Regulatory Solutions

The regulatory solution proposed herein is simple, yet far reaching. It comes in two parts, the first is to limit the amount lenders can loan to borrowers with a rather unique enforcement mechanism, and the second is to increase the penalties for borrowers who commit mortgage fraud. The following is not in legalese, but it contains the conceptual framework of potential legislation that could be enacted on the state and/or federal level. A detailed discussion of the text follows:

Loans for the purchase or refinance of residential real estate secured by a mortgage and recorded in the public record are limited by the following parameters based on the borrower’s documented income and general indebtedness and the appraised value of the property at the time of sale or refinance:

1. 1. All payments must be calculated based on a 30-year fixed-rate conventionally-amortizing mortgage regardless of the loan program used. Negative amortization is not permitted.
2. 2. The total debt-to-income ratio for the mortgage loan payment, taxes and insurance cannot exceed 28% of a borrower’s gross income.
3. 3. The total debt-to-income of all debt obligations cannot exceed 36% of a borrower’s gross income.
4. 4. The combined-loan-to-value of mortgage indebtedness cannot exceed 90% of the appraised value of the property or the purchase price, whichever value is smaller except in specially sanctioned government programs.

Any sums loaned in excess of these parameters do not need to be repaid by the borrower and no contractual provision is permitted that can be interpreted as limiting the borrower’s right to exercise this right, make the loan callable or otherwise abridge the mortgage agreement.

Regulatory Solutions

The regulatory solution proposed herein is simple, yet far reaching. It comes in two parts, the first is to limit the amount lenders can loan to borrowers with a rather unique enforcement mechanism, and the second is to increase the penalties for borrowers who commit mortgage fraud. The following is not in legalese, but it contains the conceptual framework of potential legislation that could be enacted on the state and/or federal level. A detailed discussion of the text follows:

Loans for the purchase or refinance of residential real estate secured by a mortgage and recorded in the public record are limited by the following parameters based on the borrower’s documented income and general indebtedness and the appraised value of the property at the time of sale or refinance:

1. 1. All payments must be calculated based on a 30-year fixed-rate conventionally-amortizing mortgage regardless of the loan program used. Negative amortization is not permitted.
2. 2. The total debt-to-income ratio for the mortgage loan payment, taxes and insurance cannot exceed 28% of a borrower’s gross income.
3. 3. The total debt-to-income of all debt obligations cannot exceed 36% of a borrower’s gross income.
4. 4. The combined-loan-to-value of mortgage indebtedness cannot exceed 90% of the appraised value of the property or the purchase price, whichever value is smaller except in specially sanctioned government programs.

Any sums loaned in excess of these parameters do not need to be repaid by the borrower and no contractual provision is permitted that can be interpreted as limiting the borrower’s right to exercise this right, make the loan callable or otherwise abridge the mortgage agreement.

This last statement is the most critical. This is how the enforcement problem can be overcome. Regulators are pressured not to enforce laws when times are good, and decried for their lack of oversight when times are bad. If the oversight function becomes a potential civil matter policed by the borrowers themselves, the lenders know exactly what their risks and potential damages are. Any lender foolish enough to make a loan outside of the parameters would not need to fear the wrath of regulators, they would need to fear the civil lawsuits brought by borrowers eager to get out of their contractual obligations. If any borrower could obtain debt forgiveness by simply proving their lender exceeded these guidelines based on the loan documents, no lender would do this, and regulatory oversight would be practically unnecessary. One key to making this work is to prohibit lenders from introducing a “poison pill” to the loan documents that would make borrowers hesitant to bring suit, otherwise lenders would make their loan callable in the event of a legal challenge forcing the borrower to refinance or sell the property. Basically, if the borrower brought suit and won, they would see principal reduction equal to the deviation from the standards, if they brought suit and lost, they would have no penalty. Most of these cases would be decided by summary judgment based on a review of the loan documents thus minimizing court costs.

Another pillar to the system is the documentation of income as part of the loan document package–the “borrower’s documented income” from the proposed legislation. One of the most egregious practices of the Great Housing Bubble was the fabrication of income by borrowers that was facilitated and promoted by originating lenders. Stated-income loan programs were widespread, and they were the cause of much of the uncertainty in the secondary mortgage market during the initial stages of the credit crunch in the deflation of the bubble. Basically, investors had no idea if the borrowers to whom they had lent billions of dollars were capable of paying them back. Without proper documentation of income, investors lost all confidence in the secondary mortgage market. Stated-income loan programs were one of the first casualties of the credit crunch. These programs should be eliminated totally due to the inherent potential for fraud and the undermining of confidence in the secondary mortgage market stated-income loans create. If lenders can be sued based on the content of the loan documents, and if borrowers can be fined or go to jail for committing fraud or misrepresentation on loan documents, both parties have strong incentive to prepare these documents completely and correctly. Originating lenders will argue this adds to their costs and will result in higher application fees. The amount in question is very small, particularly relative to the dollar amount of the transaction. A small amount of additional expense here will provide huge benefits by assuring investors the borrowers to whom they are loaning money really have the income to pay them back. The benefit far outweighs the cost.

If such a law were passed, agency interpretation and court case precedents will end up defining adequacy in loan documentation. A single W2 does not establish a work history, but 2 years worth is probably excessive documentation. One of the most contentious areas will likely be documenting the income of the self-employed. In theory, the self employed must document their incomes to the US government either through Schedule C reports or corporate K-1s. The argument the self-employed have traditionally made is that these documents understate their income. Since many self employed take questionable tax deductions, there is probably some truth to the claim that tax records understate their income; however, why should the self-employed get to have both benefits? If the self-employed had to use their tax returns as loan documentation, they probably would not be quite so aggressive in taking deductions. A new business without a tax return or with only one year of taxable receipts probably is not stable enough to meet standards of income necessary to assume a long-term debt.

The poor quality of loan documentation during the bubble was a mistake of originating lenders; therefore, in this proposal much of the burden of paperwork and liability for mistakes falls on the lenders. During the deflation of the bubble, lenders paid an enormous price for some of their lax paperwork standards, but much of the problem was also due to borrowers misrepresenting themselves in the loan documents. There were instances where lenders encouraged this behavior, but in the majority of cases, the document fraud was perpetrated by the borrowers. The only recourse available to a lender is a civil suit as there are few criminal penalties associated with loan documentation and almost no enforcement. It can be very difficult and costly for lenders to pursue civil damages, and few lenders attempt it even when they have a strong case. To create a more balanced set of responsibilities, the borrowers must face criminal penalties for fraud and misrepresentation on loan documents. If borrowers know the lender can turn documents over to a prosecutor who will charge the borrower with a crime if they make false material statements, borrowers will be much less likely to commit these acts.

The parameters of the forming limitations on the debt-to-income ratio and combined-loan-to-value are essential to prevent bubbles in the housing market and to prevent the banking system from becoming imperiled in the future. People will commit large percentages of their income to house payments when prices are rising quickly; however, they do this out of fear of being “priced out” and greed to make a windfall from appreciation. These are the beliefs that inflate a bubble. Borrowers cannot sustain payments above the traditional parameters for debt service without either defaulting or causing a severe decline in discretionary spending. The former is bad for the banks, and the latter is bad for the entire economy. This must be prevented in the future. There are a number of reasons why high combined-loan-to-value lending is a bad idea: it promotes speculation by shifting the risk to the lender, it encourages predatory borrowing where borrowers “put” the property to a lender, it promotes a high default rate because borrowers are not personally invested in the property, it discourages saving as it becomes unnecessary, and it artificially inflates prices as it eliminates a barrier to market entry. This last reason is one of the arguments used to get rid of downpayment requirements. The consequences of this folly became readily apparent once prices started to fall.

The payment must be measured against “30-year fixed-rate conventionally-amortizing mortgage regardless of the loan program used.” One of the worst loan programs of the Great Housing Bubble was the 2/28 ARM sold to large numbers of subprime borrowers. These borrowers were often qualified only on their ability to make the initial payment, and these borrowers were generally not capable of making the fully amortized payment when the loan reset after 2 years. Regulations like this would prevent a recurrence of the foreclosure tsunami triggered by the use of this loan program. It is also important to ban negative amortization because it would allow the loan balance to grow beyond the parameters of qualification, and it invites property speculation. Perhaps borrowers would not be concerned because they would receive debt forgiveness of the expanding balance. Lenders should be wary of these loans after their dismal performance in the deflation of the bubble, but institutional memory is short, and these loan programs could make a comeback if they are not specifically outlawed. This provision is careful to allow interest-only loans. They are still a high-risk product, but an argument can be made that these loans have a place, and there is no need to completely ban them. They will not have a future as an affordability product capable of driving up prices if the borrower must still qualify for the fully amortized payment.

For the lending provisions to have real impact, they must apply to both purchases and to refinances, thus the clause, “Loans for the purchase or refinance of residential real estate.” If the rules only applied to purchases, there would be a tremendous volume in refinances to circumvent the regulations. The caps on debt-to-income ratios, mortgage terms and combined-loan-to-value only have meaning if they are universally applied. The combined-loan-to-value standard is based on the “appraised value of the property at the time of sale or refinance.” The new appraisal methods will have impact here. It is important that the records need only be accurate as of the time of the transaction. If a borrower experiences a decline in their income or if the property declines in value to where they no longer meet the loan standard, it does not mean they can go petition for debt relief.

The regulations would only need to apply to loans “secured by a mortgage and recorded in the public record.” People can still borrow money from any source they wished as long as the lender knows they will not have any claim on residential real estate. If a lender wanted to issue a loan secured by real estate outside of the outlined standards, the borrower would not have to pay back that money. If a borrower has non-recorded debts which create a total indebtedness requiring more than 36% of their gross income, they would not be eligible for a home equity loan even if they met the other qualifications. In such circumstances, it is better to limit borrowing than increase the probability of foreclosure.

Many states have non-recourse laws on their books. These laws serve to protect the borrower from predatory lending because the lender cannot go after other assets of the borrower in the event of default. In theory this should make lenders more conservative in their underwriting; however, the behavior of lenders in California, a non-recourse state, during the Great Housing Bubble was not conservative. These laws do serve to protect borrowers, and they should be enacted for purchase-money mortgages in all 50 states.

Since one of the goals of regulatory reform is to inhibit the behavior of irrational exuberance, the sales tactics of the National Association of Realtors should be examined and potentially come under the same restrictions as securities brokers through the Securities and Exchange Commission. After the stock market crash which helped precipitate the Great Depression, Congress created the Securities and Exchange Commission to regulate the sales activities of securities brokers. There are strict regulations in place governing the representations made concerning the future performance of investment opportunities. These protections were put in place to protect the general public from the false promises made by stockbrokers in the 1920s which many naïve investors believed. The same analogy holds true for Realtors. The National Association of Realtors has launched numerous advertising campaigns suggesting erroneously that residential real estate is a great investment and appreciation will make home buyers wealthy.

The result of these restrictions will be that all homeowners will have at least 10% equity in their properties unless they have borrowed from a government program like the FHA where the combined-loan-to-value can exceed the limits. This equity cushion would buffer lenders from predatory borrowing and a huge increase in foreclosures if prices were to decline. Home equity in the United States has been declining since the mid 1980s, and it actually declined while prices rose during the Great Housing Bubble due to the rampant equity extraction. The lack of an equity cushion exacerbated the foreclosure problem as many homeowners who owed more on their mortgage than the house was worth simply stopped making payments and allowed the house to fall into foreclosure.

Summary

A future bubble in the housing market must be prevented. The economic and personal problems resulting from the deflation of the Great Housing Bubble must not be inflicted on another generation. Just as those who endured the Great Depression struggled to understand what went wrong and prevent its reoccurrence, we must prevent another bubble in the housing market. There are both market-based alternatives and regulatory-based policies that could serve to prevent the next housing bubble. The market based solution proposed herein is to expand the use of the income approach to property appraisal to tether prices to fundamental values. The regulatory solution proposed herein is a multifaceted approach that limits lending to within certain standards. The policing mechanism is a shift to civil enforcement through allowing borrowers to obtain debt forgiveness for amounts lent outside of the approved parameters.

The Great Housing Bubble was an epic event impacting the lives of nearly every household in the United States and around the world. At first it was a giant house party fueled by excessive borrowing and spending by homeowners. The hangover was not pleasant. As of the time of this writing the full history of the fallout is not yet recorded. The decline in prices to this point has been breathtaking and unprecedented. When the full history is written, and the final impact of the bubble is measured, many will remember the Great Housing Bubble as one of the most important historical events of their lifetime.

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In 2008 the National Association of Realtors launched a commercial advertising campaign claiming that residential real estate doubles in value every 10 years. Besides the obvious inaccuracy of the claim, it is the kind of claim no stockbroker would be allowed to make. The mantra of all realtors is that house prices always go up. There are currently no limits to the distortions and outright lies realtors can tell prospective buyers with regards to the investment potential of residential real estate. Buyers are already prone to believe the fallacies of unlimited riches in real estate, and these fallacious beliefs lead to housing bubbles. Realtors should be prevented from making representations concerning the investment potential of real estate. Since the regulatory framework for this kind of regulation and oversight is already in place under the auspices of the Securities and Exchange Commission, Congress would merely need to make Realtors subject to these regulations in order to solve the problem.

I have scheduled a party night at JT Schmids for Wednesday 16 June 2010 at 6:30 – 9:00. You are invited. I hope to see you there.

Irvine Home Address … 208 GUINEVERE Irvine, CA 92620

Resale Home Price …… $469,000

{book1}

There's a party goin' on right here

A celebration to last throughout the years

So bring your good times, and your laughter too

We gonna celebrate your party with you

Come on now

Celebration

Let's all celebrate and have a good time

Celebration

We gonna celebrate and have a good time

Kool & The Gang — Celebration

IHB News

Block Party

I have scheduled a party night at JT Schmids for Wednesday 16 June 2010 at 6:30 – 9:00. It has been over six months since our last gathering, but we are ready to revive the tradition. This will be primarily a social gathering, and everyone is invited. The IHB staff will be in attendance to talk real estate if you wish.

IHB Exclusive Access Properties

We have launched Ideal Home Brokers Exclusive Access Properties. We have an arrangement with a number of listing agents to provide an exclusive look at properties up to seven days before they are put on the MLS. These are generally not going to be REO properties that require am MLS listing before they can be sold. Depending on the seller, the properties may not be put on the MLS if the offer is attractive, and the property may bypass the MLS entirely.

Potential buyers have the opportunity to preview these properties before others in the general public are made aware of its availability. In our constricted supply market, exclusive access can be an advantage.

If you would like more information about this program, or if you would like to see any of the IHB exclusive access properties (like 26152 Via Pera Mission Viejo, CA 92691), please contact us at sales@idealhomebrokers.com.

Writer's Corner

I am becoming more comfortable with the daily cartoons; in fact, it is the most enjoyable part of the process for me. I have found that going with my first idea and working quickly generally gets the best results. I like reading the thoughts of bystanders in the cartoons, and my favorite this week was the family dog.

I have assembled a large database of American Gothic parody images, and each time I need to express the thoughts of homeowners, pulling up one of these usually does the trick. My two recent favorites are:

My favorite cartoon of the week was an afterthought, but each time I look at it, I still laugh.

When a character in an image is looking directly at you, it is gripping. That is one of the features of the American Gothic images that works well.

Going on vacation

I am planning my family vacation for the last week of June through the 6th of July. I don't know yet what I will do for posts during that 10 days. I will have my iPhone, and I will be able to read the comments, but don't expect any long-winded diatribes from that interface.

Since I will have to do the posts in advance, they will probably be short, and the news won't be current. Maybe I can talk Zovall and Shevy into taking up the slack….

Housing Bubble News from Patrick.net

Fri Jun 4 2010

Why does government subsidize mortgage debt? (money.cnn.com)

Should you rent or buy? (money.cnn.com)

Bay Area jobs hit harder by recession than U.S. (sfgate.com)

Foreclosure storm continues in Central Valley (centralvalleybusinesstimes.com)

Public Union Parasites Move To Bar California Bankruptcies (Mish)

Greece to Sell Assets to Help Pay Down Deficit (nytimes.com)

Sydney quickly becoming the city few can afford to live in (nzherald.co.nz)

China's Housing Bubbles: Quality Research Required (scoop.co.nz)

Krugerrand Output Jumps to 25-Year High on European Debt Crisis (bloomberg.com)

Econophysicist Accurately Forecasts Gold Price Collapse (technologyreview.com)

Panic then silence over suspicious Chinese drywall (miamiherald.com)

Builder: Buyer-bait tax credit disappointing (washingtonpost.com)

National debt hits $13 trillion (washingtontimes.com)

Mortgage, credit card, student loan, auto loan debt also $13 trillion! (mybudget360.com)

"Banks" allow members to pay with time, not cash (news.yahoo.com)

Car dealer gets 12 years for mortgage fraud; used voodoo dolls targeting investigators (latimes.com)

Buyer on a stick (scroll down a bit) (patrick.net)

Bizarre ad about wrecking your house before foreclosure (givingbackthehouse.com)

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Thu Jun 3 2010

Mortgage Walkaways Have Huge Incentive (cnbc.com)

The next generation of house buyers has too much college debt (bayarearealestatetrends.com)

Foreclosure crisis hitting hard on the west side of the Salt Lake Valley (sltrib.com)

Real Estate Dumbass of the Decade (longbeachhousingblog.blogspot.com)

Buffett Says He Expects `Terrible Problem' for Municipal Debt (preview.bloomberg.com)

Moody's Chief Says CDO Ratings Deeply Disappointing (businessweek.com)

Home-debtor epiphany (doctorhousingbubble.com)

Congress Eyes $15 Billion Construction Loan Guarantee Program (builderonline.com)

Realtors (TM) Want Congress to Corrupt the Tax Credit Timeline (blogs.wsj.com)

Five Failed Banks Cost the FDIC $317m, on Track for Record Year (housingwire.com)

Net worth of FDIC increased slightly, to negative $20.7 billion (fdic.gov)

Canada raises interest rates (finance.yahoo.com)

The Future Of America's Working Class (newgeography.com)

Strategic Foreclosure (patrick.net)

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Wed Jun 2 2010

Foreclosures shifting to affluent ZIP codes (sfgate.com)

Bank price on some houses: 'Unrealistic' (mortgage.freedomblogging.com)

Latest Lie about Strategic Default: Borrowers Are Emotional Fools (irvinehousingblog.com)

Calif. jobless claims at record high (economy.freedomblogging.com)

Next Up — 5 Years of Financial Hell (safehaven.com)

Euro Bailout Plan is all about Rescuing Banks and Rich Greeks (Mish)

Clarke and Dawe: Lending merry-go-round (youtube.com)

China's shift away from cheap labor hard on all (news.yahoo.com)

China told property risk is worse than U.S. (cnn.com)

Answers on Credit Ratings Are Long Overdue (nytimes.com)

Is Massive Refinancing During Bubble Years a Ticking Bomb? (realestatechannel.com)

U.S. gov't still supporting ponzi scheme that will drag house prices lower (thepanicnews.com)

Federal Housing Finance Agency demands Fannie and Freddie drive the poor into debt (fhfa.gov)

Review of 'Life Would Be Perfect If I Lived in That House' (online.wsj.com)

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Tue Jun 1 2010

Stop Paying The Mortgage, Live Free For Years (nytimes.com)

IMF Economist Argues House Prices Still Have Far To Fall (blogs.wsj.com)

New House Sales Set to Plunge in Former Bubble Markets (bloomberg.com)

21 year supply in Vegas high-rise condo market (lvrj.com)

NY Owners Bet on Raising the Rent, and Lost (nytimes.com)

The Property Tax: Unsung Hero (taxvox.taxpolicycenter.org)

CA's Prop 13 means tax burden falls on houseowners, not businesses (freedomblogging.com)

Ponzi scheme cases on rise in Bay Area (contracostatimes.com)

Go Ponzi, Young Debtor! How to Manage Your Finances The California Way (irvinehousingblog.com)

Arizona commercial real estate brokers: Some lenders ignore crisis (azcentral.com)

Commercial property owners facing declining rents (heraldtribune.com)

Hosed in Canada; Housing Crash is a Given (Mish)

Soldier in Iraq Loses House Over $800 Debt (motherjones.com)

Australian real estate agents accused of price inflation scam (abc.net.au)

Racing China: The Australia Housing Bubble (newgeography.com)

Deflation now, inflation later? (biztimes.com)

Lent, spent and guaranteed: The merger of state and corporate powers (theautomaticearth)

Building industry wants the U.S. Treasury Dept to guarantee builders' loans (hadd.com)

What Your 401k Really Costs You (usnews.com)

Student Loan Debt Means Slavery, Bankruptcy Not An Option (nytimes.com)

Irvine Home Address … 208 GUINEVERE Irvine, CA 92620

Resale Home Price … $469,000

Home Purchase Price … $661,500

Home Purchase Date …. 12/22/2005

Net Gain (Loss) ………. $(220,640)

Percent Change ………. -29.1%

Annual Appreciation … -7.6%

Cost of Ownership

————————————————-

$469,000 ………. Asking Price

$16,415 ………. 3.5% Down FHA Financing

4.91% …………… Mortgage Interest Rate

$452,585 ………. 30-Year Mortgage

$96,118 ………. Income Requirement

$2,405 ………. Monthly Mortgage Payment

$406 ………. Property Tax

$167 ………. Special Taxes and Levies (Mello Roos)

$39 ………. Homeowners Insurance

$300 ………. Homeowners Association Fees

============================================

$3,317 ………. Monthly Cash Outlays

-$395 ………. Tax Savings (% of Interest and Property Tax)

-$553 ………. Equity Hidden in Payment

$31 ………. Lost Income to Down Payment (net of taxes)

$59 ………. Maintenance and Replacement Reserves

============================================

$2,459 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$4,690 ………. Furnishing and Move In @1%

$4,690 ………. Closing Costs @1%

$4,526 ………… Interest Points @1% of Loan

$16,415 ………. Down Payment

============================================

$30,321 ………. Total Cash Costs

$37,600 ………… Emergency Cash Reserves

============================================

$67,921 ………. Total Savings Needed

Property Details for 208 GUINEVERE Irvine, CA 92620

——————————————————————————

Beds: 3

Baths: 2 full 1 part baths

Home size: 1,950 sq ft

($241 / sq ft)

Lot Size: n/a

Year Built: 2006

Days on Market: 31

Listing Updated: 40312

MLS Number: S616084

Property Type: Condominium, Residential

Community: Woodbury

Tract: Wdgp

——————————————————————————

According to the listing agent, this listing may be a pre-foreclosure or short sale.

This is a three bedroom townhome style open floorplan that is perfect for entertaining. Bring your must discerning buyer and notice all the fine detail in the finely open gourmet kitchen. could have a main floor bedroom or office. Woodbury is one of the nations finest communties with a walk to destination mall amenties to fit any five star accomodations and the finest schools. Come see this gem. Model perfect.

communties? amenties? accomodations?