Real Estate Blog

We can now enter a new acronym into our lexicon: TALF. And what is TALF? The Federal Reserve and the Treasury announced on November 25^th that a Term Asset-backed securities Loan Facility will be created to provide liquidity for purchasers of ABS’s (Asset-Backed Securities, which include mortgage-backed securities). Asset-backed securities also include student loans and car loans, which under normal conditions are packaged and sold to investors willing to take a risk that has been evaluated by another institution.

The trouble is, no one can be certain how thorough those institutions (specifically banks) were in their risk assessment process. Banks need to package and sell these securities in order to remove potential liabilities from their balance sheets, but when it becomes virtually impossible to slog through the tranches of loans within those securities, investors can easily become gun shy. To witness the headaches that these loans are causing banks, take a look at the chart below.

So as our trusted officials continue their efforts to restore confidence in the markets, and as the demand-led recession deepens, this task seems increasingly Herculean. Paulson & Company have resorted to some extremely desperate measures to pull this one off. To fund the TALF, approximately $600-800 billion will have to be committed, which nearly equals the amount of the original bailout plan. $20 billion of that money is, in fact, coming from the bailout plan. The other remaining billions are being leveraged, a fairly astonishing fact whose implications remain unclear. One thing is for certain: if the Fed wishes to avoid an inflationary spiral, destruction of money will become a necessity once this crisis begins to abate.

It would appear that the Fed’s announcement caused a positive reaction in the mortgage markets, however, Mortgage prime rates dropped from 6.3% to 5.5%, a relatively massive decline, and a huge wave of refinancing ensued…in a matter of hours, essentially. Could that be a forward indicator? Credit Suisse Group mortgage strategist Mahesh Swaminathan thinks so, saying that he expects to see rates drop below 5% in the near term. While there are some strict requirements for homeowners hoping to refinance, this is obviously a positive for the consumer. And while these measures do little to halt the rising tide of foreclosures, it does help the demand side of the issue. And in a demand-led recession, such as the one we are in, has the Fed finally stumbled upon the right combination to stimulate the markets?

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Can the TALF Return Demand to the Markets?

In a recent story published on BusinessWeek’s website, the subprime mortgage industry is taken under the microscope and picked apart, bit by scandalous bit. The article, entitled “Sex, Lies, and Subprime Lending,” presents many of the familiar excesses of subprime lending (pressure from investment banks and mortgage-backed securities brokers, data manipulation by loan officers) with a new twist: that’s right, a Babylonian saga of loan officers and mortgage lenders exchanging sexual favors for subprime loans to unqualified borrowers. For what purpose? Commissions of course.

At this point, it would be virtually impossible to further demonize the world of subprime lending. It doesn’t get much worse than the predatory and sinful actions that are described by the “Sex, Lies, and Subprime Lending” article. So do these tales of excess spell an end for the subprime lending industry?

The simple answer is yes and no. Everyone now understands that the much of subprime loan origination functioned on the sort of irrational exuberance that are often induced by bubbles in economies. That bubble is burst, and the lending practices that went along with it have all but disappeared. Subprime lending, however, has been in practice for over two decades, gaining traction in the 1980s after Congress eased lending laws for first-time home buyers. For a bubble to exist, there has to some sort of substantive material to prop it up.

An article written for Slate by Daniel Gray highlights a number of virtuous institutions in the business of lending to subprime borrowers, some of whom have also been able to turn million dollar profits for the services. These include credit unions and other community-based banks, and CDFI’s (Community Development Financial Institutions), and they do share a few things in common with the Ameriquests and Countrywides who are now infamous for inflating the housing bubble. Most significantly, they intentionally look past the credit scores of applicants in determining creditworthiness. Where they differ is what they look for in applicants, which is significant.

Where the Ameriquests and Countrywides were willing to manipulate and disregard data in order to originate loans, the CDFI’s simply used a different set of criteria when evaluating applicants. These criteria included their ratio of savings to income, affordability of the house in relation to income, and their ability to manage their budgets and monthly bills.

These institutions also do not incentivize lending or bundle and re-sell loans, and thus were able to avoid the excessive risk taken on by others in the subprime industry. Tellingly, their delinquency and foreclosures statistics are much lower than the national average. For example, compared to the national rate of subprime delinquencies as cited by the Mortgage Bankers Association, which is nearly 19 percent, the National Federation of Community Development Credit Unions delinquency rate is 3.1 percent. That is an absolutely staggering difference. For Clearinghouse CDFI, a California-based institution, the difference is even greater. Less than 1 percent of their subprime loans have been foreclosed on, compared to the national average, which is over 11 percent. Clearinghouse, a for-profit company, expects to report record profits, proof that trickle-up economic

While the era of the subprime bubble may have ended, responsible subprime lending will, and should be, a part of any healthy economy. For further macroeconomic insight into the virtues of this sort of lending, I would point you to the success and benefits generated by the microfinance industry in the developing world, for which Bangladeshi economist Muhammad Yunus won the Nobel Peace Prize 2006. Responsible microfinance lending, which conceivably includes the practice of subprime lending in the developed world, is an example of trickle-up economics having a perceivable and beneficial effect on society. And correct me if I’m wrong, but isn’t that why we chase the promise of economic growth?

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In the grips of a brutal financial crisis that continues to worsen despite all efforts by the governments across the world to stop it, and foreclosures continuing their unstoppable climb, there’s no question that things are pretty bad out there. Banks, in particular, have been given no reprieve at all by shareholders even as they tap into government provided funds to shore up their balance sheets and (supposedly) use that money to continue lending. With all of this chaos and hardship caused by an industry that lost sight of any sense of risk management and proper diversification, someone has to be responsible right? This wasn’t all one big mistake, obviously, someone was there to knowingly pull the trigger. The question is, two years into this crisis, who?

The answer, according to William Black, who was counsel to the Federal Home Loan Bank Board during the Savings and Loan Crisis and one of the men who blew the whistle on the “Keating Five” in 1989, says that while we know the lenders that were involved (looking at you IndyMac and Countrywide), we don’t have the investigative power or resources to know yet. The answer to why not is actually pretty straightforward, according to Black: “There is no poster child [for the housing scandal] because you need to investigate, and you need to bring cases and we haven’t done either against the major players.”

That’s because the FBI made a “strategic alliance” with the Mortgage Bankers Association which, as you might have guessed, served the major industry players. So while investigations were focused on individual mortgage brokers, major industry leaders were responsible for plenty of recurrences of fraud as well. So, as the article puts it: “In this case, the foxes truly were guarding the hen house”

What’s that mean for the future? There will undoubtedly be investigations and arrests and someone will be punished along the way, but it’s going to take time as the FBI ramps up investigations that they should have opened previously. It’ll be especially difficult for them to gather that evidence since these firms in many cases have already shut their doors, so the FBI can’t send in undercover agents to catch them in the act. The FBI will also need a lot of additional resources if we expect them to track these fraud cases down and prosecute those responsible. Unfortunately for all of us, however, plenty will still get away.

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Mortgage Fraud: Where Will the Hammer Fall?

A guest post from Frank Shump. Frank is a veteran from the financial services industry, and currently authors a blog called Thefinancecastle.com, which documents his thoughts on money matters and his adventures in self employment.

Even with bargain hunters starting to come out of the wood work and credit just barely starting to thaw out, things are still fairly bleak in the real estate market. Home prices saw a record decline in the third quarter, with foreclosures doing the most damage. Bailout money has been plentiful, from the $350 billion spent so far to help struggling financial institutions to Freddie Mac eating such huge losses that it had to tap taxpayer money already. What about struggling mortgage owners, though? The government has clearly stated that they aim to help out the homeowners too, but how will Uncle Sam decide who will get the helping hand? That answer may not come easy.

The Bush administration recently announced a new foreclosure prevention program that aims to help troubled borrowers and keep them in their homes. The plan, spearheaded by the Federal Housing Finance Agency, has worked with a coalition of lenders, servicers, investors and community groups called Hope Now to target the “most-at-risk” homeowners. Who does that mean specifically?

At present, Fannie and Freddie are looking to extend aid to homeowners that are more than three months past due on their loans so that the most troubled borrowers get the most immediate attention. You’ll have to jump through a few hoops, of course, including having to write a “hardship letter” to explain why you fell behind on your payments for a “good reason.” Good reasons could or could not include job loss, divorce, and medical bills. Borrowers will also have precious little equity in their homes, and if you exceed the mortgage balance by more than 10%, you’re too “well off” to get help. Other homeowners are so far deep underwater that there’s no way to pull them out. If you were already up to your eyeballs in debt and then lost your job for example, you’re out of luck there, too. Prepare for bankruptcy and giving up your home.

Lenders participating in the program will be sending out letters to those who qualify and requesting information like pay stubs and bills and the aforementioned hardship letters. If you’re busting your ass to keep your mortgage current, don’t expect anything but a hefty tax bill somewhere down the line.

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Mortgage Aid: Who is Worthy of Help?

I’m afraid many of the New World Order conspiracy theories will have to be laid to rest after this weekend’s G20 meeting. Worldwide coordination of anything other than a rate cut here and there will never fly. Not even the power of the dark side is sufficient to get substantive agreement among the G20. So, what came out of this weekend’s meeting? Pretty much nothing But, you ask, no new world currency, no new North American currency, no revaluation of the price of gold, no renegotiation of trade agreements, no dropping the US$ as the world’s reserve currency? Nope, nothing. However, based on their recent track record, this was probably the best outcome.

Telling It Like It Is

Last week I said the economy was going through deflation. That was just a trial balloon and an attempt at being PC. We’re entering into a depression. Things are a lot worse than underwater mortgages and SUVs losing trade-in value.

“The economy faces a slump deeper than the Great Depression and a growing deficit threatens the credit of the United States itself,” former Goldman Sachs chairman John Whitehead, 86, said at the Reuters Global Finance Summit on Wednesday. “I think it would be worse than the depression,” Whitehead said. “We’re talking about reducing the credit of the United States of America, which is the backbone of the economic system.” When you’re 86 years old and Social Security and Medicare’s got your back, why mince words.

Here’s what another senior citizen, George Soros, has to say, “Our greatest economic depression is ahead of us.”

One more retiree, Warren Buffet, in September said, “This is an economic Pearl Harbor. There’s no plan B for this . . . we were at the brink of something that would have made anything that happened in financial history pale.” (Pale by comparison . . . finish your sentences Warren).

Former Fed chairman Paul Volker, a downright New Age positive thinker by the standards of this group, says, “There’s a 75% chance of financial collapse within the next five years.”

From academia: “The United States is bankrupt. Our economic situation is worse than Brazil, worse than Argentina, worse than any nation in the world,” according to Professor Laurence Kotlikoff of Boston University. I never heard of this guy before, but he’s got a way with words. And from government service: “When we look back 10 years from now, we will see 2008 as a fundamental financial rupture,” says Peer Steinbruck, Financial Minister of Germany.

Associated Press on Friday reported that the mayors of Philadelphia, Atlanta, San Jose, and Phoenix are requesting bailouts. They’ll have to get in line behind the entire state of California, NYC, Chicago, Detroit, and LA.

There are a few bright spots, though; gun sales are one of them. The FBI reports that gun sales increased 13% in October and had a huge 49% spike in the first six days following the election. Hurry and get yours before supplies run out.

It’s time to prepare for hard times. There are a number of lists of “100 Things that Disappear First.” Google one that addresses your lifestyle and climate. Many of these items, like manual can openers, make good stocking stuffers. By the way, no Gift Cards this year. Gift cards are not yet guaranteed by the FDIC. If the store goes out of business, that’s the end of the gift card. Same thing with product maintenance contracts.

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G20 Meeting a Non-Event, Depression Full Speed Ahead

One of the terms that veterans of the stock market often use to describe buying patterns is ‘smart money.’ Smart money refers to buyers who are informed, intuitive, and quick enough to anticipate market trends before they actually occur. Conversely, the term ‘dumb’ money is the money from buyers who rush in after the boom occurs, and get stuck holding assets that are worth less than they paid for them in the first place. The relationship between smart money and dumb money is a natural part of any speculative market, and is as old as time. Ironically, a smart investor can easily become dumb money when the market turns against him.

Nowhere was this more evident than in the housing market. The problem with the housing market is that while it was a speculative market for many, a large amount of buyers simply regarded it in the same way that they would regard a car. The mindset of these buyers was that housing, like food and clothing, was a fundamental need. As a result, many of these people assumed that whatever price they were able to negotiate and afford for their house must have been a reasonable one. They planned on living in their houses for an extended period of time, perhaps even the life of the loan. Sure, they might occasionally withdraw equity from the house, but only in cases of need and importance: things like college tuition, home improvement, or paying down other debt. All of these seemed reasonable, since home values would always go up in the long run, right?

But even though the paradigm of rising home values is still intact over the long-term, no one had considered the possibility of a severe short-term decline in home values. Unfortunately, that is precisely what has happened over the last year and a half. Suddenly, a huge swath of people suddenly seemed like dumb money. What separates dumb money from smart money, of course, is the ability to react constructively and profitably to a negative situation.

So I spoke with a veteran real estate agent (of 30 years, no less!) last week, to get her opinion on what be smart money might be doing in these market conditions. In no uncertain terms, she said both herself and her colleagues believe that the market is not anywhere near its trough. A true rebound, she said, would only occur when prices dropped far enough that credit-worthy first-time buyers would feel comfortable making purchases. These would be the buyers who fit into the profile I mentioned above, who regard housing first as a necessity, and second as a long-term investment.

These people weren’t quite the same as the smart money I had in mind, so I clarified my line of questioning.

“The people with money to spend, who know how to spend it…what are they doing right now? Are they just waiting on the sidelines, or have they started to brave the waters again?”

With that definition, she immediately knew who I was referring to. She pointed me to a few recent statistics, conveniently located on a website she frequents.

“You’ll see that it shows a [5.5%] rise in existing-home sales, but an 11.5% drop in new-home sales,” she commented. “Now think about it…does that seem rational?”

Of course, those numbers, indicating a huge spread, do not seem reasonable in the least. I told her so.

She explained the discrepancy by saying that “What it means is you have banks who are just beyond desperate to get rid of these, and are willing to do so in any way they can.”

As she said this, I realized that I had my answer. “So smart money could be hedging the values on their own properties by swooping in on foreclosures and short sales.” Yes, I said it more as a statement than as a question.

She responded with a characteristically Midwestern aphorism (she is originally from Nebraska, I discovered). “I can’t say for sure, but I’m pretty sure. So take that and two dollars, and buy yourself a cup of coffee.” I took her advice, and took a walk to my neighborhood Starbucks that evening.

The next day I discovered during a meeting at my office that my manager was considering making a hedge play on her own real estate property. She lives in a three-bedroom condo about twenty minutes from Los Angeles (by my estimation, probably worth around $600,000), but shared with us that she was strongly considering buying either a house or a condo in San Diego.

Sometimes the difference between smart money and dumb money can simply be the ability to sense opportunity. As I said above, the long-term paradigm for home-ownership has not changed. Unlike tulips and tech-stocks, people will always need homes, and it logically follows that home values will always appreciate over the life of a mortgage. So when banks start accepting short-sales (as in low-ball) offers on homes, smart money sees a potential profit at a very low risk. It’s worth noting that these are not the flippers, who so famously created artificial levels of demand in the housing market that contributed to the bust we are all suffering through. These are shrewd individuals with high credit scores, who see a significant opportunity to improve their net worth over a long period of time.

It doesn’t mean that we’re in for a quick recovery. But that is logic you can’t argue with.

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The Housing Crisis: What is the Smart Money Doing?

Is American International Group, Inc.’s (AIG) hosting of a conference for independent financial planners a sign that the company is rising from the ashes with the help of a newly announced bailout from the U.S. Treasury and Federal Reserve or just the latest in a string of high-profile and expensive mistakes?

Two months ago, the U.S. government and American taxpayers saved AIG from collapse by loaning the company a record $85 billion. AIG executives used the money to go on the now infamous hunting trip. Not long after that, the company paid more than $400,00 to send top-performing insurance agents on a week-long retreat. So it is understandable that people - the media, taxpayers, politicians, regulators - view AIG’s hosting of a $343,000 conference in Phoenix, Arizona with some skepticism.

The skepticism is deserved. Especially since the bailout increased to more than $150 billion on Monday. The solution, outlined in a public statement from AIG distributed to the media on Monday includes:

• The purchase of $40 billion in newly issued AIG perpetual preferred shares and warrants to purchase the equivalent of 2 percent of outstanding AIG common stock by the U.S. Treasury Department. The perpetual preferred stock carries a 10 percent coupon with cumulative dividends. Proceeds from the sale of the preferred and common stock will be used to pay down the credit issued by the Federal Reserve Bank of New York (FRBNY).
• The existing FRBNY credit will be revised to reflect a total commitment of $60 billion, an interest rate of LIBOR (London Interbank Offered Rate) plus 3 percent annually, a 0.75 percent fee on undrawn commitments and a 5-year loan term.
• AIG will transfer mortgage-backed securities to a newly created financing entity capitalized with $1billion in subordinated funding from AIG and up to $22.5 bilion in senior funding from FRGNY.
• The purchase of approximately $70 billion in Multi-Sector CDO exposure by a second financing entity created by AIG and FRBNY.

“Today’s actions send a strong signal to our policy holders, business partners and counterparties that AIG is on the road to recovery,” Edward M. Liddy, AIG Chairman and CEO said in a statement. “Our comprehensive plan addresses the liquidity issues that threatened AIG, and gives us the financial flexibility to complete our structuring process successfully for the benefit of all our constituencies.”

Comparatively, the $23,000 that the Arizona Republic reports as the total cost AIG said it incurred for the Phoenix conference barely registers. Even if AIG picked up the full cost of the conference, it’s only slightly more than 0.2 percent of 1 percent of the total bailout cost so far. In addition, the company reports that financial planners like those attending the conference generated almost $200 million in revenues this year, as of September 30.

After being exposed by local then national media, Larry Roth told the Arizona Republic “Our success in enlisting product sponsors to pay for the vast majority of costs, while charging financial planners a registration fee and for their travel, has resulted in minimal cost to AIG.”

Liddy concurs, saying “We conducted a top-to-bottom review of all expenses of the Phoenix meeting in advance and found that it was consistent with my October 10th directive [to reduce expenses, conserve cash and cancel all nonessential conferences and meetings, unnecessary travel and excessive overhead]. This conference was approved because it provides the kind of communication we must conduct with the people who sell our products if we are to be successful and repay the U.S. taxpayer.”

Minimal cost is not free. The public is understandably skeptical of AIG’s explanations given their past behavior. There are some indications, however that this explanation has some truth to it.

Phoenix is the headquarters of AIG Financial Advisors (AIGFA) minimizing travel costs for AIG employees. Nearly 2,000 independent, fee-based financial advisers are affiliated with AIGFA, a registered broker-dealer and member of financial Industry Regulatory Authority (FINRA). On of the responsibilities of a registered-broker dealer under National Association of Securities Dealers (NASD) Rule 1120, Continuing Education Requirements, is providing registered covered persons with formal product- and regulatory-related training.

The goal of the bailout was to allow AIG to survive. Some conferences and formal training are part of doing business for a financial company. If AIG is to continue operations, let alone begin rebuilding itself or repaying taxapyers, they are going to have to spend some money to do it. but they have only themselves to blame if the public uses past experience to judge the company’s present and future actions for some time to come.

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Past Haunts AIG as Bailout Solution Announced

A guest post from Constantine von Hoffman, veteran business journalist and author of the blog CollateralDamage.biz, a humorous look at marketing, business and his dog.

Popular opinion has it that Barack Obama won because he took some red states away from John McCain. Nonsense. Obama won all the red states. And McCain won all the black states. But this has nothing to do with that stupid red state/blue state dichotomy. This is about the much more tangible difference between red (ink) states vs. black (ink) states.

As this chart from the Wall Street Journal shows, Obama carried 18 of the 20 states where housing prices have dipped into the red – according to the Office of Federal Housing Enterprise Oversight house price index for the second quarter. Those two that went for McCain? Arizona and Alaska – which makes their anomalous standing understandable.

The real red states

McCain carried nearly all the states where housing prices were in even slightly in the black. Of the thirty states which saw any positive growth in housing prices twenty-two went for McCain. It’s worth noting that Missouri, where McCain barely won – was also barely a gainer in housing prices. Increasing by a mere .89. Likewise, all those states which went for Obama this year after going for Bush in the last election had among the lowest price increases in housing. (For some reason the chart shows Indiana as a McCain win.)

Black is beautiful for the GOP

Of the three economic indicators measured – housing price, unemployment rate and change in personal income – housing was the only one that correlated with voting trends. It would be incredibly useful for someone to do a similar chart for the 1992 and 1980 elections – the last two elections where the economy was the over-riding factor in determining the outcome.

There is a silver lining for the GOP to spin out of all this: If you want to protect your investment in your home, buy in a state that’s overwhelmingly Republican.

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As went housing prices, so went the vote

A guest post from Frank Shump. Frank is a veteran from the financial services industry, and currently authors a blog called Thefinancecastle.com, which documents his thoughts on money matters and his adventures in self employment.

I was up late much like millions of other viewers to see the final results of the presidential election last night. I was not at all surprised to see that Obama won by a significant margin, but after the votes were tallied and the celebration died down, I thought to myself: “I’m glad I’m not that guy!” Historic significance aside, the next president-elect is going to have his hands full. From the economy being in the dumper to housing prices continuing to redefine the pricing floor, how is Obama going to help bring stability in the face of a ballooning Federal deficit? Let’s look at what we have so far.

Obama on Homeownership

In terms of home ownership, according to Obama’s official site, he aims to provide new mortgage interest tax credits in place. The credit will “ensure that middle-class Americans beneft fromt his home ownership tax incentive.” The proposal claims to provide 10 million home owners, most earning under $50,000 annually, with about $500 in savings. Direct relief to home owners could certainly be seen as a plus. Obama also says he’s been “closely monitoring” the subprime mortgage situation for years and introduced legislation two years ago to fight off mortgage fraud and protect consumers from abusive lending. The act, aptly named STOP FRAUD (how clever?), increases funding for federal and state law enforcement programs and creates new punishments for mortgage professionals that are guilty of fraud. Also a plus, right?

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A guest post from Frank Shump. Frank is a veteran from the financial services industry, and currently authors a blog called Thefinancecastle.com, which documents his thoughts on money matters and his adventures in self employment.

By and large the average American consumer is usually a resilient creature. Even through minor recessions and increasing prices in the past, we’ve managed to just keep on trucking and buy things we need (and of course some things we don’t). In most times when our economy was heading into a recession, the general public’s view was to downplay the amount of fear we’re feeling and keep on doing what we’re doing until the cycle trended back upward. This time, however, things appear to be different. An increasing number of consumers are scared, jittery, and angry about the current economic condition, and they have every right to be.

A recent poll put out by CNN/Opinion Research Corp. showed that seventy-five percent of those surveyed believe that things are going badly in the United States. After years of easy credit and rampant consumerism, it appears that as a nation we may finally be coming to the realization that the party, is in fact, over.

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Another guest post from MG who went from Wharton to Wall St. to real estate to Blown Mortgage.

Some of my best friends wear tinfoil hats. These days, though, no sooner has a good conspiracy theory made the rounds, but it’s proven to be fact. This past weekend there were outrageous rumors that Argentina would confiscate citizens’ pension money. By Wednesday afternoon it was a done deal. There’s little point in providing a link; it’s old news now.

However, and borrowing heavily from a comment on Global Economic Trend Analysis, let this be a warning to us all. The Argentine state is taking control of its citizens’ privately-managed pension funds in a drastic move to raise cash. This could be a harbinger of what will happen across the world as governments discover that tax revenues are insufficient and bond markets unwilling to cover their obligations and deficit spending.

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Politics caused the global economic crisis. Can politics fix it? Doubtful.

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Sub-prime Mess Leads to Global Summit

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The problem remains

Once we have moved past this current economic crisis, Fannie and Freddie must be fully privatized.

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Fannie & Freddie Should Be Fully Privatized

Once we have moved past this current economic crisis, Fannie and Freddie must be fully privatized.

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Fannie & Freddie Should Be Fully Privatized