Legal & Legislative Updates – 2011

Legal/Legislative Update – December, 2011

MULTIFAMILY LOOKING BETTER

The good news keeps coming for rental property owners: To the reports of tightening occupancy rates and rising rents, you can add steady improvement in the quality of residents, measured by their credit histories and incomes. A recent article in Multifamily Executive reported that trend, quoting upbeat statistics from several large-scale property owners.

“We end up with a more qualified resident…. [better-able] to pay even in the face of rising rental rates,” Ric Camp, CEO of Houston-based Camden Property Trust, told the industry trade publication.

Other property owners reported the same upbeat trend, but data compiled by CoreLogic SafeRent was less encouraging. The company reported that stated income for households increased by less than 1 percent between 2010 – a smaller rate of increase than in the previous three years. The trend was even more negative for individuals, with stated income for applicants in Class A apartments declining by 0.3 percent in 2011 compared with gains of 1.2 percent and 8.2 percent, respectively, in 2010 and 2009. The 1.2 percent increase reported for Class B apartments was the smallest gain in that category in the past four years.

While incomes are not increasing uniformly in the rental housing applicant pools, landlords are still able to qualify a larger proportion of applicants, industry executives said, partly because their evaluation tools have improved, but also because they have revised their qualifying standards to reflect the impact of a devastating recession on job histories and credit scores.

“With the recent shifts in the economy and the housing market in particular, property management companies are fundamentally changing the way they evaluate credit reports,” one industry analyst observed.

COMMUNITY ASSOCIATIONS STILL STRUGGLING

While the outlook may be improving in the multifamily sector (see related item, above) many community associations nationally continue to struggle with the fallout from the foreclosure crisis and the economic downturn.

Nearly half (46 percent) of the approximately 600 community managers responding to a Community Associations Institute (CAI) survey said their client associations are facing “serious” problems as a result of the housing and economic downturn, while 10 percent described the impact as “severe.” Among the major challenges they cited:

  • High vacancy rates. Nearly one-quarter of the respondents reported vacancy rates of 5 percent or higher, and 30 percent reported vacancies between 3 percent and 5 percent, attributable to foreclosures, the inability of investors to sell the units, or owners walking away from properties worth less than their outstanding mortgages.
  • High delinquency rates – almost triple the level in 2005, according to the CAI survey – with 63 percent of associations reporting delinquency rates exceeding 5 percent, up from 22 percent in 2005. One in three associations report delinquency rates exceeding 10 percent and nearly 1 in 10 (about 30,000 communities nationally) are struggling with delinquencies exceeding 20 percent. A separate CAI survey found that financial institutions are not making timely assessment payments on more than 70 percent of the condominium units on which they have foreclosed.

“High delinquency rates place tremendous pressure on associations to meet their obligations to the homeowners who are paying their fair share,” Thomas Skiba, CAI’s chief executive officer, said in a press statement. “When some owners—including lenders that have foreclosed on homes and now own them—don’t pay their share, other homeowners often must make up the difference in higher regular assessments or special assessments. Associations must still pay their bills.”

Managers responding to the survey indicated that their association clients are taking a variety of steps to address the budgetary shortfall they face:

  • 50 percent have increased homeowner assessments
  • 40 percent have reduced contributions to reserve accounts
  • 39 percent have reduced landscaping services
  • 38 percent have deferred maintenance of common elements
  • 38 percent have postponed planned capital improvement projects
  • 28 percent have reduced professional costs or management fees
  • 22 percent have borrowed from their reserve accounts
  • 20 percent have levied special assessments

CHANGING VIEW

As American consumers continue tightening their belts in the face of continued economic weakness and stagnant income growth and employment concerns, the mortgage interest deduction appears to be among the things they have decided they can do without. In a recent poll conducted by Bloomberg News, 48 percent of the respondents said they would be willing to give up all tax deductions, including the one for home mortgage interests, in exchange for lowering tax rates across-the-board; 45 percent opposed the idea. When the same question was posed a year ago, 51 percent opposed eliminating the deduction and only 41 percent favored it. A USA Today poll conducted in April of this year found that more than 60 percent of respondents opposed eliminating the tax break for home ownership.

Richard Green, director of the Lusk Center for Real Estate at the University of Southern California, said the shift in consumer sentiment reflects growing concern about taming the federal deficit. “Everything is on the table,” he told Bloomberg. “People are so desperate to figure something out that they’re willing to consider anything.”

Housing industry executives and many industry economists warn that the interest deduction is an essential component of the nation’s home finance structure; eliminating it would undercut future demand and “decimate” home values.

One study predicted that home prices would fall by from 2 percent to as much as 13 percent, with the greatest impact in areas with the highest home prices. San Francisco, for example, “would just get whacked,” Green said.

Recent opinion polls notwithstanding, support for the deduction – especially by higher income taxpayers who benefit most from it – remains strong, and eliminating it will not be politically popular. That’s one reason proposals to replace the deduction with a tax credit – supported by two different advisory commissions (one appointed by President Obama, the other by his predecessor, George W. Bush) haven’t garnered much public support from lawmakers.

Ending the break is difficult, Green told Bloomberg, because “the cots are widespread and barely noticed, while the benefits are concentrated in a vocal minority” that strongly supports the status quo. “It’s only in the context of overall reform that you might see something happen,” he said.

IN PLAIN SIGHT

Corporations don’t have to tap phones or mount hidden cameras in order to steal the secrets of their competitors; they can find pretty much anything they might want to steal published in plain sight on Facebook and other social media sites.

When a Hewlett-Packard vice president was writing at length about himself and his job on Facebook, he included detailed information about the company’s then secret plans to introduce cloud-computing services. HP’s competitors were very interested, to say the least. HP executives, presumably, were not amused.

Researchers trolling social media sites aren’t just looking for background information about prospective employees, although that is one focus of these searches; they are also looking for “competitive intelligence,” and, as HP’s experience illustrates, they are finding it in abundance.

“Social media has become a much more efficient way of getting information that could only be gotten in the past by things like surveillance,” Rich Plansky, senior managing director at Kroll, Inc., told Bloomberg News. Kroll, which provides investigative services to corporations, isn’t alone in its reliance on social media as an information source. More than 82 percent of the 150 companies responding to a Forrester Research survey last year said they, too, monitor these sites for competitive information.

Executives and employees at all levels should heed the warning implicit in this survey, Michael Fertik, chief executive officer of Reputation.com, Inc., told Bloomberg.

“Everybody who is in business with you, in a personal, professional, romantic, transactional relationship with you, is looking up information about you, is finding information about you, and then, most importantly, making decisions about what they find about you on the Internet,” Fertik said. “That’s why everybody has a need and obligation to themselves, to their family members, to their shareholders, to manage their footprint on the Internet.”

LEGAL BRIEFS

POINT AND COUNTERPOINT

Massachusetts Attorney General Martha Coakley has filed suit against five major mortgage servicers because of their allegedly shoddy foreclosure practices, and one of them – GMAC Mortgage —has retaliated by announcing it will no longer purchase mortgages originated in the state.

“GMAC Mortgage has taken this action because recent developments have led mortgage lending in Massachusetts to no longer be viable,” a company press statement explained.

Coakley responded by suggesting that GMAC “has acknowledged it has a problem” complying with the foreclosure procedures mandated by state law.

Her suit accuses GMAC, Bank of America, Wells Fargo, JP Morgan Chase and Citi of unlawful and deceptive conduct in the foreclosure process, including unlawful foreclosures, false documentation, and robo-signing…and deceptive practices related to loan modifications.” The suit also accuses the banks of using the electronic loan registration system operated by MERS, which is also named in the suit, to avoid registration fees in the loan closing process and to conceal the identities of loan purchasers from borrowers.

Coakley has described the suit as “the nation’s first comprehensive lawsuit against the five major national banks regarding the foreclosure crisis.”

Spokesmen for Bank of America, Chase, and Wells Fargo all expressed “disappointment” at the state’s action, saying it will undermine ongoing efforts by state attorneys general in conjunction with the federal government to negotiate a uniform, nationwide settlement to resolve allegations of widespread foreclosure abuses.

“We continue to believe that collaborative resolution rather than continued litigation will most quickly heal the housing market and help drive economic recovery,” Lawrence Grayson, a spokesman for Bank of America, told the New York Times.

“Regrettably, the action announced in Massachusetts today will do little to help Massachusetts homeowners or the recovery of the housing economy in the Commonwealth,” a Wells Fargo spokesman agreed.

But Coakley said she filed the suit precisely because negotiations have been going on for more than a year, “and I believe the banks have failed to offer meaningful and enforceable relief to homeowners. They’ve had more than a year to show they’ve understood their role and the need to show accountability for this economic mess, and they’ve failed to do so.”

Attorneys General in other states, including New York, California, Delaware and Nevada, have also balked at proposed settlement terms that preclude the broader investigation they feel is justified into the role played by syndicators, as well as loan servicers, in the foreclosure mess. Dissident AGs also have complained that the proposed settlement amount – between $20 and $25 billion — is too small, and the liability release for lenders too expansive.

Responding to the Massachusetts suit, Iowa Attorney General Thomas Miller, who head the AGs’ coordinating committee, said he remains optimistic that a broad-based settlement will be reached. He noted that Coakley has indicated she will review the settlement terms and “we’re optimistic that we’ll settle on terms that will be in the interests of Massachusetts.”

RETHINKING DISPARATE IMPACT

A case pending before the U.S. Supreme Court has the potential to limit the ability of plaintiffs to bring “disparate impact” claims under both the Fair Housing and Equal Credit Opportunity Acts. Consumer advocacy groups and the Justice Department have won many court judgments against lenders or negotiated settlements with them to resolve allegations that policies had a discriminatory effect on protected classes, even if there was no intent to discriminate against them.

The underlying case (Magner v. Gallagher) doesn’t involve a lender; it stems from a dispute between rental property owners and the city of St. Paul Minnesota over the city’s housing code enforcement actions. The property owners claimed that the city’s insistence on sweeping improvements to correct code violations resulted in the forced sale of some properties and the condemnation of others. The policy, thus, had a “disparate impact” on lower-income and minority residents by reducing the availability of housing affordable for them, the landlords contended.

A trial court dismissed the case but an Appeals Court agreed with the property owners. The Supreme Court will decide whether disparate impact claims can, in fact, be brought under the Fair Housing Act (a question the High Court has not addressed), and if so, what legal standards should be used to evaluate those claims.

“If the Supreme Court holds that disparate impact claims cannot be pursued, it will take away one of the legal avenues that private and governmental litigants could use in such cases,” Ballard Spahr, a Philadelphia law firm, wrote in a note to clients. “But, more broadly, if the Supreme Court holds that disparate impact claims are not actionable under the Fair Housing Act … and disagrees with HUD’s interpretation of the statute, it would carry serious implications for disparate impact claims under the Equal Credit Opportunity Act [as well].”

Many banking industry attorneys are predicting that the court will, in fact, use this case to reduce the scope of disparate impact claims, at a time when the Justice Department has been ramping up its enforcement of fair lending laws. The court’s decision to hear the case is significant because it could clarify the standard banks must meet to comply with both the Fair Housing and Fair Lending statutes, Greg Taylor, vice president and senior counsel at the American Bankers Association, told American Banker. “That’s the big one, certainly,” he said.

Consumer advocates share the general view that the case bodes well for banks. “Whenever [the court] has a chance to whittle down, if not obliterate, disparate impact, they will,” an attorney who represents plaintiffs in fair lending cases, told American Banker. “And that’s no secret,” he added.

WORTH QUOTING:

“Foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism.” — Economist Alan Blinder in a Wall Street Journal column, rebutting arguments that foreclosures should be allowed to play out in order to “clear” the housing market.

Legal/Legislative Update – September, 2011

UNHAPPY TALK

Can simply talking about a recession create one? Some analysts think that’s possible. The continuing drumbeat of bad economic news, they suggest (USA Today tallied 1,900 references to a “double-dip recession” in U.S. publications in July and August alone) is undermining the confidence of consumers, investors, and business executives, discouraging spending and business expansion, which, in turn, is hampering economic growth, creating a vicious and self-perpetuating economic cycle.

“All the negativity puts a chilling effect on risk-taking and prompts investors, consumers and businesses to play defense. The potential fallout,” a USA Today article explains: “Austerity replaces spending. Hoarding cash trumps longer-term investing. Businesses spend less on future initiatives and hire fewer workers, [creating] a negative feedback loop that could cause worries about recession to turn into a self-fulfilling prophecy.”

Bankrate.com’s September Financial Security Index indicated that 40 percent of consumers had reduced their spending in the previous 60 days. With consumers accounting for 70 percent of the nation’s economic output, “any sort of cutback can ripple through the economy very quickly,” Greg McBride, Bankrate’s senior financial analyst, told Reuters recently. “Obviously, if this reduction in consumer spending continues, the U.S. economy will slide back into recession,” he warned.

Some analysts see a “disconnect” between the grim mood reflected in confidence surveys, and the more nuanced, mixed messages reflected in the economic data. One recent example: Bloomberg’s “Comfort Index” fell to its second lowest level ever two weeks ago, even though a revised economic report indicated that the economy grew faster in the second quarter than initially estimated.

“We are in the middle of a mania of pessimism,” James Paulsen, chief investment strategist at Wells Capital Management, told USA Today. The country, in his view, is suffering from “Armageddon hypochondria.”

If lack of confidence is impeding growth, a confidence rebound — which could be triggered by a few stronger-than-predicted rather than weaker-than-expected reports in key sectors – presumably could reverse the trend. “If people just start feeling better, look out,” Paulsen said. Of course, the reverse also applies – if people don’t start feeling better, look out for that, too.

HAPPIER TALK

If you’re looking for optimists, you’ll find them today at gatherings of rental housing executives. “The percentage of renters is on the rise, the number of households is increasing, and more Americans are downsizing, all of which point in a single direction: rents are on the rise,” Brian Davis, president of ezLandlordForms, wrote in a guest commentary for Inman News.

Davis cited statistics from Reis, Inc. indicating that rental vacancy rates declined to 6.2 percent in the first quarter of this year from 8 percent a year ago, allowing landlords to begin raising rents; 75 of the 82 metropolitan areas Reis tracks recorded year-over-year rent increases between early 2010 and early 2011. Separately, the apartment market research firm Axiometrics predicts that rents will rise by almost 6 percent this year – the largest annual jump since 2005.

“The bottom line is, the rental industry is on the rise,” Davis wrote, “and some real estate experts believe its growth will accelerate rapidly over the next three to five years.”

Investors share his bullish outlook. More than 40 percent of the senior level industry executives responding to an August survey by Apartment Finance Today said they are actively seeking to acquire multifamily projects and 36.5 percent said they anticipate developing more projects this year.

“What the data—and interviews with active players in the industry—indicate is that multifamily firms are feeding their growing appetites for new construction and acquisitions more aggressively than at any point since the Great Recession,” the industry publication, Multifamily Executive, reported.

Pent-up demand, a scarcity of new product after several years of anemic construction activity, the unwinding of households that combined during the depths of the recession (roommates tripling and quadrupling up, adult children moving in with their parents) and a continuing “reticence” on the part of prospective homebuyers to make a purchase commitment will make the current year “the beginning of a boom time for multifamily property investors and operators,” the magazine predicts.

A DIFFERENT VIEW

Excessive regulation is discouraging lending, killing jobs and generally hamstringing the economic recovery. That’s the gist of the argument financial institutions have mounted in their effort to overturn the bevy of rules, regulations and restrictions mandated by the Dodd-Frank Financial Reform legislation. And the cry has been taken up, loudly, by Republicans on the presidential campaign trail. The law, designed to prevent a repeat of the 2008 financial market meltdown, “has created such uncertainty that the bankers, instead of making loans, [have] pulled back,” Mitt Romney, the current frontrunner in the bid for the Republican Presidential nomination, has said repeatedly. “We have to end it [Dodd-Frank] now, Texas Governor Rick Perry, has agreed.

But several studies have questioned the premise that Dodd-Frank specifically and over-regulation generally are hampering the recovery by making it impossible for businesses to grow and for lenders to lend. The most recent study to challenge that view comes from economists at the International Monetary Fund, who contend that the problem is not over-regulation but overly lax regulation, which, they argue, “contributed disproportionately” to the housing market meltdown and the continuing foreclosure crisis resulting from it.

The economists, Jihad Dagher and Ning Fu, see a direct correlation between the mortgage boom-bust cycle and the growth of thinly regulated non-bank mortgage companies. Originations by those lenders increased from 31 percent of the total in 2003 to 60 percent in 2007, and their increasing market share “is a strong predictor of the increase in foreclosure rates between 2005 and 2007,” the economists report in their working paper, “What Fuels the Boom Drives the Bust: Regulation and the Mortgage Crisis.”

Operating outside of the regulatory framework that constrained depository institutions, Dagher and Fu suggest, the independents increased their market share “by originating increasingly risky loans,” contributing to an industry-wide reduction in lending standards. On the down side of the boom-bust cycle, the authors note, foreclosures have been highest in markets where the independents were most active. Their conclusion:

“Overall our findings lend support to the view that more stringent regulation could have averted some of the volatility on the housing market during the recent boom-bust episode.”

A SHAKIER LADDER

“Who will buy?” an old song asks. When it comes to houses, the answer over the next decade is a bit murky.

Rod Dubitsky, an analyst with PIMCO, posed the question in a recent report, asking “Are There Any Rungs Left on the Housing Ladder?” He finds that the two groups that have driven home sales in the past – existing owners and first-time buyers — aren’t likely to provide much momentum in the future. Baby boomers, the largest group of existing owners by far, are looking to down-size in retirement while younger first-time buyers are leaving college with huge debts and uncertain job prospects that will delay their entry into the market indefinitely, Dubitsky says. Student debt loads (now averaging $23,000) have been increasing and starting salaries for recent graduates have been declining. The PIMCO report sees both trends as part of a “longer-term phenomenon that could serve to limit college graduate home purchasing power for the foreseeable future.”

Older homeowners, meanwhile, are less likely to be trading up or purchasing second homes or investment properties, the report says, because they are feeling more urgency about boosting retirement savings in the face of uncertain prospects for the economy and the Social Security fund. Renting will become a more appealing prospect for older workers and a longer-term necessity for younger ones, the report predicts, pointing toward “downsized housing choices, [which] could serve to reduce the dollars committed to housing investment.”

A separate report by Morgan Stanley also describes an accelerating shift from an “ownership” to a “rentership” society, driven, this report suggests, by record foreclosures, tighter credit standards and economic uncertainty. The U.S. homeownership rate has declined from a high of 69.2 percent in 2004 to 66.4 percent and would be even lower, the Morgan Stanley report says, if the statistics included the more than 7.5 million homeowners who are behind on their mortgage payments and may lose their homes to foreclosure.

But a recent study published by the Research Institute for Housing America points out that, viewed in perspective, homeownership rates have declined from what were really unsustainable levels to something closer to the historic average of 64 percent to 65 percent that prevailed from the late 1960s through the mid-1990s. “The question of why homeownership rates are falling now is really a question of why they were so high during the middle of the last decade,” according to Stuart Gabriel, an economist at UCLA’s Anderson School and a co-author of the report.

LEGAL BRIEFS

THEY’VE GOT MAIL

It started, as many community association disputes do, with a minor dispute, in this case, Florida condominium owner Nancy Wear’s request for a trash receptacle in the mail room; it ended with a $200,000-plus judgment against the community association.

Wear, an attorney, wanted a convenient container in which to toss her junk mail, but the board rejected the request, citing concern that residents would not limit their deposits to unwanted mail. Annoyed by the decision, Wear began dumping her mail on the mail room floor and the dispute took off from there. The board cited her for creating a nuisance, eventually seeking and winning an arbitration judgment allowing the board to evict her. Wear challenged the decision in court and a jury sided with her, dismissing the arbitration judgment and ordering the association to pay her legal expenses.

The association appealed and a circuit court judge reversed again, ruling that Wear was, in fact, a nuisance, because she had “defaced condominium postings.” Wear appealed again and the Third District Court of Appeals reversed once more, ordering the circuit court to reinstate the jury verdict in her favor. The association’s insurance company, apparently tired of the expensive ping pong match, cut Wear a check for $201,347 to cover her legal costs. Wear used the money to pay off her mortgage, suggesting that she intends to remain in the community.

“This was a hard lesson for [the] community association,” an article in the Sun-Sentinel observed. Hard and expensive. The article didn’t note whether the board has decided to provide that trash can (which would have cost a lot less than the litigation) or where, in its absence, Wear has been depositing her junk mail. □

SEEKING COMPENSATION

There’s more than one way to hold lenders accountable for the questionable policies and procedures that contributed to the financial meltdown and the collateral damage that continues to plague the housing market. While state and federal regulators continue to hammer out the details of an agreement targeting the foreclosure-related abuses of loan servicers, the Federal Housing Finance Agency (FHFA) has filed suit against 17 banking giants, accusing them of fraud (among other things) in the sale of more than $190 billion in mortgage-backed securities to Fannie Mae and Freddie Mac.

Accusing the targeted institutions of “falsely represent[ing]” the quality of the underwriting on the underlying mortgages and “significantly overstat[ing]” the repayment potential of borrowers, the suit seeks a combined total of more than $120 billion, including more than $33 billion from JP Morgan and nearly $25 billion from Bank of America-Merrill Lynch, to reimburse Fannie and Freddie for their portfolio losses.

The defendant institutions are expected to argue that Fannie and Freddie were sophisticated investors, capable of analyzing the securities and understanding their risks.

Critics have warned that the suits will further impede an already sluggish economic recovery by inhibiting new lending, and could threaten the viability of some of the institutions targeted.

“While I believe that FHFA is acting responsibly in its role as conservator [for Fannie and Freddie], I am afraid that we risk pushing these guys off of a cliff and we’re going to have to bail out the banks again,” Tim Rood, a former Fannie Mae executive, now a partner at the Collingwood Group, which offers consulting services to banks, told the New York Times.

Richard Bove, a banking analyst at Rochdale Securities, offered an even harsher critique, charging that the FHFA suit and other government actions are “destroying the infrastructure of the mortgage finance market in the United States.”

Addressing claims that the suit will impede the economic recovery, the FHFA said in a press statement, “While everyone is concerned with these important issues, “the long-term stability and resilience of the nation’s financial system depends on investors being able to trust that the securities sold in this country adhere to applicable laws.”

While most analysts are predicting the litigation will ultimately be resolved by an out-of-court settlement, many of the targeted institutions are facing suits by individual investors alleging claims similar to those of the FHFA, and may be reluctant to settle for that reason.

“If the representations and warrants from one failed mortgage-backed security are the same as another MBS with the same kinds of loans, the first settlement will likely set a precedent for the other,” Michael Stegman, director of policy and housing at the John D. and Catherine T. MacArthur Foundation, told the on-line news service, Marketwatch.

WORTH QUOTING:

“Multifamily is the food group of choice among investors,” — Jeff Meyers, principal with RealFacts, speaking at a recent housing industry conference.

 

Legal/Legislative Update – August, 2011

MORTGAGE INTEREST TARGETED

The home mortgage interest deduction is in the political cross-hairs once again, as lawmakers seek cost-cutting measures that can win bipartisan support in a divided Congress and make a significant dent ($2.4 trillion is the target) in the federal budget deficit lawmakers are trying to tame.

The interest deduction would clearly hit the second mark (denting the deficit); it costs the Treasury more than $100 a year, making it, according to critics, the single largest federal housing subsidy program by far. Preserving the deduction has enjoyed consistent bipartisan support, with lawmakers on both sides of the aisle united in their refusal to touch what has traditionally been viewed as the most popular middle class tax break on the books. But growing concern about the nation’s economic problems and a shift in voter attitudes may be making this political sacred cow somewhat less sacred than it has been in the past.

Nearly half of the respondents to a recent poll said they would support eliminating the deduction as part of a broader plan to reduce tax rates overall; only 45 percent opposed the change. That represents a sea change from previous polls, in which supporters of the deduction outnumbered those willing to kill it by a ratio of two to one, according to a Bloomberg News report. And the recent poll, reflecting more willingness to jettison the deduction, came before the Congressional stand-off that took the country to the brink of financial default.

Housing industry trade groups, led by the National Association of Realtors, steadfastly oppose any move to eliminate the deduction, arguing that it is a cornerstone of the nation’s commitment to home ownership. In any event, the current fragility of the housing market makes this “the worst possible time” to contemplate a change, Lawrence Yun, the NAR’s chief economist, argued at a recent housing forum.

Advocates of rethinking the deduction say eliminating it or retaining it unaltered aren’t the only options. Reducing the deduction cap (currently set at $1 million) or limiting it to primary residences, would also generate significant savings, they note. The President’s deficit reduction committee estimated that replacing the deduction with a 12 percent tax credit for homeowners, capped at $500,000 (a move the committee recommended) would raise an estimated $48 billion in tax revenue.

The strongest argument for rethinking the mortgage interest deduction, Dean Stansel, an adjunct fellow at the Reason Foundation, suggested at the housing forum, is its limited scope: The benefits accrue primarily to wealthier homeowners with larger mortgages; “seventy-five percent of taxpayers don’t benefit from this at all,” he said.

WHAT’S WRONG WITH THIS PICTURE?

Phil Angelides, chairman of the Financial Crisis Inquiry Commission, poses that question, pointedly, in an op-ed article published in the Washington Post. His panel blamed Wall Street largely for the problems that wrecked the housing market and nearly destroyed the nation’s financial infrastructure – a view shared at least in part by most of the analysts who have studied the causes of the financial collapse.

But three years after the fact, Angelides notes, Wall Street is flourishing while Main Street still flounders. The problem, he suggests, is not the failure of those involved to learn from history but their ability to rewrite it.

Angelides skewers in equal measure:

  • Rep. Paul Ryan (R-WI), chairman of the House Budget Committee, for “disregarding the reality that two-thirds of the deficit increase is directly attributable to the economic downturn and bipartisan fiscal measures adopted to bolster the economy.”
  • Former Federal Reserve Chairman Alan Greenspan for forgetting his admission earlier this year that deregulation was partly to blame for the meltdown and now condemning “the current ‘anything goes’ regulatory ethos” that seeks to strengthen regulatory oversight.
  • “Most” Congressional Republicans for “ignor[ing] the evidence of pervasive excess that wrecked our financial markets and attempt[ing] to cut funding for the regulators charged with curbing it.”

“Does historical accuracy matter?” Angelides asks. “You bet it does.” Ignoring the true causes of the financial crisis will prevent policymakers from implementing the measures needed to prevent another crisis in the future, he warns, and “will divert us from the urgent task of putting people back to work and creating real wealth for America’s future…. We can still get history and the future right,” Angelides concludes, “but time is running out.”

INVESTORS WANTED

Uncle Sam wants you — or someone — to buy $30 billion in foreclosed properties from Fannie Mae, Freddie Mac and the Federal Housing Administration, and then convert them into affordable rental properties. The new initiative, the most recent in a series of Obama Administration efforts to cope with the nation’s housing crisis, targets two problems with a single policy bullet: The glut of foreclosed properties depressing home prices and impeding home sales and the nation’s critical need for affordable rental housing.

“Millions of families nationwide have seen their home values impacted as their neighbors’ homes fall into foreclosure or become abandoned,” Shaun Donovan, Secretary of Housing and Urban Development (HUD), said in a prepared statement announcing the plan. At the same time, he added, “with half of all renters spending more than a third of their income on housing and a quarter spending more than half, we have to find and promote new ways to alleviate the strain on the affordable rental market”

HUD and the FHA have issued a “request for information,” asking private investors, industry stakeholders and community organizations to suggest ideas for disposing of the more than 250,000 government-owned foreclosed properties. A more formal “request for proposals” will follow the request for information, but probably not for several months, government officials indicated.

Administration officials are reportedly considering a plan that would sell foreclosed properties in pools to investors, who would manage them as affordable rentals. But they have indicated a willingness to consider other means of achieving their key policy goals: Reducing foreclosure losses for the GSEs, stabilizing home prices and neighborhoods (both of which are depressed by high-volume distress sales and the glut of unsold properties), and increasing the supply and quality of rental housing.

“Taking steps to encourage private investment in REO properties and transition them into productive use will help stabilize neighborhoods and home values at a critical time for our economy,” Donovan said in his press statement.

Industry executives and community advocacy groups have both responded favorably to the proposal. “Without question, in order to settle the markets and move the foreclosed inventory, we’re going to need both owner-occupied and non-owner-occupied solutions,” David Stevens, CEO of the Mortgage Bankers Association of America (MBA), told the Los Angeles Times.

John Taylor, president of the National Community Reinvestment Organization, praised both the rental proposal and the way the Administration is pursuing it. “Asking for input [through the request for information] is a good sign,” Taylor told the LA Times, “because they’re looking to do something other than say, ‘OK, this property is available and who’s the highest bidder. I think they recognized that’s not going to work.”

In addition to easing negative pressures on the housing market, the foreclosure-to-rental strategy would also help preserve properties that will deteriorate if they remain vacant for too long, industry executives point out.

The plan would also slow the torrent of foreclosed properties flooding the for-sale market, short-circuiting a cycle that other Administration initiatives, including its flagship Home Affordable Mortgage Program (HAMP) have been unable to break.

The plan indicates that the Administration “has finally recognized the urgent need to be proactive and creative in pulling the housing market out of the foreclosure tailspin,” Sen. Jack Reed (D-RI), told reporters.

Reed has been urging federal agencies to convert vacant foreclosed homes into rental housing, but has included energy-efficiency upgrades in his plan – an approach that, he says, would reduce energy costs for renters and future owners and create jobs in the construction industry, which has been decimated by the prolonged housing downturn.

Separately, the House Financial Services Committee is considering a bill introduced by Rep. Gary Miller (R-CA) that would allow Fannie, Freddie, and FDIC-insured lenders to rent foreclosed properties back to their owners (or to other tenants) for five years. The bill has strong bi-partisan support on the committee, with backing from both chairman Spencer Bachus (R-AL) and ranking member Barney Frank (D-MA).

“[This legislation] will reduce the number of houses coming into the housing inventory and will preserve the physical condition of foreclosed properties, which will ultimately help stabilize the aesthetic and economic values of homes and neighborhoods,” Miller said. □

GETTING FOCUSED

The housing crisis, which was supposed to sort itself out over time, has lingered and deepened instead, spewing a continuing stream of foreclosures into already burgeoning inventories, depressing home prices and, in the view of many economists, impeding the economic recovery. That consensus view has led the Obama Administration and Congress to refocus attention on efforts to keep struggling homeowners in their homes and streamline the foreclosure process, hoping, at a minimum, keep an already grim situation from getting worse.

Administration officials reportedly are considering a number of options, including asking Fannie Mae and Freddie Mac relax the loan-to-value requirements that are preventing many under-water borrowers from refinancing into lower-rate mortgages that would ease their financial burden and reduce their foreclosure risks.

The Federal Housing Administration (FHA) recently announced one new initiative that would allow unemployed borrowers with FHA-insured loans to miss up to 12 months of loan payments without facing foreclosure while they look for work. Another new FHA program establishes a $1 billion fund to provide interest-free loans of up to $50,000 to help unemployed homeowners remain current on their mortgages.

Both the House and Senate are also considering measures aimed at reducing foreclosures. In the House, Rep. March Kaptur (D-OH) is sponsoring a resolution urging President Obama to declare “a national residential mortgage foreclosure emergency” imposing a temporary moratorium on foreclosure actions. A Senate bill, co-sponsored by Sens. Jeff Merkley (D-OR) and Olympia Snowe (R-ME), calls for a number of mortgage servicing reforms, including an independent third-party review before lenders can foreclose on homeowners.

“We won’t get the economy moving again until we deal with the foreclosure crisis,” Merkley said in introducing the measure as an amendment to a broader economic development bill.

Banking industry executives and many economists oppose both the House and Senate measures, arguing that they delay foreclosures that will occur eventually, thereby prolonging the housing market downturn. In a letter to Senate Majority Leader Harry Reid (D-NV) and Minority Leader Mitch McConnell (R-KY), the American Bankers Association argues:

“The on-going price declines in the housing market, foreclosures relating to job losses, and other impacts of the recent recession are devastating to borrowers and lenders alike. This legislation, however, will only exacerbate an already difficult situation. Delaying legitimate foreclosures and increasing costs associated with them will only prolong the pain of the current situation.”

Industry executives are backing another measure, sponsored in the House by Rep. Bill Posen (R-FL), that would allow lenders to count modified loans on their books as assets rather than liabilities. Under this measure, a loan would be considered to be “accruing” as long as it is current and the borrower has not missed a payment in the preceding six months.

Industry executives say the measure would address the artificial constraints on lending created by overly restrictive examination standards. But banking industry regulators say the bill simply mirrors existing examination standards, but goes beyond them, allowing lenders to ignore problems of which they are aware and understating both their risks and their capital requirements.

“Institutions could disregard currently available borrower financial information indicating that the borrower lacks the ability to repay the principal and interest on the loan going forward,” George French, deputy director of the Federal Deposit Insurance Corporation’s (FDIC’s) risk management division, testified at a hearing on the measure. “This in turn would enable institutions to include accrued but uncollected interest income in regulatory capital, when its collection in full is not expected,” he explained.

Simon Johnson, a professor of entrepreneurship at the Massachusetts Institute of Technology, agreed. The regulatory forbearance the bill mandates has been applied in the past, he told legislators at the House hearing. The result: The savings and loan crisis of the late 1980s that decimated the S&L industry and resulted in a $150 billion clean-up.

Policy makers should be requiring financial institutions to build their capital cushions, Johnson argued, not allowing them to pretend they have more capital than they do. □

LEGAL BRIEFS

TARGETING FRAUD

Mortgage fraud is escalating and so are efforts to combat it. Financial institutions filed 70,472 suspicious activity reports (SARs) involving mortgage fraud in 2010, 5 percent more than the previous ear and the largest number since the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) began tracking this data. That trend continued in the first quarter of this year, with SARs filings up 10 percent compared with the same period last year and mortgage fraud, again, responsible for most of the increase, according to FinCEN.

Many of the fraudulent transactions lenders are reporting occurred several years ago and are surfacing now as borrowers default and lenders undertake pre-foreclosure loan documentation reviews. These belated discoveries indicate that “the industry is slowly making its way through the most problematic mortgage,” James Freis, director of FinCEN, said in the agency’s report.

A separate report by LexisNexis Mortgage Asset Research Institute (MARI) shows a 41 percent decline in verified reports of fraud and material misrepresentation – the first such decline in more than five years. (The MARI report reflects verified instances of fraud, while the FinCEN report tallies activities deemed suspicious, where wrong-doing has not been verified.) Jennifer Butts, manager of data processing for MARI, attributed the downward trend in that report to a continuing decline in loan originations, a reduction in the resources available to investigate fraud, and the increasing complexity of fraudulent transactions, making them more difficult to identify.

Even so, efforts to identify and prosecute fraud are intensifying. MARI reports that the FBI obtained 1,531 indictments resulting in 970 convictions related to mortgage fraud last year. Through February of this year, FBI officials were reporting 3,020 pending investigations, nearly three-quarters of them involving losses of more than $1 million.

Separately, the Financial fraud Enforcement Task Force, coordinating the efforts of U.;S. Attorneys’’ Offices, more than 25 federal agencies, federal regulators and state and local law enforcement officials, charged more than 1,200 defendants with mortgage fraud, double the number in 2009 before the task force was created. The task force also doubled the number of defendants sentenced to more than two years in prison.

“While we have accomplished much in the first year of the Task Force, our work is far from complete,” U.S. Attorney General Eric Holder, who chairs the task force, said in a press statement. “A healthy economy and, in these times, a full economic recovery, requires our continued vigilance in protecting American businesses and consumers from financial fraud.” □

WORTH QUOTING:

“The root of our current problem is that there are no grown-ups in positions of serious power in Washington. I’ve never felt this way before — and I’ve written business stories for more than 40 years, and about national finances for more than 20.” —Alan Sloan, senior editor for Fortune Magazine, in an op-ed that appeared in the Washington Post.

Legal/Legislative Update – July, 2011

GETTING FOCUSED

The housing crisis, which was supposed to sort itself out over time, has lingered and deepened instead, spewing a continuing stream of foreclosures into already burgeoning inventories, depressing home prices and, in the view of many economists, impeding the economic recovery. That consensus view has led the Obama Administration and Congress to refocus attention on efforts to keep struggling homeowners in their homes and streamline the foreclosure process, hoping, at a minimum, keep an already grim situation from getting worse.

Administration officials reportedly are considering a number of options, including asking Fannie Mae and Freddie Mac relax the loan-to-value requirements that are preventing many under-water borrowers from refinancing into lower-rate mortgages that would ease their financial burden and reduce their foreclosure risks.

The Federal Housing Administration (FHA) recently announced one new initiative that would allow unemployed borrowers with FHA-insured loans to miss up to 12 months of loan payments without facing foreclosure while they look for work. Another new FHA program establishes a $1 billion fund to provide interest-free loans of up to $50,000 to help unemployed homeowners remain current on their mortgages.

Both the House and Senate are also considering measures aimed at reducing foreclosures. In the House, Rep. March Kaptur (D-OH) is sponsoring a resolution urging President Obama to declare “a national residential mortgage foreclosure emergency” imposing a temporary moratorium on foreclosure actions. A Senate bill, co-sponsored by Sens. Jeff Merkley (D-OR) and Olympia Snowe (R-ME), calls for a number of mortgage servicing reforms, including an independent third-party review before lenders can foreclose on homeowners.

“We won’t get the economy moving again until we deal with the foreclosure crisis,” Merkley said in introducing the measure as an amendment to a broader economic development bill.

Banking industry executives and many economists oppose both the House and Senate measures, arguing that they delay foreclosures that will occur eventually, thereby prolonging the housing market downturn. In a letter to Senate Majority Leader Harry Reid (D-NV) and Minority Leader Mitch McConnell (R-KY), the American Bankers Association argues:

“The on-going price declines in the housing market, foreclosures relating to job losses, and other impacts of the recent recession are devastating to borrowers and lenders alike. This legislation, however, will only exacerbate an already difficult situation. Delaying legitimate foreclosures and increasing costs associated with them will only prolong the pain of the current situation.”

Industry executives are backing another measure, sponsored in the House by Rep. Bill Posen (R-FL), that would allow lenders to count modified loans on their books as assets rather than liabilities. Under this measure, a loan would be considered to be “accruing” as long as it is current and the borrower has not missed a payment in the preceding six months.

Industry executives say the measure would address the artificial constraints on lending created by overly restrictive examination standards. But banking industry regulators say the bill simply mirrors existing examination standards, but goes beyond them, allowing lenders to ignore problems of which they are aware and understating both their risks and their capital requirements.

“Institutions could disregard currently available borrower financial information indicating that the borrower lacks the ability to repay the principal and interest on the loan going forward,” George French, deputy director of the Federal Deposit Insurance Corporation’s (FDIC’s) risk management division, testified at a hearing on the measure. “This in turn would enable institutions to include accrued but uncollected interest income in regulatory capital, when its collection in full is not expected,” he explained.

Simon Johnson, a professor of entrepreneurship at the Massachusetts Institute of Technology, agreed. The regulatory forbearance the bill mandates has been applied in the past, he told legislators at the House hearing. The result: The savings and loan crisis of the late 1980s that decimated the S&L industry and resulted in a $150 billion clean-up.

Policy makers should be requiring financial institutions to build their capital cushions, Johnson argued, not allowing them to pretend they have more capital than they do.

PUSHING BACK

Pushback is intensifying against a proposal that would make 20 percent down payments the qualifying standard for the best mortgage rates. And the criticism is coming from consumer advocates and legislators as well as from financial industry executives. All are warning that the so-called “skin-in-the-game” rule requiring lenders to retain a portion of the risk on mortgages they originate, could permanently bar the door to home ownership for millions of potential buyers.

The proposed regulations would exempt from the risk retention requirement “qualified residential mortgages,” which the regulatory agencies have defined as loans to borrowers with pristine credit histories who make down payments of at least 20 percent. Critics say the exemption is too narrow and focuses unreasonably on down payments to the exclusion of other factors that also help to determine a borrower’s ability to manage a mortgage.

“Well-underwritten low down payment home loans have been a significant and safe part of the mortgage finance system for decades,” a report produced by a coalition of housing and consumer groups, contends. Coalition members include the Center for Responsible Lending, the Mortgage Bankers Association, the National Association of Home Builders and the National Association of Realtors, among others.

The Dodd-Frank financial reform legislation established the risk retention requirement, but left it up to regulators to establish the standards for loans that would be exempt from it. Many lawmakers now say the proposed regulation is not at all what they had in mind.

In fact, several noted at a recent hearing that legislators intentionally avoided specifying a down payment minimum in the law, in order to avoid unnecessarily disqualifying many eligible borrowers. The legislation, they noted, directed regulators specifically to consider factors other than the down payment – -including the borrower’s debt burden and the characteristics of the loan – in establishing the exemption standards.

“I was definitely surprised and disappointed [by the proposal],” Sen. Kay Hagan (D-NC), one of the lawmakers who pushed successfully for an exemption from the risk retention requirement, said at the hearing.

Rep. Barney Frank (D-MA), who co-sponsored the financial reform legislation, said he found arguments against the 20 percent benchmark “persuasive. [It] does seem very high,” he agreed.

The hearing revealed that some of the regulators involved in writing the regulation disagree among themselves on the down payment requirement. Bob Ryan, acting commissioner of the Federal Housing Administration (a division of the Department of Housing and Urban Development, which is one of the agencies crafting the rule) said he is “definitely concerned” about the impact the requirement would have on potential buyers and the housing market recovery. (Last year, more than 50 percent of all U.S. homebuyers made down payments of less than 20 percent, according to LPS Applied Analytics.) Ryan said he supported the 10 percent threshold that regulators are reportedly considering as an alternative.

The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, on the other hand, thinks 20 percent is a reasonable requirement, necessary to reduce risks to lenders. A 10 percent minimum would increase those risks without significantly increasing the number of eligible borrowers, Patrick Lawler, the FHFA’s chief economist, argued at the recent hearing.

Consumer advocates agree that lowering the down payment requirement to 10 percent would not significantly increase the number of qualified borrowers, but they think that’s an argument for making the underwriting standard even more flexible.

“Even a 10 percent down payment would put homeownership beyond the reach of many creditworthy families who would otherwise have succeeded in homeownership,” Ellen Harnick, senior policy counsel at the Center for Responsible Lending, told lawmakers at the hearing.

Regulators are accepting comments on the proposed regulation through June 10. It is supposed to take effect one year after it is adopted.

BLOODIED BUT (MOSTLY) UNBOWED

The dizzying collapse of the housing market and its slow, uneven recovery, are making homeowners and prospective buyers a bit schizophrenic – discouraged about market conditions and pessimistic about the prospects for a rebound in home values, but still convinced that housing remains a desirable goal and a good investment.

On the negative side, the U.S. home ownership rate declined to 66.4 percent at the end of the first quarter of this year, the lowest level in nearly 15 years, erasing virtually the entire gain recorded during the housing boom. Foreclosures, converting former homeowners to renters, and tight credit, preventing many would-be buyers from purchasing homes, partly explain that trend, Paul Dales, senior economist for Capital Economics, suggests. “But it also seems likely there has been a reduction in the desire to own a home now that it’s clear housing is not a one way bet,” he told DS News.

A nationwide survey conducted by the Pew Research Center challenges that view. More than 80 percent of the respondents said they still view buying a home as “the best long-term investment” they can make. Even those who said their homes have declined in value (about half the 1,222 respondents were in that category) agreed either “strongly” or “somewhat” with that positive assessment.

Although the poll reflects continued confidence in homeownership, the intensity of that faith has declined. A year ago, 49 percent “agreed strongly” and 35 percent agreed “somewhat” that homeownership is a good investment. In the more recent poll, only 37 percent were in the “agree strongly” category, while the less confident column increased to 44 percent.

Although existing homeowners view ownership more positively than renters, renters still view ownership as a desirable goal. Only 24 percent said they are renting out of choice and 81 percent said they hope to become homeowners one day.

All things considered the residual faith in homeownership is “impressive,” Paul Taylor, co-author of the Pew report, said. “In modern economic history, we’ve never had a five-year period where home values have fallen as long or as far as they have now.”

The favorable view of homeownership may be impressive, but isn’t blind. Homeowners who say their homes have lost value think it will take at least three years for them to recover that lost ground; 42 percent say recovery will take at least six years.

“GIVE ME THE BARE NECESSITIES…”

Americans are cutting back, tightening up and doing without in the face of the continuing economic downturn, denying themselves luxuries and limiting expenditures to life’s essentials. This is not surprising. It’s the way rational consumers usually behave when the outlook is uncertain and their finances are constrained. In that respect, consumer behavior in this downturn is no different than it has been in the past, with one exception: The definition of “essentials” seems to have changed. To the traditional list — food, shelter, clothing, and the like – many consumers have added cell phones and Internet access.

In a recent Financial Literacy Opinion Index poll sponsored by the National Foundation for Credit Counseling, consumers had no problem eliminating premium coffee, on-line shopping and eating out from their budgets. Only 1 percent of respondents listed those items as the “last thing” they would sacrifice in the interest of austerity and only 8 percent balked at eliminating cable TV. But more than half (53 percent) said they couldn’t do without their cell phones and 32 percent identified Internet access as the service they would be least likely to eliminate.

“People have chosen technology over eating, drinking and shopping, the preferred pastimes of just a few short years ago,” Gail Cunningham, a spokeswoman for the NFCC, told reporters. “Staying connected is apparently considered the new must-have.”

The results aren’t surprising, Cunningham noted. Computer use “has become ingrained” in the lives of many consumers, and many have eliminated their land lines, relying entirely on cell phones. Cunningham described the poll results overall as “encouraging,” indicating, she said, that consumers “appear to have thought through their cost-cutting decisions and made wide choices. “This level of awareness will not only help people ride out the difficult economic times they’re currently experiencing, but result in a more stable financial future,” she predicted.

LEGAL BRIEFS

NO EXEMPTION

In a decision Florida community associations have cheered, a circuit court has ordered the West Palm Beach Housing Authority (PBHA) to turn over to an association rent owed on an apartment occupied by a tenant receiving Section 8 rental assistance and owned by an individual who had fallen behind on common area payments to the association.

A newly enacted Florida law allows associations to collect rent payments from tenants who are leasing units from delinquent owners. In this case, the tenant paid only $275 of the $1,784 charged by the landlord/owner, with the balance subsidized by the PBHA. The tenant turned over his portion of the payment to the association, as required, but the PBHA refused to pay the balance, arguing that the law did not apply to public agencies. A Circuit Judge in Palm Beach Country disagreed, ruling that the housing authority must pay the balance of the rent due to the association until the landlord/owner’s back payments have been cleared.

While the decision does not set a legal precedent, association attorneys predicted that it would prove “persuasive” to other housing authorities confronted with similar payment demands.

WORTH QUOTING

“The people who are part of the business sector, the people in this room, have got to stop complaining about government and get some action underway. There’s no excuse today for lack of leadership. The truth is we all need to be part of the solution.” €GE Chairman Jeffrey Immelt, chair of President Obama’s Council on Jobs and Competitiveness, exhorting business executives at a U.S. Chamber of Commerce Jobs Summit, to do their part to kick start the economy by starting to create jobs.

Legal/Legislative Update – June, 2011

 

NOT YET

State attorneys general are still trying to formulate a settlement agreement that loan servicers will accept and that will overcome disagreements among the AGs themselves about how to resolve allegations of widespread abuses and procedural lapses in the foreclosure process. So far, they haven’t managed to overcome either hurdle.

Financial institutions have balked at initial proposals, objecting particularly to requirements that they reduce the principal balance on some loans. Some attorneys general have also objected to that requirement and to demands to impose stiff financial penalties as part of the settlement. Others are insisting that both principal reductions and hefty penalties should be part of any agreement. According to recent press reports, the principal reduction provision has been eliminated from the most recent proposal.

Iowa Attorney General Tom Miller, who is leading the state negotiations, says he remains confident that “there’s a settlement everyone can agree to. There are still some major obstacles between here and there,” he acknowledged in a recent interview with the Washington Post, “and something like this can always get off track. But I still think we can come to a resolution.”

Perhaps, but after more than a year of trying, that resolution remains elusive.

Separately, Senate Democrats are urging federal regulators to work cooperatively with the attorneys general to “fix the broken foreclosure processes,” The federal bank regulators negotiated consent orders with 14 leading mortgage servicers, requiring them to overhaul their foreclosure processes. Critics have complained that the federal agreement undermines the AGs’ negotiations, which are still ongoing.

The letter to Walsh, signed by 12 Senators, urges the OCC to “use the full scope of its authority” to ensure that servicers “not only account for past harms, but also take steps to prevent future servicing deficiencies, so that homeowners going forward are treated fairly.”

The OCC and the Office of Thrift Supervision recently agreed to extend the deadline by which 12 of the 14 servicers must submit their plans for reviewing past foreclosures — one requirement of the consent agreement. The other two servicers are regulated by the Federal Reserve, which has not announced a deadline change. The agencies indicated that the delay, requested by the Department of Justice, will permit coordination between federal and state regulators dealing with the foreclosure complaints.

UPWARD TREND

Even without the conservative underwriting standards regulators have proposed in their definition of “qualified” mortgages that will be exempt from the new risk retention requirements for lenders, down payments for home loans have been increasing steadily over the last two to three years.

The median down payment in nine major U.S. cities increased to 22 percent (for conventional loans), according to a study by Zillow.com, conducted for the Wall Street Journal. That trend represents a sharp departure from the low- and no-down payment mortgages that became common during the housing boom and, most agree, contributed significantly to the bust that followed it. The median down payment fell steadily from around 20 percent in the’90s to a low of 4 percent in the fourth quarter of 2006, the Zillow study found.

Higher down payments – meaning more “skin-in-the-game” for borrowers – combined with tighter underwriting standards will improve credit quality and reduce default risks, but those measures will also reduce access to credit, industry executives agree.

“There is no question that the tightening of criteria prices households out of the market,” Stan Humphries, an economist for Zillow, told the WSJ. “The middle ground buyer is the one having to fight to get a conventional mortgage,” he added.

Some industry executives and regulators – FDIC Chairman Sheila Bair among them, are pushing for higher down payment requirements; others fear the negative impact on the housing market as the pool of eligible mortgage borrowers shrinks.

“Lower leverage means less risk for banks,” David Berson, chief economist of the PMI Group told WSJ. But it also means “less activity. A balance between the two is best,” he suggested.

A Federal Reserve economist has suggested that the federal government consider offering down payment assistance to buyers as a means of reducing lending risks and encouraging “sustainable” home ownership, without undercutting home buying activity.

“Historically, [home buying] assistance has taken the form of either interest rate or down payment subsidies,” a recent study published by the Federal Reserve Bank of Cleveland, points out. “But recent research suggests that down-payment subsidies are much more effectively. They create successfully homeowners – homeowners who keep their homes – at a lower cost.”

GETTING RENOVATION RELIGION

Apartment tenants trying to persuade landlords to make essential repairs in sub-standard buildings have a new ally: The lenders holding mortgages on those properties. A major driver of this trend, industry executives say, is the poor condition of many multifamily properties lenders have reclaimed in foreclosure proceedings. That experience (and the losses related to it) has made them much more proactive about monitoring the condition of properties secured by performing loans

“Now that money has gotten tight, they’re coming out and seeing some of these properties they haven’t seen in a while,” one contractor told Multifamily Executive. “[They’re discovering] the buildings have deferred maintenance issues, and they’re telling owners, ‘our loan-to-value ratio no longer matches up.’”

HUD is also looking more critically at properties when owners apply for refinancing, according to this Multifamily Executive report, which noted that agency officials are focusing not just on a property’s projected remaining economic life but on its current functionality. “They’re not going to do a refi for 35 years on a project that was built in the ‘70s and still has the same windows it had when it was built,” one industry executive quoted in the article observed.

NO KIDDING!

You can file this under, “DUH!” A recent survey has found that rising gas prices encourage home buyers to seek properties closer to where they work. Nearly three quarters of the Realtors responding to a Coldwell Banker survey said the pike in gas prices has had an impact on where their clients want to live; 93 percent agreed that if prices remain high, more prospective buyers will opt for locations that will reduce their community distance.

Somewhat more interestingly, although not surprisingly, the survey found that buyers are more interested today than they were five years ago in a home office; 68 percent of the respondents attributed that trend partly to rising transportation costs.

“The decision to buy a home has always been tailored around the personal, multi-faceted lifestyle needs of each buyer,” Jim Gillespie, CEO of Coldwell Banker Real Estate, noted in a press release describing the survey results. Increasingly, he said, rising gas prices are influencing how buyers are defining their lifestyle preferences and their housing needs.

Brokers who see the price of gas as an increasingly important factor in the home buying equation said 89 percent of the buyers they see are seeking homes closer to where they work and 45 percent are seeking locations close to shops and services, reflecting what many respondents reported as an increasing interest in urban living. More than half (56 percent) of the industry professionals responding to the survey noted that trend, and 93 percent of them agreed “strongly’ that a desire to reduce commuting costs was a major factor.

The more significant question, of course, is whether the trends noted in this survey and others will persist or, as in the past, evaporate quickly if gas prices begin to decline.

HOUSING HURDLES

Industry analysts have offered a number of explanations for the sluggish housing market recovery, high unemployment and concern about falling home prices, among them. But a major factor may be the difficulty prospective buyers are having obtaining a loan. Lenders are rejecting nearly 25 percent of all mortgages today, according to Federal Reserve statistics. And those numbers don’t reflect the borrowers who hear how difficult it is to qualify, even with decent credit, and so don’t even try.

Reflecting the stiffer underwriting standards lenders are applying, the average credit score on loans purchased by Fannie Mae and Freddie Mac has increased to 760 from 720 a few years ago, and the median down payment has increased from – virtually zero during the boom to 15 percent, the Fed data indicate. The new risk retention requirements will further narrow the market, industry executives warn. “Only the wealthy will be able to buy homes at low interest [rates],” Jerry Howard, CEO of the National Association of Home Builders, told reporters recently.

Those concerns notwithstanding, there have been a few positive signs recently in a housing market that has been almost unremittingly bleak. In one major shift, large single family builders are once again shopping for land, joining a queue that, until recently, has been limited almost entirely to multi-family developers.

“Twelve months ago, there was no Pulte (one of the largest builders in the country) looking at land in this market,” one multi-family developer told Multifamily Executive, an industry trade publication. “Now they’re back again, and I’ve seen these companies pay incredibly high prices.”

A Prudential Real Estate poll spotted another encouraging trend: An increasing number of potential buyers and sellers think the housing market is poised to recover. Sixty-eight percent of the respondents to this poll said they expect the market to recover within the next two years, up from 47 percent who held that relatively optimistic view a year ago.

Prudential analysts think the survey may reflect a “down so long it looks like up” perspective – the market has been depressed for so long, many believe, recovery has to be in the cards.

WORKING HARD HALF THE TIME

Take the statistics indicating that worker productivity levels are increasing with a grain or two of salt; a recent study finds that employees are truly productive only half of every working day; the other half is spent on work-related but not terribly useful tasks, such as responding to e-mail and managing incoming information and correspondence.

That is the unsettling, if not terribly surprising, conclusion of a recent study by Fonality, a business communications company. The conclusion isn’t surprising, because the company’s recommended strategy for reducing unproductive time is to purchase the cloud-based communications management systems it sells. Still, the statistics are interesting.

The study estimates that employees spend about 36 percent of their time trying (not always successfully) to contact customers or colleagues, find information or schedule meetings; 14 percent of the day is devoted to managing information – forwarding e-mails, making follow-up calls, and disposing of spam. The study’s authors calculate that reducing “unproductive” time by 25 percent will add six weeks of productive time annually per employee, “which should be an immediate call to action for business owners,” a company spokesman suggested.

LEGAL BRIEFS

 

WHOSE HOUSE IS IT?

Homeowners in Massachusetts and other states have successfully challenged foreclosures initiated by lenders and servicers that could not document their right to foreclose. But what about the innocent buyers who purchase properties at foreclosure sales later found to have been improper? Should they be allowed to retain ownership of those homes?

The Massachusetts Supreme Judicial Court is going to consider that question in a case that is being closely watched by industry executives nationwide. The state’s high court ruled previously in another closely watched case (U.S. Bank v Ibanez) that because the lender did not own the mortgage at the time, a foreclosure was invalid. In this case (Bevilacqua v. Rodriguez), the court is reviewing a lower court ruling that the buyer who purchased the home at the Ibanez foreclosure does not have a valid claim to it.

The buyer, Bevilacqua, had submitted a “try title” petition, asking the Massachusetts Land Court to verify his title to the property, but the court ruled that, because the foreclosure sale was invalid, Ibanez did not have standing to initiate that action. In his appeal, Bevilacqua contends that the quitclaim deed he received at the foreclosure sale gave him “record title,” and sufficient standing to use the “try title” process.

“If the [Land Court] decision is upheld, and generally applied, it likely will have adverse implications for hundreds or even thousands of Massachusetts property owners if they find themselves in Bevilacqua’s shoes,” the Mortgage Bankers Association wrote in a friend-of-the-court brief.

Representing the state, Assistant Attorney General John Stephen argued that while Bevilacqua’s position as an “innocent buyer,” who purchased the property in good faith “engenders some sympathy,” it doesn’t alter the underlying legal principle: The deed he received was invalid and, as a result, “he lacks standing to bring a try title action.”

The court is expected to issue its decision before the end of this year.

UPWARD TREND

Mortgage-related litigation is on the rise – hardly a window-rattling revelation to anyone who has been following the news about foreclosure flaws, robo-signing attorneys, and consumer advocates who are recommending strategies delinquent homeowners can use to defeat foreclosure actions against them. Somewhat more surprising – most of the suits plaintiffs filed against mortgage lenders and servicers didn’t allege improper foreclosures; they targeted failures in loan modifications designed to avoid them. And a significant number of the suits were initiated not by borrowers but by investors who purchased the loans.

The ‘Mortgage Litigation Index,” produced jointly by Mortgage Daily and the Washington, D.C. law firm Patton Boggs, increased by 42 percent in the fourth quarter as plaintiffs filed 151 mortgage-related law suits compared with 106 in the third quarter. Foreclosure suits and investor suits nearly doubled while modification-related activity increased by more than 200 percent.

A nationwide investigation of foreclosure “abuses” and mortgage servicing practices launched by state attorneys general and related inquiries by courts and legislators, “have fostered an environment where mortgage-related litigation has expanded on all fronts,” according to Anthony Laura, a partner in the law firm’s Newark office, specializing in mortgage banking issues.

Although the ongoing investigation, and most of the publicity surrounding foreclosure problems have focused on consumer complaints, the investor suits are likely to prove more problematic and more costly for financial institutions, Laura noted in a press statement, because hundreds of millions of dollars are often at stake in those loan portfolio repurchase cases.”

While mortgage lenders are seeing an upward trend in litigation, securities lawyers are reporting a decline in securities class action settlements, which fell to their lowest level in more than a decade, reversing what had been a steady climb.

That’s according to an analysis by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse, which also reported declines in both the aggregate settlement value ($3.1 billion in 2010 vs. $3.8 billion in 2009) and the average settlement, which slid about 2 percent to $36.3 million from $37.2 million.

But the median settlement amount jumped by more than 40 percent to $121.3 million compared with $8.0 million in 2009, representing the largest percentage increase in the past decade and the first time the median has exceeded $10 million.

The median settlement is the number that attorneys in the securities field watch, according to Matt Larrabee, a partner in the San Francisco office of Dechert, who told National Law Journal, “If you exclude the mega settlements, that’s what most people experienced in 2010.”

An increase in complaints filed by the Securities and Exchange Commission is partly responsible for driving median settlement amounts up, according to Larrabee, but plaintifffs’ attorneys are becoming more selective about the cases they bring, he noted, and that is also contributing to this trend. “The plaintiffs’ bar is bringing what they would describe as stronger cases, and following t SEC actions more closely,” Larrabee observed in the NLJ article.

Laura Simons, senior adviser to Cornerstone, underscored that point in a press statement released with the research report, noting that SEC-initiated actions typically involve “relatively high damages and large defendants, who not surprisingly, tend to settle for higher amounts.”

WORTH QUOTING

“We’ve gotten inconsistency, hesitancy and unevenness [in economic growth]. I’m troubled by what you might describe as a lack of conviction in this economy.” — Dennis Lockhart, president of the Atlanta Federal Reserve Bank.

Legal/Legislative Update April, 2011

 

COMMERCIAL CONCERNS

You might not assume this from all the headlines about the housing market implosion and its devastating ripple effects, but it is commercial real estate loans, not residential mortgages, that have been responsible for many recent bank failures.

Analyzing the six banks the Federal Deposit Insurance Corporation (FDIC) closed in mid-April, a research report from Trepp, LLC found that of the aggregate total of $394 million in nonperforming assets at those institutions, 77 percent ($300 million) were in commercial real estate. An analysis of 12 banks that failed in February found troubled assets similarly concentrated (72 percent) in commercial real estate, according to Trepp, which provides commercial mortgage information to the securities and investment management industries.

In a year-end report, the company estimated that commercial real estate values have declined by 42 percent since they peaked in 2007, putting 50 percent of the commercial loans maturing between 201 and 2015 currently “under water.” Trepp analysts also tallied 1,300 banks with “significant” commercial real estate concentration.

Testifying at a recent Congressional hearing, Matt Anderson, managing director at Trepp, told lawmakers, “We remain concerned about the volume of underwater commercial mortgages that will mature over the next several years, despite gradual improvement in the economy.”

SPREADING THE BLAME

If the report on the financial crisis published by the Senate Permanent Subcommittee on investigations were a photograph, it would require a wide-angle lens to encompass all the villains it identifies. Lenders, regulators, securitizers and credit agencies, some more than others, but all in some part, share the blame in this report for the mortgage market implosion that nearly brought down the nation’s financial infrastructure.

The report, issued with bi-partisan support, describes a financial marketplace riddled with conflicts of interest and perverse incentives that led lenders, investment banks, and credit rating agencies to understate or ignore the risks in the loans they were originating, rating, securitizing and selling to investors.

“Blame for this mess lies everywhere from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild and members of Congress, who failed to provide oversight,” said Sen. Tom Coburn (R-OK), who co-chaired the panel with Sen. Carl Levin (D-MI).

The committee paints with a broad and scathing brush, but singles out two of the credit rating agencies (Standard & Poor’s and Moody’s) and the Office of Thrift Supervision for conflicts of interest at the former (classifying as investment grade securities that were anything but) and overly “deferential” regulation at the latter, resulting in the failure of Washington Mutual, the largest bank failure in U.S. history.

The report cites the “sudden mass downgrades” of mortgage-backed securities and collateralized debt obligations the rating agencies issued as “the immediate trigger” for the financial crisis. The conflict of interest inherent in their fee structure (the agencies are paid by the issuers of the securities they rate) led them to ignore warnings sounded by their own analysts more than a year before they finally began issuing the belated downgrades, the researchers found.

“The problem was that neither company has a financial incentive to assign tougher credit ratings to the very securities that for a short while increased their revenues, boosted their stock prices, and expanded their executive compensation,” the report concluded.

The report faults all the banking industry regulators, but it heaps particular scorn on the OTS for essentially allowing Washington Mutual “to police itself” despite overwhelming evidence of problems with the bank’s underwriting standards and securitization practices. “OTS did not once, from 2004 to 2008, take a public enforcement action against Washington Mutual to correct its lending practices, nor did it lower the bank’s rating for safety and soundness,” the report notes.

The criticism of the investment banks, Goldman Sachs and Deutsche Bank in particular, is equally white hot. Both are blasted for selling securities to investors that they knew to be flawed (“crap” and “pigs” is how one internal Deutsche Bank memo described them), but Levin has accused Goldman Sachs of actually misleading some clients by betting against the securities the company sold them and misleading Congress in testimony about the company’s practices.

“In my judgment, Goldman clearly misled their clients and they misled the Congress,” Levin said at a press briefing. He indicated that the committee plans to turn its information over to the Justice Department to investigate possible perjury charges against Goldman executives who testified before Congressional committees.

UNCOMMON INDICTORS

The financial press focuses endlessly on signals conveyed by leading, lagging and other common economic indicators. But some analysts rely on less mainstream, even slightly offbeat, information to inform their forecasts. For example, one retail analyst watches sales of a certain brand of bra at Victoria’s Secret to tell him whether economic forces are pushing up or down. If women purchase these very pricey items for themselves, they are probably willing to buy other luxury items, John Morris, a retail analyst at BMO Capital Markets, reasons.

A recent Associated Press article reporting this unusual indicator noted several others, among them, the way retailers advertise promotions. Company-wide discounts and hand-scrawled easels outside of stores indicate that the discounts are unplanned – a sign that sales are worse than anticipated. Strong sales of big-ticket items, on the other hand, are an obvious indicator that times are getting better, as is the reliance on credit to pay for them.

For collectors of unusual indicators how about car leases – as a predictor of home sales? LeaseTrader.com, which maintains a database of third party car leases, reported recently that 43 percent of Realtors backed out of car leases in 2010 – -down from 63 percent who terminated their leases early in 2008, and an indicator, this report suggests, that the housing market is strengthening.

“Never mind economic outlooks or market statistics telling us that things are terrible,” says Christine Ricciardi, in an article on housingwire.com reporting the auto leasing analysis. “Forget about low interest rates as a sign of nonexistent demand. Things are good enough that the head honchos on Wall Street no longer have to give up their pretty toys to pay their bills.” But it is also possible this trend doesn’t say anything at all about the housing market, Ricciardi concedes. “Maybe this is just the backlog of Realtors and financial execs who didn’t deleverage in 2008.”

GOING UP

Reflecting the tighter underwriting standards lenders are applying, the average FICO score on single-family loans purchased by Fannie Mae and Freddie Mac last year increased to 750, up from 715 on loans purchased in 2006 and 2007. Loans originated during that problem period — 2006-2008 – account for most of the losses the two government services enterprises have absorbed as they struggle to regain their financial balance under government conservatorship.

The Federal Housing Finance Agency (FHFA), which regulates the GSEs, highlighted the higher credit scores in its most recent report to Congress. While reducing portfolio risks for Fannie and Freddie, the improved scores have also slashed their income from loan guarantee fees, the report notes. The FHFA report also warns that credit losses attributable to loans originated in the 2006-2008 period “will remain substantial” and notes that future financial results “will be greatly affected by the success or failure of [the Administration’s] loss mitigation initiatives” under the Home Affordable Mortgage Program. Testifying recently at a Congressional hearing, Acting FHFA Director Edward DeMarco said the GSEs will continue to impose “loan level price adjustments” on the non-vanilla mortgages they purchase.

GREENER GRASSES

Anemic home sale numbers notwithstanding, there is some demand for residential property; it just seems to be coming primarily from foreign buyers. “I have never seen such a high concentration of foreign nationals acquiring real estate,” Peter Zalewski, founder of a real estate consulting and brokerage firm, told the Associated Press. Zalewski estimates that close to 80 percent of condo purchases in downtown Miami involve foreign buyers, a trend he described as “unprecedented.”

A report by the National Association of Realtors (NAR) confirmed that trend. According to the NAR, 28 percent of the brokers responding to a recent survey said they had worked with at least 1 international client in the past year, with 18 percent reporting at least 1 completed sale. In the 2009 survey, 23 percent reported dealings with international clients, resulting in sales for 12 percent of them.

Industry analysts say depressed home prices and stock market volatility are persuading many foreign investors that real estate for now represents the better option. The weak U.S. dollar increases the appeal.

Although foreign buyers alone (which represent only about 7 percent of the total) can’t revitalize the nation’s housing market, industry analysts agree, the trend is helping to stabilize some particularly hard-hit markets, such as Miami, Los Angeles, and San Francisco.

“It’s a positive in a sea of negatives,” one real estate consultant told AP.

Legal Briefs

REVERSAL ON REVERSE MORTGAGES

Facing a legal challenge by AARP, the Department of Housing and Urban Development (HUD) has had second thoughts about a policy change that required the surviving spouses of reverse mortgage borrowers to pay off the outstanding loan, even if it exceeded the value of the home, in order to continue living in the property. That change, announced in guidance published in 2008, reversed the agency’s long-standing policy extending to surviving spouses the guarantee offered reverse mortgage borrowers, that they could continue living in the home (as long as they maintained insurance and property tax payments) until they died or moved voluntarily. HUD’s new policy held that the guarantee did not apply if the spouses were not joint owners of the property.

AARP challenged the revised policy, arguing that it violated both HUD’s rules and contracts between reverse mortgage borrowers and lenders. HUD officials said they were rescinding the controversial guidance because “there has been some uncertainty” about it. They indicated that the agency intends to issue “new guidance” on this issue in the future.

AARP officials welcomed the reversal, but said it will not end their legal challenge. While HUD’s action “is definitely going in the right direction,” Jean Constantantine-Davis, a senior attorney with AARP Foundation Litigation, told Bloomberg News, AARP wants the agency to formally revise its regulations, not just issue new guidance, to ensure that the rights of surviving spouses are protected.

“We think the surviving spouses shouldn’t be displaced,” she said. “They have the right to stay there.”

WORTH QUOTING

“Apartment owners have been on a tear for a couple of years, and should continue to do well,” “Some people refer to it as a propensity to rent but in reality, it’s an aversion to buy.” – David Harris, a REIT analyst with Gleacher & Co., in a CNN interview, discussing the relationship between declining homeownership rates and increasing demand for rental housing.

Legal/Legislative Update March, 2011

 

RECOUNT?

The National Association of Realtors (NAR) has documented the housing market’s dizzying decline statistically with regular reports, as home sales and prices have plunged during the downturn. It turns out that the association’s dismal figures may actually have understated conditions.

CoreLogic estimates that home sales declined by close to 12 percent in 2010 – more than twice the NAR’s estimate of a 5 percent reduction. Based on those figures, CoreLogic puts the current inventory of unsold homes at 16 months – a much bleaker picture than the NAR’s estimate of a 9.5-month overhang.

The problem, according to CoreLogic, is that the NAR has been using an out-dated calculation to adjust for the Multiple Listing Services that don’t report their sales figures. The calculation doesn’t reflect the consolidation of MLS organizations over the past several years and the increase in sales that occur outside the system. As a result, CoreLogic analysts contend, the NAR adds more sales to its totals than it should.

If CoreLogic is correct, the housing downturn has been deeper and recovery is likely to take considerably longer than the NAR’s figures indicate.

The real problem is the failure to account for fundamental changes in the housing market, Sam Khater, senior economist for CoreLogic, told Inman News. “Any time you’ve got fundamental changes in the market, it’s going to cause market data to go haywire,” he said. “It’s important to have data from a wide range of sources, to see e the truth lies in between them.”

NAR officials told Inman that they will be making planned benchmark revisions in their data this year, but they expect any “data drift” issues to be “relatively minor.”

KEEPING SKIN IN THE GAME

Since Congress enacted the Dodd-Frank financial reform legislation, financial institutions have been trying to soften some of its sharper edges. The “skin-in-the-game” provision, requiring mortgage lenders to retain at least 5 percent of the risk in the loans they originate, has been a particular concern.

Industry lobbyists have been urging regulators, who are drafting the implementing rules, to broadly define the “qualified residential mortgages (QRMs) that will be exempt from the risk-retention requirement. But it appears they may be losing that battle.

New York Times columnist Floyd Norris reported recently that regulators appear to be resisting industry arguments that a narrow exclusion will limit the availability of credit and increase its cost, closing home purchase doors to all but the most affluent borrowers. They also appear unlikely to adopt the flexible standards lenders have suggested, applying risk retention rules only to loans with negative amortization or balloon payment features.

“It now appears regulators will not go nearly that far,” Norris reported, citing Congressional sources who predict that the rules will set a minimum 20 percent down payment for qualified mortgages, including some adjustable rate loans under the QRM umbrella, but with strict limits on the adjustments allowed.

Industry efforts to secure a more flexible carve-out were set back considerably when John Gibbons, executive vice president at Wells Fargo Home Mortgages, publicly endorsed the risk-retention requirement as sensible and necessary. “You gain confidence when you go to a restaurant and see an owner is eating his own food,” he said during one Congressional hearing.

Some state lawmakers are proposing to go even further than federal regulators in the effort to prevent the underwriting lapses that contributed to the mortgage meltdown. The Oregon Legislature is considering a proposed bill that would require lenders to hold on to the loans they originate and the servicing rights related to them for at least five years.

The Oregon Association of Mortgage Professionals is opposing the measure, arguing that it would be devastating for borrowers and lenders.

“This is another bill intended to inaccurately attack non-depository lending institutions in hopes of improving quality to the consumer, which, if passed, would drastically create the exact opposite result,”

Industry executives say they don’t think the legislation stands much chance of winning approval, simply because, as one mortgage broker told reporters, “it is so outlandish, it can’t pass.”

UPWARD TREND

Even without the conservative underwriting standards regulators are considering for their definition of “qualified” mortgages under the new risk-retention rule (see above), down payments for home loans have been increasing steadily over the last two to three years.

The median down payment in nine major U.S. cities increased to 22 percent (for conventional loans), according to a study by Zillow.com, conducted for the Wall Street Journal. That trend represents a sharp departure from the low- and no-down payment mortgages that became common during the housing boom and, most agree, contributed significantly to the bust that followed it. The median down payment fell steadily from around 20 percent in the’90s to a low of 4 percent in the fourth quarter of 2006, the Zillow study found.

Higher down payments – meaning more “skin-in-the-game” for borrowers – combined with tighter underwriting standards will improve credit quality and reduce default risks, but those measures will also reduce access to credit, industry executives agree.

“There is no question that the tightening of criteria prices households out of the market,” Stan Humphries, an economist for Zillow, told the WSJ. “The middle ground buyer is the one having to fight to get a conventional mortgage,” he added.

Some industry executives and regulators – FDIC Chairman Sheila Bair among them – are pushing for higher down payment requirements; others fear the negative impact on the housing market as the pool of eligible mortgage borrowers shrinks.

“Lower leverage means less risk for banks,” David Berson, chief economist of the PMI Group told WSJ. But it also means “less activity. A balance between the two is best,” he suggested.

A Federal Reserve economist has suggested that the federal government consider offering down payment assistance to buyers as a means of reducing lending risks and encouraging “sustainable” home ownership, without undercutting home buying activity.

“Historically, [home buying] assistance has taken the form of either interest rate or down payment subsidies,” O. Emre Ergungor, notes in a recent study published by the Federal Reserve Bank of Cleveland. “But recent research suggests that down-payment subsidies are much more effectively. They create successfully homeowners – homeowners who keep their homes – at a lower cost,” he concluded.

WHO ‘DUNNIT’?

In “Murder on the Orient Express,” one of Agatha Christie’s most famous mysteries, the answer to “who dunnit” turned out to be “everyone.” All of the potential suspects stabbed the despicable victim so that no single murderer could be blamed. In much the same way, the Financial Crisis Inquiry Commission, charged with finding the causes of the financial meltdown, spreads the blame widely, citing “dramatic failings of corporate governance and risk management” at many strategically important financial institutions and shortsighted, inexcusably lax oversight by federal regulators who should have recognized the early warning signs, among the major causes of a crisis that the commission concluded could and should have been avoided.

“The crisis was the result of human action and inaction, nor of Mother Nature or computer models gone haywire,” the 585-page report contends. “The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss,” the report argues, “not a stumble….The greatest tragedy,” the report cautions, “ would be to accept the refrain that no one could have seen this coming and thus nothing could have been done [to prevent it]. If we accept this notion, it will happen again.”

Although the report spares no one in assigning blame, it singles out Goldman Sachs for feeding the subprime bubble by securitizing and selling billions of dollars in toxic loans, Merrill Lynch executives, for failing to disclose to investors the extent of the company’s problems, and (among the regulators), the Securities and Exchange Commission, for failing to set adequate capital and liquidity standards and the Federal Reserve for “a pivotal failure to stem the flow of toxic mortgages” by halting high-risk and abusive lending practices. “The Federal Reserve was the one entity empowered to do so and it did not,” the report asserts.

The report provides little new information about the details of the financial crisis, but it does recall the fear that gripped financial institutions, investors, regulators and elected officials as the markets seemed to be spiraling out of control. At the peak of the crisis, Fed Chairman Ben Bernanke told the commission, 12 of the nation’s 13 largest financial institutions “were at risk of failure.”

Partisan differences divided the commission, delaying publication of the report and raising questions about its impact. All six Democrats supported the conclusions but all four Republican members refused to do so. The issue that divided the commission most sharply was the role Fannie Mae and Freddie Mac played in the subprime mortgage debacle. Democrats faulted the two Government Services Enterprises (GSEs) for following the financial herd over the subprime lending cliff, but concluded that it was competitive concerns – a fear of losing market share – and not government pressure to boost homeownership rates for minorities, that drove their ill-fated lending decisions.

Fannie and Freddie “followed rather than led Wall Street and other lenders,” pursuing high-risk practices that, the report says, were undertaken “to meet Wall Street expectations for growth, to regain market share, and to ensure generous compensation for…employees.”

In one of two Republican dissents, Peter Wallison, a fellow at the American Enterprise Institute, disagrees, insisting that the push for homeownership “[fostered] the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high-risk residential mortgages.” “If the U.S. government had not chosen this policy,” Wallison contends, “the great financial crisis of 2008 would never have occurred.”

In a separate dissent, the other three Republican members faulted the majority for painting their analysis with a brush too wide to draw a clear picture of what caused the crisis, providing “more an account of bad events than a focused explanation of what happened and why. When everything is important,” the dissenters complain, “nothing is.”

The Republicans criticized the majority report in particular for overstating the role of lax regulation and understating the global nature of the crisis. “By failing to distinguish sufficiently between causes and effects,” the minority report says, “the majority’s report is unbalanced and leads to incorrect conclusions about what caused the crisis.”

LEGAL BRIEFS

PRELIMINARY BUT BINDING

Commercial property owners and prospective tenants typically exchange multiple proposals before inking a final agreement to buy or sell buildings or lease space in them. But a California Appeals Court has ruled that one such agreement, though labeled a “final proposal,” was in fact an enforceable lease agreement, notwithstanding language indicating that the parties contemplated signing a final agreement in the future.

The companies involved, First National Mortgage Company and Federal Realty Investment Trust, negotiated for several years trying to agree on terms for a property First Realty wanted to purchase for development purposes. Initial proposals included standard contract language indicating that the documents were non-binding letters of intent. But First Realty omitted that provision from the “Final Proposal” at issue, to ensure that neither party could alter the major terms on which the companies had agreed.

When the negotiations ultimately collapsed, along with the real estate market, First National sued Federal Realty, seeking to enforce the agreement and demanding reimbursement for loss of rental income resulting because an existing tenant had been given notice to vacate.

Federal Realty argued that the final proposal was just that – a proposal that did not even specify the terms of the ground lease it included, and so was not an enforceable contract. But California’s Ninth Circuit Court of Appeals ruled that while an “agreement to agree” is not necessarily a binding contract, the intent of the parties can make it so. And in this case, the court found that an enforceable ground lease, with a put and call option to purchase, had been created. The court thus upheld a lower court’s award of $15.9 million in damages to compensate First National both for lost rent and for the un-exercised put option.

Several industry trade associations argued unsuccessfully on Federal Realty’s behalf that this conclusion would impede commercial realty negotiations by discouraging parties from executing preliminary documents that are part of the normal deal-making give-and-take. And that is, in fact, one of the messages practitioners should read in the court’s decision, Ann Lisa Braun, a partner in LeClair Ryan, suggests. “One must now take additional precautions to ensure that preliminary documents, at the letter-of-intent stage of a negotiation, remain just that – preliminary,” Braun told National Mortgage News. The other clear message, she said: “One should never remove non-binding language [from a negotiating document] without being fully prepared to live with the consequences of creating an enforceable, binding agreement.” 

BANKRUPTCY COURTS STEP IN

As lawmakers and regulators continue to debate the need for and effectiveness of federal foreclosure prevention programs, some bankruptcy courts are taking matters into their own hands, establishing “loss mitigation programs” as part of the bankruptcy process.

A recent analysis by the National Consumer Law Center found that bankruptcy courts in Rhode Island, New York and Vermont are now requiring mortgage lenders to negotiate with borrowers seeking bankruptcy protection in an effort to forestall foreclosure.

“Bankruptcy courts can play an important role in avoiding unnecessary foreclosures and facilitating mortgage modifications through implementation of LMPs,” John Rao, a researcher with the NLC, wrote in a recent issue of the ABI Journal.

The court-mandated programs include a variety of borrower protections, administrative checks and accountability provisions that critics say the Home Affordable Mortgage Program – the Obama Administration’s flagship foreclosure assistance program – lacks.

Specifically, Rao writes, the court programs set time limits for negotiations, require lenders to report on their status, and inform the court before terminating the discussions. According to Rao, approximately 35 percent of the negotiations ordered by Rhode Island and New York bankruptcy judges between November, 2009 and December 31, 2010, resulted in successful modifications.

“The number of modifications attained should not be the only goal of the LMPs,” Rao wrote. “Providing for a fair and transparent process, judicial efficiency and speedy outcomes are other measures of success.”

A Rhode Island bankruptcy judge recently affirmed the court’s authority to mandate loan modification discussions, rejecting the arguments of lenders who had challenged the program.

U.S. Bankruptcy Court Judge Arthur N. Votolato emphasized that the court’s program does not mandate settlement terms – it simply requires lenders to negotiate with borrowers. Court action was needed, he said, “[to respond] to the home mortgage and foreclosure crisis generally,” and because the court was being required to reschedule bankruptcy hearings repeatedly because of the delays borrowers encountered in trying to obtain loan modification agreements. “This practice of parties repeatedly seeking more time simply because they had not yet connected was counterproductive, it was a huge waste of time for the parties and the Court, and was forcing needless litigation …” Judge Votolato said in his order. “We decided to break the log jam” [by creating a process that would] open communications between debtors and the lenders’ decision-makers.”

Rhode Island Congressman Sheldon Whitehouse praised the decision as “a win for Rhode Island homeowners.” The bankruptcy mediation programs, he added, provide an effective alternative to the troubled HAMP [program, which has consistently fallen short of its projected goals.

Whitehouse has filed legislation modeled on the Rhode Island program that would give bankruptcy judges the authority to require foreclosure mediation. Unlike the “cramdown” measures Congress has rejected in the past, Whitehouse emphasized, his bill would not allow judges to restructure loan terms; it would simply empower bankruptcy judges to require “good-faith negotiations” between borrowers and lenders.

“As the foreclosure crisis continues…across the nation, the administration’s Home Affordable Modification Program [HAMP], while well-intentioned, has not succeeded in producing anywhere near enough modifications to stem the tide of foreclosures,” Whitehouse said at hearing on his bill. “Servicers too often act in their own fee-driven interests and not in the interests of the investors who actually hold the mortgages,” he added. “A court-supervised negotiation can ensure that servicers don’t reject reasonable settlements.”

Legal/Legislative Update February, 2011

WELCOME REVISION

Responding to lobbying pressure from the Community Associations Institute (CAI), the Federal Housing Finance Administration has revised a proposed regulation that prohibits Fannie Mae and Freddie Mac from purchasing mortgages on properties subject to deed-based transfer fees.

The regulations are aimed primarily at the long-term covenants developers have begun attaching to homes in large residential developments, triggering a payment to the developer every time the properties are sold. But as drafted initially, the restriction would have applied to all transfer fees, including those many community associations levy to fund reserves, offset operating expenses and finance capital improvements.

The transfer fee ban would have rendered an estimated 11 million condominium residences “instantly unmarketable,” CAI warned in comment letters urging the FHFA to rethink its proposal. The agency responded by adding language exempting transfer fees that benefit community associations or the properties in them.

“This was a critical revision for the financial health of tens of thousands of community associations,” CAI Chief Executive Officer Thomas Skiba, chief executive officer of CAI, said in a press statement. “Protecting traditional transfer fees is beneficial to homeowners, potential homebuyers, the associations and the housing market. The government should avoid doing anything that could stifle home sales and put communities in further financial jeopardy.”

The regulation, published in the February 1 Federal Register pending final approval, will still apply to other deed-based transfer fees, including those that do not directly benefit common interest ownership communities.

Several real estate industry trade groups, including the National Association of Realtors and the American Land Title Association, have led the campaign to ban most private transfer fees, arguing that they provide a lifetime revenue stream for developers, while providing no benefits for homeowners or for the communities in which encumbered properties are located.

Praising the FHFA’s proposed rule, ALTA President Anne Anastasi said it will “limit the spread of this predatory scheme, which adversely impacts [the housing market.]”

According to industry reports, 19 states have approved legislation or are considering measures that would restrict or ban private deed transfer fees. Like the FHFA’s revised regulation, the state laws typically exempt fees imposed by community associations. 

WINNERS AND LOSERS

Every financial crisis, no matter how severe, has winners as well as losers, and the current one is no different. While the housing market as a whole continues to struggle, the rental market is showing signs of strength. And that’s a serious understatement, if a recent article in Multifamily Executive is even remotely accurate.

“So this is how the Great Recession ends in the multifamily industry?” the trade publication exulted. “Not with a whimper, but with a bang, and not just any bang, but a screaming eagle, sonic-booming, avenging angel bang that is blasting apartment operators to an unheard of zenith in rent fundamentals. Mark 2010 down as the year of the recovery, and then fasten your seat belts for 2011 and beyond.”

National apartment vacancy rates declined to 6.6 percent in the fourth quarter from 8 percent in the same period a year ago, according to Reis, which measures rental trends in major metropolitan areas. The Multifamily Executive article quoted a slew of industry executives predicting double-digit increases in rents over the next two years. “Definitely the strongest performance since 1999 to 2000 and we might even beat that record,” Hassam Nadji, managing director of research and advisory services at Marcus & Milichap, told the publication.

The rebound in the rental market is coming without the strong employment growth that is typically needed to boost apartment demand. Success in preventing at least some of the foreclosures and keeping those homes out of the rental market, accounts for some of the improvement, analysts say, while signs of an improving economy have boosted consumer confidence sufficiently to “de-couple” some renters who were doubling and tripling up, while encouraging some younger renters who had been living at home to find apartments of their own.

Changing attitudes toward home ownership may also be a factor in the improving rental picture. A recent survey by Apartment.com found that prospective renters now include many former homeowners for whom renting is a lifestyle choice, not a financial necessity.

Of the 2,700 visitors to the Apartment.com Web site who responded to the survey, 60 percent said they prefer to rent. Among former homeowners who are renting for the first time, 65 percent said they now view renting as a more affordable option and homeownership as a less appealing investment because of uncertain price trends and high maintenance costs.

Providing some academic support for this presumed shift in the rent vs. buy calculation, a recent study has concluded that the benefits of homeownership have been oversold. The study, “American Dream or American Obsession,” published by the Philadelphia Federal Reserve Bank, suggests that the two traditional arguments for ownership – as an enforced savings strategy and a solid long-term investment – “are no longer valid.”

While the savings argument has had merit in the past, “the changing economic environment has rendered it flawed,” the study’s authors, Wenli Li, an economist at the Philadelphia Fed and Fang Yang, an assistant professor at the University of Albany, contend.

The investment value of ownership has similarly been eroded both by economic trends and by government policy, they suggest, noting: “Even after households have accumulated some equity…[they] are now so easily able to tap their home equity to pay pressing bills that they simply do not accumulate wealth.” Moreover, the study notes, the recent financial crisis has demonstrated that home prices can decline as well as rise, making home ownership no safer an investment option than equities.

“I don’t think you are going to see too many people opting for home purchases,” Greg Willett, vice president for research and analysis, agreed, telling Multifamily Executive, “As a consumer, you’d have to be more confident in your employment picture, and you’d have to be confident that housing prices have hit bottom or are close to bottom. I don’t think that describes very many people.” 

GOOD, BAD AND UNCERTAIN

Four years of steadily declining home prices have made home ownership more affordable than at any time since the housing boom began in 2003. The ratio of median home prices to annual household income in 74 major markets declined from 2.3 in late 2005 to 1.6 in the third quarter of last year, according to data compiled by Moody’s Analytics – -the lowest ratio in the 35 years this information has been collected.

“Based on incomes, this is as affordable as it gets,” Mark Zandi, chief economist at Moody’s, told the Wall Street Journal.

That represents the good half of what is a good news-bad news story. The bad news: The price decline that has boosted affordability ratios has left 27 percent of homeowners who have mortgages underwater, with loan balances exceeding the current value of their homes and facing the prospect that prices could decline another 10 percent or more, some analysts believe, before finally hitting bottom next year. Markets that are already seriously undervalued “are going to get even more undervalued,” Zandi warns.

Expectations that the housing recovery will continue to lag have revived concerns that more buyers will “strategically default,” making an economic decision to walk away from homes in which they have no equity and little hope of rebuilding it any time soon. In a recent survey by Housing Predictor, an on line real estate forecasting firm, nearly half the respondents said they would walk away from their homes even though they can still make the payments, if prices continue to fall.

But another study by economists at the Federal Reserve Bank of San Francisco suggests that the concern about strategic defaults may be exaggerated. Borrowers will make a strategic default decision if home values fall too far below their mortgage balance, economists John Krainer and Stephen LeRoy agree. But the tipping point is a lot lower than many analysts assume, they contend in a recently published working paper.

When the home value and mortgage balance are equal, the owner, though in a zero equity position, still has an incentive to remain in the home, Krainer and LeRoy say, because he is in a “heads-I-win, tails-you-lose” position with the lender. If prices decline more, the borrower can walk, increasing the lender’s loss but leaving the borrower no worse off; if prices recover, the borrower benefits. “With both upside potential and downside protection against future losses, the borrower rationally should wait before defaulting,” Krainer and LeRoy argue.

Strategic default predictions based on negative equity alone also fail to recognize the distinction borrower’s make between the “book value” of their equity – a function of the home’s price – and the “market value” which incorporates other variables, including the borrower’s expectation that prices will recover and the costs incurred by walking away, such as moving expenses and a lower credit rating.

“The possibility of price appreciation and the costs of default – [both actual and perceived], move the rational default point well below the underwater mark,” the economists conclude. “One of the key lessons from this area of research is that analysts must be careful in calculating the precise default point on mortgages,” they caution. “We should not expect a discrete jump in default rates once house prices fall to the threshold at which home value equals the remaining book balance on the mortgage.” 

STUDYING FORECLOSURES

Record foreclosures are clearly wrecking havoc on personal finances, home prices and neighborhood stability. But look on the bright side; the trend is providing a mother lode of research material for economists and social scientists. Two recent examples focused on the impact foreclosures have on, respectively, consumer credit scores and defaults on second mortgages.

It is no surprise that a foreclosure damages a consumer’s credit rating – a lot and for a long time. Somewhat more surprising, and a bit counterintuitive, is the evidence in the first of these studies that borrowers who start with lower credit scores recover more quickly than those who had stronger financials before a foreclosure.

Kenneth Brevort, a senior economist at the Federal Reserve Board and Cheryl Cooper, a research associate at the Urban Institute, studied “The Credit Experiences of Individuals Following Foreclosure” by analyzing the anonymous credit scores of about 370,000 consumers who had suffered foreclosures. They found that borrowers with pre-foreclosure scores of 680 suffered an 85-point decline, on average, while those with scores of 780 lost nearly 160 points.

The declines for both groups resulted because of spill-over delinquencies on other loans – credit cards, auto loans, etc. But the declines were steeper for those with higher scores, who also recovered more slowly. After two years, only 10 percent of prime borrowers had restored their scores to pre-delinquency levels, and only 40 percent had fully recovered after 7 years. Sub-prime borrowers fared much better. After two years, more than 60 percent had repaired the damage to their credit scores and after 7 years, the recovery rate was 94 percent.

The researchers don’t have a definitive explanation for the difference, but one possibility they suggest is that foreclosure “may change prime borrowers’ perception of creditworthiness,” making them more likely than they were before to default on other loans. Having a lower credit score in itself “may reduce the incentive to make on-time payments,” the study notes.

In the second of these studies, researchers at the Federal Reserve Bank of Philadelphia offer an intriguing explanation of why second lien holders have resisted pressure to modify those loans in order to make modifications of first mortgages viable for lenders and borrowers. This study found that 20 percent of borrowers who entered foreclosure on their first mortgage often continued making payments on the second, and 40 percent of borrowers receiving loan modifications kept their equity loans current.

One likely reason, the authors suggest: In order to qualify for some loan modifications, borrowers must first default on their primary mortgage, creating an incentive to default on one loan, but not on the other. On the contrary, the study points out, borrowers have a strong incentive to remain current on their second liens (primarily home equity lines of credit), in order to preserve access to their credit lines. Supporting this theory, the larger the credit line, the less likely borrowers were to default. Interestingly, this study found that 90 percent of credit lines were not adjusted following a foreclosure; a few (3 percent to 6 percent) were actually increased.

Other studies have focused on the rise in “strategic defaults” by owners with negative equity. But this study suggests that borrowers may be overlooking an even more effective strategy. A second lien behind a first mortgage that already exceeds the value of the property is virtually worthless. So borrowers could default on the second lien, possibly generating enough revenue to remain current on the first mortgage, without much risk that the lender will foreclose on the second.

“The data indicate, however, that most borrowers rarely engage in this strategy,” the study says, “even though it appears to be viable.”

BAD SCORES

The Department of Housing and Urban Development (HUD) is investigating allegations that 22 lenders discriminated illegally against borrowers obtaining FHA (Federal Housing Administration)-insured loans by requiring higher credit scores than the FHA itself mandates.

The National Community Reinvestment Coalition (NCRC) initiated the complaint after an investigation that found many of the leading FHA lenders failed to offer FHA loans to potentially qualified borrower with credit scores of 620, even though the FHA will accept scores of 580 or lower, depending on the size of the borrower’s down payment.

Of the lenders targeted by NCRC “mystery shoppers,” 32 (65 percent) required credit scores of at least 620 for FHA loans and 22 percent set their minimum scores at 640. Under the FHA’s underwriting standards, borrowers making the minimum down payment (3.5 percent) must have credit scores of 580 or higher; borrowers with lower scores (between 500 and 580 are still eligible for FHA loans but must put a minimum of 10 percent down.

The NCRC contends that the higher credit score requirements have a disproportionately negative impact on Black and Latino borrowers and have no business justification, because the FHA ill insure loans to borrowers with lower scores.

“Critical to our nation’s economic progress is the ability of homeowners to get quality refinancing, and for homebuyers to reclaim vacant houses by accessing quality mortgage credit,” John Taylor, president and chief executive of the NCRC, said in a press statement. “The housing crisis is not the fault of working-class families,” he added, “but they are the ones suffering the consequences of Wall Street’s malfeasance.”

The Community Mortgage Banking Project (CMBP), representing mortgage bankers, replied that the higher credit scores reflect industry efforts to tighten the loose credit standards that contributed to the financial melt-down and underscore “the compelling need for lenders to apply judgment and discretion” in establishing underwriting standards.

“FHA has always recognized the need for lenders and investors in FHA loans to establish and maintain their own risk-management tolerances,” Glen Corso, managing director of the industry trade group, said in a statement. “By setting common sense credit standards, FHA lenders are exercising prudent judgment and protecting borrowers, neighborhoods, the FHA and U.S. taxpayers from another round of excessively high defaults and foreclosures.”

Industry critics have excoriated lenders for the lax credit standards that contributed to the financial melt-down, Corso noted. “To ask mortgage lenders [now] to ignore risk factors for certain loans is reckless and misguided.”

LEGAL BRIEFS

PESTICIDE CLAIM

An Indiana family has won a $23.5 million judgment against a landlord, whose pesticide use, they claim, sickened their two children.

The jury found in favor of the parents, Todd and Cynthia Ebling, in their suit against the Prestwick Square Apartments and its management company. The couple filed the suit more than 12 years ago, when their two young children were hospitalized with serious neurological and other problems a few months after the moved into the apartment building.

Experts testifying for the plaintiffs said their medical problems resulted from exposure to Creal-O – a Diazinon-based pesticide. Although residential use of the pesticide was legal at the time (the EPA banned its sale after December, 2004), the experts said it was applied improperly.

BIG DEAL

A federal court in Los Angeles has approved what is believed to be the largest settlement in a securities action related to the housing market meltdown. The settlement, approved by U.S. District Judge Mariana Pfalelzer, requires Countrywide (now owned by Bank of America) to pay more than $600 million to hundreds of investors who alleged that Countrywide executives knowingly misled investors about the company’s financial condition and the quality of its mortgage securities.

The settlement involves about 970 institutional investors, but nearly two dozen opted out, preferring to litigate instead. The opt-out group included the California Public Employees’ Retirement Pension System, T. Rowe Price, and Black Rock Investment Management, among others.

While many of the institutions that rejected the settlement were large, their claims represented “a relatively small portion of the entire pie,” according Joel Bernstein, a senior partner at Labaton Sucharow in New York, the lead counsel for the plaintiffs. Although the potential damages were estimated in the billions of dollars, the cost of litigation and the difficulty of proving that Countrywide executives knowingly defrauded investors, argued for the settlement, Bernstein told National Law Journal.

WORTH QUOTING: “The spring market is going to be the first test of the proposition that there’s an underlying improvement in new-home fundamentals. If we don’t see the needle move, it will be very discouraging.” – Richard DeKaser, economist at the Parthenon Group, in an interview with the Wall Street Journal, predicting that new home sales will strengthen this year.

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FORECLOSURE CHANGES

Legislation requiring judicial review of all foreclosures is one of several bills Massachusetts lawmakers will be considering this year, targeting perceived abuses in the foreclosure process. Others would require lenders to attempt a negotiated agreement with borrowers before proceeding with a foreclosure action and would require foreclosing lenders to produce a valid title for the property before evicting a resident.

Massachusetts is by no means the only state looking at ways to tighten foreclosure practices. The Virginia Legislature is considering a measure requiring lenders to provide written notification to owners at least 45 days before a foreclosure sale occurs; lawmakers in Vermont and New Jersey are considering similar measures that would require foreclosing entities to document their right to foreclose and verify the accuracy of their foreclosure documents. California lawmakers are reportedly considering amendments to that state’s real estate laws that would require foreclosing lenders to produce documentation for all transfers and all assignments of the loan.

These legislative initiatives respond to evidence of sloppy, poorly documented foreclosure procedures that have led some courts to reject or overturn foreclosure actions. In a decision that has attracted national attention, the Massachusetts Supreme Judicial Court (SJC) ruled recently (in U.S. Bank v. Ibanez) that lenders must produce documentation establishing their ownership of the mortgages on which they are foreclosing. (See Legal Briefs below.)

Industry executives in Massachusetts and elsewhere are urging lawmakers to proceed cautiously with any changes in existing foreclosure laws.

“We need to calm down a little bit and take a more judicious approach and figure out what the problems are and not use this as a pretext to completely change our foreclosure process,” Ward Graham, a member of the legislation and title standards committees for the Massachusetts Real Estate Bar Association, told the Boston Globe. “Basically, the foreclosure process has worked pretty well going on 200 years,” he noted.

RENT VS. BUY: A NEW CALCULUS

A soaring foreclosure rate has funneled many former homeowners into the rental market, pushing home prices down and rental rates up. As a result, in many of the nation’s largest cities, it now costs more to rent a home than to buy one. A rent vs. buy index created by Trulia, the on-line search and marketing firm, finds that in 36 of 50 major metropolitan areas, the equation now tips toward ownership.

“Since the start of the ‘Great Recession,’ many former homeowners have flooded the rental market,” Pete Flint, CEO and co-founder of Trulia, said in a statement. “Following the principles of supply and demand,” he said, “renting has become relatively more expensive than buying in most markets.”

The rental markets are being swelled not only by former homeowners’ who have lost their homes to foreclosure, but also by prospective buyers, unable to qualify for a mortgage under the tighter underwriting standards lenders have adopted.

“Though necessary for achieving true economic recovery, stricter bank lending practices have also further aggravated the struggling housing market in the short term,” Flint noted. “Even highly qualified homebuyers face intense scrutiny on their income, savings, existing debt and credit history before they can get a mortgage loan.”

Still, the perception that homeownership is desirable remains strong. A recent survey by the National Association of Realtors found that “a substantial majority” of renters and homeowners agreed that owning a home is still a wise financial choice over the long term. In the on-line survey of 3,793 adults, 95 percent of owners and 72 percent of renters agreed with that conclusion.

A majority of renters (63 percent) said it was at least “somewhat likely) that they would purchase a home in the future, with younger adults (18-29) expressing the strongest desire for ownership. Only 8 percent of respondents in this age group said it was “not at all likely” that they would ever purchase a home.

SELLING SHORT

Short sales, in which lenders agree to accept less than the amount owed on a mortgage when a borrower sells the home, are generally recognized as a less detrimental alternative to foreclosure for struggling borrowers and often for lenders, as well. But short sales are also increasingly vulnerable to fraud, according to a recent study, which estimates that financial institutions are booking $310 million annually in unnecessary losses as a result.

The study, by CoreLogic, found fraud risks in 1 of every 53 short sale transactions, with resulting losses averaging $41,500 per sale. Approximately 4 percent of properties sold in short sales are resold within 18 months – a red flag suggesting a high likelihood of fraud, according to the study.

Risk concerns are growing with the volume of short sales, which has tripled since 2008, the study noted, with more than half of the sales (55.8) concentrated in four states – California, Florida, Texas and Arizona. Revisions in the federal government’s Home Affordable Mortgage Program (HAMP) provide incentives to encourage buyers to pursue short sales and lenders to accept them. The resulting increase in short sales, and the pressure on lenders to process them quickly to help borrowers avoid foreclosure, is increasing the fraud risks, industry executives say.

“As the government has pressured us to do short sales faster, we don’t have time to check them out,” Anthony DiMarco, executive vice president for government affairs at the Florida Bankers Association, told the Palm Beach Post. The “bad guys” exploit the resulting vulnerabilities, DiMarco noted. “They know how to defraud the system and will rush in to do it.”

Short sales “will continue to be a necessary part of the mortgage industry as it seeks stabilization,” Tim Grace, senior vice president of Fraud Analytics at CoreLogic, said in a press statement, and those sales “by definition” will result in losses for lenders. The goal, Grace said, is not to eliminate short sales, but to reduce the risk of “unnecessary losses,” and the best way to do that, he said, “is through a collaborative effort where lenders collectively share pre-closing and post-closing information [on short sale transactions] in real time.”

HOME OWNERSHIP FLAME BLAZING OR FLICKERING?

The National Association of Realtors (NAR) is confident that the desire for homeownership remains as strong as ever, despite the body blows the housing market has absorbed from the subprime implosion, a prolonged recession and the continuing foreclosure crisis. As evidence that Americans have not given up their dream of homeownership, industry executives cite the NAR’s most recent Housing Opportunity Pulse Survey, which found that nearly 80 percent of respondents still view a home purchase as a solid financial decision, unaltered by the much-publicized decline in home sales and home values. Of the 1,209 urban and suburban adults responding to this year’s survey, more than two-thirds (68 percent) agreed that this is a good time to buy a home, while 39 percent described buying a home as “one of their highest priorities.” Only 21 percent said home ownership is not a priority at all.

Other analysts see more cause for concern. While the home ownership dream may still beat strongly in American hearts, they suggest, the pulse is noticeably weaker in the hearts of younger Americans. These analysts are particularly concerned about members of Generation Y – the approximately 85 million people born between 1981 and 1999, who will drive housing market trends for the next two or three decades, but whose employment prospects and life views have been battered severely by this recession.

“With a 30 percent unemployment rate and an average $23,000 post-college debt, they’re not saving for a down payment, and their parents, struggling to recover their own retirement savings, can’t help,” John McIlwain, senior resident fellow at the Urban Land Institute (ULI), said during a recent ULI housing forum.

Other panelists echoed his concern. Having witnessed the struggles of family members and friends, trapped by falling home prices and rising unemployment, they noted, Gen Y is far less likely than previous generations to view home ownership as an automatic and essential wealth-builder. The likely result, McIlwain predicted: Less home buying and “unprecedented” rental activity over the next decade.

RECESSIONARY DIVISIONS

An old joke – more perceptive than funny – suggests that the difference between a recession and a depression is defined more by individual experience than economic statistics: A recession exists, this joke suggests, when other people lose their jobs; a depression, when you lose yours.

A recent study by the Pew Research Center reflects that division, finding that while the recession affected all Americans, it did not affect them in the same way, with more than half (55 percent) suffering “a mix of hardships,” and the other 45 percent more inconvenience than harmed by the downturn.

Age, location, and (to some extent) political identification were among the variables determining the recession’s impact, the study found. More than 7 in 10 retirees held their own, while a large majority of “20-somethings” lost financial ground. People living on the East coast fared better than residents of the South, West and Midwest, suburban and rural residents did better than city dwellers, and Republicans had a somewhat easier time, as a group, than Democrats.

Those hard-hit by the recession described severe economic hardships – 55 percent said they are “just getting by” or not making ends meet and more than 4 in 10 said the recession forced them to make “major changes in the way they live.” Those who “held their own,” by contrast, said they are “living comfortably.” And while some said they have cut back on discretionary spending, none said the recession has forced them to make major lifestyle changes.

Not too surprisingly, those in the “lost ground” group are more likely to think the economy remains mired in recession (60 percent vs. 45 percent of those holding their own). Nearly half of the ‘holding their own’ group thinks the economy is starting to recover, a view shared by only 35 percent of those who see themselves as “losing ground.” But hardly anyone in either group (3 percent in “lost ground” and 4 percent in ‘holding their own’) thinks the recession is definitely over.

BANKRUPTCY TRENDS

Although the economy appears to be strengthening, consumer bankruptcies, something of a lagging indicator, continue to rise. The rate of increase has slowed, but the trend line continues to reflect the damage inflicted by an unemployment rate that remains stubbornly high and an economic recovery that hasn’t yet been strong enough to make much of a dent in it.

More than 1.5 million consumers filed for bankruptcy protection in 2010, an 8 percent increase over the 2009 total, but a significant year-over-year improvement compared with annual increases of 32 percent and 33 percent in 2008 and 2007.

Still, the 2010 filing volume equaled that in 2004, the highest level recorded before the implementation of bankruptcy reform legislation in 2005. The reforms, which made it more difficult for consumers to erase their debts, were supposed to reduce bankruptcy filings significantly. In fact, consumer bankruptcies have increased every year since the law was enacted, according to the American Bankruptcy Institute (ABI).

“Families continue to turn to bankruptcy as a result of high debt burdens and stagnant growth,” Samuel Gerdano, executive director of the ABI. Gerdano predicts that filings will continue to rise this year as unemployment remains high and income growth continues to lag.

TAX TOIL TALLIED

Few would dispute that the annual tax-filing ritual is a time-consuming – not to mention frustrating, painful, infuriating and a lot of other adjectives we shouldn’t use here – exercise. The emotional strain is hard to quantify, but the Taxpayer Advocacy Service), which monitors the Internal Revenue Service, has calculated that individuals and businesses collectively spend 6.1 billion hours annually complying with the tax code. Translated into labor terms, TAS estimates that tax compliance and filing efforts would keep 3 million workers occupied full time, which makes tax compliance “one of the largest industries in the U.S.,” the agency states in its annual report to Congress.

The length and complexity of the tax code create problems for both taxpayers and the IRS, the report notes, driving an estimated 60 percent of filers to purchase tax preparation software and 30 percent to hire professionals to do the work for them. But even with that level of outside assistance, the report notes, the IRS received 110 million calls from perplexed filers in each of the past two years, “a staggering number,” TAS says, exceeding the capacity of the IRS, which responded to less than 25 percent of them.

The solution, according to National Taxpayer Advocate Nina Olson, who heads the TAS, is comprehensive, revenue-neutral tax reform – simplifying the tax code for filers without significantly altering their tax bills.

Congress should address tax reform and government spending separately, Olson suggests. Otherwise, she warns, “the debate over revenue levels could overshadow and derail meaningful…reform.”

The report also suggests sending a “taxpayer receipt” to filers, itemizing how tax revenues are spent. “Better public awareness of the connection between taxes and government,” the report says, “may improve civic morale, improve tax compliance, and make more productive the national dialogue over looming fiscal policy choices.”

LEGAL BRIEFS

PROOF OF OWNERSHIP

A Massachusetts court has delivered a ruling that mortgage lenders all over the country have feared. The Supreme Judicial Court (SJC), the state’s highest court, invalidated two foreclosures, finding that the lenders involved – Wells Fargo and US Bancorp – had not proven that they held the mortgages when the foreclosures were initiated.

The ruling replaces the jabs plaintiffs’ attorneys have been landing on mortgage lenders and servicers with a square-on body blow to industry efforts to deflect challenges that some analysts say could undo thousands of foreclosures. The Congressional Oversight Panel overseeing the $700 billion federal bank bailout has warned that the problem “could potentially threaten financial stability” if lenders are required to buy back billions of dollars in loans backing securities sold to investors.

The SJC decision (U.S. Bank v. Ibanez) upheld a ruling by the state Land Court holding that the lenders had no standing to foreclose because the documents establishing their ownership of the mortgages were transferred several months after the foreclosure sales were completed.

“We agree with the [Land Court] that the [lenders], who were not the original mortgagees, failed to make the required showing that they were the holders of the mortgages at the time of foreclosure,” Associate Justice Ralph Gants wrote for the SJC majority.

The key legal issue here is the conflict between common securitization practice (in which mortgages in securitized pools are often transferred without naming a recipient) and real estate laws in Massachusetts and many other states holding that foreclosing entities must be the mortgage holders of record – that is, they must be named in the documents.

The SJC ruling makes it clear that the assignment of the loan does not necessarily have to be recorded in order to be valid, “although recording is likely the better practice….However, there must be proof that the assignment was made by a party that itself held the mortgage.”

The financial industry argues that documentation shortcuts are justified to ensure securitization efficiency and have no substantive effect on the ownership of the loans or the legitimacy of the foreclosures. Plaintiffs’ attorneys, consumer advocates and many real estate law experts counter that documentation accuracy is a cornerstone of real property law and essential to the trust required to transfer ownership of real property.

A concurring SJC opinion noted the “utter carelessness with which the plaintiff banks documented the titles to their assets. … There is no dispute that the mortgagors of the properties in question had defaulted on their obligations, and that the mortgaged properties were subject to foreclosure,” Associate Justice Robert Cordy wrote. “Before commencing such an action, however, the holder of an assigned mortgage needs to take care to ensure that his legal paperwork is in order.”

MORTGAGE LITIGATION ESCALATING

Mortgage-related litigation increased by more than 40 percent in the third quarter, as investors joined, and outpaced, consumers in pursuing lenders and loan servicing companies for negligence, fraud, or both, in originating loans and initiating foreclosure actions. Patton Boggs, a law firm specializing in bank litigation, tracked more than 100 civil and criminal cases involving mortgage lending in the third quarter, compared with 75 in the second.

“In recent months, the focus of mortgage litigation has begun [to shift] from primarily consumer foreclosure disputes toward loan documentation and servicing issues,” Patrick McManemin, a partner in the firm’s Dallas office, said in a press statement. “Therefore, an increase in residential note repurchase litigation from investors in securitization trusts and banks that face indemnity claims from government-sponsored enterprises should be expected.”

In a related development, the attorneys general in Arizona and Nevada have filed suit against Bank of America, accusing the lender of “widespread fraud” in its handling of loan modification requests. Specifically, the suit claims, the bank:

  • Encouraged consumers to seek modifications and then foreclosed on them anyway, despite assurances to the contrary;
  • Advised borrowers, incorrectly, that they would not be eligible for modifications unless they defaulted on their loans first;
  • Promised that modifications would be made permanent after a trial period, but then withdrew the promise;
  • Manufactured pretexts for rejecting modifications that actually met the bank’s criteria for approval.

“Bank of America’s callous disregard for providing timely, correct information to people in their time of need is truly egregious,” Catherine Cortez Masto, the Nevada Attorney General, said in a press statement.

The law suit represents a window-rattling salvo in a battle banks are fighting on multiple fronts as consumers, investors, industry regulators and lawmakers (state and federal) target flawed foreclosure procedures.

Separately, industry analysts have reported that courts in several states have dismissed foreclosure actions in which documents were not actually signed by the attorneys whose signatures appear on them, threatening sanctions against the attorneys involved.

If widespread, the practice could overturn thousands of foreclosure judgments, in addition to those already in question because of alleged “robo-signing” practices, in which attorneys signed documents without actually reviewing them.

“What you have here is a non-lawyer engaged in unauthorized practice of law,” Max Gardner, a consumer bankruptcy attorney who specializes in foreclosures, told ProPublica. “And that would be a serious problem in terms of that foreclosure judgment [withstanding a challenge.] I think this is the next huge issue,” he predicted.

WORTH QUOTING: “So be wary of politicians bearing promises of a perfect world where average Americans can get the mortgages to which we now all feel entitled and the government is nowhere to be seen. It’s a mirage.”   Bethany McLean, co-author of “All the Devils Are Here,” in a New York Times op-ed commentary, noting the difficulty of eliminating the government’s role in the housing finance system.

Legal/Legislative Update January 2011

 

A DEEPER HOLE

Standard advice when you’re in a hole is – before you do anything else, stop digging. But that strategy doesn’t seem to be working for the financial institutions trying to find a way out of the foreclosure morass in which they are buried. While the institutions have tossed their shovels aside, lawmakers, consumer advocates, class action attorneys and investors are digging furiously around them, widening a hole that is already plenty deep.

Courts, which had been approving foreclosure petitions almost automatically, are now requiring lenders and loan servicers to provide clear and copious proof that their standing to foreclose is clear and their documentation is in order. Under newly adopted rules in Maryland, for example, judges can appoint outside experts to review foreclosure paperwork and require attorneys representing lenders to attest to the accuracy of the documents they file. A similar rule in New York State requires attorneys to submit an affidavit affirming “under pains and penalties of perjury” that they have verified the accuracy of their foreclosure documents. Judges in Ohio County, meanwhile, have given attorneys 30 days to verify the accuracy of their foreclosure documents; if they can’t provide that assurance, their foreclosure actions will be dismissed.

The courts are now aware of potential “flaws” in the foreclosure system, “and we decided we couldn’t turn a blind eye to that,” Judge Eileen Gallagher, head of the Cuyahoga County court system’s foreclosure committee, told the Washington Post. Attorneys in New York City estimate that the courts are dismissing between 20 percent and 50 percent of foreclosure petitions because of flawed paperwork, the Post reported.

Expressing similar concerns, the sheriff of Cook County, IL (which includes Chicago) has said he won’t enforce foreclosure evictions initiated by bank of America, JP Morgan Chase and GMAC/Ally Financial until they can provide assurances that their foreclosures were handled “properly and legally.”

“I can’t possibly be expected to evict people from their homes when the banks themselves can’t say for sure everything was done properly,” Sheriff Thomas Dart said in a press statement.

As media coverage of the foreclosure mess intensifies, more borrowers are challenging foreclosure actions, collectively as well as individually, and consumer class action suits are mounting. One proposed class action suit filed against Morgan Stanley asks the court to dismiss pending foreclosure actions against thousands of borrowers, declare their loans null and unenforceable, award members of the class actual and punitive damages plus court costs and attorneys’ fees. Other financial institutions facing similar suits have acknowledged that they can’t estimate their potential losses from mortgage-related litigation.

Investors are also beginning to rattle litigation swords that are, if anything, more threatening than those being waved by consumers. Investors sustained “enormous damages” from securities they purchased between 2005 and 2007, when the housing bubble was inflating and the subprime mess was brewing, one attorney representing investors in a suit against a Massachusetts hedge fund, told Reuters.

“This could be a large hit for the entire industry,” Brian Maillian, CEO of Whitestone Capital Group, agreed. “It’s a very, very large problem,” he told MSNBC, adding, “we really don’t know how deep the hole is.”

The Congressional Oversight panel charged with monitoring TARP (shorthand for the financial industry assistance plan, or ‘bail-out’, depending on how you felt about it) has warned that the foreclosure fiasco could have far-reaching and potentially devastating impacts on financial institutions and the broader economy. In an extensive and unusually blunt analysis, the committee notes that Bank of America alone faces a potential $47 billion buy-back claim from one investor. “It is possible that widespread challenges along these lines could pose risks to the very financial stability that [TARP] was designed to protect,” the report says.

The committee doesn’t suggest that this worst case scenario is inevitable, only that it is possible if financial institutions are forced to reimburse investors on a large scale for the toxic mortgages the investors purchased.

Assurances from Treasury Department officials that the foreclosure problems pose “no systemic risk to the financial system” drew a skeptical response from members of the oversight panel during a recent hearing. Given the litigation against major financial institutions pending and rumored, “it is not a plausible position that there is no systemic risk here,” Damon Silvers, a member of the panel and director of policy and special counsel to the AFL-CIO, said.

Sen. Ted Kaufman (D-DL), the panel’s outgoing chairman, agreed. “If investors lose confidence in the ability of banks to document their ownership of mortgages,” he said, “The financial industry could suffer staggering losses. “ That prospect is particularly “alarming,” Kaufman added, “coming so soon after taxpayers spent billions of dollars to bail out these very same institutions.” 

LESSONS LEARNED – OR NOT

Analysts searching for a silver lining in financial statistics that remain more grim than uplifting have focused on the decline in credit card debt outstanding as evidence that consumers have learned their lessons and are living less on credit and more within their income limits.

These statistics look encouraging. The Federal Reserve reports that household liabilities – a category that includes mortgages, credit card accounts and non-revolving loans – declined by $200 billion between the second quarter of 2009 and the same quarter this year. Credit card accounts alone declined from $915 billion to $83222.2 billion, according to the Fed report.

But some economists think loan balances are declining not because borrowers are voluntarily reducing their debt loads but because banks are charging off unpaid balances and denying credit to borrowers who have defaulted in the past.

“Non-defaulting borrows are reducing their overall credit exposures, but not at an especially rapid pace, given stagnant incomes and wealth,” Cristian deRitis, director of credit analytics at Moody’s Analytics, told the New York Times. The preliminary results of an incomplete analysis of credit card debt suggest that charge-offs are responsible for most of the overall decline in credit card debt, deRitis said.

Analysts at CardHub.com have reached the same conclusion. They found that credit card debt declined by $12 billion between the first and second quarters of this year, but banks charged off nearly $22 billion in credit card debt during the same period. The nearly $10 billion difference reflects new credit card debt incurred, Odysseas Papadimitriou, chief executive and founder of the company, told the New York Times, suggesting, he said, that consumers may not have learned much of a lesson after all. 

NO CHANGE

The recession may have altered many financial patterns, but it has left at least one long-standing trend intact: Minorities continue to have a harder time obtaining mortgage loans than whites. Loan denial rates for African Americans and Latinos were “notably higher” than for white applicants in 2009. Minorities were also more likely to obtain “high-cost” mortgages and FHA-insured or VA-guaranteed loans, and more likely to lose their homes to foreclosures.

Those trends, reflected in the 2009 Home Mortgage Disclosure Act (HMDA) statistics compiled by the Federal Financial Institutions Examination Council (FFIEC) have been stubbornly consistent since federal regulators began collecting detailed data on home mortgage origination and refinance activity as part of an effort to identify discriminatory lending patterns.

The Center for Responsible Lending (CRL), a consumer advocacy group, said the “highly disturbing” trends reflected in the statistics constitute “a national tragedy.” While a “superficial” analysis views the subprime crisis as evidence that minorities had too much access to mortgage credit, in fact, the CRL contends, the problem was a mortgage system that pushed minorities improperly into unaffordable loans. “If there had been high access to sustainable mortgages,” the CRL says, “the subprime market would have behaved quite differently.”

The release of the new HMDA statistics coincides with Federal Reserve hearings on proposals to revamp the annual report, as mandated by the financial reform legislation enacted earlier this year. Among other changes, the legislation calls for adding the ages and credit scores of borrowers to the information lenders are required to collect and report. Industry executives have opposed those changes, arguing that the additional information could compromise consumer privacy. “I don’t know that we should know that [much] about our neighbors,” Greg Ohlendorf, president and CEO of First Community Bank and Trust, testified at the Fed hearing. “That’s a hug concern,” he added. “It’s like handing your loan application to your neighbor.”

Community advocates argue that the expanded data will improve efforts to identify abusive lending practices and discriminatory patterns. “There are substantial concerns about the re-emergence of redlining as borrowers in communities of color devastated by the foreclosure crisis experience difficulty accessing mortgage credit,” Geoff Smith, senior vice president of the Woodstock Institute, a Chicago-based advocacy group, said at the Fed hearing.

Separately, a report sponsored by the Mortgage bankers Association warns that the statistical models used to identify lending discrimination and credit risk are flawed and “have likely contributed to recent problems in [the] mortgage markets.”

These models lack “robust theoretical support,” and reliance on them produces “false findings of discrimination” and erroneous assessment of credit risks, Anthony Yezer, a professor at George Washington University, contends in his research paper, “A Review of Statistical Problems in the measurement of Mortgage Market and Credit Risk.”

“Though the problems with these simplistic modes of analysis are well known to the academic world,” Yezer contends, they “continue to be overlooked….If these limitations are not recognized and naive reliance on them continues,” he warns, “current problems are likely to recur in the future. Alternatively, there are major gains to be made if economic analysis of mortgage market discrimination and mortgage credit risk can be improved.”

AFTER SHOCKS

As the shock waves from robo-signed and otherwise flawed foreclosures intensify, it is becoming clear that the collateral damage may spread to the paperless mortgage system that has taken root and flourished over the past decade.

That system is embodied in MERS – the Mortgage Electronic Registration System – created to track and hold mortgages that are originated electronically. MERS holds title to mortgages filed on its system as agent for the owners of those loans, retaining that position, including the right to foreclose, as long as the loan is owned by a MERS member. MERS members include Fannie Mae, Freddie Mac, and most of the major loan originators and syndicators in the country. According to press reports, about 60 percent of newly originated loans are recorded through MERS rather than the old-fashioned way, by filing documents in the government recording office in the county in which the purchased property is located.

The MERS process has proven to be faster and less expensive than the paper-based alternative, but it also seems to have created a serious disruption in the chain of title necessary to establish the ownership of loans and the authority to foreclose on delinquent borrowers. That problem has surfaced in foreclosure proceedings, when attorneys representing MERS have been unable to produce the original note or other documentation proving ownership of the loan.

The Kansas Supreme Court has disqualified MERS as a foreclosure agent, finding that its structure makes it impossible for borrowers facing foreclosure to identify and confront the entity that owns the loan. Courts in Arkansas and Maine have similarly ruled that MERS has no legal standing in foreclosure actions. New York trial court judge Arthur Schack, who has attracted national attention for his angry dismissal of foreclosure actions, also has found the assignment of loans to MERS to be “defective.”

Other courts have been troubled by the fact that MERS itself has no employees; the attorneys foreclosing on its behalf also typically represent the owner of the loan or the trustees of investor groups that own the securities in which the loan was packaged – leading more than one judge to question how MERS can be both the owner of the loan and the agent for the owner.

Some courts have ruled otherwise, finding no problems with MERS’ legal structure or its standing to bring foreclosure actions, so the legal questions are far from resolved. And other questions loom. A class action suit filed in California claims the company owes the state between $60 billion and $120 billion in land recording fees that the electronic registry process illegally circumvented. Other states will almost certainly file similar claims if California prevails in this one. If the MERS structure is invalidated, the foreclosures the company has initiated in the past three years could, similarly, be overturned. And further movement toward a completely paperless mortgage system could be stalled indefinitely.

Some analysts think the foreclosure mess, and MERS’ role in it, have raised even more fundamental questions about property ownership that may be even more difficult to resolve. The ability to convey property – a cornerstone of the American real estate market and, some say, of capitalism itself – requires confidence the seller has clear title to the property that is conveyed to the buyer. The foreclosure mess, some believe, has shaken that essential trust.

Ownership disputes that once could have been resolved easily by paper documents on file with county recorders, now can’t be resolved very easily at all, Christopher Peterson, an associate dean and law professor at the University of Utah, told the New York Times. “For the first time, there is no longer an authoritative, public record of who owns land in each county,” he said.

Peter Coy, a columnist for Business Week, sees a disturbing link between the crisis of confidence that froze the financial markets in 2008 “when banks and other financial players couldn’t tell whose balance sheets were stuffed with toxic subprime mortgage debt and whose weren’t” and the chain-of-title questions that are surfacing in foreclosure actions today.

“Lenders can’t say for sure who holds a mortgage,” Coy wrote, “which means that sales can’t go through. Buyers won’t put down good money for a property if they aren’t sure they’ll get clear title to it, nor will lenders extend loans. And buyers of hundreds of billions of dollars’ worth of mortgage-backed securities may have grounds to sue.”

The legal challenges to MERS’ structure and standing may ultimately be resolved in MERS’ favor, Coy suggests. But the more fundamental questions about trust in the system for buying and financing real property may continue to cloud the real estate market and impede it recovery for years to come.

ON THE RISE

In the shambles of the home finance market, it is possible to find at least one sector that is still growing  fraud. The number of suspicious activity reports involving mortgage fraud increased by 4 percent in 2009 compared with the previous year, according to the most recent report from the Financial Crimes Enforcement Network (FinCEN). The number of fraud-related filings in the fourth quarter alone increased by 6 percent compared with the same period in 2008.

Separately, CoreLogic reported that losses resulting from mortgage fraud increased by 17 percent last year after declining by nearly 60 percent between 2006 and 2008. The CoreLogic data, compiled for the Wall Street Journal, also indicate that 0.7 percent of the residential mortgage loans originated last year, totaling about $14 billion, were based on fraudulent applications.

“Fraud continues to be a pervasive issue, growing and escalating in complexity,” a recent report from the Mortgage Asset Research Institute, concluded, citing easy Internet access to financial records and the vulnerability of struggling homeowners among the factors driving the increase.

Reflecting this trend, the Mortgage Fraud Risk index compiled by Interthinx is at its highest level since 2004. The index increased by 11 percent year-over-year in the first quarter, according to Interthinx, which found that 6 of the 10 metropolitan statistical areas deemed to be at the highest risk for mortgage fraud a year ago are still among the top 10 today.

Not surprisingly, the states hardest hit by the housing decline also rank highest on the fraud index, which lists Arizona as riskiest, followed by Nevada, California, Florida, and Michigan.

LEGAL BRIEFS

JOINING THE CHASE

Investors are joining the growing throngs chasing loan originators and syndicators, demanding compensation from them for flawed foreclosure procedures.

In one of many recently filed or threatened suits, shareholders have sued Lender Processing Services for fraud, alleging that the company’s officers “made materially false and misleading statements” failing to disclose that the company “had been engaging in deceptive document execution and preparation related to foreclosure proceedings.”

The suit, filed by a public pension fund, seeks class action status, claiming that LPS falsely inflated its stock price by withholding negative information and making false statements in press releases and news reports. The suit cites, among other examples, statements from company officials dismissing as “immaterial” reports that employees had improperly processed thousands of foreclosures.

In another case pitting investors against a mortgage lender, a federal district court has ruled that executives at BankAtlantic Bancorp Inc. misled investors about the risks in its loan portfolio. That decision, in one of only a few class action securities fraud cases to go to trial, has rattled financial industry executives, in part, because the court rejected a standard defense – that financial institutions were victims of a market melt-down they didn’t cause and could not foresee.

Depending on how many investors join the action, claims against BankAtlantic could total “tens of millions of dollars,” attorneys representing the investors have estimated.

BankAtlantic officials termed the decision “disappointing” and said they plan to appeal it.

“If this outcome is allowed to stand, it would take public companies back to the day before Congress passed the Securities Litigation Reform Act,” which severely restricted the ability of investors to sue companies for fraud, Alan Levan, chairman and CEO of BankAtlantic, said in a press statement. “We will pursue every avenue to set this verdict aside and are confident of success in that endeavor,” he added.

NOT STUCK ON YOU

The New Jersey Supreme Court has cleared the way for homeowners to sue the company that manufactured stucco siding that had become detached from their home. Rejecting the “integrated product doctrine,” the court held in Dean v. Barrett Homes, Inc. that strict application of that theory would bar the plaintiffs in this case “and any other similarly situated home purchasers from pursuing products liability relief against the manufacturer of an allegedly defective product affixed or adhered to the outside of the home for damage done by the product to the home.”

The decision is interesting because it rejects a long-standing interpretation of products liability statutes in New Jersey and many other states, holding that siding is an integral part of a dwelling, not a separate component of it. In this case, the court held that the owners could sue the manufacturer for damage caused by the defective siding but not for the cost of removing and replacing it.

The 6-1 decision found a distinction between the siding and the home to which it was attached. “As we understand it,” the court said, “the [siding] was affixed to the exterior walls to create a moisture barrier, much like exterior vinyl siding. As such, it did not become an integral part of the structure itself, but was at all times distinct from the house.”

The sole dissenting judge questioned that reasoning and warned about its consequences. “The notion that an exterior finish that can only be removed by extensive demolition work is not ‘integrated’ into the structure is so fanciful, so nonsensical, that it beggars the imagination,” Justice Roberto Rivera-Soto wrote in his dissent. “It is a conclusion that can germinate only in the minds of lawyers and can root only in the rarified air of this Court’s decision; it cannot, however, survive in the atmosphere of the real world.”

DOUBLE FAULT

Most community association boards know it is illegal to discriminate against racial minorities or families with children. An Indiana condominium association got into trouble on both counts. As a result, the Autumn Ridge Condominium Association and three members of its board of directors have agreed to pay $120,000 to resolve allegations that they refused to approve the sale of a unit to an African-American couple, both because of their race and because they had two children.

The association’s rules in effect at the time specifically prohibited the sale of units to anyone with minor children. Statements made by one of the board members reflected bias against blacks.

When the purchase was blocked, the prospective buyers, the sellers and the real estate agents involved in the transaction complained to the Department of Housing and Urban Development, which investigated and, finding evidence to support the complaint, referred it to the Department of Justice (DOJ).

The settlement, which must still be approved by the District Court judge presiding in the case, requires the association to pay $106,500 to the purchasers and the real estate brokers and an additional $13,500 in penalties to the DOJ. It also requires the association to revise its rules to eliminate restrictions based on family status and to obtain training in the Fair Housing Act for board members. Additionally, the agreement requires one of the trustees to resign permanently from the association’s board. 

WORTH QUOTING

“If you want a serious discussion about changing the structure or mandate of the fire department, the time to have it is not when the entire squad is out fighting a three-alarm blaze.”  Washington Post columnist Steven Pearlstein, arguing that criticism of the Fed’s effort to stabilize the economy comes “at the worst possible time.”

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HOUSING ASSISTANCE

In the face of persistent unemployment and still rising foreclosure rates, the Obama Administration is ratcheting up its efforts to help struggling homeowners hang on to their homes.

The Department of Housing and Urban Development (HUD) is offering no-interest loans of up to $50,000 to help borrowers in hard-hit areas make their housing payments for as long as two years.  The $1 billion program targets borrowers who have experienced “a substantial reduction” in their income because of involuntary unemployment, underemployment or medical problems, a HUD press release explained.  The new “Emergency Homeowner Loan Program” will supplement an existing program through which the Treasury Department is providing assistance $2 billion in aid to 17 states with unemployment rates above the national average, to help finance their foreclosure prevention efforts.

These initiatives “will ultimately impact a broad group of struggling borrowers across the country and in doing so, further contribute to the administration’s efforts to stabilize housing markets and communities,” Bill Apgar, HUD’s senior adviser for mortgage finance, said in the press statement.

Separately, Fannie Mae announced a new program offering relief for borrowers suffering “unique hardships,” allowing them to skip up to six months of mortgage payments.  The aid is limited to borrowers whose financial problems result from the injury of death of a spouse serving in the military or from problems related to the installation of drywall imported from China, which has caused structural damage to homes and a range of medical ailments for many occupants.

CREDIT SCORING SCORECARD

 

There’s good news and bad news in recent reports on credit score trends.  The bad news is for consumers ¾ their average scores are declining nationally, with more than 25 percent (43.4 million consumers) now below 549, making it difficult if not impossible for them to obtain credit.

 

The good news is for Fannie Mae and Freddie Mac, the secondary mortgage market giants struggling under the weight of the bad loans they have purchased.  The average FICO score on loans in their portfolios is now 750, up from 715 for loans purchased in 2006 and 2007 ¾ the years that produced the lion’s share of the losses that pushed the companies into federal receivership.

 

The higher scores for Fannie and Freddie reflect the stricter underwriting standards they have adopted ¾ clearly good for them, but, again, not so good for prospective mortgage borrowers, an increasing number of whom aren’t able to qualify for loans.

 

But there is some good news for consumers, too.  While their average FICO scores have declined, the number of consumers with top scores of 800 or more has increased, now representing 17.9 percent of the total compared with the historical average of 13 percent, according to a recent analysis by FICO Inc.

 

The FICO report also found a small but potentially significant decline in the number of people with “moderate” scores in the 650-699 range.   It is borrowers in this middle range who are feeling the brunt of tighter lending standards, according to a recent Associated Press article, highlighting what it described as a “serious drawback” in the reliance on credit scores:  Lenders can’t distinguish between  the borrower whose default resulted from irresponsible behavior and the one who defaulted because of a job loss. Both would be rejected based on their credit scores, the article noted, even though the unemployed borrower, who has obtained a new job, now represent a much better credit risk.

Some industry executives say risk aversion is making lenders focus too much on credit scores and not enough on individual circumstances that distinguish one borrower from another.  “We absolutely swung way too far in the liberal lending,” one mortgage broker quoted in the AP article acknowledged.  “But did we have to swing so bar back the other way?”

HOME REDUCTIONS

 

Expanding waist lines have made “super-sized” portions less appealing to some consumers; financial restraints and energy concerns have led them to rethink the mega-home preferences that prevailed before the economy and the housing market imploded.

 

After increasing steadily for nearly 30 years, the average size of newly-constructed single-family homes declined in 2009, slicing about 100 sq. ft. off the 2007 average 2,521 sq. feet, according to a recent Census Bureau report.

 

The last recession, in the early 1980s also triggered a decline in home sizes, quickly reversed when the economy recovered.  “But this time, the decline is related to other phenomena, such as the increased [proportion] of first-time buyers, a desire to keep energy-costs down, smaller amounts of equity in existing homes to roll into the next one, tighter credit standards, and less focus on the investment component of buying a home,” David Crowe, chief economist for the National Association of Home Builders, suggests.  “And many of these tendencies are likely to persist and continue affecting the new home market for an extended period,” he predicts.

 

New homes completed last year had fewer bedrooms and fewer bathrooms than homes completed in    2009, reversing a 20-year trend that had added rooms as well as square footage to homes.  The proportion of homes with 4 bedrooms declined from a peak of 39 percent in 205 to 34 percent last year, while the proportion with 3 bedrooms fell from 53 percent to 49 percent during that period.  Bathrooms followed the same trajectory.  The proportion with 3 baths fell   to 24 percent from 28 percent in 2007 and 2008, while the percentage with 2-1/2 baths has remained flat, at 31 percent.  The percentage with 2 bathrooms, meanwhile, increased from 35 percent to 37 percent, according to the Census data.

Builders are also constructing fewer two-story homes.  Starting in 1973, the number of multi-story homes began to increase, rising from 23 present to a high of 57 percent in, while the proportion f single-family homes, which represented 67 percent of the total in 1973, declined, reaching a low of 43 percent in 206 and   200.  Since 2006, that trend has reversed, however, with the proportion of single-family homes increasing to 47 percent last year, while the share with two or more stories declined to 53 percent.

The Census Bureau’s annual report on the characteristics of new homes also identified some interesting regional differences in, among other areas, air conditioning, single-family homes and   the selection of exterior wall material.  According to the report:

  • 99 percent of the homes in the South and 90 percent in the West had air conditioning, compared with 69 percent in the West and 75 percent in the Northeast.
  • Nationwide, only 17 percent of new single-family homes completed last year had three-car garages, with that regional distribution ranging from 11 percent in the Northeast and South, to 30 percent in the Midwest and 26 percent in the West;
  • Nationwide, 34 percent of new homes had vinyl siding, but that was the choice for 74 percent of new homes in the Northeast and 62 percent in the Midwest.   In the South, only 28 percent of new homes had vinyl siding while 40 percent had brick, the choice   for only 11 percent of homes in the Midwest.

LOOK WHO’S WALKING

We’ve been hearing a lot about borrowers who are walking away from their mortgage loans.  Turns out many of them are wearing designer shoes.  More than 1 in 7 borrowers with mortgages of more than $1 million are “seriously delinquent” on those loans, a recent study by CoreLogic found. That compares with only 1 in 12 borrowers with mortgages of less than $1 million.  The investment home picture is similar – the delinquency rate on properties on which the original mortgage was more than $1 million is 23 percent, compared with 10 percent for less expensive properties.

These statistics suggest that more affluent households are more likely than less affluent borrowers to strategically dump loans they could afford to repay, the New York Times, which commissioned the study, reported.

“The rich are different, they are more ruthless,” Sam Khater, senior economist for CoreLogic, told the Times.

They are also less fearful of the consequences of default, Khater noted, and, as a result, less susceptible both to warnings about the impact on their credit rating and to arguments about the negative consequences their default will have on the property values of their neighbors.  They are also more likely to view repayment of their loan as a strategic choice rather than a moral obligation.

Illustrating that point, the rapper Chamillionaire expressed publicly a sentiment that analysts say many affluent borrowers embrace privately.  Explaining his decision to default on the mortgage on his $2 million home, the Times reported, Chamillionaire told a television interviewer, “I just didn’t feel like it was a good investment.”

Legal Brief

CHINK IN THE BANKRUPTCY ARMOR

A federal appeals court has found a chink in the armor limiting consumer access to bankruptcy protection.  The bankruptcy reform legislation Congress enacted in 2005 requires consumers seeking to file for bankruptcy to obtain credit counseling.  But the Second U.S. Circuit Court of Appeals has ruled that the failure to obtain counseling does not invalidate a bankruptcy petition and does not terminate the automatic stay (barring credit collection efforts) a filing triggers.

The court upheld a bankruptcy judge’s decision to “strike” bankruptcy petitions, but not to invalidate them for failure to meet the consumer counseling requirement.

WORTH QUOTING

“This financial crisis has made us all too aware that we live in a Catch-22 world: the performance of the housing market drives the economy, and the performance of the economy drives the housing market. But housing has perhaps never been a better bargain, and sooner or later buyers will regain faith, inventories will shrink to reasonable levels, prices will rise and we’ll even start building again. The American dream is not dead — it’s just taking a well-deserved rest.” – Economist Karl Case in a New York Times op-ed commentary.

“Although an individual may be ineligible to be a debtor under the Bankruptcy Code for failure to satisfy the [counseling requirement], the [statutory] language does not bar the debtor from commencing a case by filing a petition; it only bars the case from being maintained as a proper voluntary case under the chapter specified petition,” the three-judge appellate panel concluded in Adams v. Zarnel, the lead case in three separate cases consolidated for this appeal.  As a result, the court ruled, the automatic stay becomes effective with the filing and remains in effect, even if the debtor has not initially met the counseling requirement.

“Much of the value of the stay is in the clarity of its implementation,” the court said, explaining, “If it were unclear whether the stay was in place immediately following a debtor’s filing for bankruptcy, creditors would likely continue their collection efforts.”

The bankruptcy judge whose decision triggered the appellate ruling questioned the value of the counseling the bankruptcy code now requires. That requirement, he noted, “was intended to provide debtors with education as to all of their options when experiencing financial difficulty before a resort to bankruptcy protection was necessary.”  But as a policy matter, the judge said, counseling has “not proven to be of assistance to debtors in seeking relief outside of the bankruptcy context.”