with a working conscience.

Option ARMs expected to unleash the next wave of defaults

At first glance, the Option ARM loan seems like a great product, but only if it's used responsibly. In the past, it was tapped by astute borrowers who had a varied income (such as salespeople and the self-employed), who could elect to pay a minimum amount during some months (like on a credit card) but then make up for the shortfall when more money was available. What it wasn't intended for was as a gambit in which borrowers pay only the minimal amount and hope to refinance as housing prices rose (as least not officially). But brokers really pushed these loans, as they paid far higher commission than the traditional 30-year fixed variety.

According to an article in Business Week, the the next housing crisis -- and wave of foreclosures to hit the market -- will be the result of Option ARMs re-setting, either as the result of higher interest rates or because the borrower, through negative amortization, has added so much to the loan balance that it's triggered a re-set to a fully amortizing loan:

With the subprime mortgage crisis already crippling the U.S. economy, some experts are warning that the next wave of foreclosures will begin accelerating in April, 2009. What that means is that hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset. About a million borrowers have option ARMs, but only a fraction have already fallen due.

That was the catch to option ARMs; borrowers were offered low initial payments that would recast higher after several years. Many home buyers thought they could resell their homes before their payments increased. But instead, many of them got trapped. According to Credit Suisse (CS), monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010. Some of these loans have already started to recast. About 13% of option ARMs that were issued in 2006 were delinquent by 60 days by the time they were 18 months old, Credit Suisse said...

Among the states expected to be worst-hit is already battered California. Today, outstanding option ARM loans in the U.S. total about $500 billion, about 60% of which were sold to California homeowners, according to Credit Suisse. Option ARMs were especially popular in the state, where they were heavily marketed during the boom by such companies as Countrywide Financial (CFC) in Calabasas, Calif.; Washington Mutual (WM) in Seattle; and Wachovia (WB) in Charlotte, N.C. Moreover, on top of their ARMs, many homeowners also refinanced their homes, driving themselves even deeper into a debt they thought they could escape by flipping their homes.

But California won't be alone. Homeowners are also frighteningly vulnerable in states such as Arizona, Florida, New Jersey, and others...

The option ARM loan defaults could accelerate next year even if subprime defaults subside, said Chandrajit Bhattacharya, vice-president and mortgage strategist at Credit Suisse Securities. He said California will see the bulk of the option ARM foreclosures and the rest will be spread out across the country...

Option ARMs, which were originally designed for self-employed people with fluctuating incomes, gained popularity with other workers during the peak of the real estate boom in 2004, when rapidly rising home values would have otherwise kept many buyers out of the market.

The loans, which were generally given to borrowers with better-than-subprime credit, give homeowners the option of making a minimum monthly payment, which covers none of the principal and only a portion of the interest, the rest of which is added to the loan balance. With years of unpaid interest accumulating and house prices falling, some homeowners have seen their equity disappear and now owe even more than their initial loan balance.

The loans automatically recast after five years, but many will recast sooner as loan balances hit specific principal caps—typically between 110% and 125% of the initial loan amount. Many of these loans are expected to recast within the next two years, meaning that borrowers' monthly payments will swell to include both principal and interest...

William Purdy, a lawyer at Simmons & Purdy in Soquel, Calif., a firm that specializes in home refinance issues, said some borrowers with option ARMs are defaulting before the loans recast because they couldn't afford even marginal increases in the minimum payments.

"It's a ticking time bomb inside your house that you can't get rid of," Purdy said. "They can try to slow down the inevitable, but sooner or later their loan is going to cap. …This year is going to be a blood bath. Next year, we'll start out just about the same."...

But options are available—even if refinancing isn't possible. Lenders have been working with borrowers to reduce loan amounts and interest rates and, in some cases, simply accept the deed in lieu of foreclosure.

The Mortgage Bankers Assn. says it appears that a growing number of homeowners are avoiding foreclosure by getting help from the Hope Now hotline (888 995-HOPE), a mortgage-counseling phone line backed by lenders and the federal government that gets 4,000 calls a day. Hotline counselors help borrowers negotiate with banks and offer advice on refinancing options. Even though foreclosure rates are rising in California and Florida, they've slowed elsewhere, the bankers association said.

Some callers to the hotline have complained about long wait times, but the group says it has beefed up its counseling staff and now gets to calls quickly.

Other option ARM borrowers could benefit from government plans now in the works. A bill approved by the House in May would allow the Federal Housing Administration to guarantee up to $300 billion in new loans to help homeowners facing foreclosure. Borrowers could get more affordable loans worth no more than 90% of the home's value, meaning that participating lenders would have to take a significant loss on the loan. The bill was sponsored by House Financial Services Committee Chairman Barney Frank (D-Mass.). Senate Banking Chairman Christopher Dodd (D-Conn.) has a similar measure....

Many California homeowners, including some with $2 million homes, are simply making their minimum payment, waiting for the recast. Then they plan to walk away, even if it damages their credit, Bedard said.

Lenders finally slashing prices, creating new bidding wars

After months of denying reality, lenders are finally slashing prices to the point that buyers are interested in buying -- in fact, interest has risen to the point that there are now bidding wars for some of these properties. Could that bring the end of the housing bust faster? From an AP story via MSNBC.com:

Lenders stung by the housing bust are slashing prices dramatically to rid themselves of an unprecedented number of foreclosed properties, sparking bidding wars in some places that harken back to the market's go-go years and may signal the bottom is near.

The trend is most dramatic in many parts of California, Florida, Nevada and Arizona, where prices skyrocketed during the housing boom and are now falling precipitously. Sales of foreclosures, vacant new homes and other distressed properties now dominate some markets, causing grief for individual homeowners who need to sell for other reasons, like a job in a new city.

Nationwide, one out of every four sales between January and March was a distressed sale, and that figure jumps to more than 50 percent in the hardest-hit areas like Las Vegas, Detroit and distant suburbs of Los Angeles, said Mark Zandi, chief economist at Moody's Economy.com. The number can be as high as 90 percent in some newly built subdivisions, where loose lending standards and speculation ran rampant, real estate agents say...

By setting prices at extraordinarily low levels, say, $175,000 for a house that sold for $350,000 three years ago, banks can spark multiple offers.

"It's not uncommon to have 10 to 20 offers on one house, and for the house to end up selling for more than its market price," said Erin Attardi, a Sacramento Realtor. The strategy, she said, allows the bank to be selective, picking buyers with solid financing or those able to pay in cash...

Investor demand could be swamped by the foreclosures expected to hit the market over the next year.

A record of almost 3 million American homeowners were at least one month late on their mortgages in the first quarter, the Mortgage Bankers Association said Thursday. And another record of almost 450,000 had entered the final stage of foreclosure...

Some in the real estate industry see such competition as a sign that the housing market's gloom is lifting...

For real estate agents, helping banks sell off properties is one of the only flourishing businesses these days. But it's not for everybody.

Agents can easily pay hundreds of dollars a month on upkeep — including utility bills, cleaning and lawn care — and must go through the hassle of getting reimbursed by the bank. They sometimes have to evict homeowners, tenants or squatters. And in many cases, they have to deal with vandalism or theft of everything from copper pipes to appliances and air conditioners.

Jeff Dolfinger, a broker in Poughkeepsie N.Y., who specializes in managing and selling foreclosed properties, estimates that about 90 percent of those homes in his market are being bought by investors.

"To them, this is the best real estate market ever," he said. "They'll wait for this turmoil to end and they'll put the properties right back on the market again"...

A quick way for a lender to dispose of properties is through an auction. However, lenders lose an average of 56 percent of a property's value through auctions, compared with a 40 percent loss for ordinary sales, according to a report last month by Fitch Ratings.

Nevertheless, the report found that the use of auctions has been rising as lenders try to cope with rising inventory.

Some are more hesitant to cut prices. Chris Bowden, vice president of HomeSteps, a division of Freddie Mac that handles foreclosure sales, says being too aggressive on price can affect the value of nearby properties, which sometimes are also owned by Freddie Mac.

Bargain hunters help push up pending sales index

It looks like prices have dropped enough in certain markets that bargain hunters are re-emerging, raising pending sales during April by 6.3% from the previous month. In the West, the news is even better: pending sales up by 8.3% from March and by 4.0% from April of 2007. From a Wall Street Journal story:

A forecasting gauge of home sales climbed to its highest level in six months during April, given a lift by bargain hunters.

The National Association of Realtors' index for pending sales of previously owned homes rose 6.3% to 88.2 from March, the industry group said Monday...

Lawrence Yun, NAR chief economist, said pending sales contracts picked up in areas where housing prices have dropped significantly.

"Bargain hunters have entered the market en masse, especially in areas that have experienced double-digit price declines, but it's unclear if they are investors or owner-occupants," he said.

In its monthly forecast on the industry, the NAR projected existing-home sales at 5.40 million this year and 5.74 million in 2009. That compares with 5.65 million in 2007.

The median price for an existing home is seen at $205,000 in 2008 and $213,900 in 2009. It was $218,900 in 2007.

A month ago, the NAR forecast 2008 sales at 5.39 million and 2009 sales at 5.72 million. The 2008 median price was projected at $213,700 and the 2009 price at $222,600.

The NAR pending sales index, based on signed contracts for previously owned homes, was 13.1% below the level of 101.5 in April 2007...

By region, pending sales in the Northeast decreased 1.9% in April from March; they had fallen 12.2% since April 2007. The Midwest rose 13.0% in April from March; it had dropped 13.1% since April 2007. The South increased 4.6% in April from March; it had fallen 22.5% since April 2007. The West increased 8.3% in April from March; it has gone up 4.0% since April 2007.

Banks about to face the real estate music

According to a story in the Wall Street Journal, the second phase of financial pain from the real estate bust is about to begin: whereas phase one was focused on the 'demand' side (i.e., homebuyers & mortgages), phase two will be centered on the 'supply' side (i.e., banks forced to mark their real estate collateral to current pricing). As Ivy Zelman concludes, "...this period of procrastination is nearly over."

Federal regulators warned Thursday that banking-industry turmoil would continue as financial institutions come to terms with piles of bad loans they made to finance the construction of homes and condominiums.

Until now, most of the damage to banks from the housing crisis has come from homeowners defaulting on their mortgages. But amid a dismal spring sales season for new homes, loans to home and condo builders are looking increasingly shaky. Banks have begun to dump them at what will likely be steep discounts, setting the stage for billions of dollars in fresh losses...

The surprisingly gloomy outlook is at odds with the sentiment of investors, who appear to have moved on from worrying about the health of the financial system to obsessing about gasoline prices and consumer spending. The Dow Jones Industrial Average rose 213.97 points, or 1.7%, on Thursday on the back of surprisingly strong retail-sales data.

The health of the economy is heavily dependent on the willingness of banks and other financial institutions to lend to consumers and businesses. Many banks have already taken substantial losses, and either will have to pare their lending or raise new capital to rebuild their safety nets. The Federal Reserve and Treasury Department have been pressing banks to raise capital so as not to further reduce lending.

Banks with swelling portfolios of troubled loans tied to land and housing are struggling to unload some of their real-estate debt. IndyMac Bancorp Inc., a Pasadena, Calif., lender, is trying to sell $540 million in loans made to finance land purchases and housing construction projects. Winning bids on many of the loans were, on average, about 60 cents on the dollar, according to people familiar with the matter. But some winning bids were only about 20 cents on the dollar...

The sales are a response to a growing problem: Home builders are falling behind on loan payments, and the value of the land and housing developments that serve as loan collateral is plummeting. Over the next five years, U.S. banks could "charge off" as bad debt between 10% and 26% of their loans tied to residential construction and land assets, which would amount to about $65 billion to $165 billion, according to a report sent to clients Thursday by housing research firm Zelman & Associates. That compares with charge-offs of about 10% of construction-related bank assets, totaling $31.6 billion, when adjusted for inflation, during the last housing downturn in the late 1980s and early 1990s. In 2007 and the first quarter of this year, banks wrote down just 0.7% of such assets, according to Zelman...

The prospect of a new wave of losses worries federal regulators, given the large proportion of loans to housing developers held by many banks and thrifts. The problems are worse at small banks that can't easily absorb losses, and at banks with big exposure in states hit hard by the housing crisis. Banks in Arizona have 36% of their total loans tied to construction and development. In Georgia that number is 34%, and in North Carolina it's 28%. Zelman said construction and development loans, as a percentage of total loans, are at their highest levels since at least 1975.

IndyMac is trying to sell debt backed by a grab bag of assets, including partially built subdivisions, condo buildings and large parcels of raw land covered in sagebrush in parts of California, where the housing crisis is acute, according to people familiar with the offering.

Selling real-estate loans could help larger lenders like IndyMac shore up their balance sheets. But such sales, by setting a market value for distressed real-estate loans, could trigger problems at smaller banks with real-estate exposure, which might have a difficult time absorbing such losses...

Real-estate lenders had been hoping for a decent spring sales season for new homes, which would have helped builders stay current on their loans. But the selling season has been a bust. The rate of foreclosures on homeowners hit a record, as did the rate at which they fell behind on their mortgage payments. In the first quarter, 6.35% of mortgages were at least 30 days delinquent, not including those already in foreclosure, a rise of 1.51 percentage points from the year-earlier period.

"We've seen a real change in the market," says Ricardo Chance, a managing director at KPMG Corporate Finance LLC, who is helping troubled builders restructure their businesses. "Finally the banks are capitulating and saying, 'Let's mark to market and flush this all out.' The market is going to get worse. We don't want to hold on to this stuff."

Richmond American (MDC Holdings) claims to be positioned well for recovery

Building as Richmond American Homes, MDC Holdings reported at the J.P. Morgan third annual Basics and Industrials Conference in New York that it's positioned itself well for an eventual rebound in the housing market:

M.D.C. builds homes as Richmond American and also runs a mortgage finance company (HomeAmerican) and a company to supply escrow services, title insurance, and homeowners insurance (American Home). Reece, who is scheduled to step down at the end of June after 18 years with the company, told analysts and investors at the J.P. Morgan third annual Basics and Industrials Conference in New York that M.D.C. has maintained a strong cash position and a relatively short land position through the current downturn, while aggressively cutting general expenses by shrinking its employee head count from more than 4,000 to around 1,800...

Keeping a handle on land commitments is a primary focus of that effort, said Reece. From a high of 300 active communities, said Reece, M.D.C is now down to just 260 active communities in 13 states and has kept its land investments lean, helping to rein in the kind of impairment charges that have plagued many builders in the current downturn.

"We consider land as a raw material in our home building process," explained Reece. "So we like to buy it like a raw material. We buy it just in time, as much as we can." The cautious approach to land acquisition is a key reason for the strong condition of the company's balance sheet presently, said Reece: "We try to keep our land supply very low. We have a rule of keeping our land at about a two-year supply-not only broadly speaking as a company, but when we look at individual divisions or even individual communities. We like to, from the first closing to the last, be in and out in two years or less."

The company has bought very little land since 2005, he reported, and all land purchases-even individual lot take-downs-go through a rigorous process of management review. The roughly 10,000 lots the company currently owns, he said, are mostly fully developed and don't represent a future expense for developing before building can happen...

On the operating side, Reece emphasized several strategies, including a sales effort focused around the company's innovative "Home Gallery," which allows potential buyers to customize units to their personal preferences and a push for a high-quality "customer experience," in which community manager bonuses are tied to third-party rating surveys of customer satisfaction. In addition, said Reece, the company is working to "un-bundle" labor and materials costs in order to gain more control over home construction costs.

And with land and inventory issues under firm control, Reece argued, Richmond American is well poised to concentrate on those production values, without the distraction of overcoming balance-sheet difficulties.

Robert Toll speaketh again

You do have to hand it to Toll Bros. CEO Robert Toll: he does like to speak his mind. Perhaps it's because he's not a hired hand to lead just another public company, but helped build the company from the ground up and so has seen his share of peaks and troughs. In his latest remarks -- made a day after reporting a less-than-expected loss for the second quarter -- Mr. Toll insists we're in a housing 'depression' that could last another couple of years:

The chief executive of Toll Brothers Inc., the nation's largest luxury-home builder, said Wednesday the housing industry is in a "depression" and any recovery could be two or three years away.

In candid remarks at the JPMorgan Basics & Industrials Conference a day after reporting a second-quarter loss, Robert Toll said he's not ready to call a bottom yet since the housing market could still get worse.

"Can the market go down another 10 or 20 percent? Sure," said Toll, whose Horsham-based company will sit on cash unless a bargain land deal comes along.

He said the current housing crisis is the worst he's seen since the mid-1970s, but back then the decline was relatively short-lived. The current downturn started in late 2005...

Buyers' lack of confidence that home prices will stop sliding is what's keeping them out of the market, rather than lack of access to credit, he said.

He said the underpinnings for a healthy housing market are still in place: low interest rates, a low jobless rate, increases in population and accumulation of wealth. Moreover, home prices have fallen to levels seen around 2002 and 2003, making them more attractive to buyers.

When the market recovers, home prices will march right back up, Toll said.

In the meantime, builders face another headwind as the cost of materials rises -- and there aren't a lot that can still be cut.

"Labor has gone along with us and squeezed themselves to the bone," Toll said.

As for materials, he added, "there's a whole bunch of them that's oil based ... I see costs going up from here. So we're caught in a squeeze. Certainly, our clients aren't going to pay more money because our costs our going up."

Banks costing themselves (and shareholders) more money by delaying short sales

According to an article at CNNMoney.com, lenders which delay responding to short sale requests are costing themselves much more as homes needlessly go into foreclosure:

Banks say they want to help troubled homeowners, but they are delaying deals that could save everyone - including the lenders themselves - a lot of time and money.

Lenders are taking much longer than necessary to approve short sales, according to Duane LeGate, of House Buyers Network, a short sale specialist...

Ideally in a short sale, everyone wins. Borrowers avoid the ugly foreclosure process that destroys their credit, while lenders recoup more of their costs than they would by spending the time and money it takes to kick an owner out and resell the property.

Lenders typically lose about 19% of a mortgage's value in a short sale, according to Clayton Holdings, a Conn.-based, provider of loan analytics, while they lose an average of 40% on loans that go into foreclosure.

Coldwell Banker CEO Jim Gillespie agrees that short sales are taking too long to complete. And he speaks from firsthand experience; a short-sale offer he made on a house in Marin County, Calif. in late fall didn't win approval until April...

The difficulty in getting short sales approved stems from the same hurdles facing all the other foreclosure prevention efforts. The fact that the majority of mortgages are pooled and securitized makes it hard to get approval to change the terms of the mortgages.

"It has to do with who owns the loan," said LeGate. "If a mortgage is stuck in a pool somewhere, when something goes wrong, no one knows who the actual owner of the note is."

Additionally, the volume of troubled borrowers makes it hard for lenders to keep up. The housing crisis has put an enormous burden on mortgage servicers, the companies that manage loans for securities investors.

At many servicers, said LeGate, "There's no one really skilled at loss mitigation, and these guys have more work than they were prepared to do."

And with foreclosure filings breaking new records each month, there's no sign that this problem will ease any time soon.

Translation: we still need actual some leadership on this issue.

Slight uptick in new home sales for April

The Commerce Department stats for new home sales during April have been released, and are showing a slight uptick in activity - 3.3% -- although they're still down by 42% from April of 2007 (see previous post about the latest numbers from the Case-Shiller index). From a New York Times story:

A government report released Tuesday showed that sales of new single-family homes rose 3.3 percent in April but were down 42 percent from a year ago...

sales of newly constructed single-family homes rose 3.3 percent in April to a 526,000 annual rate but they were down 42 percent from a year ago, which was the largest year-over-year drop in nearly 27 years, government data on Tuesday showed.

The Commerce Department estimate showed the first increase in new home sales since October, but the increase came after a big downward revision to the previous month.

Economists polled by Reuters were expecting new home sales to slip to a rate of 520,000. The department revised down its March estimate to a rate of 509,000 from 526,000, or a 11.0 percent decrease from a first-reported 8.5 percent decline.

The inventory of homes available for sale in April fell 2.4 percent to 456,000, which was the 12th straight monthly decline. The April sales pace put the supply of homes available for sale at 10.6 month’s worth.

As always, expect revisions to this government data next month, as the Commerce Department polls less than 5% of permit-issuing places nationally and then calls builders to see if the homes they've built have sold.

Case-Shiller index shows steep pricing decline

The S&P/Case-Shiller index for March 2008 is out, and shows a 14% pricing decline for the 20-city index during the first quarter of 2008 versus 2007. From an L.A. Times story:

U.S. home prices continued to fall at a record pace through March, according to a major indicator released today. The Standard & Poor's/Case-Shiller U.S. national home price index fell 14.1% in the first three months of 2008 compared with the same period a year earlier. The decline was the largest in 20 years for the index, which covers all U.S. Census divisions... The index showed an even sharper drop in Los Angeles and Orange County, where March prices fell 21.7% from a year earlier. Las Vegas showed the biggest year-over-year drop in March (down 25.9%), followed by Miami (24.6%) and Phoenix (23%). Charlotte, N.C., was the only city among the 20 to record a March price increase, 0.8%... More bleak housing news came today from the U.S. Commerce Department, which reported that April home sales were down 42% from the same month a year earlier. The traditional March-to-April bounce in home sales was also much smaller than in previous years. April sales were up 3.3% from March this year. In 2007, sales rose 10% from March to April.