Dec132013

Bankers are the biggest and worst slumlords in US history

Landlords profit by charging high rents and spending little on maintenance. Good landlords charge reasonable rents to avoid excessive turnover, and they spend wisely to maintain the quality of their property. Slumlords charge unreasonable rents, and spend only what they are forced to by regulation and code. Landlords maintain properties to the quality of the neighborhood whereas slumlords deteriorate neighborhoods through deferred and avoided maintenance of their properties. Lenders behave as slumlords.

Technically, lenders are not true slumlords; most often they stay off title to avoid any direct responsibility. However, borrowers who are on title but owe more than the property is worth technically own the property, but since the lender’s encumbrance exceeds the value, the loanowner rents from the bank with only the hope of future equity. The underwater borrower’s financial position resembles an option contract currently out-of-the-money. The borrower pays the lender to stay in the property like a renter, and often they pay a healthy premium for the privilege, so the borrower can maintain a claim to potential future equity if prices rise high enough.

Since underwater borrowers rent from their lenders, the lenders act as landlords; only in this case, lenders act as slumlords. Lenders charge rent (through house payments) often far in excess of market rents. Further, lenders spend nothing on maintenance as they defer those expenses to the underwater borrower. So lenders gain above market rents and pay no expenses; the definition of slumlording.

Lenders profit from this arrangement in one other way as well. Both landlords and slumlords profit from appreciation. Since the borrower is underwater, 100% of the appreciation accrues to the lender, at least until the market value exceeds the outstanding loan balance — which is often puffed up by junk fees for loan modifications.

Some housing market pundits label large institutional investors slumlords. Some investors undoubtedly fit the definition, but most investors recognize the need to maintain the quality of the property for future resale, so most operate as good landlords. These owners wield great power over the housing market, but they are dwarfed by lenders. Banks are the largest players in the REO-to-rental space. The value of underwater loans is more than 1,000 times larger than the combined investment of all private equity hedge funds over the last few years — 1,000 times larger. Bankers are the biggest and worst slumlords in US history.

Zombies Make Dangerous Neighbors

Casey Research –December 2, 2013 10:02AM

On March 16, 2009, the Financial Accounting Standards Board (FASB), a private-sector organization that establishes financial accounting and reporting standards in the US, … motivated banks to become the worst slumlords and neighbors imaginable.

Most people believe accounting is conservative, the rules cut and dried. Accountants make economists look frivolous. But accountants are people too, and FASB succumbed to pressure from Capitol Hill in the wake of the 2008 financial crash.

How It All Started

… major bank failures seemed a certainty. Somebody had to do something—and in stepped the accounting board prodded by the House Committee on Financial Services.

The board changed financial accounting standards 157, 124, and 115, allowing banks more discretion in reporting the value of mortgage-backed securities (MBS) held in their portfolios and losses on those securities. Floyd Norris reported at the time for the New York Times,[dfads params=’groups=165&limit=1′]

The change seems likely to allow banks to report higher profits by assuming that the securities are worth more than anyone is now willing to pay for them. But critics objected that the change could further damage the credibility of financial institutions by enabling them to avoid recognizing losses from bad loans they have made.

“With that discretion,” fund manager John Hussman writes, “banks could use cash-flow models (“mark-to-model”) or other methods (“mark-to-unicorn”).”

And author James Kwak wrote on his blog “The Baseline Scenario” just after FASB amended their rules: “The new rules were sought by the American Bankers Association, and not surprisingly will allow banks to increase their reported profits and strengthen their balance sheets by allowing them to increase the reported values of their toxic assets.”

Banks were loaded with securities containing subprime home loans. When borrowers stopped paying en masse, the value of these securities plunged. Until the change in March 2009, these losses had to be recognized. With financial institutions leveraged at upwards of 30-1 at the time, the sinking valuations made much of the industry insolvent… until March 16, 2009. Since then the S&P has nearly tripled.

This is the genesis of mark-to-fantasy accounting, the rise of shadow inventory, and the launch of lender can-kicking.

Nobody has more friends on Capitol Hill than bankers, who are not wild about free-market capitalism when it works against them.

“Bankers bitterly complained that the current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their value in a normal market,” Norris wrote for the New York Times on April 2, 2009.

The change in the rules first of all allowed banks to remain in business. Second, with banks having wide discretion in valuing mortgage-backed securities, they had little incentive to care for the collateral of the loans contained in those MBSs. It may even be in a bank’s best interest to leave houses in what the Sun Sentinel newspaper called “legal limbo.” …

Banks that do foreclose with tenants living in a property are notorious for not maintaining their newly acquired properties. “Some banks are failing to follow local and state housing codes, leaving tenants to live in squalor—without even a number to call in the most dire situations,” writes Aarti Shahani for NPR.

I’m not sure why anyone would expect banks to be good property managers. “Banks don’t want to take your home and own it,” Paul Leonard, senior vice president of the Housing Policy Council, told NPR. “They’re stuck with plumbing and electrical maintenance that is well beyond their mission. They have to hire a property manager to take care of the property.”

Ideally, lenders want occupants in the property because vacant properties deteriorate more rapidly. In a perfect world (for banks), the occupant would pay for the right to live there. Banks charge rent to some, obtain full payments from most borrowers, modify loan terms to make occupancy affordable to other borrowers, and they allow everyone else to squat and pay nothing. All income, no expenses: slumlording.

If banks, not to mention Fannie Mae, Freddie Mac, and FHA, had been allowed to fail, the housing market would have cleared and stories like these would be a thing of the past. However, one intervention begets another, and the market is held stagnate.

Bank will retain their status as slumlords as long as toxic mortgage loans remain in the system. Since the current plan is to liquidate these loans through an equity sale at higher prices, and since success will take a very long time, slumlord lenders will inundate the housing market for years to come.

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High-end foreclosures hit the market

Mike recently reported that High End Foreclosures are getting their due. Today’s featured property is one such foreclosure. The lender thinks prices inflated to the peak in North Tustin. This REO is asking more than its peak purchase price. Do you think they will get it?

[idx-listing mlsnumber=”OC13241333″]

12326 BAJA PANORAMA North Tustin, CA 92705

$1,399,900 …….. Asking Price
$1,200,000 ………. Purchase Price
3/2/2005 ………. Purchase Date

$199,900 ………. Gross Gain (Loss)
($111,992) ………… Commissions and Costs at 8%
============================================
$87,908 ………. Net Gain (Loss)
============================================
16.7% ………. Gross Percent Change
7.3% ………. Net Percent Change
1.7% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$1,399,900 …….. Asking Price
$279,980 ………… 20% Down Conventional
5.02% …………. Mortgage Interest Rate
30 ……………… Number of Years
$1,119,920 …….. Mortgage
$291,506 ………. Income Requirement

$6,026 ………… Monthly Mortgage Payment
$1,213 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$292 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$7,531 ………. Monthly Cash Outlays

($1,888) ………. Tax Savings
($1,341) ………. Principal Amortization
$548 ………….. Opportunity Cost of Down Payment
$370 ………….. Maintenance and Replacement Reserves
============================================
$5,220 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$15,499 ………… Furnishing and Move-In Costs at 1% + $1,500
$15,499 ………… Closing Costs at 1% + $1,500
$11,199 ………… Interest Points at 1%
$279,980 ………… Down Payment
============================================
$322,177 ………. Total Cash Costs
$80,000 ………. Emergency Cash Reserves
============================================
$402,177 ………. Total Savings Needed
[raw_html_snippet id=”property”]