The Unacceptable Face of Capitalism

Yesterday, I received an email from Mick Pattinson, a longtime builder and founder of the Building Industry Coalition for Economic Recovery. Mick was one of the first home building executives I met when I started working in the building industry, and as President of Barratt American, he was also a prominent voice for the industry through local, state and national BIA groups.

While the email itself was a reminder of a special seminar this week at the Pacific Coast Builders Conference (PCBC) entitled Surviving Lender Action, as well as a summary of a recent lawsuit against lenders who had pulled promised funding immediately prior to the real estate crash, it was his commentary entitled "The Unacceptable Face of Capitalism" that I found compelling. I asked and received permission to reprint that commentary here on this blog:

THE UNACCEPTABLE FACE OF CAPITALISM, by Mick Pattinson

What happened to Wall Street?

Before Congress and the eyes of the world the executives of financial giant Goldman Sachs admitted that they bet against America. They created financial instruments that they compared with manure so that they and their clients could place big bets on mortgages and housing. For the winners there were fortunes to be made, even if our financial system was taken to the point of destruction and our children handed a debt burden of unimaginable proportions.

In his latest best seller "The Big Short" author Michael Lewis tells the stories of others who made the same bet against subprime and the financial institutions who pedaled them. Savvy investors who from their insider's vantage point could predict the end game. They forecast the mass of foreclosures across the country, the broken dreams and busted businesses. They saw the evaporation of life savings and the arrival of massive unemployment. They knew we faced a financial Armageddon and they placed their bets in the Wall Street casino. Big bets that paid off when the misery index was at its maximum and our financial institutions were forced to beg for a bail out to save our financial system.

This is the unacceptable face of capitalism. Power brokers who were supposed to generate the capital to drive the American economy are instead creating financial instruments of mass destruction. Worthless mortgages given triple A ratings because the big financial houses paid the agencies to do it. As simple as that. A rigged game if ever there was one.

With all of our regulatory agencies asleep at the switch or outsmarted by the slick operators of Wall Street, the law abiding citizens of the country were left defenseless. None more than America's homebuilders. Big Builder magazine recently predicted that 80% to 90% of the nation's private home builders will close their doors before the recovery arrives. A recovery that still appears to be a long way off.

One of the great mysteries for builders has been the failure of banks to conduct "workouts" during this recession. Unlike previous downturns when lender and borrower would come together to solve problems and mitigate the damage this time lenders have just rushed for the exit door. This time co-operation and patience has been replaced with arrogance and litigation.

Today's hearings and media revelations are filling in the blanks and giving us the "rest of the story". The events leading up to the great bank bailout of 2008 are very revealing to America's home builders. Why did profitable and solvent builders suddenly lose their funding? Why were projects suddenly being appraised and re-appraised until the lender got the number he was looking for? Why were performing loans torpedoed for no apparent reason? Why were builders the victims of "contrived defaults"?

We can now see the scale of the catastrophe created on Wall Street and what it meant for our industry. A trillion dollars lost on the subprime fiasco and the total undermining of housing markets all over the country. Do we need bank reform? Of course we do, but streamlined and efficient regulatory oversight is more important.

It doesn't end there. While the citizens of America have suffered mightily the culprits have not. Most of those responsible for this national nightmare are still in the positions they held, while others have left with big pay offs. This too is the unacceptable face of capitalism.

We can only hope that the hearings now underway in Washington D.C. as well as the work of investigative journalists and authors will generate the charges that justice demands. This November the politicians will feel the countries anger at the polls but that will not be enough. Those who put their personal greed ahead of the national interest need to pay a price as well.

As for the rest of that email, here it is:

PCBC

As a reminder, our Surviving Lender Action Seminar is scheduled for the Pacific Coast Builder's Conference this Wed, June 9th from 9:00-11:00am in Moscone Center Mezzanine room 228, San Francisco. There is no fee to see this seminar. Again, this seminar is designed to help builders and other privately held industry related businesses survive the current liquidity crisis. Discussion will include damage assessment through the reappraisal process, exhaustion of cash, discontinuation of funding, and subsequent loan default. The emphasis of the program will be a detailed discussion of prejudgment remedies and lender liability, and life after chapter 11 & chapter 7. Speakers include workout specialists, attorneys and accountants who are very current and experienced with these topics and have helped guide dozens of companies through difficult situations.

Lawsuits

A bankrupt arm of Sacramento's New Faze Development filed a $10 million lawsuit Monday against banks in Dixon and Stockton alleging that they cut off promised funds to a key housing project just as the real estate crash began.

Read more: http://www.sacbee.com/2010/04/13/2674007/builder-sues-two-banks-for-10.html#ixzz0l5tHSyra

More importantly, we would like to hear of any successes of lawsuits filed against any lenders who forced a default in spite of promises made to the borrower.

Please share with us if you hear of any so we can spread the word.

Banks foreclosing even on builders who never missed a payment

Imagine buying a new car for 10% down and a 5-year loan. As soon as you drive it off the lot, it immediately loses up to 25% of its value, which could technically mean that the value of the asset -- the car -- is worth less than the loan. Now let's say the bank is low on capital and, even though you've made all the payments on time, sends the repo man out (perhaps captured on a reality TV show) to grab your car in the middle of the night to re-sell because they'd rather get 75% of what they lent you now rather than risk the thought that you'd stop making your payments. Only they don't sell the car -- they just let it sit there and rust until its value plummets to almost nothing.

Sound far-fetched and unfair? Couldn't happen to you? Well, it is happening to private builders across the country, whose projects are being foreclosed upon even when they've never made a late payment. In fact, some builders contend that lenders encourage them to keep paying so they'll have nothing left for legal fees to fight the now-inevitable foreclosures. Expect some very nasty legal battles in the very near future about this.

So how is this good for the real estate industry, the country, or U.S. taxpayers? It isn't. It's due to bankers now under intense pressure from regulators to do something about real estate-related loans, even if building out a project could net more to them, the federal government, and ultimately, you. This is no longer about punishing greedy builders who over-built during the boom years. This is about something else entirely -- something Charles Darwin would likely appreciate. In the future, fewer builders could mean less competition -- meaning higher prices, fewer choices and crappier construction. From a New York Times story:

After riding high on one of the greatest housing booms in American history, the nation’s home builders today face a devastating reversal of fortune.

Although the housing crisis is nearly two years old, many banks had refrained from cracking down on small home builders.

They are starting to do so, and a wide swath of the industry could be forced out of business in the next few years. The trouble is concentrated especially in the Sun Belt, the scene of so much overbuilding.

Not only have new-home sales stagnated, but builders confront a rising wave of foreclosed properties coming to market at prices below the cost of building a new home. To move houses, they have to mark them down to less than the cost of construction.

The convergence of these problems is bringing many small and medium-size builders — who account for about 70 percent of new-home construction in the United States — to their knees...

No hard count exists of precisely how many builders have gone out of business since the downturn began. According to an estimate by the National Association of Home Builders, at least 20,000 builders — about a fifth of the total nationwide — have closed up shop in the last two years...

With the pullback accelerating, complaints among builders of hardball tactics and shoddy treatment by banks are mounting, as is a general sense of betrayal.

“The behavior of the banks is unprecedented,” said Mick Pattinson, a home builder from Carlsbad, Calif. who has organized a national coalition of builders to draw attention to what they regard as unreasonable treatment. “Yes, there was overleveraging in the industry. But the aftermath doesn’t need to have been as brutal as it has been.”

Some experts defend the banks, saying they are starting to do what is necessary to come to grips with the turmoil in real estate. For months, they have been under pressure from federal bank regulators and their own shareholders to curtail lending to a faltering industry...

In this climate, keeping loan payments up to date — something many builders are struggling mightily to do — is not necessarily any protection.Many loans in the building industry are of short duration, coming up for renewal at least once a year.

This allows banks to take a fresh look at the financial health of a borrower, as well as the assets securing their debt. A steep fall in cash flow or a decline in the value of the collateral — usually building lots or half-built houses — can mean an automatic default, whether a borrower has missed payments or not...

Click here for full story.

Barratt American files for bankruptcy

Private home builder Barratt American, based in San Diego County, CA, has finally filed for bankruptcy protection after months of wrangling with its lenders, chiefly Bank of America. From a BigBuilderOnline.com story:

On Christmas Eve, coal filled the stocking of Barratt American Inc., as the company filed for Chapter 11 protection in the U.S. Bankrupcty Court for the Southern District of California.

Mick Pattinson, president of Barratt American, said the company will "continue to build custom homes and fire replacement homes as we sell existing assets and reorganize our company with a view to re-commencing new-home construction in 2010. We do not foresee any recovery in the housing market that would prompt speculative home development in 2009."...

According to Pattinson, the trouble started when, after a 27-year relationship, Bank of America froze the company's credit lines in August 2007. The bank has since foreclosed on 11 of Barratt American's assets, Pattinson added...

In June, Pattinson formed the Building Industry Coalition for Economic Recovery to promote awareness of what he saw as "bad behavior" by banks serving the home building industry. To date, there are 154 coalition members who, according to Pattinson, are "victims of contrived defaults and made to order appraisals as banks disengage themselves from residential lending and instead pursue builders for recovery and fulfillment of personal guarantees."...

Barratt American has been a key Californian home builder for more than 25 years. In 1991, Pattinson became president and CEO of Barratt American, a wholly-owned subsidiary of U.K.-based Barratt Group. In 2004, Pattinson purchased the North American operations of the company for $165 million.

A sad day indeed. Barratt built a nice, high-quality home and was once a regular client of mine. I'm hopeful they'll return better and stronger for the rebound.

Latest article on builders taking on the banks now online

For my latest column in Builder & Developer magazine, I covered the Building Industry Coalition for Economic Recovery's efforts to force banks to deal fairly. From the article:

With the federal government partially nationalizing the banking system, large investment banks a thing of the past, more bank failures on the horizon and nervous lenders still hoarding cash, it’s hard to predict what the future holds for the building industry. But if the recently formed Building Industry Coalition for Economic Recovery (www.pathtosolutions.com) has anything to say about it, the chaos in financial circles certainly shouldn’t be taking down developers and homebuilders with it.

The coalition, formerly named the “Homebuilders’ Coalition for Responsible Bank Behavior” (www.pathtodefault.org) was formed earlier this year in San Diego by a collection of private builders, attorneys and work-out specialists, and hopes to force lenders to play by a consistent set of rules versus what the group’s members say have been a series of contrived defaults that have led not only to foreclosed projects, but hibernating or bankrupt development companies. At the same time, the coalition’s 110 members (as of October 2008) – whom are now geographically dispersed across the country – are focused on assembling the type of intelligence required to warn other builders about to face similar circumstances.

Click here for full article.

Builders taking on the banks

With large investment banks a thing of the past, more bank failures on the horizon, the American financial system in disarray and lenders hoarding cash, it’s hard to predict what the future holds for the building industry. But if the recently formed Coalition for Responsible Bank Behavior (www.pathtodefault.org) has anything to say about it, the chaos in financial circles certainly shouldn’t be taking down developers and homebuilders with it.

The coalition, formed earlier this year in San Diego by a collection of builders, attorneys and work-out specialists including Barratt American President Michael (Mick) Pattinson, hopes to force lenders to play by a consistent set of rules versus what the group’s members say have been a series of contrived defaults that have led not only to foreclosed projects, but hibernating or bankrupt development companies. At the same time, the coalition’s 85 members – whom are now geographically dispersed across the country – are focused on assembling the type of intelligence required to warn other builders about to face similar circumstances.

“The banks aren’t straightforward with customers regarding bank policy or decision making, so we’re left to piece together the jigsaw puzzle, and now can forewarn other builders who aren’t yet in the process but know what’s coming,” explained Pattinson to me in a recent phone interview.

The short-term goals of the coalition are quite specific, intending to leverage the political power of a key economic sector and put pressure on a banking industry that’s already proven itself to be less than responsible. These goals include raising the consciousness of both banks and builders about an entire industry in peril, encouraging builders to fight banking abuses, enlisting the media to tell the builders’ stories, contacting federal and state agencies and carefully documenting any patterns of poor and unethical bank behavior.

At the heart of the issue are inconsistencies between banks in their work-out dealings with builders. Citing regulatory issues that tie their hands, many banks are reportedly forcing their clients into defaults when other banks continue to work in tandem with builders to maximize the return of assets. And the stakes are significant: according to the coalition’s website, many lenders are selling foreclosed properties at 30 to 40 cents on the dollar when they could be getting twice that amount by avoiding the foreclosure process in the first place. Moreover, by forcing builders into default or bankruptcy, an entire supply chain of subcontractors, suppliers and consultants don’t get paid, leading to more layoffs and exacerbating the housing recession.

In many cases, these defaults aren’t due to the natural progression of a transparent series of steps but the contrived inventions of banks desperate to hold onto as much cash as possible. “In many cases, the banks encourage the builder to continue with the hope of potential loan renewal,” states the coalition’s website. “The banks seek to be made whole while the builder exhausts its cash. When the cash is depleted, the bank informs the builder they will not continue funding.”

So how does the lender justify such decisions? By relying on a ‘made to order’ deflated appraisal that backs up its findings – which, in a twist of irony, is the polar opposite of the puffed-up appraisals that helped mortgage lenders justify lending on $600,000 homes really worth closer to $500,000 during the boom years. In both cases, the true victims seem to be analytical objectivity, and eventually, the U.S. taxpayer.

Over time, the coalition also has other solutions it’s exploring to help an industry avoid similar scenarios in the future, such as eliminating the personal guarantee and making construction loans, like many purchase mortgages, non-recourse. Another major goal is to revamp the current commercial appraisal process so the process is transparent to the borrower, halting ‘mark-to-market’ rules that include panic-stricken sales comps and which don’t adequately reflect stabilized values, and initiating a three-appraisal rule to compete against sole in-house appraisals which tell the lenders exactly what they want to hear in order to declare a technical default.

Finally, the group suggests that the timetable required for a work-out on a multi-million dollar development should be expressed not in weeks or months but three to five years, and future loans should last the life of the project. Given the list of half-finished projects strewn across the country, I’d imagine that a host of cities, counties and homebuyers would certainly agree that the current solutions simply aren’t working.

While it’s undoubtedly sad that long-standing relationships between banks and builders have deteriorated to this point, it’s understandable that part of the conditions of a $700+ billion taxpayer bailout should have required both mortgage and commercial lenders to act with objectivity, fairness and transparency. Concludes Pattison, “We need every state and Washington, D.C. to ask lenders to explain themselves. If this isn’t the biggest fraud in the history of the world, then I don’t know what is.”

Builder speaks out against fickle banks and impact fees

Mick Pattinson, president of the homebuilding company Barratt American, has recently been very vocal about banks which have declined to renew revolving credit facilities (thus potentially putting more builders out of business) as well as cities which became overly reliant on impact fees for new development during the boom, thus driving home prices even higher. Mick was one of the first builders I met when entering the building industry as a consultant, and Barratt is known for building very solid, high-quality homes (and no, they're not a client). As other builders keep mum on these issues, it's ironic that it takes a Brit to speak his mind. From a BuilderOnline.com story:

Exposing the duplicity of lenders and municipalities in the downfall of home builders is the latest crusade for one Southern California-based builder that is fighting desperately to keep his own company afloat.

Barratt American, formerly one of the 200 largest home builders in the country, is for the moment “essentially out of the game” as far as production building goes, says its president, Mick Pattinson. He spoke with BUILDER by phone from London, where he’s been attempting to raise new financing after Bank of America told his company last spring that it would no longer fund Barratt’s $125 million credit facility...

But Pattinson isn’t twiddling his thumbs waiting for the housing market to rebound. He’s focusing more of his energies on calling attention to what he says have been two negative forces that crippled the housing industry: banks abandoning distressed builders, and municipalities squeezing builders for higher impact fees, which in his market can exceed $100,000 per house.

Pattinson doesn’t hide his disdain for Bank of America, or for much of the lending community, either, which he insists pulled the financing rug out from under builders at their greatest time of need. “Builders are mad as hell, but they’ve been reluctant to put out their dirty linen about how they’ve been screwed over.”

So to force banks to “explain themselves” to lawmakers and the public, Barratt is working with the Homebuilders Coalition for Responsible Bank Behavior, a newly formed group that he says now involves 43 builders. Most are located in California, but the Coalition also includes builders from Oregon and Washington D.C. The group is developing a Web site, and plans to lobby in California and nationally. (It is close to hiring a public relations person.) Pattinson isn’t sure how much dust the Coalition can kick up, but he claims it’s already gained some traction with officials in Sacramento, California’s capitol.

Lawmakers there are also weighing builders’ complaints about how municipalities have used residential development as their own piggy banks by imposing impact fees that, during the boom years, “got to the point where the housing industry wasn’t working anymore,” says Pattinson. He’s been railing for years against impact fees, which makes him the perfect choice to chair a fee reform task force that the California Building Industry Association recently formed.

Pattinson is buoyed that several California towns have passed fee payment deferral statutes. And if towns start going bankrupt because the housing downturn is depriving them of fees to which they’ve grown accustomed, Pattinson expects more municipalities will be forced to consider weaning themselves from this revenue stream.