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/

Smoke, Mirrors and The Shadow Inventory

The Wall Street Journal “Smart Money” Will Short Sales Hit Home Prices?  By Anna Maria Andriotis - pub. August 22, 2012

 Why is there a ‘shadow inventory’ of homes?

  

In last quarter of 2008, U.S. banks and their lobbyists pushed the U.S. Congress to force the Financial Accounting Standards Board (FASB) to postpone the implementation of mark-to-market accounting (FAS #157).* The FASB eventually acquiesced.  So, after the acquiescence, banks and other collateralized mortgage obligation [CMO] investors can continue to carry these investments at origination value, rather than at the investment’s current market value.

 

But, if a bank or other mortgage investor forecloses, renegotiates the mortgage, or sells the home (the collateral) the new ‘book value’ of the investment is based upon the new selling price (or mortgage value) - as determined by the terms of the new deal (auction, renegotiation, or sale).

 

By not foreclosing, renegotiating, or formally taking back properties (REO) banks and other mortgage investors can, to some extent, manage what  their losses appear to be, and hopefully offset the losses - they recognize - against other revenue, over time.

  

Key-words-search: “Congress Helped Banks Defang Key Rule” By Susan Pulliam & Tom McGinty WSJ 6/3/2009 | Professor Adam Levitin Congressional testimony “Federal Regulators Don’t Want to Know” YouTube | Zombie Banks | Japan Lost Decade (Please note that, at the beginning of Japan’s lost decade our current Treasury Secretary, Timothy Geithner was living and working in Japan as a Treasury Department attaché in the U.S. Embassy.)

 

*  See, FAS #157 [mark-to-market accounting] and scroll down to the section heading: Effect on subprime crisis and Emergency Economic Stabilization Act of 2008 , at http://en.wikipedia.org/wiki/Mark-to-market_accounting

 

Federal Regulators Don't Want To Know


Recovery, Twisting in the Wind

I find that, when discussing The Shadow Inventory, almost all real estate specialists, lawyers, regulators and many financial analysts can’t tie one very significant cause into the conversation.

The very significant cause that is missed is a rational explanation of why banks and other mortgage investors are so reluctant to liquidate (or renegotiate) bad investments.

Why do they hold significant amounts of mortgage investments which have little hope of being profitable (over the long term)? When a mortgage is in serious default, why don’t mortgage investors accept a ‘short sale’ - and why do they allow a property to go into the potentially higher loss alternative of foreclosure?

I believe the key to understanding why mortgage investors appear to be behaving irrationally, is to understand the implications of the delay in the implementation of Financial Accounting Standard #157 (mark-to-market accounting).(1)

To understand the implications of the delay in the implementation of FAS #157 read an article from the Wall Street Journal titled, Congress Helped Banks Defang Key Rule By Susan Pulliam & Tom McGinty | pub. 6/3/2009.(2)

 Then watch Georgetown University Law Professor, Adam Levitin’s Congressional testimony titled, Federal Regulators Don’t Want to Know . . . (3)

The point that I believe most commenters miss:

The postponement of the implementation of mark-to-market accounting (FAS 157) gives banks and other mortgage (product) investors the opportunity to delay recognition of their market losses until legal ownership of the property changes (foreclosure). Thus, for the investor, the hoped for offset of losses against future revenue is 'the gating factor’ for the liquidation of the shadow inventory.

Most mortgage investors are institutions. These institutions want to delay the recognition of, and the reporting reporting of, any losses to their investors - and to their regulators - for as long as possible.

As Professor Levitin explains in his Congressional testimony, these institutional investors hope to offset losses against income (fees and penalty revenue) over the next decade.

So, the shadow inventory seems to be a consequence of the rational ‘work-out’ in a world in which institutions can carry (and report) highly depreciated assets at (fantasy) origination value.

P.S. I believe in creative destruction.(4)

Footnotes:
1. See Wikipedia Mark-to-Market accounting scroll to, Effect on subprime crisis and Emergency Economic Stabilization Act of 2008, at: http://en.wikipedia.org/wiki/Mark-to-market_accounting
2. Congress Helped Banks Defang Key Rule By Susan Pulliam & Tom McGinty | pub. 6/3/2009. http://online.wsj.com/article/SB124396078596677535.html
3. Georgetown University Law Professor, Adam Levitin’s Congressional testimony titled, Federal Regulators Don’t Want to Know . . . at: http://youtu.be/ibgdgl0PoBw
4. Creative Destruction (Shumpeter) see: http://en.wikipedia.org/wiki/Creative_destruction

End Note: Even some fairly sophisticated observers can’t put the delay in the implementation of FAS 157 into its proper perspective. Why do mortgage investors prefer foreclosure over a short sale? Watch Congressman Bobby Scott (D-VA) question a panel of mortgage professionals asking, ‘Are there things in accounting principals that we need to change to get everybody to do what’s in everybody's best interests?’at:

 Then listen to Thomas Cox, of Main Attorney’s Saving Homes Project, answer Rep. Scott. Mr. Cox emphasizes a different point (the conflict of interest created by servicer fee revenue) in The Short Sale Conundrum - Misaligned Incentives of Mortgage Servicers, at: and when James Kowalski, a Florida Trial Attorney for Saving Home Project, gets his turn he moves to The MERS Mess. Mr. Kawolski explains the increase in the shadow inventory as a documentation problem rather than an accounting problem, at:

Zombie Accounting and The Shadow Inventory

I recently watched a U.S. House of Representatives Judiciary Committee Hearing on C-SPAN. The hearing, which was held on December 15, 2010, was titled “Mortgage Services and Foreclosure Practices”.1 The testimony and the questions and answers in the hearing provided a significant amount of interesting information about the processes, and the legal and practical issues surrounding the mortgage servicing industry, and the Mortgage Electronic Registration System (MERS).

Because I followed the history of Congress’s involvement in pressuring the Financial Accounting Standards Board (FASB) to delay the implementation of FAS #157 in early 2009.2 I found a question, which was asked by Congressman Bobby Scott (D. VA) troubling.

At approximately 1 hour 36 minutes into the hearing Congressman Scott asked, in essence, if there was anything in “accounting standards” that might provide incentives for mortgage investors and mortgage servicers not to agree to short sales and to prefer alternatives that might be less advantageous for all parties.

I was surprised by the question because of Congress’ significant role in pressuring the FASB for a delay in FAS #157 and I was also bit surprised that none of the witnesses could directly answer the question - from an accounting standards perspective. In general, the witnesses only discussed the mis-alignment of incentives, where mortgage pooling and servicing agreements provide ongoing revenue for servicers when a short sale is not agreed to and a foreclosure is delayed.3

Footnotes: 
1. The December 15, 2010 House Judiciary Committee “Mortgage Services and Foreclosure Practices” hearing may be seen at:  http://www.c-spanvideo.org/program/297095-1
2. See a Wall Street Journal article titled, Congress Helped Banks Defang Key Rule By Susan Pulliam and Tom McGinty pub. 6/3/2009 at: http://online.wsj.com/article/SB124396078596677535.html Also see, For Your Reading Pleasure By Jack Ciesielski pub. in the Analyst’s Accounting Observer 2/25/2010 at: http://www.accountingobserver.com/PublicBlog/tabid/54/EntryId/12583/For-Your-Reading-Pleasure.aspx
3. Under the typical mortgage securitization “Pooling and Servicing Agreements” mortgage investors agree to pay mortgage servicers fees for arranging: home inspections, arranging broker ‘opinion of value’, preparing and filing documents, general documentation, notifications, forced insurance fees, and etc.