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Commentary on the Real Estate Market - August 2009
by Peter L. Zachary, MAI, MRICS

Following up on my last commentary about mortgage servicers, the Thursday, July 30, 2009 edition of the New York Times had a cover story "Late Fee Profit May Trump Plan To Modify Loans". The subtitle of the article was "A Perverse Incentive". "Mortgage Servicers Add Charges and Collect at Foreclosure". Most people don't have to read beyond the headline to understand the gist of the story. My last commentary quoted people as saying "many services can't cope" with the volume of loan modifications. However, the New York Times reported: "But industry insiders and legal experts say the limited capacity of mortgage companies is not the primary factor impending the governments' $75 billion program to prevent foreclosures. Instead, it is that many mortgage companies are reluctant to give strapped home owners a break because the companies collect lucrative fees on delinquent loans. Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue - fees for insurance, appraisals, title searches and legal services. The Times continues on the next page: "It frustrates me when I see; the government looking to the servicer for the solution, because it will never ever happen," said Margery Golant, a Florida lawyer who defends homeowners against foreclosure and who worked in the law department of a major mortgage company, Ocwen Financial. "I don't think they're motivated to do modifications at all. They keep hitting the loan all the way through for junk fees. It's a license to do whatever they want."

The Times article continues: "Legal experts say the opportunities for additional revenue in delinquency are considerable, confronting mortgage companies with a conflict between their own financial interest in collecting fees and their responsibility to recoup money for investors who own most mortgages. The rules by which servicers are reimbursed for expenses may provide a perverse incentive to foreclose rather than modify," concluded a recent paper published by the Federal Reserve Bank of Boston. Under the Obama administration's foreclosure program, a servicer that modifies a loan for a homeowner collects $1,000 from their government, followed by $1,000 a year for each of the next three years. A senior Treasury adviser, Seth Wheeler, said these payments amounted to "meaningful incentives to servicers to help overcome the challenges and competing demands they face in considering and completing loan modifications." He added that mortgage companies "are contractually obligated to the terms of this program, which require them to offer modifications to qualified borrowers." But experts say the administration's incentives are often outweighed by the benefits of collecting fees from delinquency, and then more fees through the sale of homes in foreclosure. "If they do a loan modification, they get a few shekels from the government," said David Dickey, who led a mortgage sales team at Countrywide and Bank of America, leaving in March to start his own mortgage advisory firm, National Home Loan Advocates. By contrast, he said, the road to foreclosure is lined with fees, especially if it is prolonged. "There's all sorts of things behind the scenes," he said. When borrowers fall behind, mortgage companies typically collect late fees reaching 6 percent of the monthly payments.

The Times continues: "Data on delinquencies reinforces the notion that servicers are inclined to let problem loans float in purgatory - neither taking control of houses and selling them, nor modifying loans to give homeowners a break. From June 2008 to June 2009, the number of American mortgages that were 90 days or more delinquent soared from 1.8 million to nearly 3 million, according to the realty research company First American Core Logic. During that period, the number of loans that resulted in the bank taking ownership of the home declined to 245,000, from 333,000. As a home slides toward foreclosure, mortgage companies pay for many services required to take control of the property and resell it. They typically funnel orders for title searches, insurance policies, appraisals and legal filings to companies they own or share revenue with. Ocwen established its own title company, Premium Title Services, in part to keep more of the revenue from foreclosures, said Ms. Golant, who helped start it. "It was hugely profitable," she said. "Premium Title would charge for the title when it got transferred to Ocwen, then charge again when it got transferred to the new buyer, and then sell title insurance. It was easy money." Mortgage companies not only gain this extra business through their subsidiaries, but also collect reimbursement for the payments when the houses are sold. The investors who own bad mortgages accept whatever is left. Investors typically do not notice how much they give up to the servicers, because fees are embedded in complex sales. "It's under the radar," Ms. Golant said. Ultimately, the benefits of delinquency erode incentives for mortgage companies to dispose of troubled loans quickly, say experts, allowing distressed houses to decay and fall in value - a fact of little interest to the servicer. "At the end of the day, it doesn't matter what the house sells for, because they don't take that loss," said Ms. Golant. "Meanwhile, they are collecting all these fees."

In conclusion, the banks and mortgage companies make money on mortgage loans at the beginning of the loan and at foreclosure. After all, it's not their money that they are lending.

On Wednesday, July 29, 2009, the New York Times headline on the front page was: "2–Year Descent in Home Prices Appears at End." The subtitle of the article was "New Hope of Recover. 8 Cities Show Gain but Overall Index Is Flat – Some Skeptics". The Times reports: "After a plunge lasting three years, houses have finally become cheap enough to lure buyers. That, in turn, is stabilizing. Prices, generating hope that the real estate market is beginning to recover. Eight cities, including Chicago, Cleveland, Denver and San Francisco, showed price increases in May, up from four in April and one in March, according to data released Tuesday. Two other cities, Charlotte, N.C., and New York, were flat. For the first time since early 2007, a composite index of 20 major cities was virtually flat, instead of down. "We've found the bottom," said Mark Fleming, chief economist for First American CoreLogic, a data firm. The release of the surprisingly strong Case-Shiller Price Index, compiled by Standard & Poor's, followed earlier reports that sales of existing homes rose last month for the third consecutive time, while sales of new homes rose in June by the largest percentage in eight years. All of the improvements are tentative, and come after a relentless decline that knocked more than half the value off of houses in the worst-hit cities. Some skeptics say they believe the market is merely pausing before it resumes falling and that much of the life in the market is coming from speculators. Even the most enthusiastic analysts acknowledge that rising unemployment, another leap in foreclosures or a significant jump in interest rates could snuff out progress. Still, hope is growing in some quarters that the worst hag passed. "Recession is over, economy is recovering - let's look forward and stop the backward-looking focus," John E. Silvia, the Wells Fargo chief economist, wrote Tuesday in a research note. The Case-Shiller figures released Tuesday showed May prices were down 17.1 compared with May 2008. As bad as that may sound, it was the fourth consecutive month that price declines slowed - a step in the right direction, but perhaps not cause for widespread celebration. More attention was focused on the news that, when May was compared with April, the price index for 20 major cities showed a half-percent gain. It was the first month-over-month increase in the index in 34 months. "It is very possible that years from now we will say that April 2009 was the trough in home prices," said Maureen Maitland, vice president for index services at Standard & Poor's. When the numbers were adjusted for seasonal factors, however - the usual way housing figures are presented - the slight gain disappeared and the index was essentially flat. Half of the cities showed continued declines. One reason the market is perking up in some places, real estate agents say, is the encouragement offered by such measures as the first time buyer's tax credit of $8,000. All the more reason, said the National Association of Realtors, to not only extend the credit but expand it. The association is lobbying for the current credit, which expires in December, to be replaced with a $15,000 credit for all buyers. "This is a relatively low-cost way to keep the housing market moving forward," said Paul Bishop, the association's managing director of research. Another reason for the market's resurgence is the prevalence of foreclosures, which make up about a third of all existing home sales. In some troubled regions, agents say they cannot remember the last transaction that did not involve a bank disposing of a property. These communities are not yet showing any improvement in prices. Las Vegas was the worst-performing city in the May Case-Shiller index, falling 2.6 percent. Prices have fallen there by a third in the last year. "The mom and pop that work at the Hilton can now afford a home here again," said Justin Pechonis, a Las Vegas real estate agent. "Las Vegas is a great place to buy now." But not from him. Sickened by seeing so many clients foreclosed on, he is getting out of the business. He now drives a taxi. All this uncertainty breeds a hesitancy that seems to show up in nearly every sale, especially at the higher end of the market. When Margot and Pascal Lalonde decided in April to sell their two-bedroom condominium in the North End of Boston, they methodically quizzed six experienced agents about a good price. List it for under $500,000 unless you want to be here for months, said one agent. Two others said they should demand $675,000. The other three were in between. "In a market with so few sales, no one knows what to do," said Ms. Lalonde, a consultant. After 80 days on the market and two small price reductions, the condo is now under contract for $550,000. The buyers examined the apartment six times. The Lalondes, who are moving to Short Hills, N.J., expect to be no less careful when they buy.

And to make things even better, the headline on the first page of the New York Times on Saturday, August 1, 2009 was "In Hopeful Sign, Output Declines at a Slower Pace." The subtitle of the article was "Economy Contracts 1% Consumers Still Fearful of Spending Slow Come Back Seen." The Times Stated: "The American economy's long I decline leveled off significantly - from April through June, the government reported on Friday, crystallizing expectations of a turnaround in the second half of the year. The nation's output shrank at an annual pace of 1 percent in the second quarter, after contracting at a rate of 6.4 percent earlier this year. Government spending, helped by the first payments from the administration's $787 billion stimulus package, propped up activity in the latest quarter and accounted for 20 percent of the country's output. But consumer spending, which makes up about 70 percent of overall economic activity, has continued to fall as fearful Americans save more. Many economists express concern about what will happen once government spending lets up if consumers remain worried about losing their jobs and their weakened household finances. "The most severe part of the decline is behind us," said Joshua Shapiro, chief United States economist at MFR, an economic consulting firm. "But it's hard to say how sustainable whatever bounce we might see will be. It depends largely on whether the consumer has the genuine ability to' spend, or if it's all just government cheese being handed out." The growing reliance on the government to fuel the economy could put the Obama administration and other Democrats in a difficult position. Many economists say that any recovery could be painfully slow, lasting months if not years, and could stoke dissatisfaction among voters. Indeed, the report released Friday included revisions that revealed this recession had been deeper than previously believed, and officially cast the downturn as the longest since the Great Depression, at 18 months. "We're going from recession to recovery, but at least early on, it's not going to feel like one," said the chief economist at Moody's Economy.com, Mark Zandi. Bright economic spots include a pickup in the stock market, corporate profits and some housing markets, coupled with a slowing pace of job losses. But employers tend to wait to hire more workers until their businesses strengthen, so the job market may not improve for some time. The threat of sustained double-digit unemployment remains in coming months. And with about 15 million people already out of work, pressure may mount on government officials to speed up the recovery. At some point it becomes Obama's economy, not Bush's economy anymore," said Dean Baker, co-director of the Center for Economic and Policy Research, a liberal research group in Washington. "He made a big mistake in overselling the first stimulus, and then in celebrating all the 'green shoots.' That just opens the door for people to say, 'Where are my green shoots? I still don't have a job. " Historically, American consumers have not recognized that a recession is over until well after the economy has begun expanding, in part because they focus on job creation. Still, recent improvements in the stock market, as well as the easing pace of job losses, could help consumers feel that they are finally rebuilding their nest eggs. With a larger cushion, and a little more breathing room, economists say, families may eventually start to feel comfortable spending again. "I don't know when it'll happen, but the savings rate will plateau at some point," said Greg McBride, a senior financial analyst at Bankrate.com. "Consumers will strike that balance between living within their means but still living life." Now, even as jobs are vanishing and wages remain flat, many forecasters expect the downturn to level off. Economists say that businesses as diverse as small manufacturers and big automakers are poised to rebuild their depleted inventories, which fell by an annualized $141 billion in the second quarter. That restocking could spur economic growth later this year. The Commerce Department's quarterly G.D.P. assessment provided a tour through a dreary year. The economy withered during each of the last four quarters, its longest string of declines in at least 60 years. Businesses cut their investments and laid off millions of workers. Imports and exports tumbled. In interviews, small-business owners say that the ground is slowly firming under their feet. Business investment in structures like new factories and office buildings fell at an annual rate of 8.9 percent in the second quarter after declining by more than 40 percent in the previous three months. And investment in equipment and software, which fell 36 percent this winter, dropped a more modest 9 percent in the second quarter. But many employers who have laid off workers or scaled back say they are not about to increase their spending or add to their staffs. In Nashville, Jerry Robertson laid off one of his 15 employees, cut his budget for advertising and trade shows and moved into a smaller office space to reduce costs at his company, which helps trucking companies manage, their operations. His business is down about 10 percent from last year, and clients are still fading. "We do see it not declining as fast as it was, but we don't see any growth," Mr. Robertson said. "We're still going down."

Despite the good news about housing prices stabilizing and the rate of decline of the nation's economic output slowing, there is still some pain that we will all feel until the unemployment rate increases.

Many years ago, in the early 1990's, I appraised a major office building on Fifth Avenue in Manhattan. If you recall, we were in a recession in the early 1990's. I asked my client when he thought the economy would get better. He rubbed his thumb and first two fingers (the money sign) and said "People have no money, when they have money to spend the economy will get better." An economist could not say it better.

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