The United States is following the Japanese model of slow deflation using the amend-extend-pretend dance. Will it take the US 15 years to deflate its bubble?

Irvine Home Address … 26 SHADOWPLAY Irvine, CA 92620

Resale Home Price …… $740,000

Are you still too blind to see

We're living in a fantasy

It's you and i who'll pay the cost

Where will we turn when all hope is lost

Lionsheart — Living in a Fantasy

Amend Extend Pretend

Banks are living in a fantasy, and you and I will end up paying the cost. They are refusing to write down the values on their bad loans. They amend the terms, extend the period of repayment, and pretend that delinquent borrowers will diligently make payments under the new terms. Lenders genuinely believe they will get their money back plus interest.

It isn't going to happen.

The reason banks amend, extend, and pretend is simple: lenders cannot afford to write down the loans to actual recovery values because they would be broke, either insolvent or bankrupt. Without factoring in the lowering of prices caused by the liquidation, if every bad property loan was written down to is realistic level of recovery in today's market, the losses would exceed the total capital in the banking system — even now after three full years of mark-to-fantasy accounting at our major banks. Banks refuse to recognize HELOC and second mortgage losses; thus, our housing market sits in limbo while lenders and loan owners pray for prices to go back up.

The amend-extend-pretend policy has one intended consequence, and one unintended one: the intended consequence is that supply is restricted to the point that demand exceeds supply and prices are forced higher. Banks want higher prices to increase their loss recovery on each property and maintain the value of their portfolios. The unintended consequence is the moral hazard of indefinite squatting by delinquent mortgage holders.

As banks continue to pursue the amend-extend-pretend policy, delinquent borrowers are being given a free ride. Word travels quickly, and as some quit paying their mortgages and nothing happens, others who are struggling also quit making payments. What many term as strategic default (I call it accelerated default) is becoming more common. Why wouldn't it? Why does anyone keep paying their mortgage when not paying has no consequence? Squatting is becoming a way of life for many delinquent borrowers.

The other unintended consequence is a huge buildup of loans where the borrower is not making payments, but the banks have done nothing about it: shadow inventory. Most delinquent mortgages are simply being ignored by the banks. Right now, if you are a loan owner, and if you quit paying your mortgage, there is a 60% chance your lender will do nothing, and your lender will likely choose to do nothing for a very long time.

60% of Delinquent Mortgages Not in Loss Mitigation

by JACOB GAFFNEY — Tuesday, August 24th, 2010

According to a study from the State Foreclosure Prevention Working Group (SFPWG), 60% of borrowers with mortgages delinquent by 60 days or more are not being forwarded to the servicer's loss mitigation department.

That is shadow inventory: pure and simple. Those delinquent borrowers have not been served any notices, so they don't show up in the foreclosure statistics, and they have not signed up for a loan modification, so they don't show up in the government data. Sixty percent of delinquent borrowers are being allowed to squat in peace.

The SFPWG is a consortium of the Attorneys General of 12 states, three state bank regulators and the Conference of State Bank Supervisors. For the past two years, it collected delinquency and loss-mitigation data from the largest servicers of subprime mortgages in the country, totaling 4.6m loans as of March 2010.

While some serious delinquent loans remain ignored, foreclosures are outpacing modifications. Since October 2007, the servicers completed 2.3m foreclosures.

As HousingWire reported, HAMP cancelations number 616,839. Richard Neiman, superintendent of banks for New York State said such modifications are more likely to fail without principal reduction.

“We expect banks to take the performance of these modifications into account when deciding the best options for both consumers and investors," Neiman said.

Despite what Mr. Neiman may expect, banks are not going to write down principal outside of a foreclosure. That leads down a slippery slope where every borrower quits paying in order to get a principal reduction.

"Without improvements to foreclosure prevention efforts, the group anticipates that hundreds of thousands of these seriously delinquent homeowners could end in foreclosure," according to the SFPWG statement.

With cure rates under 10%, nearly all of those who are more than 60 days late will end as foreclosures.

The group said improvements in more recent loan modifications are yielding some positive results, such as lower rates of redefaults. According to the data SFPWG collected from nine mortgage servicers, loans modified in 2009 are 40% to 50% less likely to be seriously delinquent six months after modification than loans modified during the same period in 2008.

"As servicers have increased their use of payment reduction in making loan modifications, many more homeowners have succeeded in keeping their home," said Mark Pearce, North Carolina chief deputy commissioner of banks.

In other words, as we have converted more loans into government-backed Option ARMs, people have been able to make the teaser payments. That should extend this crisis for a couple more years until the terms of the government's Option ARMs explode. This solution is simple a way to extend the pain over a longer period of time to prevent the insolvency of our banking system from becoming undeniable. Anyone who believes loan modifications are intended to keep owners in their homes is fooling themselves. This program is designed to keep banks solvent and keep loan owners in perpetual debt servitude.

780 days on the market

Evidence of the amend-extend-pretend is captured in the macro-economic data, but it isn't difficult to find specific properties that show just how ridiculous the lenders have become. Today's featured property is a short sale that has been on the market for 780 days!

The owners of today's featured property paid $814,000 on 11/29/2004. They used a $651,200 first mortgage and a $162,800 down payment. The obtained a $125,000 HELOC on 4/14/2006 and a $250,000 HELOC on 10/17/2006. It isn't clear wether or not they took this money. If they did, they got their down payment back and then some. If they didn't, they are out $162,800. It is likely they did take this money or it would not have been a short sale at $699,000 in July of 2008.

I first profiled this property not long after it was first listed.

Date	Event		Price
Jul 20, 2010	Relisted		—
Jul 01, 2010	Delisted		—
Jun 02, 2010	Price Changed		$740,000
May 10, 2010	Price Changed		$760,000
May 10, 2010	Relisted		—
Feb 11, 2010	Price Changed		$620,000
Oct 28, 2009	Delisted		—
Oct 02, 2009	Relisted		—
Oct 01, 2009	Delisted		—
Sep 17, 2009	Relisted		—
Mar 20, 2009	Delisted		—
Jul 16, 2008	Price Changed		$699,000
Jul 11, 2008	Listed		$599,000
Nov 29, 2004	Sold		$814,000

When the property was first listed, they put a very low asking price to attract attention, then they raised it up to the level of bids they had at the time. Then they embarked on the amend-extend-pretend dance:

Foreclosure Record

Recording Date: 06/01/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 03/30/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 08/11/2008

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 05/05/2008

Document Type: Notice of Default

The current owners squatters have not made a consistent payment since 2007.

Why would banks permit this other than to avoid taking a write down? Now, with 4.5% interest rates, they may obtain a significant recovery; although, with two and half years of missed payments, they are probably no better off.

The amend-extend-pretend dance must end. Of course, it won't end until the insolvent banks can afford the write downs. Until then, we are following the Japanese model of slow deflation until the market reaches fundamental values. It took the Japanese over 15 years. How long will it take the US?

Irvine Home Address … 26 SHADOWPLAY Irvine, CA 92620

Resale Home Price … $740,000

Home Purchase Price … $814,000

Home Purchase Date …. 11/29/2004

Net Gain (Loss) ………. $(118,400)

Percent Change ………. -14.5%

Annual Appreciation … -1.7%

Cost of Ownership

————————————————-

$740,000 ………. Asking Price

$148,000 ………. 20% Down Conventional

4.50% …………… Mortgage Interest Rate

$592,000 ………. 30-Year Mortgage

$144,622 ………. Income Requirement

$3,000 ………. Monthly Mortgage Payment

$641 ………. Property Tax

$250 ………. Special Taxes and Levies (Mello Roos)

$62 ………. Homeowners Insurance

$120 ………. Homeowners Association Fees

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

$4,073 ………. Monthly Cash Outlays

-$715 ………. Tax Savings (% of Interest and Property Tax)

-$780 ………. Equity Hidden in Payment

$247 ………. Lost Income to Down Payment (net of taxes)

$93 ………. Maintenance and Replacement Reserves

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

$2,917 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$7,400 ………. Furnishing and Move In @1%

$7,400 ………. Closing Costs @1%

$5,920 ………… Interest Points @1% of Loan

$148,000 ………. Down Payment

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

$168,720 ………. Total Cash Costs

$44,700 ………… Emergency Cash Reserves

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

$213,420 ………. Total Savings Needed

Property Details for 26 SHADOWPLAY Irvine, CA 92620

——————————————————————————

Beds:: 4

Baths:: 4

Sq. Ft.:: 2492

$0,297

Lot Size:: –

Property Type:: Residential, Condominium

Style:: Contemporary

Year Built:: 2004

County:: Orange

MLS#:: 08-295511

Source:: TheMLS

Status:: ActiveThis listing is for sale and the sellers are accepting offers.

——————————————————————————

On Redfin:

Final approved!!!Elegant & luxurious 4 bedroom attached town home, very bright interior, spacious living space(2,492 sq. ft)built in2004,$120,000 upgraded option when purchased, This is a short sale property! Price & Commission are subject to lender approval. Commission will be 50:50.For showing, see private remark.

Final approved!!! Is that exclamation because the short sale if "finally approved" or because it has received its final approval?

The spring rally is officially over as sales in Southern California have dropped dramatically. Sellers are getting frightened and greatly reducing their asking prices.

Irvine Home Address … 14911 DOHENY Cir Irvine, CA 92604

Resale Home Price …… $499,000

You’re such a catastrophe

Hold on, you’ve been running for oh so long

And soon I’ll be gone

You’ve got to build it up and then break down

Four Year Strong — Catastrophe

The Federal Reserve and the government spent the last 18 months engineering a market bottom through a variety of market props. The powers-that-be hoped the market would support itself as the artificial props were removed. Well, it isn't working out that way.

Home sales slump in July

Southern California sees a 21.4% drop in home sales from 2009 but tax credits skew the figures.

[Before the article even starts, the writer has to put in some reassuring bullshit for nervous bulls. It goes downhill from here.]

August 18, 2010 — By Roger Vincent, Los Angeles Times

Southland home sales fell dramatically in July as federal tax credits for buyers expired, yet the median home price declined only slightly from June.

Volume always precedes price. In 2007 volume dropped off, inventory ballooned, and prices began to roll over. It was the beginning of a slide that went unabated until early 2009 when supply was constricted enough to prevent further declines. Since the bubble was not allowed to naturally deflate, we are awaiting another leg down to return us to reasonable valuations.

Observers say buyers' rush to take advantage of the tax benefits pushed forward sales that would otherwise have taken place later in the summer, creating a statistical drop that didn't signify sudden underlying market weakness.

Observers say? Well, I am an observer, and I say that the volume drop has far exceeded any "statistical drop" and falls into the category of complete disaster showing underlying market weakness. This guy is trying to make a huge drop in sales volume sound like no big deal. Typically, a sudden 20% drop in sales is a signal that the market has topped. The last time a similar event occurred was June of 2006.

When averaged, home sales have been fairly flat in recent months, said Gerd-Ulf Krueger, principal economist at HousingEcon.com.

"The lack of progress on the economic front is just having a very problematic impact on the psychological situation of a lot of American consumers," Krueger said. "They are very cranky."

So now we are all cranky? That explains a lot. Perhaps we will change our mood with a few more feel-good nonsense stories in the newspaper.

Notice how this is being portrayed as a completely psychological problem. This implies that the condition will change as quickly as people can change their mind. Such an idea is comforting to bulls, but it ignores the structural problems of foreclosure-induced bad credit, increasing unemployment, and tightening credit standards that are preventing people from buying. There is a legitimate reason for people's "crankiness" that will not disappear if people suddenly change their state-of-mind.

The median price for all new and resale single-family homes, condominiums and town homes in July in Southern California was $295,000, according to MDA DataQuick of San Diego. Although that was a 1.6% drop from June, it represented a 10% increase from a year earlier, the real estate research firm said Tuesday.

Prices have rolled over at the peak of the spring selling season. That is not a good sign. What is going to happen in the historically weak fall and winter? Notice the writer had to spin it with some good news about a higher median to lessen the impact. Of course he ignores that a higher median only reflects a change in product mix and not a real increase in prices.

Year-over-year price increases have occurred throughout 2010, with the exception of a 1% dip in April. But such advances will be harder to come by in future months, DataQuick analyst Andrew LePage said. Median prices — the point at which half the homes sold for more and half for less — were depressed early last year by a glut of distressed sales in cheaper inland markets, then moved up in later months as sales activity spread to wealthier neighborhoods.

"The high end came alive in the middle of last year," LePage said. "Sellers got real and buyers started buying."

"came alive" and "started buying" Let's put on our cheerleader uniforms and shout "Go team!" The real point lost in the rah rah is that sellers finally started lowering their prices in order to sell their properties.

A total of 18,946 homes were sold in the six-county region, a 20.6% drop from the previous month and a decline of 21.4% from July 2009, DataQuick said.

Those numbers are a catastrophe. New home sales plummeted 33% with the expiration of the tax credits. And now resales are confirmed at 20% off what was already 20% below historic norms. People can try to spin that all they want, but another 20% decline from already a weak sales volume does not bode well for the market.

"It was to be expected," LePage said, because many sales closed in May and June after buyers rushed to take advantage of a federal tax credit of up to $8,000.

Let's be a bit more specific here. Some kind of decline in sales was expected; that much is true. Nobody forecast a 33% drop in new home sales or a 20% drop in resale volume. If anyone had credibly forecast such a decline, the government probably would have extended the credit. I'm glad they didn't ask me.

About 34% of resales of existing homes involved foreclosed properties, compared with 33% in June and 43.4% in July 2009 in Los Angeles, Orange, Riverside, San Bernardino, San Diego and Ventura counties. Foreclosure sales have been flat for the last few months, LePage said.

Home prices will also be mostly flat in the months to come, perhaps with a slight upward trend, Krueger predicted.

That is pure NAr shilling nonsense. What is going to make prices trend upward? Ballooning inventory? Falling demand? A weakening economy? The only thing holding up prices at all is the falling interest rates, and Low Interest Rates Are Not Clearing the Market Inventory.

"That won't change until we hit the wall in terms of supply," he said.

Irvine's inventory hit 879 homes on Saturday, August 21, 2010. Where exactly is this wall Mr. Krueger speaks of? Is it when we eclipse the 2008 inventory peak of 948 houses? Or have we already hit it because of low demand?

Krueger found some encouragement in the number of homes being snapped up by investors. Almost 22% of July home sales were to absentee owners who intend to resell or rent them to tenants.

Krueger found some encouragement? Good for him. Why do I care? Is this supposed to be a news story giving me information, or is this an NAr press release to make homeowners and knife catchers feel good about their speculative bets.

"There is pent-up demand for speculative product," he said, and even a shortage of foreclosure-related bargain properties on the market as far as investors are concerned.

The old "pent-up demand" nonsense. Desire is not Demand. If we had actual demand — people with desire who can put dollars behind it — we would not have a huge decline in sales volumes. What we have done is pull all our available demand forward with a plethora of government incentive programs. The evidence clearly shows a total lack of demand, nothing is pent-up.

Recent first-time buyer Steven Kaplan said he and his wife were not impressed with the distressed properties they saw on the market around Melrose and La Brea avenues in Los Angeles. Many were "short sales" priced for less than the banks were owed.

"What we were seeing for $600,000 were totally trashed houses," the 33-year-old sound engineer said.

The couple ended up buying a smaller house for less than $600,000 last month that didn't need a lot of work. He and his wife, Lola Stewart, had been thinking about buying a house for about five years. They decided to plunge ahead when they saw both home prices and apartment rents tick up a bit earlier this year.

This couple bought out of fear of being priced out. Very sad. This false price signal from the bear rally has enticed many to buy prematurely.

"We were looking to get a better place," he said, "and low interest rates made us able to actually afford something."

The lure of loans at rock-bottom interest rates, though, still isn't strong enough to overcome weak consumer confidence, said broker Syd Leibovitch, president of Rodeo Realty Inc. in Los Angeles.

"Interest rates are at 1950s levels," he said. "I am surprised that hasn't spurred more activity."

Inventory on the market is almost double what it was in February, Leibovitch estimated. "Agents are no longer complaining they have nothing to show. There are lots of choices now."

Mr. Krueger said we won't have any problems until inventory hits a wall. Isn't a doubling of inventory a telltale sign that we have have hit the wall already?

Agent Lynette Williams, who specializes in northeast Los Angeles and Pasadena, said she was also seeing more houses on the market, and some of them in select neighborhoods sell rapidly. Still, she is apprehensive about how the market will perform without federal tax credits. State subsidies are also phasing out.

Interest rates may be low, but getting financing is no picnic, she added. "Banks are scrutinizing everything."

roger.vincent@latimes.com

Banks are scritinizing everything? LOL! Let's go back to 100% financing on stated income and see how that turns out.

WAMU Option ARM

Today's featured property was purchased for $815,000 on 1/18/2007. The owner used a $652,000 Option ARM from WAMU and a $163,000 down payment. That has got to hurt….

She has squatted for about 18 months so far, so I suppose she is getting some of that value back.

Foreclosure Record

Recording Date: 05/10/2010

Document Type: Notice of Default

Foreclosure Record

Recording Date: 08/12/2009

Document Type: Notice of Rescission

Foreclosure Record

Recording Date: 05/06/2009

Document Type: Notice of Default

She has not received her notice of trustee sale yet, so she will likely get to drag this out for quite some time.

The real story with this property is the dramatic price reduction.

Date	Event		Price	Appreciation
Aug 20, 2010	Price Changed		$499,000	—
Jun 18, 2010	Price Changed		$625,000	—
May 27, 2010	Listed		$650,000	—
Jan 18, 2007	Sold (Public Records)		$815,000	0.0%/yr

This has been for sale since May, and apparently it has not attracted the kind of bid the holder of WAMUs trash wants to see. I imagine the seller hopes this will start a bidding war. At $499,000 with low interest rates, no HOAs and no Mello Roos, the price is attractive. The total cost of ownership is less than $2,000 per month. Surely this would rent for that much. To be honest, an updated 3/2 with a pool at less than $500K piques my interest (Did you see the cool home theater?)

Over the weekend, I profiled 5 FERN Cyn Irvine, CA 92604, also being offered for under $500K. It too had recently witnessed a dramatic price drop. That property might actually transact because it was an equity seller. These are both solid middle-class properties with costs of ownership at $2,000 a month. That kind of value — prices with a cost of ownership below rental parity — will entice buyers.

Perhaps two properties does not make a trend, but both today's featured property and 5 Fern Canyon show desperation by the sellers. Ballooning inventory and swooning demand will prompt more sellers to lower their prices if they want to transact. If enough of them lower their prices, that becomes the market, and prices fall.

Is this a trend, or are these two properties outliers that will be snapped up quickly for above their asking prices?

Irvine Home Address … 14911 DOHENY Cir Irvine, CA 92604

Resale Home Price … $499,000

Home Purchase Price … $815,000

Home Purchase Date …. 1/18/2007

Net Gain (Loss) ………. $(345,940)

Percent Change ………. -42.4%

Annual Appreciation … -12.9%

Cost of Ownership

————————————————-

$499,000 ………. Asking Price

$17,465 ………. 3.5% Down FHA Financing

4.51% …………… Mortgage Interest Rate

$481,535 ………. 30-Year Mortgage

$97,637 ………. Income Requirement

$2,443 ………. Monthly Mortgage Payment

$432 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$42 ………. Homeowners Insurance

$0 ………. Homeowners Association Fees

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

$2,917 ………. Monthly Cash Outlays

-$392 ………. Tax Savings (% of Interest and Property Tax)

-$633 ………. Equity Hidden in Payment

$29 ………. Lost Income to Down Payment (net of taxes)

$62 ………. Maintenance and Replacement Reserves

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

$1,983 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$4,990 ………. Furnishing and Move In @1%

$4,990 ………. Closing Costs @1%

$4,815 ………… Interest Points @1% of Loan

$17,465 ………. Down Payment

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

$32,260 ………. Total Cash Costs

$30,300 ………… Emergency Cash Reserves

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

$62,560 ………. Total Savings Needed

Property Details for 14911 DOHENY Cir Irvine, CA 92604

——————————————————————————

Beds: 3

Baths: 2 baths

Home size: 1,880 sq ft

($265 / sq ft)

Lot Size: 5,000 sq ft

Year Built: 1971

Days on Market: 87

Listing Updated: 40410

MLS Number: S618914

Property Type: Single Family, Residential

Community: El Camino Real

Tract: Wl

——————————————————————————

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

Expanded home in the Willows. Located on a culdesac. Remodeled kitchen with beautiful cherrywood cabinets. Bathrooms feature spa tubs. Bamboo style laminate flooring.

The latest regulatory body created by Congress and the Obama administration will fail to prevent future housing bubbles because they lack the understanding of what is required.

Irvine Home Address … 35 NIGHTHAWK Irvine, CA 92604

Resale Home Price …… $845,000

It's hard not to cry

It's hard to believe

So much heartache and pain

So much reason to grieve

With the wonders of science

All the knowledge we've stored

Magic cocktails for lives

People just can't afford

Say it's not true

You can say it's not right

It's hard to believe

The size of the crime

Queen — Say It's Not True

The scope and scale of the housing bubble is hard to comprehend. Lenders created four trillion dollars in excess debt, 12 million borrowers are delinquent on their mortgages, and 6 to 8 million loan owners are going to be forced to leave their family homes. And what was gained? There was no innovation or advancement, no long-lasting infrastructure that will enhance future economic growth, nothing we can point to as a silver lining — unless you consider a sea of McMansions in the hinterlands a great societal investment. And don't forget the rampant consumerism from HELOC spending.

Never in the course of human events has so much been given to so many for doing so little. In my opinion, the housing bubble was a colossal waste.

Buyer, Be Aware

By DAVID LEONHARDT

Published: August 13, 2010

During the great housing bubble and bust, journalists spent a fair amount of time searching for the perfect mortgage victim. This victim would be someone who played by the rules, took a conservative approach to his finances and simply wanted a decent place to live. He made his monthly payments on time, right up to the day that the bank informed him that his payments would balloon because of a fine-print technicality that no borrower could have understood. Just like that, the homeowner was facing foreclosure.

By and large, these searches failed.

That's because Responsible Homeowners are NOT Losing Their Homes. They were searching for a borrower that did not exist.

The stories of the housing bust tended to be more complicated. Many borrowers stretched to buy homes, figuring that they would be making more money soon enough or that housing prices would keep going up. In Southern California, one homeowner told me he was well aware that his monthly payments would eventually balloon. He thought everything would work out, though, because he assumed that ever-rising home values would allow him to refinance. Much of the country shared this belief.

This is also why education is not the answer. You can't educate the kool aid intoxicated. I know; I have tried for several years now, and by and large, I am preaching to the choir.

Banks, mortgage brokers and real-estate agents were only too happy to encourage these fantasies, of course. In many cases, their encouragement crossed the line into malfeasance. But the bubble grew as large as it did because this malfeasance fed on human frailty, naïveté and even irresponsibility.

I dig this guy calling out the corrupt players.

This summer, with the bubble long gone, Congress and the Obama administration enacted a sweeping new law meant to change the business of lending and borrowing money.

The bubble is not long gone.

The part of the law that will directly affect the most people will be the new Consumer Financial Protection Bureau, which has already been the subject of heated debate. And the central question facing the bureau will be how to distinguish between corporate malfeasance and consumer frailty.

It is not an easy task. For as long as there has been money, people have been doing stupid things with it. We borrow more than we can afford. We pay higher interest rates than we need to. We play the lottery. The new consumer bureau can prohibit some of the banks’ worst practices. But figuring out precisely where to draw the line will be much more nuanced than the past year’s black-and-white, left-and-right debate over whether an agency should exist at all.

Elizabeth Warren — the Harvard law professor who first proposed such an agency, in a 2007 article in the journal Democracy — has pointed out that the history of consumer financial protection is a history of “thou shalt not.” The government bans lenders from doing something, and the banks stop. Quickly, however, they come up with new ways to separate people from their money. Last year’s credit-card legislation, for example, cracked down on overdraft fees (the frequently steep charges for people who tried to withdraw more money on a debit card than they had in their account). Banks have responded by raising other fees.

The writer's view that the credit-card legislation was flawed because lenders raised their fees is short sighted. Lenders raised their fees because they could. They have a large number of borrowers treading water that could not avoid the fees if they tried. The fees that were banned should have been banned long ago. Just because legislation is difficult and the results are delayed doesn't mean the legislation is not the right solution to problems of bad lender behavior.

This is why the thou-shalt-not approach, Warren says, “means you’ll always be behind.” Or, as Richard Thaler, the University of Chicago behavioral economist, puts it, “Regulating what financial companies can and cannot charge for is a losing game, because they’ll always think of something else.”

Their agreement on this point is notable, because Warren has come to represent the muscularly progressive vision of the new bureau, while behavioral economists like Thaler (who is close to several Obama advisers) are seen as more technocratic. And there is no doubt that the bureau will need to make judgment calls that some regulators would make differently than others. But the basic vision for the bureau is not in dispute, at least not among the people who are likely to run it under Obama.

When the Republicans get back in, they will gut the bureau like they did with the EPA.

The overriding goal of the bureau will be to help people understand their financial choices. More often than not, it will allow banks to continue a given practice — but force them to explain, in clear terms, what it means for consumers. Earlier this summer, I refinanced my mortgage and was reminded yet again of how much modern finance depends on obfuscation. Nowhere in the pile of documents was there a simple explanation of the only information that mattered to me: how much the bank was charging in fees, how much the lawyer was charging, how much the government was charging and how much my monthly payment would fall. Instead, I was confronted with a blizzard of terms that I did not fully understand: origination, title services, release tracking and the like.

Done right, the new bureau can begin to change this. It can require banks to speak in the language of customers, not internal bureaucracy. Another part of last year’s credit-card legislation offered a preview. As of February, banks have had to give people the often-bracing calculation of how much it will cost them to pay off their balance if they make only the minimum monthly payment, as well as how many years it will take. To see if such steps are working — and to keep pace with Wall Street ingenuity — the new bureau will have a research budget allowing it to test whether consumers truly know what they’re signing up for.

I challenge anyone to find a way to explain the Option ARM in language plain enough for the financially illiterate to understand. In fact, I challenge anyone to explain it to experts in the industry in a way that they understand. There are some loan products that are simply too complex for mere mortals to comprehend. To me regulation would be much simpler if we banned all loan products where payments can increase. That is the only method of ensuring people understand the risks they are taking on because they won't be taking on much risk. Do you really think the average Joe understands interest-rate risk? Do you?

The ultimate goal is pushing banks to compete in ways that benefit consumers, rather than having them compete over which methods can most cleverly fool consumers. If people know the true costs of their mortgages, credit cards, debit cards and mutual funds, they are more likely to gravitate to those offering low costs and good benefits. This will have the added feature of reducing the enormous, historically abnormal profits that Wall Street has enjoyed in recent years. It is also the way a market is supposed to work.

Still, no matter how well we grasp the implications of fees and interest on our credit cards, we may still decide to use a card to buy a new television or kitchen we can’t really afford. The new consumer bureau will not try to stop us. And it almost certainly will not be enough to prevent another bubble, in some other realm, sometime in the future.

But that is probably not a realistic goal anyway. Prohibition, after all, has a decidedly mixed record. A better goal may simply be making sure we understand what we are doing and hoping that is enough to make us a little less frail.

Nonsense. We could regulate lending in a positive way. Education is not enough.

Educating Borrowers is doomed to fail

The first step in a borrower education program would require a consensus on what borrowers should be taught. Lenders will game the system to peddling unstable loan products as safe if borrowers can be taught how to use them. I saw a scholarly study from the bubble that said the Option ARM was a great loan program if borrowers could be educated. Obviously, that is crazy.

Lenders will also use the political system to create doubt as to what loan programs are safe and which are not. I recently wrote about Another Ignorant and Misguided Attack on the 30-Year Fixed-Rate Mortgage. This appears to be an attempt by some right-wing political operatives to create a smoke screen to obscure the real danger of adjustable rate mortgages.

Adjustable rate mortgages are a dangerous loan product, and any reasonable education effort should encourage people to use fixed-rate financing instead, particularly at the bottom of the interest rate cycle. No amount of education will stop the use of adjustable-rate mortgages, and those loans will almost certainly lead to more foreclosures when interest rates rise.

With poorly reasoned attacks on the 30-year fixed-rate mortgage floating around, it creates the impression there is some legitimate difference of opinion on the matter. There isn't. However, if lenders can create enough confusion and dissent, it will make the job of a government-sponsored education bureau impossible — which is what lenders want. The Consumer Financial Protection Bureau will fail because it will get bogged down in the political process.

Further, the goal of education is unattainable: borrowers will not make good choices. Borrowers will borrow all they can no matter how much they are educated on the risks. Most ignore the risks or don't believe it will happen to them. Half of my masters curriculum was real estate finance, so recognized the risk and chose not to participate. However, there were plenty of Ivy League educated MBAs that didn't recognize the risk and got wiped out by the housing bubble. Education is not enough. We must have laws that limit lending.

There is a better way….

How regulators could prevent the next housing bubble

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. 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. The total debt-to-income ratio for the mortgage loan payment, taxes and insurance cannot exceed 28% of a borrower’s gross income.
3. The total debt-to-income of all debt obligations cannot exceed 36% of a borrower’s gross income.
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.

The proposals I outlined in The Great Housing Bubble sound extreme by California lending standards, but Texas has had similar laws on the books for the last 150 years, and it was the restrictions on mortgage equity withdrawal that made their market avoid the housing bubble.

If the new Consumer Financial Protection Bureau wanted to curb housing bubbles and restore stability to our banking system, they should implement the proposals I have outlined above. Will they do it? Not if the banking lobby has anything to say about it.

When you read about today's HELOC abuser, ask yourself if you think educating borrowers would have stopped this behavior. I don't think it any amount of government education programs would have made the slightest difference.

Long Term HELOC Abuse

It's obvious from looking through the property records that many borrowers supplemented their lifestyles with regular trips to the home ATM machine. The regularity and the size of these withdrawals is astonishing. It also explains much about why houses are so popular in California. If owning real estate gives you the opportunity to obtain hundreds of thousands of dollars for doing absolutely nothing, ownership will be highly desired; in fact, it becomes the primary reason people buy homes. Californian's live in their own personal ATM machines.

• The owners of today's featured property paid $441,000 on 4/25/1991. I don't have their original mortgage information, but it is likely that they put 20% down ($88,200) and borrowed $352,800.
• On 5/27/1997 they obtained a stand-alone second for $50,000.
• On 12/7/1998 they refinanced their first mortgage for $387,500.
• On 3/26/1999 they got a $47,500 stand-alone second.
• On 12/28/2000 they refinanced with a $441,000 first mortgage and crossed the threshold of borrowing more than they paid.
• On 3/31/2004 they refinanced with a $536,250 first mortgage.
• On 10/5/2004 they obtained a $628,000 first mortgage.
• On 11/30/2005 they refinanced with a $686,250 Option ARM with a 1.5% teaser rate.
• On 5/3/2007 they obtained a second mortgage for $15,764.
• On 7/3/2007, after witnessing the above patter of serial refinancing, World Savings Bank brilliantly loaned them $788,000 in an Option ARM.
• Total property debt is $788,000 plus negative amortization and missed payments.
• Total mortgage equity withdrawal is $435,200 including their down payment.
• Total squatting time was minimal as the bank moved quickly to evict these squatters.

Foreclosure Record

Recording Date: 05/11/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 02/09/2010

Document Type: Notice of Default

The listing agent is Mike Dunn, and I have seen a prospectus for a fund he is forming to purchase and improve trustee sale flips. My guess is that he is also the flipper on this deal.

If you would like to learn how you can get involved with trustee sales like this one, please contact me at sales@idealhomebrokers.com.

Irvine Home Address … 35 NIGHTHAWK Irvine, CA 92604

Resale Home Price … $845,000

Home Purchase Price … $711,100

Home Purchase Date …. 6/2/2010

Net Gain (Loss) ………. $83,200

Percent Change ………. 11.7%

Annual Appreciation … 71.0%

Cost of Ownership

————————————————-

$845,000 ………. Asking Price

$169,000 ………. 20% Down Conventional

4.51% …………… Mortgage Interest Rate

$676,000 ………. 30-Year Mortgage

$165,337 ………. Income Requirement

$3,429 ………. Monthly Mortgage Payment

$732 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$70 ………. Homeowners Insurance

$80 ………. Homeowners Association Fees

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

$4,312 ………. Monthly Cash Outlays

-$818 ………. Tax Savings (% of Interest and Property Tax)

-$889 ………. Equity Hidden in Payment

$283 ………. Lost Income to Down Payment (net of taxes)

$106 ………. Maintenance and Replacement Reserves

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

$2,993 ………. Monthly Cost of Ownership

Cash Acquisition Demands

——————————————————————————

$8,450 ………. Furnishing and Move In @1%

$8,450 ………. Closing Costs @1%

$6,760 ………… Interest Points @1% of Loan

$169,000 ………. Down Payment

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

$192,660 ………. Total Cash Costs

$45,800 ………… Emergency Cash Reserves

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

$238,460 ………. Total Savings Needed

Property Details for 35 NIGHTHAWK Irvine, CA 92604

——————————————————————————

Beds: 4

Baths: 3 baths

Home size: 2,600 sq ft

($325 / sq ft)

Lot Size: 5,750 sq ft

Year Built: 1977

Days on Market: 21

Listing Updated: 40386

MLS Number: S626030

Property Type: Single Family, Residential

Community: Woodbridge

Tract: Pl

——————————————————————————

According to the listing agent, this listing is a bank owned (foreclosed) property.

JUST REDUCED $5,000!!!***FANTASTIC OPPORTUNITY TO CHOOSE YOUR OWN UPGRADES FOR ONE WEEK ONLY BEFORE BUILDER STARTS REMODEL ON 7/30***This is a fixer but a beautiful blank canvas with an excellent location in the back of the development – high cathedral ceilings,guest suite downstairs,pool and spa size yard,two fireplaces,excellent interior location less than 75 yards to park,basketball,volleyball and less than 150 yards to beach club and community pool. Last two sales have been over $975,000. Very low tax rate and HOA dues.

I like Mike's idea to advertise the flip for sale prior to renovation. If a buyer emerges, they can get the property renovated to their taste by the flipper and the costs get rolled into the loan. He does need to lay off the CAPS LOCK, exclamation points, and asterisks though. I wonder if he thinks he can do $20,000 in cosmetic renovations and ask $130,000 more for the property ($975,000). If he can get that, buyers are not very bright.

Eliminate the myriad of government subsidies will cause house prices to drop, but it will also release capital to more productive uses.

If you would like to learn how you can get involved with trustee sales, please contact me at sales@idealhomebrokers.com.

Irvine Home Address … 21 EDEN Irvine, CA 92620

Resale Home Price …… $659,900

Two of us riding nowhere

Spending someones

Hard earned pay

You and me Sunday driving

Not arriving on our way back home

we're on our way home

we're on our way home

we're going home

Boney M. — Two of Us

Government subsidies are spending someone else's hard earned pay. All of us who work are paying for McMansions everywhere through the home-mortgage interest deduction that subsidizes the McMansion owner's loan. It's time we stopped these subsidies, allowed housing prices to fall to their natural market levels, and released trapped capital currently tied up in real estate to more productive uses.

We Can't Afford This House

Christopher Papagianis and Reihan Salam — July 20, 2010

Part 2 —

Admittedly, ending the subsidies would probably depress housing prices overall. Since most homebuyers base their purchase decisions on the monthly after-tax cost of housing, reducing the deduction for mortgage interest would mean that the same monthly payment would buy “less house.” For example, a 25 percent deduction for mortgage interest allows buyers with a 6 percent mortgage to spend an extra $30,000 on a house without seeing any increase in their monthly payments.

There is a much easier way to figure out how much eliminating the home-mortgage interest deduction would cause prices to drop. What is the marginal tax rate of the borrower? Assume that most buyers borrow the most they can afford on a monthly payment basis, and further assume intelligent ones have already factored in the tax savings. If you eliminate the tax savings, people will need to bring their payment down accordingly. This won't have much effect on the lower priced homes because many of those borrowers don't itemize, but in cities like Irvine, elimination of this deduction would cause loan balances to shrink by 25% to 40% to keep the same payment. Since about 80% of the house price is usually financed, this will lower prices 20% or more.

Similarly, an increase in down-payment requirements from the current 3.5 percent to 20 percent would mean that $20,000 of savings could be used to buy only a $100,000 house, rather than one priced at $570,000.

Increasing the down payment requirement won't directly impact prices, but it will have a major indirect effect. For instance, trustee sale prices are 15% to 20% lower than resale prices because the down payment requirement is 100%. Very few people have the entire purchase price in cash, so the limited buyer pool makes prices much lower. The same principal holds when evaluating what would happen if down payment requirements went from 3.5% to 20%: they buyer pool would get so much smaller that bids would be lower and prices would go down, probably quite a bit. The people who can put 20% down can still borrow plenty at low interest rates, but there are fewer of these people, so the law of supply and demand suggests that prices would go down.

A general decline in housing prices would constitute a one-time wealth transfer from current homeowners to future ones — but this would be well worth it if phased in over a period of years.

That isn't really true. A general decline in housing prices would constitute the evaporation of the illusory wealth that current home owners believe they have but really don't. The housing bust didn't witness a transfer of wealth, and further price declines necessary to get off the government stimulus won't either.

In 2007 (the last year of the bubble), households’ primary residences accounted for only 31.8 percent of total family assets. While primary residences make up a larger share of the assets of lower-income than of higher-income households, housing subsidies are less significant for the former because their tax rates are lower, which makes the value of deductions smaller. Because the value of subsidies provided by the FHA and the GSEs accrues to the borrower on a per-dollar-of-debt basis, their reduction is unlikely to be felt as strongly by lower-income households. The well-off take out bigger mortgages, pay more interest, and have bigger income-tax bills against which to apply a deduction: The median house value for households in the 40th through the 59th income percentiles is just $150,000, compared with $500,000 for households in the top income decile.

According to the Office of Management and Budget (OMB), the mortgage-interest deduction is expected to cost $637 billion over the five years ending in 2015. The exclusion of capital gains on primary residences is expected to cost another $215 billion over the same five years, with the deductibility of state and local property taxes on owner-occupied homes adding $151 billion. In total, these subsidies will reduce federal revenue by well over $1 trillion over a decade during which the federal government is expected to run a $9 trillion deficit. A gradual phase-out of these subsidies is therefore not only smart economics, but a fiscal necessity.

The financial argument is difficult to ignore. We spend a great deal of money inflating house prices in places like Irvine, and we obtain no observable benefits from the investment — unless you consider Irvine Ponzis something you want to see more of.

Over the years, tax experts have also zeroed in on how some of these subsidies are distributed. Under the status quo, 80 percent of the benefits from the mortgage-interest deduction go to the top 20 percent of households in terms of income. The deduction helps only those taxpayers who itemize deductions on their tax returns, which is much more common among high earners, and the value of the subsidy rises as one moves up the tax brackets. Further, as Joseph Gyourko and Todd Sinai of the University of Pennsylvania have documented, the subsidies are unevenly concentrated, with net benefits going to only 20 percent of states and 10 percent of metropolitan areas. Not surprisingly, over 75 percent of these benefits go to three high-cost metropolitan areas: New York City–Northern New Jersey, Los Angeles–Riverside–Orange County, and San Francisco–Oakland–San Jose.

A better approach would be to provide a flat tax credit to all homebuyers. This would preserve an incentive for people to buy a home but would not provide a larger incentive for people who buy bigger homes or take on outsized debts. The size of the credit could be reduced over time. Under this sort of policy, the federal government could aid middle- and working-class homebuyers at a small fraction of the cost of the current mortgage-interest deduction.

There is a better and more politically feasible alternative that changing the home-mortgage interest deduction to a flat tax. Rather than changing anything about the deduction, it could be rendered worthless by simply raising the standard deduction.

Whenever we estimate the tax benefits for an Ideal Home Brokers client, we take their estimated marginal tax rate at tax 10% off it. Anecdotally, a those that have run simulations through their tax software report that the cost of losing the standard deduction makes the home-mortgage interest deduction significantly less effective that most assume it is. Someone in the 35% tax bracket only gets about a 25% net tax advantage.

Consider what would happen if the standard deduction were raised to $50,000. The lower-middle class would receive a substantial tax break, and the upper-middle class would see a greatly reduced benefit from itemizing. In fact, this would simplify tax preparation significantly because very few people would bother to itemize. The net effect would be to shift the tax burden from low wage earners to high wage earners, and in the process, it would render the home-mortgage interest deduction worthless.

Raising the standard deduction would be much easier politically than trying to mess with the tax code to eliminate the home-mortgage interest deduction. Most people wouldn't even recognize how their deduction became worthless, and politicians wouldn't be blamed.

Dismantling the GSEs is a more difficult proposition. Taxpayers have already committed roughly $150 billion to the bailout of Fannie and Freddie. The Congressional Budget Office projects that losses could balloon to $400 billion over time, while other analysts suggest the taxpayer hit could be closer to $1 trillion if default and foreclosure rates stay high. The reason these estimates vary so much is that taxpayers can expect three different kinds of losses from the GSEs:

1. those linked to the $5 trillion of mortgage-backed securities and loan guarantees that they are responsible for;
2. those that will continue to occur as a result of regular, ongoing operations in a declining housing market; and
3. those that may result from their being used as de facto government agencies, subsidizing foreclosure-prevention efforts.

Fannie and Freddie function today as off-balance-sheet conduits for taxpayer spending on housing, and there is no mechanism in place to end this practice. What’s particularly disappointing is that Congress is on the verge of sending the president a sweeping financial-reform bill that doesn’t account for Fannie and Freddie, the most expensive part of the bailouts.

There is no chance of anything being done with the GSEs until the housing bust is over, and we are less than 50% of the way there. The various government props has done nothing but delay the inevitable and promote a great deal of market denial. People cannot afford their homes, and these homes — along with the loans that purchased them — must be liquidated. The liquidation process will cause staggering losses, and the GSEs are the only conduit banks have for dumping these losses on the US taxpayer. That is the only reason Congress did not address them in the financial reform package.

A lot of thoughtful proposals for reforming Fannie and Freddie have been issued over the past year. In late May, Donald Marron and Phillip Swagel of Georgetown University put forth one of the more balanced and straightforward plans. The crux of it is to make the GSE guarantees explicit rather than implicit, and to charge an appropriate fee for them. Marron-Swagel would turn Fannie and Freddie into private companies and force them to compete with other firms. These new businesses would have a narrow mission: to buy conforming mortgages and bundle them into securities that are eligible for government backing. The key is that the federal guarantee would be transparent, and offered only in exchange for the firms’ paying the government an actuarially fair price for what would amount to insurance.

This sounds like the kind of idea an academic would come up with. There is no way the government would ever charge a fair-market actuarial price for this insurance. We all know it would be subsidized at pennies of its value, and the government would be on the hook for the next massive bailout once lenders know all the risk has been shifted to them. This idea will not work.

An explicit government backstop might seem an unwarranted interference in housing markets, but recent experience suggests that it is unrealistic to believe that the government will stand aside next time.

To even suggest the GSEs have anything other than an explicit government guarantee is a joke. We tried the implicit guarantee nonsense for about 40 years, and everyone knew the government was going to step in when times got tough. Now that it actually happened, everyone in the market knows the guarantee is explicit. For anyone in the government to even suggest otherwise is a lie more transparent than most lies they tell us.

Some government backstop will always be implicit; better to make it explicit and price it. Once a price is established under the Marron-Swagel plan, the government would have the option of raising it, thereby reducing its support for the market, slowly and over time. The government could also reduce its footprint in the housing market by putting a ceiling on the size of the mortgages eligible to be packaged into government-backed securities. If the loan limit were capped in nominal terms, then future inflation and house-price increases would, over the course of several years, work to reduce the government’s presence in the marketplace.

If you really want to lower the government's footprint, lower the conforming limit. Change the formulas. Why do we allow jumbo conforming? Why not cap all GSE and FHA loans at $417,000, and make everything else private-label jumbo loans? If you lowered the conforming limit, over time only low-income borrowers would utilize these loans. And that is why these programs were begun. We lost our way and began subsidizing mortgages of high wage earners and inflated house prices everywhere they congregate.

Likewise, other subsidies, such as the mortgage-interest deduction, can and should be gradually eliminated.

Reforming the housing sector won’t miraculously restore robust economic growth. It will, however, help stanch the bleeding of productive resources into a sector that has been distorted for decades by misguided government subsidies. And over time, that will give workers and entrepreneurs the tools they need to build a stronger and more sustainable economy.

We spend way too much money on housing in the country, and we get little in return for that investment. Think about it. What does a house produce after it is built?

When we invest in factories, the completed factory produces goods and services and employs people. When we invest in infrastructure, the new transportation system increases commerce and stimulates the economy. When we invest in housing, we get a temporary boost from the construction itself, but the house does nothing but require additional resources for upkeep. It produces nothing.

So why are we subsidizing housing?

In California we subsidize housing because our entire economy is a Ponzi Scheme dependent upon rising home values. Rising prices generates local tax revenues that keeps governments afloat, and more important than that, it provides HELOC money to all homeowners who spend this in the local economy. Without this HELOC spending, the California economy sputters, governments teeter on the brink of bankruptcy, and Ponzis everywhere suffer the loss of their borrowed existence. I don't see things changing any time soon because we lack the understanding or the will. California seems to like its Ponzi economy. Someday it will blow up. It may already have.

Poor timing

The owners of today's featured property did not time their purchase particularly well. Like many in the first wave of knife catchers, they likely saw the first decline in prices as a buying opportunity — an opportunity to lose their down payment and destroy their good credit.

• This property was purchased on 4/3/2007, coincidentally it was the day of the collapse of New Century Financial and the implosion of subprime. They paid $750,000 using a $600,000 first mortgage, a $75,000 second mortgage, and a $75,000 down payment.
• They were too late for any mortgage equity withdrawal, but they have been allowed to squat for a year.

Foreclosure Record

Recording Date: 06/18/2010

Document Type: Notice of Sale

Foreclosure Record

Recording Date: 10/16/2009

Document Type: Notice of Default

It was trying to save buyers like these that prompted me to begin writing for the Irvine Housing Blog in early 2007. These people were likely in escrow when I first began writing in late February of that year. I doubt anyone involved in the transaction told them this would be their fate.

Irvine Home Address … 21 EDEN Irvine, CA 92620

Resale Home Price … $659,900

Home Purchase Price … $750,000

Home Purchase Date …. 4/3/2007

Net Gain (Loss) ………. $(129,694)

Percent Change ………. -17.3%

Annual Appreciation … -3.6%

Cost of Ownership

————————————————-

$659,900 ………. Asking Price

$131,980 ………. 20% Down Conventional

4.62% …………… Mortgage Interest Rate

$527,920 ………. 30-Year Mortgage

$130,789 ………. Income Requirement

$2,713 ………. Monthly Mortgage Payment

$572 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$55 ………. Homeowners Insurance

$170 ………. Homeowners Association Fees

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$3,510 ………. Monthly Cash Outlays

-$456 ………. Tax Savings (% of Interest and Property Tax)

-$680 ………. Equity Hidden in Payment

$229 ………. Lost Income to Down Payment (net of taxes)

$82 ………. Maintenance and Replacement Reserves

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$2,685 ………. Monthly Cost of Ownership

Cash Acquisition Demands

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$6,599 ………. Furnishing and Move In @1%

$6,599 ………. Closing Costs @1%

$5,279 ………… Interest Points @1% of Loan

$131,980 ………. Down Payment

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$150,457 ………. Total Cash Costs

$41,100 ………… Emergency Cash Reserves

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$191,557 ………. Total Savings Needed

Property Details for 21 EDEN Irvine, CA 92620

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Beds: 3

Baths: 2 full 1 part baths

Home size: 1,915 sq ft

($345 / sq ft)

Lot Size: 4,050 sq ft

Year Built: 1980

Days on Market: 37

Listing Updated: 40362

MLS Number: S621337

Property Type: Single Family, Residential

Community: Northwood

Tract: Ps

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

This property is in backup or contingent offer status.

Popular Floorplan with 3 Bedrooms, 2.5 Baths. Updated Kitchen and Updated Throughout Located on Cul de Sac Street & Backs to Greenbelt. Newer Tile Roof, Block Walls, Long Driveway. Walk to Award Winning Schools(Santiago Hills Elementary, Sierra Vista Middle School & Northwood High School), Close to Association Pool. Low Taxes, No Mello Roos, Association Dues $81/Mo. SMALL DOG WILL BE IN CAGE.