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Is the Foreclosure Panic the Y2K of Our Decade?

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By George W. Mantor

RISMEDIA, August 11, 2009-Just 10 years ago we were approaching the new millennium not with wonder and anticipation but with fear and loathing. Seems someone forgot to tell the computers how to change their clocks and right at the stroke of midnight the modern world as we know it would end, not with a bang but a whimper.

Banks couldn’t shuffle money and trains would not run; sure calamity and ruin awaited us all.

It didn’t happen, of course, but it was good at generating sales as people stocked up and waited for the power to go out. As a matter of fact, it generated a lot of generator sales, most of which now sit in people’s garages and have never been used.

Lately, the fear has been a persistent, yet unproven, urban legend that the worst is yet to come and that a tsunami of foreclosures are working their way through the process and will come to market soon. A raging torrent of vacant houses swamping the market and sinking prices another 14%.

“Just wait until those rate resets occur.” some have said.

Speculation has included a surge in homeowners withholding payments in an effort to force a mortgage modification and laid off workers who will soon run out of benefits, wanting to have some cash for food and utilities. We know this group exists, but it has been difficult to determine the extent of it. The rest is easy to track.

Just as the so-called experts have been wrong about just about everything else, many are also wrong about the numerous facets of our current foreclosure panic.

While there were many things that brought us to this point, the biggest factor has been the ignorance, incompetence, and arrogance of our business and political leaders. They are either grossly incompetent or dishonest to their core and now they persist in continuing this drum beat of fear and apprehension, but in this case they are busted.

Primarily, as a way of deflecting blame from themselves, and in part because they really don’t know anything about how the real world functions, they started feeding the lap-dog media a rash of nonsense about toxic loans and greedy American consumers.

Remember, our terror has been good to them, and what could be more terrifying than losing your home, whether to “extremists” or a complex, world-wide fleecing? Color my chart red.

Now, with the passage of time, we have both perspective and hard data on which to derive some conclusions about the causes and the nature of the housing picture. And, the image is far different than what we are being told.

When you consider the following, we see a housing market and an economy improving in tandem. And, while every region is at a different stage, we are finding pockets of improvement. Here are seven surprising and hopeful signs:

1. Subprime loans and liars loans are not to blame.

According to a study by Stan Liebowitz, professor of economics and director of the Center for the Analysis of Property Rights and Innovation in the management school at the University of Texas, Dallas, “51% of all foreclosed homes had prime loans, not subprime, and that the foreclosure rate for prime loans grew by 488% compared to a growth rate of 200% for subprime foreclosures.”

2. Mortgage rate resets are not to blame.

Liebowitz, writing for The Wall Street Journal, said he found “That interest rate resets did not measurably increase foreclosures until the reset was greater than four percentage points. Only 8% of foreclosures had an interest rate increase of that much.”

And, with rates remaining low, it doesn’t appear that resets will contribute much going forward.

3. Lenders are not deliberately holding back on filings.

I speculated back in June that lending institutions may have been delaying foreclosures because they did not want to alarm shareholders and regulators who might disallow their bonuses for poor performance. No, that can’t be it.

Upon further reflection, the banks themselves aren’t even involved in the process. Most mortgage payments are paid to servicing companies who collect a small fee for processing the monthly payments of millions of loans.

However, just as every circumstance creates winners and losers, in this case the greatest single beneficiary of the foreclosure crisis has been mortgage servicing companies who make their real money squeezing fees, late charges, and penalties out of distraught homeowners.

And, from everything I can see in San Diego County, notices are being filed in a timely fashion, usually dependent on the resources of the institution, in order to protect the legal position of the beneficiary as well as begin a more aggressive phase of the collection process.

For a variety of reasons not market related, including a brief moratorium affecting a small percentage of San Diego loans, it can be several months before the foreclosed property comes to market. But, public records quickly reflect the filing of notices of default and foreclosure so we know what is coming.

4. The loan servicers don’t want to stop foreclosing.

They are the Repo Men of homes. They get paid really well to do what they do. The servicing companies, who control the process, are far better compensated for foreclosing on homes than they are for achieving a workout with the homeowner.

The bailout bonus program, Hope for Homeowners, offers only a fraction of the available compensation for a workout that a skilled telephone collector can wring out of vulnerable homeowners. And, there is no downside for the servicers, because the homes that secure the loans aren’t their assets.

Most defaulted loans are eventually brought current. But, in the interim, the servicer can extract tens of thousands of dollars in late fees and penalties. On those that do foreclose, there are a host of additional services the servicer can charge back to the institution that actually holds the loan. The servicers are actually in a hurry to file default notices because they gain additional leverage with the homeowner and can begin collecting fees immediately.

5. There is no evidence of a great backlog of foreclosures in San Diego County.

Market conditions are affected by many local influences so circumstances will vary from market to market, but we are seeing some positive national trends starting to get legs, and the positive trends in San Diego appear to be playing out on a national level. Analyze the data below for your community and do your own comparison, you might be surprised.

Here, I walk the streets, fiddle with the lock boxes, see a lot of houses, and talk to other agents. They all believe that it’s coming, but they all agree that we are woefully short of inventory. There is a large oversupply of homes over $700,000.

Homes that once sold for $1 to 1.5 million can now be had for $850,000. Only a small percentage of borrowers can qualify and, even then, financing can be difficult. Good properties priced below $560,000 result in dozens of offers.

The most striking thing is what I don’t see: “For Sale” signs. To hear some people tell it, you would think that looking down a street in a moderately priced neighborhood would be like walking into a super market for sign sellers and real estate franchises, but not here. The signs are gone.

If there were a lot of short sales and REOs, why would they not be for sale in a market that is so low on inventory? Because, they already have a buyer.

A report compiled by Robert Brown, Ph.D., California State University, San Marcos, based on 34 zip codes in North San Diego County shows both defaulted loans and bank owned properties as of the end of June. With the exception of a couple of zip codes with homes constructed in the boom years, bank owned properties represent only a month or two of inventory, if that.

The combined 34 zip codes have averaged over 1,100 sales per month in the past six months which is right on par with historical averages, and there are 3,939 active listings. The vast majority of these active listings are short sales and foreclosures. Many are so “unique” that they are either tear downs or projects beyond the ability of most homebuyers.

There are also 2,796 pending transactions and 1,474 more contingent sales, likely awaiting short sale approval. The majority of these properties are in the default stage, so it appears that many of the defaulted and bank owned properties in Brown’s report are reflected here and already absorbed.

There is very little inventory. We know that about half of our sales have been short sales and REOs, although that percentage appears to be increasing as non defaulted inventory is rare. The current pending and contingent sales, sales that already have buyers, are a whopping 4,270, a number that exceeds the total of active listings.

Conclusion: the vast majority of defaulted and bank owned properties are already represented in either pending listings, contingent listings, or active listings and there is no great flood headed our way.

Defaulted properties, not yet bank owned, amount to 4,688 and represent the wild card. It is difficult to determine exactly how many of these will be foreclosed and how many will be cured. Some also represent long term litigation as homeowners sue their mortgage companies.

In a normal economy, the vast majority of all defaults are cured. Often, these defaults are the byproduct of the ups and downs of businesses and professions, or a brief job loss or illness. Others, whose prospects are not so immediately resolved, would have the option of selling. It is safe to conclude that not all of these defaulted properties will wind up as REOs.

Many of these defaulted homes make up a very large percentage of a very small number of listings, or are represented in the 4,270 already pending or contingent.

North San Diego County Foreclosure Comparison

Active Listings IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII 3,939
Avg. Sales Per Month IIIIIIIIIIIIIIIII 1,100
Total Bank Owned IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII 2,984
Total Pending Sales IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII 2,796
Total Contingent Sales IIIIIIIIIIIIIIIIIIIIIIIII 1,474
Total notices of Default IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII 4,688
Comb. Pend. & Cont. IIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIIII 4,270

6. Foreclosures related to fraud caused the first domino to fall, but are now gone.

One explanation for the higher default rate in prime loans mentioned above is that because prime loans require a high degree of documentation they are thought to require less scrutiny. Organized crime and even some disorganized criminals would rather make counterfeit documents than work for a living. Well documented prime loans fly right on through underwriting.

Take the case of San Diego’s infamous Lincoln Park street gang. They were able to pull off a $100 million mortgage fraud. If they could do it, imagine how many other street gangs got wind of this?

The first wave of foreclosures was fraud for profit. No payments were ever made on these properties and they were destined for foreclosure before the ink on the loan docs was dry. Most involved inflated appraisals and 100% financing.

These properties, not always the nicest, came to market just as builders were dumping their increasing inventory into the MLS. This glut of inventory drove prices below their replacement cost.

With declining equity, there comes a tipping point when it crosses the borrower’s mind that his home is worth half what he owes, and he gets angry.

But, here is the good news; the fraud activity peaked in 2006 as prices stopped rising and inventory began to build. These were the first wave of foreclosures. Most of these were loans on which not a single payment was ever made or intended to be made. Even at the slow pace of the foreclosure process, most of the fraud foreclosures have already worked their way through the system and have new owners.

7. Loss of equity and job losses are driving current and recent foreclosures.

It is no wonder that according to a study by Mc Dash Analytics of 30 million mortgages dating from the third quarter of 2006, in which 4.3 million homes went into foreclosure, only 12% of homes had negative equity, but they comprised 47% of all foreclosures. Further, it should come as no surprise that the next greatest factor in foreclosures was unemployment. If you don’t have a job, you cannot pay your mortgage.

San Diego County’s Leading Economic Indicators have posted positive gains the past three months except in the area of employment. This appears to be a jobless recovery, to this point. This may be a time when the demand for housing will contribute to a recovery in which the jobs will follow.

The construction industry is vital to the economy, but in San Diego County the opportunities for development are limited. Fortunately, military housing construction is on the upswing locally and there is some stimulus money ear marked for construction, so some, but not all, of those workers are already back to work. Some jobs are just never coming back.

The “Sustainability Economy” is already creating jobs in the area of energy retrofitting, including insulating, weather proofing, solar and wind systems that sell energy back to the grid, new materials and new techniques. These are promising jobs for the future, but the question is, when will they arrive?

Two circumstances are driving current foreclosures, unemployment and negative equity. Despite the push to refinance, it is obvious that that is no solution to the foreclosure crisis if the real problem is that people are upside down.

And, with servicing companies refusing to modify lucrative delinquent loans and it isn’t even clear if they can, they become a major force in inhibiting the recovery in some communities. The annoying part is that these companies have already received bail-out funds to compensate for the workout.

There will be more foreclosures. Except in times of extraordinary appreciation, there is always a baseline of foreclosures because of choices people make and things that happen in life. People will still get sick or injured, get fired, gamble, and with half of all marriages ending in divorce, foreclosures are inevitable.

Not to minimize the crushing impact on those who have lost and will lose their homes. Maybe more wouldn’t have to if our leaders had any compassion, or understood how things work. But, it now appears that after all the talk about a huge wave of foreclosures, they simply cannot be found. And, if they did exist, rather than flood the market, they would provide much needed inventory to satisfy a frustrated pent-up demand.

George W. Mantor is known as “The Real Estate Professor” for his wealth building formula, Lx2+(U²)xTFP=$? and consumer education efforts. During a career that has spanned more than three decades, he has amassed experience in new home and resale residential real estate, resort marketing, and commercial and investment property. He is currently the founder and president of The Associates Financial Group, a real estate consulting firm. Mantor can be reached at GWMantor@aol.com.

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