New bankruptcy laws and foreclosure

[midnight286]

When the new bankruptcy laws took effect last year I heard that it was going to make it harder for people to get out of their mortgages, or at least harder for them to walk away without debt. Has anyone else heard this or understand the laws?

[barnaby33]

I went and did a little more reading. Apparently in order to declare bankruptcy a person must go through a 6 month period of credit counseling. During this period they can still be foreclosed on. This gives the lender a much better chance to foreclose than once bankruptcy has started. Its a nice little touch.

Josh

[midnight286]

Obviously I didn’t understand the difference between foreclosure and bankruptcy! 🙂 Thanks for the information. Just another way the mortgage companies are going to be able to screw all these people who have taken advantage of these ridiculous exotic loan breeds.

[barnaby33]

Yes but and here is the interesting part, mortgage holders don’t really win either. They spend a huge amount of money when the foreclose. Legal fees, re-appraisal, holding the property while trying to find a buyer and sales commissions. Foreclosure isn’t really in their interests either.

Josh

[DiveUrge]

No, not in their interest… UNTIL THEY ARE “FORCED” TO CLEAR THEIR UNDERPERFORMING LOANS – LIABILITIES. And that happens. Not too long ago the RTC EVENT and regulators were “encouraging” lending institutions to clean up their financials which led to a rash of properties released at fire-sale prices. A lot of people went broke and some got very very rich.

That was then. Now we have what could easily be described as a far more dire lending situation where net debt has skyrocketed. Rapid close to 50% price declines are easily achievable.

[barnaby33]

That sort of prediction is dangerous, very dangerous, especially if its true. I don’t happen to think it is, but lets just indulge that fantasy. If prices were to rapidly decline say 50% over two years. That would mean a substantial contraction in the economy, forcing tens of thousands of white collar people to sell there homes quickly. I can think of only three things that would cause that.
1)Economic collapse
2)Terrorism
3)Natural Disaster (Other than Otay Mesa, which already is)

In that scenario, we would all baten down the hatches and get out our shotguns. I certainly wouldn’t be out house shopping, Id be hoarding, and so would everybody else.
Josh

[DiveUrge]

The Anderson UCLA Forecast for CA real estate doesn’t dismiss this outcome. With 50% increase over the past couple of years who is actually at risk in a 50% decline? Those that purchased recently and those that took a bunch of $$$$ back against equity. Hardly a crisis for someone that has been in the game for 4 years without jerking $$$$$$ out!

If the 50% decline occurs over the next couple of years and inflation ticks up to say 6% that alone accounts for ~15% of the nominal 50%.

Statistical analysis has been done that calls a 50% decline a mere correction based on the bubble’s magnitude and speed at which it ballooned…

[Mr. Drysdale]

This HAS happened before. I worked as an REO Marketing Analyst for the RTC when they took down Home Fed Bank around 1991. It was the largest bank ever taken down with hundreds of millions in REO. I personally sold bank REO for 20%-30% of what it appraised for just two and three years earlier. Banking regulators don’t give lenders alot of leeway to play the market so to speak, or hold on to get a better price. They HAVE to get those non-performing assets OFF their books. I have lots of stories about those days and I’m convinced this time it will be far worse because back then we didn’t have any of the Geo-Political crises we have now, and because the advent of the internet now facilitates the free flow of information much much faster. Look at all the housing bubble blogs there are with all the reliable data they are providing. It’s almost an avalanch.

I remember telling people in 1989-1990 that the writing was on the wall and nobody listened because there was no publicly available data, and the media, especially newspapers, weren’t going to report it because their largest source of advertising comes from brokers.

With the internet and the info that is available on it, you’ll soon see the amount of time it takes for real estate to crash significantly compacted. In fact when homeowners increasingly start putting their homes up for sale in the next few weeks to get an early start on the spring home buying season, and they realize how inventories on their local MLS’s have tripled and quadrupled and worse, you’ll see panic set in, especially now that you can monitor home inventories in any metropolitan area on ZipRealty.com and other sites. This will feed the panic. In 1991-1994 (the last time there was a real estate crash), only real estate brokers with access to the MLS were able to see the early signs. Now everyone sees the signs and is blogging about it.

The one thing I’m always amazed to find out is how many borrowers think that when their home goes back to the bank, that’s the end of their problems. What they don’t realize is that if the lender writes off or forgives any debt to them (i.e., short sale, etc.) the former borrower will get a 1099 for the amount of that forgiven debt as though they had received it as income. If they sold their home through a short sale at the begining of the year and they got a 1099 by January 30th of the following year, they not only have to pay taxes on that forgiven debt, but penalties and interest too, because it was due (unless you pay estimated quarterly taxes) at the time the debt was forgiven.

IT WILL GET VERY UGLY “/

[powayseller]

Sandiegobanker – Fascinating post! Can you explain further? Did you see the effect on the MBS market? How many banks were taken down by this? Was there any discussion of the gov’t stepping in to make the banks solvent? Why have people forgotten what happened just a decade ago, and repeated the same mistakes?

Although the internet can compact the price decline, the number of RE investors and newly minted foreclosure investors (from seminars and books) has increased the number of people who come to RE auctions. Perhaps that will keep up the REO auction price, as more bidders show up. For example, the SDCty Tax Collector had their annual auction and rented a larger hall (although the number of auction properties increased only by 10 houses from 70 last year to 80 this year), just to accomodate a larger group. Do you think there could be more bidders, thus preventing the REO auction price from falling as low as last time?

[Mr. Drysdale]

At the time I didn’t pay much attention to the MBS market. I was a licensed broker and had access to the MLS and was watching the trends. I also called U-Haul (because they had no web site at the time as did no other company that I’m aware of) repeatedly to get quotes that would reveal the net migration patterns out of San Diego and California in general despite what the media and other brokers kept saying about everyone wanting to live here. I also re-read a book I had bought years earlier in college where I majored in Real Estate Finance. The book was called “The Coming Real Estate Crash” by two authors by the names of Cardiff and English. I highly recommend getting it. Even though it’s quite dated (1st published in the early 80’s) it has a section that describes real estate market psychology better than I’ve heard anyone else try to explain it.

I can’t recall the number of Banks that went belly-up, but it was a shocking number and they were all over the USA. The funny thing I remember was that RTC’s Sr. Mgmt., at Home Fed, the RTC Credit Review Committee, was comprised of CEO’s and EVP’s from failed banks in Arizona and elsewhere in Calif. that the RTC had taken down. I also remember there were no S&L’s left in Phoenix at that time because when I was trying to sell houses there for a client in San Diego we were told there were no S&L’s left in Phoenix and the banks just weren’t lending. The mortgage companies had minimum loan amounts that were much higher than the $15,000 & $20,000 my client was selling his Phoenix homes for in 1991 (they were in crappy areas if that’s any consolation). In fact the only people willing to buy the homes were the tenants and my client had to “creatively” manufacture the down payment. He just wanted out at any cost and would have given them away to a charity if the tenants hadn’t bought them

At the time, there was alot of talk at the begining of the crash that the government would step in, but it was all wishful thinking and it won’t happen for many reasons:

The government is too far in the red already

Things have to play out to their “natural” conclusion. It’s all part of the economic cycle of life. The crash has already long been anticipated in numerous other ways. It has to play out normally.

Allowing Uncle Sam to step in and cure or mitigate the crash would create a consumer mindset that would be far more dangerous for our economy. There has to be consequences. Even though bankruptcy allows you to wipe out all your debts, you pay a big price not being able to obtain credit for years, other than maybe credit at more onerous terms.

Your question, why have people forgotten what happened just over a decade ago is one I’d really like to address because the answer says more than you’d think. The only people who “really” understand that period were those “right in the middle of it” like those working at the RTC who sold that REO at firesale prices and those who got financially burned badly. That’s a smaller group than those not part of this group, and even then, many of those never understood what caused the crash in 1989-1995, so what you have is a very small number of people out there who really understand, although I’m extremely impressed about how knowledgable Rich at Piggington and other housing bubble blogs are, and their very public discussion of the facts/data will compact the cycle this time.

The only thing I remind people is that if you don’t have to sell in a bad market, competing with the sale of bank REO, massive inventories on the MLS, etc., you can say your property is worth anything you want based on any amenity of dubious merit, because you’ll only be called on it when you actually have to compete with the market by trying to sell in competition with it. I have vivid memories of many real estate owners during the 1989-1995 period who would argue in the face of actual sale comps all day long. The point I’m making is look at the data only, not statements of subjectivity.

Regarding all the new investors seeking to scoop up deals which will hold up the market…that ocurred last time too, UNTIL the new market psychology kicked in. The emotions of optimism and greed that drove this market through the roof will invert into pessimism and frugality which over time will drive prices through the floor. There is a new emotional mindset already taking place. You can see it in many postings, not just housing bubble blogs, but real estate listings on the classified section of SDREADER.com and others where people who probably don’t consider themselves religious are actually praying for a buyer, yes they used the word praying in their ad. I saw another ad for a Hillcrest property that basically said they were sick of real estate investing. This mood will permeate the market as the market increasingly begins to grind down even slower.

As far as live auctions, they are a strange thing in my opinion and are driven more by emotion than anything else. I’ve been to many of these and am always amazed at how often investors will bid the properties up to market with less assurance than they would get if they had bought in the traditional way through a broker. People just get caught up in the emotion. Some people think “auction” and “good deal” are synonomous. I’ve heard many people brag about the deals they got at auction, but when you comp them out, they simply bought at market, with fewer assurances, which to me makes it a worse deal.

[powayseller]

Are you still in the RE field? Thanks for your informative response.

[Mr. Drysdale]

I’m a commercial lending officer with a major financial institution here in San Diego : )

[powayseller]

sandiegobanker – do you see the lax lending standards of residential lending extended to commercial lending? Are the banks going to follow the recent tightened lending guidelines, or will the banks just shrug them off? Are the banks at all concerned about the housing bubble, or are they careless since they don’t hold the loans inhouse (unless your bank does). Do you see a slowdown in lending for commercial, such as highrises or retail buildings, both as a result of tighter credit and anticipated real estate slowdown? Any other observations about the market?

[Mr. Drysdale]

Powaseller – Yes, some banks, not mine however, have been very lax in making commercial real estate loans as well. There are some banks that have chosen to accept projected income versus actual income on a property to meet the debt service coverage ratio requirements, in order to be more competitive. And some banks don’t require any secondary source of repayment as long as the numbers on the property alone fall into place, albeit with a little nudging on the part of some lenders (but definitely not mine).

If you’re familiar with the conduit loans that are so popular with commercial real estate owners, read my article at http://sandiegobanker.blogspot.com/
It describes something (the part of the article in bold red) in many commercial real estate markets that I think very few people in the profession are aware of, or think much about.

As you know, commercial real estate is bought based on the cap rate, and California commercial properties have been selling at historically very low cap rates of 4%-6.5% because alternative investments have not been yielding much more. But as interest rates rise, so too will the cap rates investors will come to expect from commercial property. If you bought a commercial property based on a historically low cap rate, what will happen down the road when similar properties like yours sell for cap rates 2-4% higher? How will that affect value? For some, the change in value caused to their property could place them upside down if they had a 90% LTV SBA loan or even a 75% LTV loan, especially if the value when they bought it was based on projected income.

Multi-family cap rates are even more ridiculous and have been driven down by investors buying them up at very low cap rates, not for their income, but to convert them into condos where those investors hope to recoup their returns selling them off as individual units. The problem is that it has created sale comps for others less knowledgable who haven’t figured out those comps have been distorted by the intentions of real estate investors who bought those properties for reasons other than income (i.e, condo conversions).

Commercial real estate will be affected as well by any crash (which to me is an overall drop in values of 30% or more) in residential real estate, it will just take longer because most commercial real estate is valued on a leased fee or income approach basis which is supported by generally strong term leases, versus market value in residential real estate, which is influenced more by other factors. But if things go really bad in the residential market, it will affect the general economy as a whole.

Personally, I think this all started in 2001 when Greenspan caused the Prime rate to drop eleven times in that year alone. It was like throwing gasoline on fire when you consider how many people got burned in the stock market and were primed (no pun intended) for another investment opportunity, which Greenspan went overboard to create for real estate in general.

[DiveUrge]

SanDiegoBanker, You said,

“The only thing I remind people is that if you don’t have to sell in a bad market, competing with the sale of bank REO, massive inventories on the MLS, etc., you can say your property is worth anything you want based on any amenity of dubious merit, because you’ll only be called on it when you actually have to compete with the market by trying to sell in competition with it.”

For many, this is true. But, as I recall, for the lending institutions that failed, there were a lot of loans, way upside down, that had perfectly happy borrowers making their full payments on time that had their loans called in full. Money got very tight and so perfectly good borrowers lost their homes simply because the market crashed and they could not afford the new terms. No one is truly safe unless they have equity greater than the post-crash appraised value.

Of course you still have divorces, people forced to move, sickness, job losses that all force a sale.

Global liquidity is something that couldmitigate a complete wipe-out. I don’t have a handle on how this will play out and it may provide a cushion?

[Author]

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