Sunday, December 9, 2007

Foreclosure Rescue Vs. the Contractor Special

If there’s anything too hopeless for President Bush’s foreclosure prevention plan, it's the “contractor special” near Codman Square in Dorchester. Located in a three-decker (photo, right) on Whitfield Street, the condo is one reason why some believe the President’s plan falls short. And it helps explain why, as Boston Mayor Thomas Menino pointed out, the resetting of adjustable mortgages to higher interest rates is only one link in the subprime chain-reaction.

"The Bush administration's proposal is simply not enough,” the mayor said in a statement issued Thursday. “An astounding 80% of the City of Boston's foreclosure prevention clients in adjustable rate mortgages never even made it to the first rate reset. I hope that Congress understands that solving the nation's foreclosure problems is going to take a lot more than a little tweaking around the edges of the mortgage industry. We need Federal assistance to help save the working class neighborhoods across the nation that are being ravaged by the greed of the lending industry over the last decade."

Like Menino, others familiar with subprime lending in Boston agree the proposal announced November 6 by Treasury Secretary Henry Paulson is too limited. It would only apply to adjustable subprime mortgages starting from between January 2005 and June 2007, with resets scheduled for three years later. The five-year freeze on interest rates would be voluntary. And the result could still be a net gain overall for lenders and investors, since the diminished returns on interest might still be greater than proceeds from sales after foreclosure.

“The limited scope of the announcement will be disappointing for the millions of homeowners at risk of foreclosure,” said a statement from the CEO of the Neighborhood Assistance Corp. of America (NACA), Bruce Marks. “President Bush is abandoning the approximately one million homeowners already on the brink of foreclosure.”

But Marks credits the plan with setting a “new standard for government intervention,” comparing the interest rate freeze to the wage and price controls imposed by President Nixon in 1971. Those controls led to short-term relief, only to be followed by double-digit inflation less than three years later. If the current spasm of tight credit were to ease up and the housing market to reverse its downslide, then the comparison with Nixon’s strategy would seem more flattering.

Marks also credits Bush with avoiding a repetition of the government’s bailout of the savings and loan industry in the 1980s. But, while Marks emphasizes an influential step toward widespread relief on mortgage interest rates, the executive director of Americans for Fairness in Lending, James Campen, sees more obstacles.

“The plan, as it seems,” said Campen, “is going to involve a lot of individual processing to see if people meet the criteria.”

Even when a mortgage meets the criteria in the President’s plan, the property owner would have to ask for help. And to get help, the owner would have to live in the property that secured the mortgage. Real estate analyst John Anderson says that’s why the plan will have limited ability to stall foreclosures and their ripple effect on hard-hit markets such as Dorchester.

“Keeping mortgage rates fixed for 3 or 4 years is not going to have any effect,” he says. “It’s going to have no effect on a condo in Dorchester that nobody moved into.” Or at least where the owner on paper might not have a principal residence.

Which brings up the case of the three-decker with the “contractor special.” After its conversion to condos, all three units were sold to a single buyer in February, 2006, each for $330,000, and each with a mortgage from a different lender. On paper, the buyer was committed to using two of the units as his principal residence. On a third unit, the lender waived the occupancy requirement. Within 19 months, there were petitions to foreclose on all three units.

By October the “contractor special,” unit 3 at 43 Whitfield St, was on the market for $77,000. An ad says the unit has been gutted, with the start of a rehab and “some great extras,” including “the start of a marble bathroom,” not to mention a jacuzzi tub and “some new cabinets.”

At least unit 3 might be better than unit 1, which is on the market for only $63,000, and which an ad says is only “partially gutted.” Also mentioned in the ad: “There is no kitchen and no working bathroom.”

How could the price have fallen so much in less than two years? Was it wear and tear from the occupants? Were the units way overpriced (and over-appraised) when they sold in 2006? What’s more definite is that the seller in 2006 made more than half a million dollars, minus anything that might have been spent on improvements. The million-dollar three-decker might be an aberration, but sales prices were real enough to feed comparisons by appraisers, even for transactions in which the buyer was an owner-occupant who kept up mortgage payments. Now those buyers could once again find their property values affected by figures from 43 Whitfield St, though in the opposite way.

“You put these prices into ‘comps,’” said Anderson, “you’ll have prices dropping off the end of the table.”

“The problem is not the fraud,” he said. “It’s the people who buy the houses predicated on the fraud.”

Until the market started going downhill, there was always the possibility that even the worst case of a foreclosure could be followed by resale at a higher price. “The whole thing,” said Campen, “was based on being able to get refinanced.” And, as Campen notes, loans that went bad for buyers and investors still made money for another party, as may very well have been the case at 43 Whitfield Street.

The idea of a reprieve on ill-advised loans has also met with some backlash, since there would be a price passed on, at least to some investors. It’s possible the price of foreclosures avoided or deferred might be smaller than a loss of revenue from interest payments, but Anderson says the best way for a market to recover is to let prices fall as abruptly as possible.

“I’m a market person,” he says. “The quicker it crashes, and the quicker you get it over with, the better.”

But Anderson and Campen agree about the need for better regulation, even if it does little for people who’ve already borrowed trouble.

“Markets do work, as long as you have standards,” said Anderson.

And the tight credit that’s currently blamed for stifling demand has been equated with a loss of trust in financial markets. Lenders modifying loans on a large scale could be even one more reason for distrust by investors needed to replenish capital for mortgages.

“You can’t run an advanced market on trust. You have to have regulations,” said Campen.

The regulations that still apply to banks have largely been sidestepped by mortgage companies in the subprime debacle. That greater freedom to innovate did in a way expand home-buying opportunity, but innovation has also meant banks losing money as investors on mortgages they would have shunned as lenders. To make that less likely, Campen says the federal government should impose regulation on mortgage companies and appraisers.

“What really has dried up the market,” said Campen, “is a lack of regulation.”