Like poker players, people attempting cram downs with their lenders are playing a game where the strength of their hand often determines whether or not the lender will call their bluff.

Today’s featured property is a large 5/3 REO. The owner bought a little too late and borrowed a little too much.

Asking Price: $639,900

Address: 50 Nebraska, Irvine, CA 92606

Poker Face — Lady GaGa

Michael Lewis wrote a book in the late 1980s called Liar’s Poker. In it he describes the inner workings of Wall Street and how the culture rewarded trickery and deceit. (He also recently wrote Panic which features a post from the IHB.) In poker the players bet against each other based on the relative strength of each other’s hands. The strongest hand wins the money — most of the time… What makes Poker such an outstanding game is that the betting itself provides an alternate method of victory. In fact, actually playing the cards to determine the victor often does not occur.

There is a new game of poker being played all over the country between borrowers and lenders. It is a high stakes game with hundreds of thousands of dollars riding on the outcome. First a little background on how it is played.

Borrowers know they can get loan modifications with principal reductions that save them big bucks. This is the pot people are playing for. In a normal market, borrowers do not have the cards to play in this game. If they try to force a loan modification, the lender would simply foreclose and take back the property. However, since many borrowers are underwater, and since lenders already have too many foreclosures, borrowers have a much stronger hand. In fact, the hand gets stronger as the borrower falls further and further underwater.

In order to play this game, borrowers must petition their lenders for a loan modification. Simply asking isn’t good enough. To play their first card, the borrower must default on their mortgage. As I mentioned in the post Reverse Liar Loans, many borrowers are now doing this. What many borrowers do not realize is that this is the first gambit in a larger game. The loan modification is not guaranteed just because they default and ask for it.

{book}

Here is where everyone can get a schadenfreude overdose: many people who are defaulting on their mortgages to gain a loan modification are being turned down by their lenders. I mentioned in yesterday’s post that I had an extended conversation with a banker at a recent event. He told me his bank routinely turns down these attempted loan modifications, particularly if they believe the borrower has capacity to continue making payments, and if they are not that far underwater.

Think about what the lenders are doing. They are calling the borrower’s bluff. Now look at the borrower’s circumstances: 1. They trashed their credit with the series of late payments, so they have the damage of a short sale or foreclosure. 2. They are way behind on their payments (do you think any of them saved the money?) 3. Now they have to decide whether or not they are really going to walk away from their homes.

This is when borrowers realize the stakes they are playing for. Anyone who attempts to force a lender into a loan modification has to be prepared to walk away from their home because the lender may call their bluff. This is where the strength of the hand of the borrower is increased by being underwater. If they are way underwater, they actually benefit by walking away and starting over. It is easier to walk when there is little hope of getting back to breakeven. Banks know this too, and they are more willing to negotiate with these people. If a borrower is only a little under water, their hand is much weaker because the lender knows they are less likely to walk away.

The game of loan modification is just like playing poker. Anyone thinking about doing this needs to consider that like any bluffing game, the other party may call your bluff. If you are not prepared to walk away from your home, you probably shouldn’t play.

Today’s featured property is a large 5/3 REO. The owner bought a little too late and borrowed a little too much.

Asking Price: $639,900

Income Requirement: $159,975

Downpayment Needed: $127,980

Monthly Equity Burn: $5,332

Purchase Price: $496,000

Purchase Date: 1/31/2003

Address: 50 Nebraska, Irvine, CA 92606

• This property was purchased on 1/31/2003 for $496,000. The buyer used a $396,800 first mortgage, a $74,000 second mortgage, and a $25,200 downpayment.
• On 2/25/2004, the first mortgage was refinanced for $528,000 cashing out the downpayment plus an additional $32,000.
• On 2/25/2004, the owner also opened a HELOC for $66,000.
• On 12/22/2004, the owner opened a HELOC for $156,000.
• In 2006, there was a lien filed by a bail bondsman…
• On 6/21/2007, the owner opened a HELOC for $286,000.
• Total property debt is $814,000.
• Total mortgage equity withdrawal is $343,200 including the downpayment.

This owner bought in early 2003, and he would probably fall underwater anyway before prices bottom. However, he added another $300K+ to the mortgage, and now it is hopeless. The property went into foreclosure, and it was purchased by the lender on 9/17/2008 for $548,666. (Notice that it is taking 90 days or more for these to hit the MLS.)

If this property sells for its asking price, and if a 6% commission is paid, the total loss on the property will be $212,494.

The auction price was 33% below the peak appraised value used to justify the final HELOC.

{book}

I wanna hold em’ like they do in Texas Plays
Fold em’ let em’ hit me raise it baby stay with me (I love it)
Luck and intuition play the cards with Spades to start
And after he’s been hooked I’ll play the one that’s on his heart

I wanna roll with him a hard pair we will be
A little gambling is fun when you’re with me (I love it)
Russian Roulette is not the same without a gun
And baby when it’s love if it’s not rough it isn’t fun, fun
Oh, oh, oh, oh, ohhhh, ohh-oh-e-ohh-oh-oh
I’ll get him hot, show him what I’ve got
Oh, oh, oh, oh, ohhhh, ohh-oh-e-ohh-oh-oh,
I’ll get him hot, show him what I’ve got

I won’t tell you that I love you
Kiss or hug you
Cause I’m bluffin’ with my muffin
I’m not lying I’m just stunnin’ with my love-glue-gunning
Just like a chick in the casino
Take your bank before I pay you out
I promise this, promise this
Check this hand cause I’m marvelous

Poker Face — Lady GaGa

How can we prevent future housing bubbles? Do we try to curb demand through draconian taxes? or do we try to limit supply by regulating lenders?

Today’s featured property is a 2003 rollback that recently sold at auction for 40% off its peak purchase price.

Asking Price: $330,000

Address: 125 Greenfield #118, Irvine, CA 92614

{book}

The Saints Are Coming — Green Day & U2

A drowning sorrow floods the deepest grief,
how long now?
Until the weather change condemns belief,
how long now?
When the night watchman lets in the thief
Whats wrong now?

Ever since the post Tax Policy and Housing, I have been carrying on an email conversation with Bill McKim, author of a pamphlet titled The Financial Crisis of 2008.
We have been discussing methods of preventing future housing bubbles.
With as painful as the deflation of this bubble is, we both hope that
as a society we recognize the importance of stopping this from
happening again, and through our politicians, we can do something to
prevent its recurrence.

My proposal for Preventing the Next Housing Bubble (PDF) focuses on limiting the supply of lender money that enables people to
borrow excessive amounts which inflates housing bubbles. Mr. McKim’s
proposal is to curb the demand for borrowing and for speculative real
estate in general by taxing the profits out of existence. If people
can’t make money beyond adjustments for inflation, they will not
speculate in real estate. If implemented, his proposal would be very
effective; however, I don’t think it could be successfully implemented.
Real estate is religion in California. If you try to tax away
everyone’s profits, it is as if you were telling them they could not
worship their God. It is a false God, and it is one they should not
worship, but telling them they cannot would be a very difficult sell.
Perhaps I overestimate the resistance to the idea.

I want to share with you a snippet of our conversation as Mr. McKim
does a great job of laying out the case for taxing the gains on housing
due to irrational exuberance at 100%:

Me: “Personally, I think the controls on irrational exuberance going
forward is going to come from the lender side. The banking industry is
going bankrupt due to their stupidity. They are going to lose more than
a trillion dollars by the time it is all added up. Congress is going to
step in to regulate them to death in order to prevent it from happening
again, particularly since they ended up picking up the tab. Of course,
regulations need enforcement, and over time there is always pressure to
relax or repeal regulations.

For as much as I would like to see demand-side regulation or
borrowers like taxation would create, I think it far more likely that
Congress will focus on supply. It is easier. It will be much, much
easier if we end up nationalizing our banks (which seems likely at some
point).”

{book}

The following is Mr. McKim’s response. The [italics] in brackets are my comments.

Mr. McKim: “You
say “The banking industry is going
bankrupt due to their stupidity. They are going to lose more than a trillion
dollars by the time it is all added up”. I posit that they are not currently
short a trillion dollars because of their stupidity, but because they were the
ultimate losers in the 2003 to 2006 housing bubble.

During the
bubble all segments of society, government, and media were entranced by the
marvelous opportunities to make money in the residential housing market. Buyers were eager to buy houses that had
increased in value 20% in the past year because they assumed that the houses
would increase 20% during the next year. Sellers were eager to sell because they had made far more on their house
during the Exuberance than they had made in the prior five or ten years. Lenders were eager to lend far more than
was currently owed on the house because its price (and, they thought, the
security value) was going up like crazy.

The media, and
therefore the government, were eager to extend this tremendous opportunity for
riches to all segments of society instead of its only being available to those
who could repay the money borrowed to buy the house out of the buyers’ income.
(After all, everyone knew that you could refinance after the buyer had been in
the house a few months or a year and take out enough money to make mortgage
payments.)

Then, as all
bubbles must, this one burst. The
winners were all those sellers who had sold during the bubble. The losers were those who had bought
late, and their mortgage lenders.

Who was
stupid? Who wasn’t stupid? Who was most stupid? What would have happened to a loan
officer of a lender if he had refused to make a loan to someone merely on the
basis that the borrower didn’t make enough money to be able to pay back the
loan? The answer to that one is
that the loan officer would have been fired from his job.

What would have
happened if some diligent regulator had told a lender that he couldn’t make a
loan to a buyer who didn’t make enough money to pay the loan back? The regulator might have been fired, or
the media would have castigated the lender for discrimination and having a black
soul, or a Congressman would have pushed through legislation making it possible
for the lender to make the loan.

That was the
then that was then. What is so
evident to us now was not evident to anyone then. [It was evident to some, and they were not listened to]

Therefore, the
late buyers that were losers have had to get second or third jobs to make the
payments, or give up the house. The
losers that were lenders are missing, as you said, a trillion dollars.

As long as the
lenders don’t have that trillion dollars they can’t lend that trillion dollars
to businesses to make payroll, order goods, or finance expansion even if their
business is booming. Without credit
there is no cash flow in today’s world.

As long as
lenders don’t have that trillion dollars they can’t lend consumers money to buy
cars, TVs, or cruises.

Obviously, an
economy that was productive and prosperous before the bill came due on the
housing bubble is not now inefficient, unproductive, and without customers
wanting to buy this short time later.

The “economy” is
not in the tank. Only the financial
system is broken.

So, if the
banking industry is given back the trillion dollars it loaned on real estate
that was worth a trillion dollars less than everyone thought, then the wheels
will start to turn and everything will be fine in the economy, with only our
grandchildren suffering, right?

Apparently not,
quite. That would seem to be what
Henry Paulsen thought when he asked for 700
billion dollars. The problem was
that no one had sat down and figured all this out, and no one could explain
where the 700 billion was going, and why it was going there. Without any understanding, pain in the
auto industry (which was caused by the lack of credit to buy cars) looked just
as serious and important as pain in the lending industry.

In order to fix
the current crisis two things are needed. The trillion dollars, and a comprehensive understanding of what went
wrong, how we are going to fix it, and that no one was more to blame than anyone
else. That what happened, happened
to all of us because we didn’t know as much in the past as we do now.

Right now
bankers, given money, are loathe to lend it, because they clearly realize that
they don’t always get it repaid. If
they, the government, the media, the economists, and, to as great an extent as
possible, the public know that the money that was lost by the lenders was
because of a specific and isolated event, then they will be able to just go back
to lending the way they always have. [I
don’t believe banks would lend right now even if they knew what they
did wrong because asset prices are too high relative to cashflow.
Prices must fall.]

Now (as though
this wasn’t too long already), you say that you think that Congress is going to
try to solve the problem by regulation or nationalization, because it is
easier. Left to their own devices,
I’ve no doubt that you are right. Certainly Congress will think that that is easier because that is what
Congress does. To them, it will be
easier to set up a severe new regulation scheme, and hire people to implement it
than to actually “change”.

Change would be
to think about the root cause of the problem and come to the conclusion that you
and I share: that irrational exuberance caused the problem, and that taxing it
out of existence would stop it in its tracks. Having done that much thinking, they
would then have to tackle the only really difficult part of the solution, which
is determination of the true value of property when it is sold. [I think this is actually the easy part. Index gains to the CPI plus 1%]

Once that very
difficult solving of the problem has been accomplished by Congress though the
implementation and enforcement of it will be hundreds of times easier and less
expensive than a new regulatory scheme or nationalization of the banks.“

The saints are coming, the saints are coming.
I say no matter how I try, I realise there’s no reply.

At some point, Congress will tackle the issue of what to do about
the housing bubble. Hopefully, it will be a carefully considered debate
rather than part of some emergency measure. One fundamental question
Congress must consider is whether to try to curb demand or limit
supply. I favor limiting supply because I believe they could accomplish
it. It will be a difficult argument for an insolvent banking industry
to oppose any regulations from the government considering the
government is the only entity keeping them afloat. I believe Mr.
McKim’s proposal is interesting because it would be very effective. If
Congress wanted to tackle this problem through tax policy, specifically
by taxing capital gains on property sales, it could go that route as
well. Whatever approach they take, I hope they come up with a workable
solution to the problem. Since this is the US Congress we are talking
about, I have my doubts they will get it right.

{book}

Today’s featured property is a 2003 rollback that recently sold at auction for 40% off its peak purchase price.

Asking Price: $330,000

Income Requirement: $82,500

Downpayment Needed: $66,000

Monthly Equity Burn: $2,750

Purchase Price: $465,000

Purchase Date: 6/19/2006

Address: 125 Greenfield #118, Irvine, CA 92614

Do you get the sense that the bank can’t think of any reason why someone would want to buy this place?

This property was purchased on 6/19/2006, right at the peak. The owner paid $465,000 (LOL) by using a $372,000 first mortgage, a $46,035 second mortgage, and a $46,965 downpayment (ouch). Downey Savings had the first mortgage, and Washington Mutual has the second. Two brilliant lenders with solid balance sheets… The property was purchased by Downey at auction on 9/2/2008 for $277,500. That is 40% off its peak purchase price. The amazing thing is that they were willing to take a $100,000 loss on their first mortgage position on the courthouse steps, and no flipper stepped forward to take it.

If this property sells for its asking price, and if a 6% commission is paid, the total loss on the property will be $154,800.

I hope you have enjoyed this week at the Irvine Housing Blog. Come back next week as we
continue chronicling ‘the seventh circle of real estate hell.’ Have a great weekend.

🙂

{book}

There is a house in New Orleans, they call the Rising Sun
It’s been the ruin of many a poor boy, and God, I know I’m one.

The saints are coming, the saints are coming
I say no matter how I try, I realise there’s no reply.
The saints are coming, the saints are coming
I say no matter how I try, I realise there’s no reply.

The Saints Are Coming — Green Day & U2