Feb122013

REO-to-rental is superior to principal forgiveness

REO-to-rental hedge funds are latest bogeymen touted by the political left. The evil Wall Street money grubbers are profiting from the disaster created by the Banksters. It’s a narrative Matt Taibi popularized, and now others are jumping on the bandwagon. The latest diatribe from the left attempts to link their pet cause principal forgiveness to the activities of REO-to-rental hedge funds. As many political screeds are, this one is loaded with emotional pandering and is weak on good reasoning.

The housing “recovery” is a myth

Wall Street is running a new profit game by buying foreclosed homes and renting them back to their former owners

[and this is a bad thing?]

Thursday, Feb 7, 2013 08:40 AM PST — By Shabnam Bashiri

Every day, it seems a new report comes out praising the ongoing housing recovery. In Georgia, home prices are up 5 percent over last year, a year in which we also had one of the highest foreclosure rates in the country. Seems a little odd, doesn’t it? Don’t foreclosures usually drive down the market?

That’s because the housing “recovery,” as they’re calling it, is fueled almost entirely by Wall Street private equity firms, hedge funds and the Fed’s unwavering support.

This article started out very promising. The title catches your attention, and the first two sentences sum up the current situation accurately. Unfortunately, it’s downhill from here.

After creating a massive bubble in home prices that eventually burst and caused our economy to go into a tailspin, these guys have decided to come back for more, and figured out a way to profit off their destruction — by turning foreclosed homes into rentals and securitizing the rental income.

Wait a minute. “These guys” paints all Wall Street money with the same brush. The private equity funds buying up properties today were not the same guys that funded the housing bubble. Further, it took two parties to inflate the housing bubble, stupid lenders willing to fund stupid loans and borrowers willing to take the money. Today’s hedge funds are buying properties cash with no borrower to facilitate their deals.

Many are claiming this is the “private-sector solution” for the recovery we need to get the economy going again. The argument goes that investors snapping up these homes and fixing them up does more for the community than letting the houses just sit there, blighting the neighborhoods and lowering values.

Yes, that is the argument, and it’s a good one. Nothing that follows refutes that point.

That argument might have made sense for the pilot program Fannie Mae launched last year. In that bulk auction deal, investors had to agree not to sell properties facing foreclosure for a designated period of time. Many of the homes were occupied with tenants, and vacant homes had been on the market and not sold for at least six months. Of course, that deal proved too restrictive for most Wall Street types, leading the sale in Atlanta to eventually fall through.

So how exactly does that invalidate the argument that this is a good private sector solution. What it does point out is the Fannie Mae almost botched it by imposing too many restrictions. The free market is working whereas the government regulated one is not.

The Blackstone group, the biggest player in the new REO to rental market, has spent $2.5 billion in the last year purchasing 16,000 homes, a number that amounts to over $100 million per week. Property records show that many of the homes Blackstone has acquired in Fulton County over the last few months were purchased on the courthouse steps at the monthly foreclosure auction, or through short sales—when a lender agrees to accept less than the amount owed on a loan. The vast majority of these homes are not empty, but occupied by homeowners who fell behind during the great recession.

Is that a bad thing? Blackstone probably kept most of these people on as tenants so they wouldn’t have to move. What’s wrong with that?

The sale often represents the last nail in the coffin of foreclosure in Georgia, a non-judicial foreclosure state where there is very little opportunity or time to make good once a homeowner falls into default.

The implication here is that somehow a normally executed foreclosure process is too fast or unfair. That’s bullshit. Further, like everywhere else in the country, foreclosure processing has been slowed in Georgia to the point that borrowers are squatting for years.

Blackstone, operating under its subsidiary, THR Georgia, buys the homes for cash, usually at deep discounts from the principle balance owed on the mortgage. Take one of the homes it snapped up at the November auction as an example: THR purchased the Southeast Atlanta home at auction for $90,000. The principle due on the mortgage that was foreclosed upon was $219,300.

Again, what’s wrong with that. The false implication here is that Blackstone got some kind of a sweetheart deal buying a $219,300 house for $90,000. In fact, Blackstone was the highest bidder at a public auction for a house probably worth about $110,000 today. The fact that it had a $219,300 mortgage on it just underscores how far prices have fallen and how stupid lenders were during the bubble.

If banks were willing to offer principle reduction on these inflated mortgages down to the same price they are willing to sell at auction, many homeowners would likely be able to afford their payments, and stay in their homes for years to come, contributing to the stability of the neighborhood.

Whoa! Stop right there! First off, Principal reductions fail to reduce future default rates, so the contention that it has a stabilizing effect is not proven. Also, foreclosure Is a superior form of principal reduction. The last thing we want to do is start widespread principal forgiveness because it is the worst policy option. It inevitably leads to moral hazard, which is central issue in housing bust.

I want to cloak this in terms those on the political left will understand. Principal forgiveness is like prayer in public schools. It’s an issue that everyone on their side of the political spectrum can agree on, but if it were every instituted, it would quickly break down to chaos. In the terms of prayer in public schools, once it were implemented, the coalition that supported the idea would quickly break down in heated arguments over which prayer it should be. Similarly, every loanowner wants free money, but if principal forgiveness were every to be implemented, it would quickly break down into heated debate over who gets what.

If you forgive the full amount of underwater borrowing, besides being extremely expensive, it tends to reward the most reckless borrowers. Those who were prudent get very little while those who were very irresponsible get a huge payday. And what about the HELOC abusers. Does anyone, other than the HELOC abusers themselves, want to see them get free money? Won’t the forgiveness of this debt change future borrower behavior in a bad way? The reality is that any principal forgiveness program is loaded with moral hazard problems. The left would rather ignore this truth and pander to those looking for a government handout.

Instead, homeowners get a flier posted on their door the day after Blackstone purchases the home, offering them the opportunity to rent the home they once owned.

One of the properties I bought in Las Vegas still has the former owners living in it. Their current rent is $1,000 per month whereas their old mortgage payment was $2,200. When we bought the place, we put $5,000 into the property fixing it up. These people still get to live in their family home, pay less than half the monthly cost, and the home is in better condition now. I don’t feel as if these people are being ripped off. Do you?

Meanwhile, the deep pockets of firms like Blackstone allows them to outbid virtually everyone else in the market—eliminating any chance of owner occupants looking for a new home to get a good deal while prices and interest rates are low.

Eliminating any chance? Really? The hyperbole is getting silly. Hedge funds can easily be outbid by owner occupants for MLS properties. Hedge funds want to get a good price whereas owner-occupants are buying a home for their family. People buying houses for themselves will always bid more aggressively because they don’t need to make an immediate cash return on their investment.

Blackstone has partnered with Dallas-based Riverstone Residential, the nation’s largest third-party property management company, to form “Invitation Homes.” In a three-minute commercial for Invitation Homes posted on the company’s Web site, Jonathan Gray, head of global real estate at Blackstone, claims that “there are 12 million single family homes for rent in America, but it’s not done on an institutional basis.”

The rental market has traditionally been dominated by mom-and-pop investors, most with fewer than a couple dozen properties. Many landlords build relationships with their tenants, and the communities in which the homes are located. They hire local contractors to do maintenance work, and spend the income generated from rent back in the local economy.

For as much as I would like to embrace the romantic picture of mom and pop investors like myself, most of that characterization is bullshit. Landlords don’t build relationships with tenants. I’ve never met my current landlord, and I don’t care to. I’ve never met any of the tenants in the properties I own, and I don’t care to. It’s a business arrangement that doesn’t require personal interaction. Tenants and landlords usually communicate through an property manager as an intermediary. Only in cases where landlords self manage do they meet their tenants.

As far as stimulating the local economy, both mom and pop landlords and huge equity funds hire local contractors, so that money continues to circulate. Most mom and pop landlords have loans on the property, so a significant amount goes out of the local economy, so they aren’t much different than hedge funds in that regard.

That’s not how Riverstone operates. Its Web site touts the array of services it offers in-house for property owners, from contracts with telecom and utility providers, and exclusive partnerships with suppliers, to in-house screening and debt collection. Riverstone is a one-stop shop for property management.

So Riverstone provides a superior level of service, and that’s a bad thing? Most of that money still circulates in the local economy. Property management is a local business. Riverstone will have employees and contractors anywhere they have properties, and those employees and contractors are spending in the local economy.

Probably the most disturbing of all is the partnership between Riverstone and credit reporting agency Experian. Riverstone entered into an agreement last year with Experian Rent, to turn over real-time payment history on all of its residents to be compiled into a national database.

A press release Experian put out when the deal was announced stated that, “by furnishing resident rental payment history data to Experian RentBureau, Riverstone will immediately enhance the effectiveness of its rental collections while decreasing bad debt levels and encouraging proactive rental payment practices among its residents, leading directly to increases in net operating income (NOI) and the bottom line.”

This kind of data will help Blackstone and other large firms to eliminate some of the doubt and uncertainty around renters and their stability to investors.

So what is so disturbing about that? It sounds efficient to me.

For the average renter, however, the consequences could be detrimental. Gone are the days of calling up your landlord to let them know rent will be there on the 7th instead of the 1st this month.

So being an irresponsible deadbeat is the right of every renter?

As more and more Americans live paycheck to paycheck, and wages continue to decline or remain stagnant, paying rent a few days late could lead to a negative credit score, impacting their ability to secure resources and move up the ladder of the middle class.

If the consequences are so dire, then perhaps they should be sure to pay their rent on time. This has to be one of the stupidest objections I have ever read.

Blackstone’s Jonathan Gray wouldn’t know much about that. He made $36.5 million in 2011. His boss, Blackstone CEO Stephen Schwarzman made $213.5 million.

Should they be penalized for their success?

This new plan further grows the disconnect between Wall Street and Main Street, and the difference between the 1 percent and the 99 percent.

Let’s stoke the class warfare meme whenever possible.

Interestingly enough, purchasing single-family homes isn’t Blackstone’s only recent foray into the housing market. In the lead-up to the crash, Blackstone’s hedge fund group, BAAM, chose to bet against the subprime market, purchasing credit default swaps and collecting billions in profits when the cards fell.

Sounds like Blackstone is run by some bright guys. How can I invest?

Blackstone’s hedge funds are now spending millions purchasing those very same subprime mortgage bonds for pennies on the dollar, betting on home prices going up, leading more homeowners to refinance and reinstating the value of these junk bonds. It’s a constant game of speculation for Wall Street, which culminates in bubbles being created, the rich getting richer, and communities losing control over the places they live.

In the wake of one of the greatest financial disasters in modern times, you’d think we’d have learned our lesson. Like they say, fool me once, shame on you. Fool me twice, shame on me. Maybe what we need this time around are solutions that help people find long-term housing stability, instead of chasing short-term fixes that will land us right back where we started.

Actually, we took a great first step toward avoiding another debacle. The new mortgage regulations will prevent future housing bubbles. What we don’t need is to embrace the stupid ideas about principal reduction expounded in this article.

REO-to-Rental is superior to principal forgiveness

Let’s say for a moment that proponents of principal reduction get their way and everyone gets free money and stays in their homes. Who does that hurt?

Everyone.

First, it obviously hurts the bankers and investors in bank stocks. That part I like, but then they will ask for another huge bailout, so in reality, it will be the US taxpayer picking up the tab.

Second, it hurts the owners. Yeah, I know it looks like they are getting a good deal, but this merely spares them the consequences of their poor decisions. Ultimately, it will lead to even bigger and most costly mistakes in the future. Plus, it will impact their attitudes and beliefs in ways that detracts from their character.

Third, principal forgiveness would screw prudent savers and first-time homebuyers. As I’ve pointed out before, the houses lost in foreclosures are found by another family. Nobody tells their story, but for each over-indebted loanowners put out of their misery, a nice family is waiting to move in.