The Rate of Foreclosures and The Shadow Inventory (Part II)

Today I noticed a recent MSN Real Estate section article titled, Foreclosure Filings Fall – But Not in All States.(1) After reading the article I began to wonder . . . .

I wondered:
Does fewer foreclosure notices being filed mean there are actually that many fewer mortgage borrowers who are, or are becoming, ‘in default’ of their obligation to pay their mortgage?

Does fewer foreclosure notices being filed mean that the foreclosure process is (temporarily) becoming even slower than it has been in the past? Does it mean that the homes of mortgage borrowers who are “underwater” and have decided to use the ‘strategic default’ strategy are not becoming part of the shadow inventory?(2) Does it mean that borrowers who have fallen on hard economic circumstances are not continuing to squat in the homes they financed with the easy mortgages they were able to get when economic conditions seemed better? Are such borrowers still squatting, biding their time and saving money, until the foreclosure notice comes and the marshal forces them out of the home? Does fewer foreclosures notices being filed mean that defaulted squatters will have even longer to save money (by not paying their mortgages) before the foreclosure notice is filed and marshal forces them to leave the home in which they are squatting?

Is it possible that filing foreclosure notices has slowed because of seasonal factors? Home purchases normally decline significantly over the holidays (during the Thanksgiving and Christmas Holidays and past the New Years Holiday). If you held the mortgage on a defaulted residence would you want that residence vacant for three or four months until the Spring home buying season begins. Is it possible that the large mortgage servicers and investors [like the Government’s GSA’s, large banks and public and private pension plans] are concerned about the public relations ‘fallout’ from continuing foreclosures, at a high rate, during the holiday season? Is it possible that mortgage lenders are delaying foreclosures so they can digest their past losses on foreclosures, and hopefully offset future losses on foreclosures against future investment revenue from other asset classes and from fee income? [Are defaulted, but not yet foreclosed homes, still “the pig in python”? (see note below)]

It seems that filing foreclosure notices is an activity which the holders of the mortgage investment can control, or ‘time’ - depending on a number of factors some of which can benefit them. As, the number and the speed of foreclosure filings varies, watch very closely for changes in the shadow inventory.

Footnotes:

1. Foreclosure Filings Fall – But Not in All States By Teresa (Real Estate) at MSN - Pub. October 11, 2012, at: http://realestate.msn.com/blogs/listedblogpost.aspx?post=89cc9dfd-19e4-48c2-b...

2. For a definition of the shadow inventory see the third paragraph of the October 9, 2012 article, CoreLogic Reports Shadow Inventory Continues to Decline in July at: http://www.corelogic.com/about-us/news/corelogic-reports-shadow-inventory-continues-to-decline-in-july-2012.aspx 

CoreLogic estimates the current stock of properties in the shadow inventory, also known as pending supply, by calculating the number of properties that are seriously delinquent, in foreclosure and held as real estate owned (REO) by mortgage servicers but not currently listed on multiple listing services (MLSs). Roll rates are the transition rates of loans from one state of performance to the next. Beginning with this report, cure rates are factored in as well to capture the rise in foreclosure timelines and further enhance the accuracy of the shadow inventory analysis. Transition rates of “delinquency to foreclosure” and “foreclosure to REO” are used to identify the currently distressed non-listed properties most likely to become REO properties. Properties that are not yet delinquent but may become delinquent in the future are not included in the estimate of the current shadow inventory. Shadow inventory is typically not included in the official metrics of unsold inventory.

NOTE: The pig in the python, see:

The Rate of Foreclosures and The Shadow Inventory (Part I)

In October of 2010 I commented on a Reuters article titled, Shadow Housing Inventory Seen Topping 2 Million.(1)

My Comment:
I believe those who attempt to minimize the size, or the significance of the shadow inventory are either in the real estate, banking, or institutional investment industries.

If you want to understand why the shadow inventory is growing do a key word search on the Wall Street Journal article, “Congress Helped Banks Defang Key Rule” by Susan Pulliam & Tom McGinty (2)

Under current accounting rules, banks and other mortgage investors are reluctant to complete a foreclosure or a loan modification because the completion of a foreclosure or modification transaction forces the revaluation of the mortgage asset on the financial books of bank’s, mortgage investor’s or Government Sponsored Enterprises (think bank loan loss reserves). And, banks and other investors would rather have a strategic defaulter, or a squatter in default, than have a vacant  foreclosed home because the squatter provides some security from vandalism and 'stripping', and because the squatter continues to be liable for property taxes, HOA fees and municipal assessments.

Unemployment is high and loan qualification standards are very restrictive, so the banks have a significantly reduced opportunity to sell foreclosed homes, so why rush to foreclose.

Stay tuned for the outcome of the investigations of the Mortgage Electronic Registration Systems (MERS). What institutions came-up with the concept of MERS and provided the funding for the start-up of MERS? Fannie Mae and Freddie Mac each provided 2 million $ in seed money to create MERS, then they invited the largest mortgage investment banks to join in the MERS process.(3)

I watched the U.S. Senate and U.S. House of Representatives hearings on problems in the mortgage industry last week. It was truly ironic to see Senators and Congressional Representatives scolding and badgering witnesses about the problems in the mortgage crises. It would seem those in Congress don’t understand how they helped to create and fuel the mortgage and real estate bubble by years of policies they endorsed and encouraged.(4)

Committees in The U.S. Senate and House of Representatives held hearings on problems in the mortgage industry and problems in the mortgage modification effort last week. Most of the testifiers commented that a general problem in foreclosures and loan modifications was a mis-alignment of incentives. They also mentioned three other more specific issues:

(1) Most Mortgage servicers are ill-suited to the task of underwriting a modification. They were set up as operations designed to process and allocate payments, not to underwrite or modify loans.
(2) Mortgage servicers have monetary motivation to keep the original loan on the books as long as possible (even while appearing to work on a foreclosure). This is because fees and penalties, which represent income to the servicing entity, accrue while the loan is being modified.
(3) Investors in mortgage notes have little incentive to approve a HAMP modification (or any other modification for that matter) if it creates a loss in the net present value of their note, and most servicers and other witnesses testifying mentioned that mortgage investors have not yet really embraced the loan modification process.

Footnotes:

1. See, Shadow Housing Inventory Seen Topping 2 Million By Al Yoon pub. Reuters 11/22/2010, at: http://www.reuters.com/article/2010/11/22/us-usa-housing-shadow-idUSTRE6AL40Z20101122

2. Congress Helped Banks Defang Key Rule by Susan Pulliam & Tom McGinty, at: http://online.wsj.com/article/SB124396078596677535.html

3. Key words search: Two Faces: Demystifying the Electronic Mortgage Registration System’s Land Title Theory by Christopher L. Peterson. Did the difficulty in tracking title and note ownership in MERS influence the robo-signing phenomenon?

4.  Watch YouTube video titled Bill Clinton: Laying The Foundation For The House of Cards at> and watch Bill Moyers and Gretchen Morgenson in the video-clip titled, Fannie Mae: The Quintessential Model For Crony Capitalism at: and Watch the video clip of Congressman Christopher Shays in the video-clip Corruption at the GSE’s at:

The Shadow Knows

[First draft, January 10, 2010] Recently I've been reading articles documenting the increasing size of "the shadow inventory" of housing. Many articles mention that in addition to foreclosed properties, and REO's, a rapidly growing portion of the shadow inventory is represented by homes for which the home loan is in default, but on which banks are not foreclosing. Many of the articles I've read explain some reasons why banks and other Collateralized Mortgage Obligation (CMO) investors would choose not to foreclose on borrowers-in-default, but none of the articles list all of the reasons I can think of for banks and investors not foreclosing. 

The change to mark-to-market accounting for certain classes of financial assets (GAAP) has been delayed by Financial Accounting Standards Board (FASB) - with pressure from the U.S. Congress and bank lobbyists (see: http://online.wsj.com/article/SB124396078596677535.html). So, the necessity to actually account for these bank assets' true market value is currently suspended. 

If a mortgage owner is a bank and the bank forecloses, the process for re-pricing the asset begins. And, the amount of the loss on the asset would then reduce the calculated bank reserves and force the regulators to require the bank to add more reserves. Under present market conditions this would not be a good thing for the bank, or for the U.S. Government. (Under present conditions banks which could not raise more reserve assets would be forced into FDIC receivership). And, if banks actually began to foreclose rapidly on all borrowers-in-default the calls for Government Sponsored Agency (GSA) loan insurance payoffs would further complicate the bail-out of the GSA's. Also, the demand for private mortgage insurance payoffs would put further stress on private mortgage insurers and impose additional stress on the financial system in general (and probably require private insurers to increase their required reserves). 

Another reason banks might avoid foreclosing on a borrower-in-default is that judges are becoming a bit cantankerous. Judges have begun to force loan modifications, mandate cram-downs, and in the absence of good physical documentation proving a bank or investor actually owns the loan, some judges have even awarded property to the (supposed) borrower when the loan documentation is missing, flawed or incomplete. 

It seems that the rush to originate loans, slice-and-dice loan tranches, construct CMO derivatives, track ownership, and re-register frequently traded CMO's (in the electronic registration system) led some necessary loan details, and even some complete documentation, to "go missing". So banks and investors are beginning to see foreclosure as a risky and potentially expensive option. (see: 10/24/09 NYT article by Gretchen Morgensen titled, "If Lenders Say 'The Dog Ate Your Mortgage' " at> http://www.nytimes.com/2009/10/25/business/economy/25gret.html )  

Another subtlety, as long as the bank allows the borrower-in-default to stay in the home the mortgage investor (bank or CMO investor) is not as greatly exposed to losses from theft, vandalism and gross depreciation of real estate value due to non-maintenance of the property. 

Also, by not foreclosing on borrowers-in-default the lender avoids becoming the owner of the property and thus avoids direct liability for property taxes, HOA Fees, and some of the more recently imposed municipality assessments levied against investors who now own foreclosed property (see: http://www.dlapiper.com/miami-dade_foreclosure_ordinances/ for another example see mosquito abatement fees in some areas of California - Indio, Palm Springs, Stockton, Mountain House, etc.)

If the "shadow inventory" came to the market all at once demand would be even further overwhelmed by supply causing even more significant price erosion.

It’s logical . . . perhaps corrupt, but logical.

Other Resources:

1. See CoreLogic.com at: http://www.corelogic.com/search.aspx?q=shadow+inventory

2. The Case-Shiller S&P Home Price Index is published on the last Tuesday of the month with a two month time lag in reporting for data gathering and data analysis, at: http://www.standardandpoors.com/indices/sp-case-shiller-home-price-indices/en...

3. Also see, YouTube video The Impact of The Delay in Implementing FAS#157 at:  

4. And, watch the YouTube video The Short Sale Conundrum - Mortgage Servicers’ Misaligned Incentives at:

5. Re: Was the strategy for delaying the pain learned during Japan's 'Lost Decade'? “Geithner worked for Kissinger Associates in Washington for three years and then joined the International Affairs division of the U.S. Treasury Department in 1988. He went on to serve as an attaché at the Embassy of the United States in Tokyo.” From Wikipedia, Timothy Geithner at: http://en.wikipedia.org/wiki/Timothy_Geithner

6. Watch a brief segment of Georgetown Law Professor Adam Levitin's Congressional testimony titled, "Regulators Don't Want to Know" at:

 

Who's Sorry Now . . .

Burdened by Old Mortgages, Banks Are Slow to Lend Now By Nick Timiraos Wall Street Journal, pub. October 3, 2012

From the article:
Part of the problem lies in changes in mortgage processing over the past few decades. Fannie and Freddie rolled out automated-underwriting systems in the mid-1990s that allowed lenders to punch borrower data into computer systems in order to receive faster approvals or denials.

The mortgage bust highlighted weaknesses. Fannie and Freddie did few upfront reviews of loans that they purchased; instead, they screened some of those that went bad, forcing banks to buy back any with obvious signs of negligence or fraud.

After the meltdown, the mortgage giants began hiring armies of auditors—called "bounty hunters" by bank executives—to conduct detailed reviews of loan files to spot errors that could justify a put-back.

deja vu

Regulation and Unintended Consequences

During the first debate between the presidential candidates (10/03/2012) there was a question about the sufficiency and adequacy of federal regulation. The candidate's comments about regulation, which followed the question, led me to think about some unintended consequences from federal regulations of the past, and how these unintended consequences contributed significantly to the housing and mortgage bubble and how they seem to have motivated some of the practices which led to the financial crisis.

In order to showcase my thoughts, in "Regulation and Unintended Consequences" I've juxtaposed a 1998 PBS NewsHour interview in which Bill Clinton provides comments about his efforts to greatly expand The Community Reinvestment Act.

The Looming Rentcropper Society

In addition to the problems mentioned in Institutional Home Buying Bubble (see post below) there are few other reasonable concerns about the programs that facilitate such institutional bulk purchases.

In addition to the operational difficulties, the operational overhead, and the lack of ‘scalability’ in the bulk ownership and the property management of single family homes – which are presumably geographically disbursed - some commenters have mentioned a few other un-intended negative consequences which might flow from federal government sponsored, and large bank sponsored, programs for the bulk sale of Real Estate Owned (REO) and foreclosed single family properties.  To read about some of the other (somewhat predictable) unintended negative consequences of the bulk sales of single family homes to institutional owners read the articles named and hyperlinked below.

Resources:
Our Coming Rentcropper Society By Yves Smith posted on NakedCapitalism 8/21/2012, at: http://www.nakedcapitalism.com/2012/08/our-coming-rentcropper-society.html#Td4eh6HzCh0JProP.99

Our Coming Rentcropper Society: Private Equity Firms Buying-up Blocks of Foreclosures Nationwide By HiPointDem posted on DemocraticUnderground 8/24/2012, at: http://www.democraticunderground.com/10021191182

Foreclosure Bulk Sales Program Allows Banks and Hedgefunds to Buy Low After Selling High By David Dayen posted on FDL March 21, 2012, at: http://news.firedoglake.com/2012/03/21/foreclosure-bulk-sales-program-allows-banks-and-hedge-funds-to-buy-low-after-selling-high/

FHA Moving Forward with Bulk REO Sales By Greg Fielding from 8/27/2012 post on Bay Area Real Estate Trends, at: http://bayarearealestatetrends.com/2012/08/27/fhfa-moving-forward-with-bulk-reo-sales/

Fraud at the GSE's?

I commented on an interesting article published September 14, 2012 in the Wall Street Journal, How Greenspan Misread the Risks at Fannie and Freddie. It’s an article based upon an excerpt (written by James Hagerty) from his new book The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall By James R. Hagerty.

My Comment:

In December of 2011 the SEC filed lawsuits against several former executives of Fannie Mae and Freddie Mac. One of the allegations in both of the two lawsuits is that former executives of Fannie and Freddie mis-categorized mortgage loans that were being bought by Fannie and Freddie and that they failed to inform investors and Fannie and Freddie’s regulator [The Office of Federal Housing Enterprise Oversight] of the true number (percentage and value) of Sub-Prime and Alt-A loans they purchased.

So, it’s not that shocking that most people who believed what Fannie and Freddie were telling them didn’t know of the significant default risk.

Only people like Michael Burry(2) Laurence Fink(3) John Paulson(4) and perhaps Stanford Kurland(5) who actually studied (or were aware of) the progressively diminishing mortgage qualification standards as the bubble formed, and who studied (or were aware of) the actual mortgage borrower income statistics, were prescient enough to become alarmed about Fannie and Freddie’s exposure to default risk.

Based upon what Fannie and Freddie were claiming as their mortgage loan quality, It should be no surprise that Alan Greenspan, John McCain, George W. Bush, Treasury Secretary, John Snow and the Office of Federal Housing Enterprise Oversight [OFEO] were more concerned about the impact of credit rate risk and accounting fraud at Fannie Mae and Freddie Mac than they seem to have been about default risk.(6) 

Footnotes:

(1) Reference SEC Website SEC CHARGES FORMER FANNIE MAE AND FREDDIE MAC EXECUTIVES WITH SECURITIES FRAUD.  

(2) Reference, Betting on the Blind Side By Michael Lewis – pub. Vanity Fair Magazine | April 2010. 

(3) Reference, Inside the Trillionaires Club at BlackRock pub. Forbes Magazine August 17, 2009. From the article: 

LESSON 2: When investments get complex, do your homework: 

. . . In late 2006 the company developed a model that put a lower, more realistic number on the incomes subprime borrowers were claiming on their "no doc" loans. The projections were shocking: BlackRock figured that when the loans reset to their new, higher rates in a couple of years, most borrowers would be spending more than half their real incomes on mortgage payments. Foreseeing an avalanche of defaults, BlackRock dumped subprime bonds in early 2007 when the prices were still lofty.

(4) See, John Paulson, Trader Made Billions on Sub-Prime By Gregory Zuckerman pub. Wall Street Journal January 15, 2008. 

(5) See, Stanford Kurland - Former Countrywide No.2 Sees Opportunity in Troubled Mortgages By Matthew Padilla Orange County Register - June 10, 2008.   From the article:  

Q. How did this venture come about?

A. I was somewhat in a state of retirement. I left Countrywide in 2006 after 27 years. From the sidelines, I was watching the mortgage market meltdown and was in communication with associates of mine over what it was going to take to improve or revitalize the mortgage market. Wall Street firms were reaching out to me on whether I had an interest in participating with them. I got a call from the chairman of BlackRock, Laurence Fink, who asked if I would meet a group of executives who were talking about how to address issues in the mortgage market, and they were working with another company (Highfields Capital Management).
I was very receptive to talking to Larry Fink. We had grown up together and have been friends since grade school days.

Q. Where did you and Mr. Fink grow up?

A. We grew up in Van Nuys. That’s the valley. 

(6) See, YouTube video-clip, Timeline: George Bush, John McCain Warn Democrats of Housing Crisis, at:

 

 

 

Bill Clinton: Building the Foundation for The House of Cards

In this PBS NewsHour video-clip aired January 21, 1998 President Bill Clinton points to his accomplishment of having his 'regulators' force banks to grant loans to applicants to whom the banks would not have otherwise granted loans.

  

In this video-clip President Clinton, claims that 85% of the loans issued under the guidelines of the (then 20 plus year old) Community Reinvestment Act were issued during his first five years in office.

  

Is it any wonder that the GSE's, Fannie Mae and Freddie Mac, under direction from Clinton and his two administration's HUD Chairmen, Henry Cisneros, and later Andrew Cuomo, continued lowering the standards for loans they would purchase from mortgage originators?

 

And, is it any wonder that investment banking interests devised ways to 'package' large numbers of mortgage loans into "tranches" of different risk level in order to diversify the risk they were being pressured through regulatory mandate, and political persuasion, to accept?

 

Notice that Clinton mentions this activity was not necessarily an affirmative action or civil rights oriented activity, but rather that it had significant impact on the economy. . . . 

 

Further Reading:

See, The Community Reinvestment Act, at: http://en.wikipedia.org/wiki/Community_Reinvestment_Act

 

Bill Clinton's Drive to Increase Homeownership Went Way Too Far By Peter Coy -pub. in Bloomberg BusinessWeek 2/28/2008, at: http://www.businessweek.com/the_thread/hotproperty/archives/2008/02/clintons_... 

  

Bill Clinton, Wanted For Crimes Against Our Economy By Jim Newman pub. 2/27/2012, at: http://kayleighmcenany.com/2012/02/27/jim-newman-bill-clinton-wanted-for-crimes-against-our-economy/

 

 Key words search for: Janet Reno threatens banks

 

The Institutional Home Buying Bubble

Many people and much of the media are pointing to recent improvements in home prices as a sign that the single family home market is bottoming and starting to recover. It seems to me that an alternative way to look at recent changes in the housing market might be to look at things a bit differently.

How about reading the tea leaves this way:

Several institutional asset managers have convinced investors that buying single family homes ‘in-bulk’ and then renting the houses or flipping them is a good business that will provide better yields than most other investments  currently available (in The Bernanke Economy). However, it seems the institutional asset managers that are doing this have ignored that single family home property management and single family home ‘flipping’ are generally not ‘scaleable’ activities. That is, the operational costs of single family property management and single family home 'flipping' are very high, and the activities involved usually cannot reach economies of scale.

Meanwhile, the media is reporting a recovering market in housing. And, some homeowners who have discretion about the timing of selling their homes make a discretionary decision not to list their home and to wait for a better price – because all indications and the media say home prices are rising. This reluctance to list reduces the LISTED inventory, which further creates the appearance of a recovering housing market.

Then, in a few months, the investors in the institutional funds that have purchased homes 'in-bulk' begin to realize the institutional managers are not reaping the expected returns and they begin to cash-out of the institutional home buying funds. This cashing-out forces the institutional funds to sell the homes they bought ‘in bulk’ at the best price they can get. 

Many very smart institutional investors have mentioned the operational difficulty and lack of ‘scaleability’ as reasons bulk home buyers may not succeed at single family home property management and / or single family home ‘flipping’.

Some Resources:

Private Equity Has Too Much Money to Spend on Homes By John Gittelsohn | pub. Bloomberg News - Jun 12, 2012:  http://www.bloomberg.com/news/2012-06-13/private-equity-has-too-much-money-to-spend-on-homes-mortgages.html

Institutional Investors Are Turning to Residential Foreclosures Investing in single-family rental market in its infancy By Arleen Jacobius | Pensions & Investments April 2, 2012: http://www.pionline.com/article/20120402/PRINTSUB/304029978  

Insight: The Wall Street Gold Rush in Foreclosed Homes By Matthew Goldstein & Jenneifer Ablan - Forbes Magazine 3/20/2012, at: http://www.reuters.com/article/2012/03/20/us-usa-foreclosures-investors-idUSB...

Investors Flock to Housing Looking to Buy Thousands of Homes in Bulk By Morgan Brennan - Forbes Magazine 4/3/2012, at: http://www.forbes.com/sites/morganbrennan/2012/04/03/investors-flock-to-housing-aspiring-to-own-thousands-of-homes/

Och-Ziff Calls Top Of "REO-To-Rental", And Distressed Housing Demand, With Exit Of Landlord Business Submitted by Tyler Durden on 10/17/2012 http://www.zerohedge.com/news/2012-10-17/och-ziff-calls-top-reo-rental-exit-landlord-business 

 The Housing Bet Warren Buffett Wishes He Could Make By Steve Shaefer pub. Forbes Markets 3/29/2012: http://www.forbes.com/sites/steveschaefer/2012/03/29/the-housing-bet-warren-buffett-wishes-he-could-make/#  

Critics Question Investment Fund’s Sacramento Rental Venture By Hudson Sangree and Philip Reese Sacramento Bee – Monday April 8, 2013 http://www.sacbee.com/2013/04/08/5323832/critics-question-investment-funds.htm

Lower Rates Push Yield Seekers to Higher Risk By A. Gary Shilling – Bloomberg News - Jan 29, 2013, at: http://www.bloomberg.com/news/2013-01-29/lower-rates-push-yield-seekers-to-higher-risk.html

Warren Buffett Says, “Buy Real Estate Now!” at the same time he mentions the problem of “scaleability” see video from CNBC Squawk Box pub. February 27, 2012: https://youtu.be/XOGP6hd0B24 

Don't Forget The Role of The Rating Agencies

Don't forget the role of the rating agencies in the financial crisis. In the 1975 the U.S. Congress designated the Nationally Recognized Statistical Rating Organizations (NRSRO's). When Congress passed the legislation anointing the NRSRO’s it gave this limited number of organizations oligopoly status and unique competitive advantage. At the same time, Congress appointed the Securities and Exchange Commission as regulator of the NRSRO's. 

Most investment advisors and portfolio managers use rating agency guidelines (ratings) to assist their evaluation of the quality and risk associated with the securities they purchase* and fiduciaries are restricted by law as to the minimum rating level from which they can select the investments they can purchase and manage. So, the rating agencies provide a seal of approval, so to speak, for the securities and companies they rate.

* In most cases, the ratings securities an investment advisor, or a portfolio manager will use are defined in a prospectus, offering circular, or by some other form of disclosure. 

If you would like to see a CEO of a rating agency squirm, watch and listen to, The Role of The Rating Agencies

and Too Little, Too Late