Friday, April 1, 2011

5-Part Series, Digging Out of America's Foreclosure Mess; Part 5, Working Investor Solution

Photo Credit - Flickr Common
The free market system must be allowed to work to stabilize the real estate market. Sustainable economic growth and recovery can only occur with a stable housing sector.

Compounding failed government programs with new government programs is not the answer. Politicians kicking the can down the road will only prolong the pain. Seeking social justice, at the expense of common sense and sound fiscal policy, hurts more than it helps by creating a second real estate bubble. It will eventually burst like the first one did and for the same reasons. We are perhaps already seeing the beginnings of this reality.

Economic stabilization will only happen when families are living in housing that allows them to make mortgage or rent payments they can manage. Living in the limbo of an inevitable foreclosure is actually cruel in many ways. It promotes living with constant stress. It delays a restart point for those in troubled situations to begin building a solid foundation and happier life again.

Private investors working with a social conscious may well in fact be our nation’s best hope for moving forward and digging out of America’s foreclosure mess.

Massachusetts lender and asset manager Bryan Ganz, CEO of Scudder Bay Capital, LLC is a socially conscious private investor whose company has already been working within this philosophy. He also knows firsthand that government’s misplaced philosophy and regulations hinder progress and revisions need to be made.

It hasn’t necessary always been easy, yet with realistic financial goals and a social conscious, Scudder Bay has made solid successful progress for its investors and homeowners. Bryan shares his experience in helping troubled homeowners. He is currently detailing this to Washington policymakers hoping they will listen.

“With the first group of homeowners, those that could afford to stay in their homes, we ran into two problems. One, it is impossible to refinance these loans. Two, it is prohibitively expensive to modify them.”

“With the second group of homeowners, those that could not afford to stay in their home, the federal government and the state attorneys general have essentially told them they do not need to make their mortgage payments in order to remain in their homes.”

“While the federal government has made much of the moral imperative that financial institutions have to modify loans, the fact is, the federal government currently penalizes any institution that actually agrees to reduce a borrower’s principal amount or even lower their interest rate.”

“It used to be when a financial institution purchased a mortgage on the secondary market and modified the loan; the homeowner was taxed on the debt that was forgiven while the financial institution was taxed on the difference between the purchase price of the loan and the new modified face amount. As a result, mortgages are rarely modified.”

“In response to the housing crisis, the tax on homeowners was eliminated, but the tax on the financial institution was left untouched. Since almost all nonperforming loans have been sold at a discount on the secondary market, this tax on ‘phantom income’ serves as a strong deterrent to modification, particularly since almost half of all mortgages modified since 2005 have re-defaulted within a year of modification.”

“It is asking much of these institutions to pay an upfront tax on a 30 year stream of future payments when these payments so often cease within a year of the modification. It only stands to reason if this tax is eliminated, the number of modifications will increase, and the number of foreclosures will decrease.

This change to the tax code would be revenue neutral over time as the tax would still be due when the lender actually receives the payments.”

“With modification no longer a viable option, we tried to find banks willing to provide refinancing for our homeowners. We thought if we agreed to write off a significant portion of the unpaid principal balance and all of the arrearages, so the property was no longer underwater, we could find banks willing to write a new loan.”

“We found refinancing for this segment of the population is an urban legend, a myth, it does not exist. As a result of missed mortgage payments, the FICO scores for these borrowers are below 600. No bank will dare venture there.”

“Consequently, the very banks which caused this problem, by lending to anyone with a pulse, have now found religion and are unwilling to extend credit to anyone but the most pristine borrowers. As my Dad always said, banks only lend money to people that don’t need it.”

“In response to this problem, the Federal Housing Administration (FHA) rolled out its Short Re-fi Program. The program was designed to help borrowers with damaged credit scores by providing government guarantees. The program is only available to deserving homeowners whom are current on their mortgage payments but underwater on their mortgage.”

“If the lender is willing to write off at least 10% of the principal balance, but as much as necessary to restore equity in the home, FHA would insure the new loan. From our perspective, this program was just what the doctor ordered. It requires banks to write down loans in order to restore equity for the homeowner in return for a getting a government insured loan.”

“Also, it is only available to deserving homeowners whom have continued to make their mortgage payments despite being underwater on their loan. This provides a strong incentive for underwater homeowners to remain current.”

“So how did the industry respond? Of the hundred plus banks we have contacted, we have found exactly none that are participating in the program, including those banks that received TARP funds.”

“How did Congress respond? The Republicans have recently proposed eliminating the FHA Short Re-fi program. Why? It is too expensive. You cannot make this stuff up.”

“What is most puzzling to us is no bank wants to participate. We would have thought they would be all over this program. After all, who wouldn’t want government guaranteed paper paying 5%? You would think they would be doing this every day of the week.”

“There is a catch, however, or should we say, two catches. First, there is no secondary market for these refinanced loans. The result is these banks would be forced to carry these loans on their balance sheets.”

“Second, if the banks keep these loans on their balance sheets, they will be penalized by federal bank regulators for making loans to individuals with poor credit scores. This is despite the fact the loan is insured by U.S. Government. Again, you cannot make this stuff up!”

“Discouraged by the fact no one was willing to participate in the program, we decided to start our own bank. The only trouble is you can’t start a new bank in America today. Despite the fact the FDIC is encouraging community bank proposals, federal bank regulators do not want to be bothered issuing new charters to ‘de novo banks’ that want to be part of the solution.”

“When we brought this de facto moratorium to the attention of our Congressman (a ranking member of the House Banking committee), he claimed to have no knowledge of this de facto moratorium. His staff did get back to us a week later to let us know we were wrong. There were in fact two new charters issued during 2010 - in the entire United States - for the entire year!”

“With the old banks shell shocked from the mortgage crisis, and still trying to work through their old problem loans, the only hope for homeowners looking to refinance lies with new banks with unsullied balance sheets. Once again, the federal government has proven how adept it is at closing the barn door after the horse has already gotten out.”

The FHA Short Re-fi program should be saved not scrapped. A secondary market for these loans should be allowed. If this could be done, the program could be a success. This could keep millions of hardworking and deserving families in their homes. It would also keep millions of homes off the already saturated market.”

“Even if a secondary market for these loans is not created, it makes no sense to have the FHA encourage banks to make these loans if regulators are going to penalize banks for making them. The penalty policy needs to end.”

“Either this is something the government supports, or it is not. And if it makes sense to support, regulators must treat these loans differently when assessing the soundness of a bank’s portfolio.”

These two simple fixes, changing the tax code to eliminate the penalty on financial institutions that actually modify loans and creating a secondary market for FHA Short Re-fi loans, would prevent millions of homes from falling into foreclosure.”

“What about the unfortunate homeowners who cannot afford to stay in their homes? We get them out of course as soon as possible – nicely, humanely – but out! While the government has made it prohibitively expensive to modify a loan and almost impossible refinance a mortgage, they have also managed to keep millions of nonperforming homeowners in homes they cannot afford.”

“The number one solution from Democrats seems to be to delay foreclosures for as long as possible. While the banks have acted like idiots, and some do have paperwork that is a mess, virtually all of the homeowners being foreclosed upon are squatting in homes. Many of them have now made no payment in years. That’s right – years.”

“Our average loan, when we buy it, is 30 months past due. If we are forced to foreclose, it generally takes us more than a year from the time we purchased the loan. Just to be clear, we are not foreclosing upon Mother Theresa.”

“When we first started Scudder Bay 2 years ago, we found most homeowners cooperative and receptive to our offer to help them with financial assistance and relocation services. Frankly, for those homeowners unable to make their mortgage payments, they knew they had two options – work out a deal or lose their home to foreclosure.”

“By working cooperatively with us, homeowners often got tens-of-thousands of dollars in financial assistance from Scudder Bay. We agreed to forgive any deficiency balance and all past due payments. This allowed our homeowners to get out from under a bad situation and move on with their lives. We want to help them in this way.”

“The actions and rhetoric of misguided politicians trying to score political points by bashing the big bad banks have encouraged homeowners to file frivolous claims to try to avoid the inevitable. The only problem is the inevitable is inevitable.”

“Ultimately these homeowners, who cannot or will not pay their mortgage payments, will lose their home to foreclosure. When they do, there will be no $35,000 in financial assistance to help them move and start over, for this money will have been squandered on lawyers and frivolous lawsuits.”

Bryan has worked successfully with several families helping keep them in their homes. He is always pleased with this outcome. You can read a few testimonies from grateful homeowner on his company’s website.

Bryan also knows from experience, “There is a mistaken belief the best way to minimize the ‘pain’ for a homeowner is to always keep them in their home. Often times, the most grateful homeowners are the ones we helped transition to more affordable housing. By getting out from under a debt they could never hope to repay and receiving cash to move to more affordable housing, these families have an enormous financial and emotional burden lifted.”

He notes, “These families can have a fresh start to get back on their feet financially. We should not assume the best way to protect homeowners is to keep them in a home they cannot afford.”

Our series experts, Bryan Ganz and his colleague Elliott Topkins of Bevan & Topkins and author of the Realtors Resource Blog hope others will support and join the Scudder Bay Capital, LLC philosophy. “When we talk about what we are doing, we are often asked if we are worried about people copying our model. It is just the opposite. We want people to copy our model.”

Bryan believes digging of America’s foreclosure mess must be done with a social conscious and realism. His final conclusion is a caution he hopes Washington will heed. “Any further steps taken to stall foreclosures will only extend the bottoming out point of the housing market. Instead of bottoming out in 2011, as originally expected, the market may now not do so until 2013 or 2014.”

“This will have a huge impact on all homeowners by depressing equity values and trapping people in their homes. By delaying foreclosures now, there is a risk that when the dam finally does break, a huge glut of foreclosed homes could come on the market all at one time. If this happens, prices could drop significantly making the ‘Great Recession’ of 2008 seem like a rehearsal dinner.”

Bryan final note is one of a working investor’s solution and hope. “This crisis is only going to be resolved if we deal with it on a retail level - one loan at a time. The best way to do that is through small, locally oriented firms like ours. There are as many as 10 million problem loans in the US. We can only handle a few hundred. We would love to see our model replicated throughout the US.”

Part 1 - Prolonged Pain

Part 2 - Failed Government Intervention

Part 3 – New Government Programs

Part 4 – Socially Conscious Private Investment

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