Government Spending vs. Austerity

Currently, there is a big debate on whether the government needs to tighten its belt and cut the deficit or whether government stimulus is needed in order to jump start the economy and keep things moving. I had a great discussion with a reader of the blog via email regarding my post last week titled One Step Forward, Two Steps Backward.

I think most people would agree that the government cannot spend our way out of recession into perpetuity and that it is in everyone’s best interest to cut the deficit. One of the proposals for the government to cut back has been to end the subsidization of the housing market. This could manifest in several different ways. This was my reply to the blog reader in regards to ending mortgage interest tax deductions and reducing the home loan amortization down from the standard 30 years:

“I read Professor Shiller’s proposal for curtailing the mortgage period down from thirty years and removing the government subsidies that go with it. I don’t think that is necessarily a bad idea, I just am hesitant to say it is the right fix right now.

ONE STEP FORWARD, TWO STEPS BACKWARD

This week, the S&P 500 is on track to have one of its best weeks in a year. The market closed last Friday, July 2, 2010 at about 1022.58. At time of this writing, the S&P stood at 1077.62; this yields a gain of more than 5% in a short (4 day) week of trading. Many big corporations, including some big banks like Bank of America, report earnings next week and investors continue to wonder whether we are on the edge of a double dip recession or a sustained rally.

Although the market has shown good signs of life this week, I think the best indicator of stability in the economy right now is going to be a stabilization and possible increase (albeit a very modest increase) in home values. Here in Arizona, the idea that home values will trend upward is optimistic but with all the foreclosures and bank owned properties, I am hesitant in thinking there will be a sustained bull housing market.

Politics aside, the current legal battle between Arizona and the Federal Government will likely have some implications for the housing market here. Time will tell whether the hot button immigration issues here will lead to an influx of homeowners or an outflow of people leaving, but personally I don’t think too many people will make the most important purchase of their life based on court battles.

Right now, so many homes are for sale, with many more owned by the banks, that it is truly difficult for stabilization to occur. Simple supply and demand dictates that too much supply and not enough demand will drive down prices because of a flooded market.

What scares me the most is the idea that even if there is stabilization, the banks could easily derail a recovery. Right now, the banks own massive amounts of homes, and a lot of banks are not putting them on the market because of the weak demand for housing. What this means is that as soon as the market starts to pick up, we will start to see more bank owned houses that are currently vacant put up for sale. This will again flood the market with supply without lockstep increases in demand, driving down prices yet again.

The obvious message of this is clear, people needing to sell their homes will face a saturated market; homeowners will be forced to compete for buyers with the banks that have the time and resources to wait out a sale and the means to finance a potential buyer.

With so many foreclosures happening the banks continue to stockpile their inventory of homes. Obviously the housing market is not a prime seller’s market right now, so these banks will likely sit on these repossessed houses, keeping them vacant, until property values show signs of appreciating. That’s when the market will be flooded yet again with these bank owned homes, killing off any increases in home values. One step forward, two steps backward.

The effect of supply without demand will also negatively impact the refinance market as well. When prices go up, the supply will be again flooded, bringing down values. What this means for homeowners needing to refinance is high volatility in appraisals. Imagine that in 2011, your neighborhood sees an increase in home prices and you successfully refinance given the newfound equity in your home; the bank suddenly puts two or three homes they own, that have sat vacant, for sale in your neighborhood to profit from the appreciation; this flood of supply will inherently drag down all the home values of the neighborhood; your home value will go down with the neighborhood, quite possibly putting the newly refinanced into a position of being underwater. This could lead to an increase in strategic defaults. One step forward, two steps backward.

Got questions? Send me an e-mail: Matt@desertedgelegal.com

DISCLAIMER:

****MATT AZARI IS NOT A LICENSED ATTORNEY. THIS BLOG IS COMPRISED OF HIS OPINIONS, OBSERVATIONS AND INTERPRETATIONS AND IS NOT INTENDED TO BE CONSTRUED AS LEGAL ADVICE. PLEASE CONSULT WITH AN ATTORNEY BEFORE RELYING ON OR TAKING ANY ACTION BASED ON THE INFORMATION IN THIS BLOG.****

Principal Reduction Coming to AZ?

Wall Street got their bailout, that’s bitter, yet old news; however the outspoken thought on the minds of the rest of America remains, where’s the bailout for Main Street? Under a new plan called Save My Home AZ, expected to launch in September of 2010, some Arizona homeowners may finally get some much needed help in reducing the balance of their mortgages by $100,000 or more. The program is a trial run, paving the way for a broader reaching program to keep homeowners in their homes.

Back in February, the Arizona Department of Housing received $125 million in federal funds to help stabilize Arizona’s declining home market. Recently, Washington, D.C. gave its blessing to allow Arizona to use the money to reduce mortgage balances for up to 1,850 households. Here are the details:

• Borrowers can receive up to $50,000 in state-issued funds to use towards what they owe on their mortgage
• 75% of the funds will be issued in Maricopa County
• These “loans” will in all probability not have to be repaid in full
• Households that have seen their incomes slashed can receive up to $12,000, to be applied to up to 1,000 households
• Incentivize lenders to work with homeowners to settle second mortgages by offering the lender up to $5,000 if they settle with the homeowner

Though this plan will certainly not neutralize the foreclosure situation across Arizona, it is a start. The pilot-program promises to show what outcomes can be expected by directly helping distressed homeowners instead of the trickle down bailouts we have seen over the past year that seem to only benefit the banks.

However, like any bit of good news that sounds too good to be true, the devil is in the details. The biggest red flag is that participation by the lenders is optional. Additionally, the program relies on a matching system where the lender matches the dollar amount of federal funds received by homeowners. With so many big lenders out there refusing to negotiate mortgage modifications, there is definitely cause for skepticism as to whether the big lenders will capitulate and participate. Moreover, eligibility guidelines are quite narrow (see “Guidelines” below), meaning the majority of the 50,000 expected foreclosures in AZ this year will not be stopped by this program.

On its face, this plan does offer a bit of pragmatism, which has been noticeably absent throughout this entire housing crisis. For example, homeowners who receive these home-saving funds would be obligated to repay portions of the “loans” if they sell the home within ten years or if the home appreciates in value.

I remain skeptical for several reasons. First, why now? Where was this program last year or the year before? It almost seems as though it is too little too late. Like previous modification programs, this plan seems plagued by strict and narrow guidelines, disqualifying most homeowners. When I worked as a mortgage banker, supposedly modification programs were available to homeowners with Freddie or Fannie backed loans; however never once did I connect with a client who qualified, regardless of whether their loan was Fannie or Freddie.

Second, is $125 million in funds enough to spur any sort of a noticeable correction in the Arizona housing market? With an expected 50,000 foreclosures in AZ this year alone, $125 million sounds like a drop in the bucket. Just for a simple comparison, figure the mortgage balance of each foreclosure averaged over the 50,000 expected foreclosures is $50,000 (completely hypothetical, just a round figure to use as an example). That yields $2.5 billion, so the $125 million in federal funds covers a mere 5%, hardly enough to correct the housing crisis here in AZ.

My biggest skepticism lies with the lenders; with participation optional, it seems unlikely that most big lenders will voluntarily take part in this plan. If they will, why wouldn’t they just negotiate with homeowners to settle a modification from the get go?

Guidelines:

Foreclosures must be imminent. Households must have exhausted all options for remaining current on payments.

Modest primary residences. Assistance may only be used for borrowers’ primary residences, and may only help households with incomes at or below 120 percent of the area’s median income.

Personal responsibility. Money may not go to borrowers who face foreclosure for “self-inflicted” reasons, such as refinancing to take out equity or basing mortgages on undocumented income.

Hardships. Applicants must demonstrate hardship, such as reduced income due to underemployment, medical condition, divorce or death.

Source: “Proposal for use of HFA Hardest-Hit Fund (Third Revision),” Arizona Department of Housing

If you have any questions, please feel free to email me at matt@desertedgelegal.com.

DISCLAIMER:

****MATT AZARI IS NOT A LICENSED ATTORNEY. THIS BLOG IS COMPRISED OF HIS OPINIONS, OBSERVATIONS AND INTERPRETATIONS AND IS NOT INTENDED TO BE CONSTRUED AS LEGAL ADVICE. PLEASE CONSULT WITH AN ATTORNEY BEFORE RELYING ON OR TAKING ANY ACTION BASED ON THE INFORMATION IN THIS BLOG.****

Video: Commercial Real Estate REALLY Is the Next Big Crisis

Commercial Real Estate REALLY Is the Next Big Crisis

On August 10, 2009 I posted an article asking readers if commercial real estate was the next big crisis. I spent a lot of time writing that article because there wasn’t a lot of reliable information on the commercial real estate situation available.

Interestingly, it turns out that we were ahead of most of the major media with this blog post. And, tooting my own horn, the video on my YouTube channel is the most-watched video, and the blog post has received the most comments of any blog post on the site.

Furthermore, I have it on pretty good authority from a source inside the Treasury (who will remain anonymous because they didn’t want to get into trouble. Makes us sound important, doesn’t it?) that the Treasury is more worried about commercial real estate than most people, even so-called real estate experts, realize. I suspect that there isn’t much information out there because the recession is supposedly over (or we’re all tired of hearing all the bad news!)

The Fed probably learned a lot from the residential mortgage crisis and it won’t be caught unawares this go round, which explains Plan C and the easing of the rules for restructuring commercial mortgage backed securities.

This week, the Wall Street Journal reported that the Fed has released new rules that make it easier for distressed property owners to restructure loans that were packaged by Wall Street firms and sold as securities. The WSJ says that most people in the industry were happy with the new rules, but others warned it would be problematic, especially for the servicers of the securities who will be under pressure from borrowers and competing classes of investors.

The IRS also helped this week by issuing new rules that will give servicers some wiggle room in negotiating with borrowers on performing loans that may not be due for some time. The new rule applies to all loan modifications that were made after Jan. 1, 2008.

Finally, for a more personal spin on the commercial real estate crisis, check out this story from Slate.com about a guy names Scott Lawlor and his company, Broadway Partners’ acquisition of Boston’s Hancock Tower and subsequent default on the loan in January 2009.

The article’s author says that Lawlor has become the whipping boy for the commercial real estate crisis, despite the fact that he was doing the same thing many other commercial real estate players were doing before the credit markets dried up.

I wonder how many more Scott Lawlors are out there.

It’s interesting to me that commercial real estate is a lagging indicator of economic problems in the country – it was still going strong when the problems with residential mortgage began. I don’t think anyone (except maybe Josh) thought that the recent economic problems were going to be as bad and last for as long as they did. Until jobs are created, commercial office space demand will remain low, creating a drag on the economy.

Clearly, we have a big problem on our hands. My bet is on another round of bailout money for the coming crisis in commercial real estate. The Treasury’s Plan C, a pre-emptive program, won’t be enough to stop a big wave of loan defaults, bankruptcies and foreclosures.

If you need help renegotiating a commercial loan modification, please contact me. We have attorneys in our network who can help you out. As I mentioned before, I just did a commercial loan audit and found some problems with the paperwork. As it turns out, residential and commercial lending guidelines have more in common than you might think.
If you offer commercial loan modification services, we’d love to hear from you – I’m open to a guest blogger who wants to explain how it works to our audience. Please comment or send us an e-mail.

Plan C: The Treasury is Preparing for a Commercial Real Estate Crisis

In the recent past, I’ve seen a lot of buzz on the internet about how a commercial real estate crisis is our next big economic problem. There has not been much in the way of commentary from reputable sources in the last several weeks, so I decided to dig a bit deeper.

Interestingly, there seems to be a wave of positive economic news coming from the media these days and discussion about the problems in the residential mortgage industry have, at least for now, died down. Whether the positive economic news is accurate is another issue. Thus, the shift of attention from the residential mortgage problems to commercial real estate makes sense.

Also, as I researched the information for this post, I concluded that commercial real estate is complex and I think the average consumer isn’t really interested in figuring out what’s wrong with commercial lending. Many of these people are still trying to save their homes.

Commercial real estate loans are structured differently from residential mortgage loans. Most commercial real estate loans have a shorter term, say, ten years. At the end of the loan term, the loan is not paid in full as a result of making monthly payments over the loan term. Instead, a percentage of the loan is due and payable as a lump sum or balloon payment.

The basic problem is that many of the commercial real estate loans that were made over the last decade will be coming due over the next couple of years. Many borrowers planned to refinance the loan, but with the commercial lending markets drying up, many borrowers face foreclosure if they cannot obtain financing.

Similar to residential mortgages, many of these commercial loans were made without regard for acceptable underwriting standards so that they could feed the demand for commercial mortgage backed securities (“CMBS’”).

I’m already seeing commercial property owners asking for help with commercial loan audits to help them get a commercial loan modification. I’m also currently auditing a loan on behalf of a commercial investor being sued by the second position lender for a deficiency after a foreclosure.

In an article published in early July, the Washington Post discussed the Treasury’s “Plan C”, of which commercial real estate is seen as one of several problems that could derail economic recovery. The Post reported:

“The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.

Banks and other firms that provided such loans in the past have sharply curtailed lending.

That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt — some estimates peg the total at more than $3 trillion — that they will need to refinance. These loans were issued during this decade’s construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.

The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.”

Or, as explained by Jon Greenlee, the Fed’s Associate Director, Division of Banking Supervision and Regulation, in his testimony before the Federal Reserve on July 9, 2009:

“The decline in the CRE market has been aggravated by two additional factors. First, the values of commercial real estate increased significantly between 2005 and 2007, driven by many of the same factors behind the residential housing bubble, resulting in many properties either purchased or refinanced at inflated values. Prices have declined about 24 percent since their peak in the fall of 2007 and market participants expect significant further declines. Second, the market for securitized commercial mortgages (CMBS), which accounts for roughly one-fourth of outstanding commercial mortgages, has been largely dormant since early 2008 while many banks have substantially tightened credit. The decline in property values and higher underwriting standards in place at banks will increase the potential that borrowers will find it difficult to refinance their maturing outstanding debt, which often includes substantial balloon payments.

The higher vacancy levels and significant decline in value of existing properties has also placed pressure on new construction projects. As a result, the construction market has experienced sharp declines in both the demand for and the supply of new construction loans since peaking in 2007.

The negative fundamentals in the commercial real estate property markets have broadly affected the credit performance of loans in banks’ portfolios and loans in commercial mortgage backed securities. At the end of the first quarter of 2009, there was approximately $3.5 trillion of outstanding debt associated with commercial real estate. Of this, $1.8 trillion was held on the books of banks, and an additional $900 billion represented collateral for CMBS. At the end of the first quarter, about seven percent of commercial real estate loans on banks’ books were considered delinquent. This was almost double from the level a year earlier. The loan performance problems were the most striking for construction and land development loans, especially for those that finance residential development. Notably, a high proportion of small and medium-sized institutions continue to have sizable exposure to commercial real estate, including land development and construction loans, built up earlier this decade, with some having concentrations equal to several multiples of their capital.”

In May 2009, the Federal Reserve’s Term Asset-Backed Securities Loan Facility (“TALF”) opened up to commercial mortgage-backed securities that were issued in 2009. This bailout might sound good, but these securities aren’t the ones with the problems. It’s the securities that were sold in before the economic crisis and based on the old economic model that’s troubled, and the government isn’t buying those.

Given all of this information, there’s no question in my mind that commercial loan defaults are going to be a problem for economic recovery. The question is, how bad will it be? Some estimates range in trillions of dollars and others say that real estate has bottomed out. I think the government is facing pressure from Main Street for a recovery, so much that they’re not going to let commercial real estate fail and further hamper the economic recovery.

What do you think? Please post your comments!