Current Market: December 2007 Archives


I was thinking we were ready for a recovery here in San Diego, but if these go through unamended, that will not be the case. Just in time to be the Grinch that Stole Christmas, the Federal Reserve has decided to perform a gigantic belly-flop into a situation that was already being dealt with, and make it worse.

From the AP story:

Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee and contender for his party's presidential nomination, called the Fed proposal a "significant step backwards." Rep. Barney Frank, D-Mass., said it shows that the Fed is "not a strong advocate for consumers, and two, there is no Santa Claus. People who are surprised by the one are presumably surprised by the other."

And these are the Democrats, who never met a government regulation they didn't like.

Alright, enough hyping it up and let's get to what's available, which isn't much yet.

Here's the Press Release, and from the Federal Reserve website, here is the summarized version (actual text not available either in Federal Register or on Federal Reserve website yet)

The proposal would establish a new category of "higher-priced mortgages" that should include virtually all subprime loans.1 The proposal would, for these loans:

* Prohibit a lender from engaging in a pattern or practice of lending without considering borrowers' ability to repay the loans from sources other than the home's value.

* Prohibit a lender from making a loan by relying on income or assets that it does not verify.

* Restrict prepayment penalties only to loans that meet certain conditions, including the condition that the penalty expire at least sixty days before any possible payment increase.

* Require that the lender establish an escrow account for the payment of property taxes and homeowners' insurance. The lender may only offer the borrower the opportunity to opt out of the escrow account after one year.

The proposal would, for these and most other mortgages:

* Prohibit lenders from paying mortgage brokers "yield spread premiums" that exceed the amount the consumer had agreed in advance the broker would receive. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.

* Prohibit certain servicing practices, such as failing to credit a payment to a consumer's account when the servicer receives it, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.

* Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.

* Prohibit seven misleading or deceptive advertising practices for closed-end loans; for example, using the term "fixed" to describe a rate that is not truly fixed. It would also require that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates.

* Require truth-in-lending disclosures to borrowers early enough to use while shopping for a mortgage. Lenders could not charge fees until after the consumer receives the disclosures, except a fee to obtain a credit report.

Let's take these bullet point by bullet point, and consider their effects upon consumers and the marketplace. Actually, let's take the first two together:

Prohibit a lender from engaging in a pattern or practice of lending without considering borrowers' ability to repay the loans from sources other than the home's value.

Prohibit a lender from making a loan by relying on income or assets that it does not verify.

Goodbye, not only Stated Income loans, but NINA loans (aka "no ratio") as well.

I'm not going to pretend stated income hasn't been abused, seeing as how I've been one of the loudest voices condemning it for the past several years. Both Stated Income and NINA nonetheless have their uses, and do help significant and increasing segments of the population. Indeed, they are necessary for increasing segments of the population. Here's why: When documenting income, there are only three acceptable ways to do it. A paper is limited to income reported on the Adjusted Gross Income line of form 1040 (or the equivalent line of forms 1040A and 1040EZ), or for certain salaried employees, W-2 forms. To this, subprime adds the ability to document income via bank statements, but they don't give credit for 100% of income, and it's only net income that finds its way onto bank statements. This makes bank statements a bad way to try and qualify for a loan, because there are a lot of situations and loans where a consumer could qualify by real income, they cannot qualify based upon bank statements. Qualification by bank statements is also subject to a lot of abuse and manipulation, so I don't like to do it as it can leave me vulnerable to a scam artist.

But if you make commission or are in construction or are a contract employee or aren't an employee at all (i.e. self-employed), all of which are large and growing fractions of the population, the only acceptable way to document income is with a 1040. But if you look at form 1040, there's a whole lot of stuff that gets deducted from income prior to this determination, not to mention a lot of other expenses are deducted on Schedule C (among others) and never show up on the main 1040 at all. Upshot: People who have to qualify via form 1040 are penalized in their ability to qualify for loans. It is very common for self-employed people to be making the money to afford the loan, but to be unable to document it. This rule would prevent those people from obtaining that loan. I have seen circumstances where the secretary could document more income than the owner of the business - and it wasn't that he was hurting or that it was a new business - it was a going concern and he was donating more than the secretary's base salary to charity every year.

Similarly, the allowance for income from investments in entirely nonsense: three percent per year. For crying out loud, savings bonds pay more than that. If I have a million dollars in investments, my income had darned well better be above $30,000. What's going on is that this is a safe harbor allowance because the investment markets are unpredictable, but it's not a realistic estimate.

Finally: What about the people who got into their current homes and current loans through stated income? How in the nine billion names of god are they supposed to refinance out of their current nightmares if nobody can do stated income or NINA loans for them? This starts the tidal wave of foreclosures we just averted all over again. I realize that it's theoretically for sub-prime loans only, but expect this proposal to have a major negative impact on every local market, if enacted.

Next up:

Restrict prepayment penalties only to loans that meet certain conditions, including the condition that the penalty expire at least sixty days before any possible payment increase.

I can get behind this. In fact, I've been begging for a mostly stronger version of this for years - that no prepayment penalty can last longer than the period of fixed interest rate. Focus on the real cost of money, dadgum it! (The way the Fed puts this merely emphasizes once again that they are bankers rather than economists or financial planners). It's possible for a loan like a thirty year fixed with an initial interest only rider to increase the payment without changing the fact that it's the same rate but that's a comparatively rare thing. How about combining the two restrictions? Negative Amortization loans have a low fixed payment, but the interest rate is variable from day one. But if the Fed won't take my suggestion, I'll take what I can get.

Require that the lender establish an escrow account for the payment of property taxes and homeowners' insurance. The lender may only offer the borrower the opportunity to opt out of the escrow account after one year.

And the Fed is back to putting their foot in their mouth (after stepping in dog doo). There have been so many impound account problems over the years that many states (California among them) have dealt with the issue and actually prohibited lenders from requiring an impound account, or even from pricing the loan differently if the consumer doesn't want one. Lest there be any doubt, this is one of the few things that the state legislature of California has done right in the last thirty years. This proposed regulation is incompatible with California state law as it exists. Upshot: I'm not a lawyer, so I'm not certain. It could be that there's no more new loans in California until the discrepancy is resolved. This is a regulation to protect bankers from themselves and from the saner moments of various state legislatures. It also raises the opportunity cost of refinancing, because as I explained in my article on Impound Accounts, the consumer has to either roll this money into the balance of their new loan (where they'll pay interest on it for as long as they have a loan) or come up with thousands of additional dollars in cash until they get the check from their old impound account. Like I've said many times, the Fed is composed of bankers, and makes its decisions for the benefit of bankers, not consumers. This proposal serves nobody but bankers.

Prohibit lenders from paying mortgage brokers "yield spread premiums" that exceed the amount the consumer had agreed in advance the broker would receive. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.

This I can live with. Not that it's not subject to manipulation, but I can live with it. As I've said when I explained Yield Spread, I just plan to make my money on origination and rebate the money for the yield spread to the consumer. Alternatively, I can "pad" what I actually expect to make by a little bit when I have the consumer sign off on the yield spread. Tell them I'm going to make a full point when I'm actually looking to make eight tenths, or three quarters when it's really a half. Of course, this is bankers trying to make brokers appear less competitive by distracting consumers from the net terms to them, because if I deliver the loan I originally said I would, it makes no difference to the consumer if I make two dollars or two million via yield spread. If my loan wasn't the best they were offered, they'd have gone with someone else. One small side benefit is that it might keep some idiots from floating the rate while telling the consumer it was locked.

Two more at once:

Prohibit certain servicing practices, such as failing to credit a payment to a consumer's account when the servicer receives it, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.

* Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.

I find it mind-boggling that these are not already prohibited by the Federal Reserve. I thought they were. Rock. Gravity. Use your imagination. Of course, this will have no impact upon state chartered institutions, but California must have dealt with this one a long time ago.

Prohibit seven misleading or deceptive advertising practices for closed-end loans; for example, using the term "fixed" to describe a rate that is not truly fixed. It would also require that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates.

I find it mind boggling that this wasn't done years ago. I've written about this many times. Must be all those congressional campaign contributions the lenders make. Once again, however, absolutely no effect upon state-chartered lending institutions.

Require truth-in-lending disclosures to borrowers early enough to use while shopping for a mortgage. Lenders could not charge fees until after the consumer receives the disclosures, except a fee to obtain a credit report.

Second part first, about not charging fees until after consumer receives disclosures: This is actually good. However, it's not a common problem, and it doesn't prohibit deposits, which a lender can then keep after they fork over the disclosures. Deposits are not fees. Once an unscrupulous lender has the money, good luck getting it back. This is why the more ethical loan providers are strictly "fees at time of service." You pay for the credit report when it is pulled. You pay for the appraisal when the appraiser does the work. You pay for the survey (in those states where it's required) when the surveyor does the work. But if the lender has your money, they can hold it hostage, even if it's not technically theirs yet. Practical effect in limiting unscrupulous practices: zero. In fact, it provides the unscrupulous with a bit of ready made misdirection. "It's just a deposit - we can't charge any fees until we give the disclosures" then immediately charge the fees out of the deposit even though the disclosures are pure nonsense.

Which is another problem. As I have gone over ad nauseum, none of the initial disclosures is in any way binding. Here is a very partial list of how lenders legally lowball each and every one of the initial disclosure forms. Truth-In-Lending, in particular, is based upon figures in the Good Faith Estimate or California MLDS, which are thus subject to low-balling. As any high school student who's ever messed up their chemistry or physics experiment can tell you, if you are basing your calculations upon bad measurements, the answer is going to be wrong. Logically, faulty premises produce a faulty conclusion. Or to quote the old programmer's maxim: Garbage In, Garbage Out. It doesn't matter how you get there. The mathematical calculations used to generate the Truth In Lending form require that the numbers used to generate the base document be complete and accurate. Since that is not the case, Truth in Lending is a joke, and for most practical purposes, you should ignore APR.

All in all, this looks somewhat like hearing Mighty Mouse's famous, "Here I come to save the Day!", only to look around and see Tennessee Tuxedo (If you're not familiar, the fact that he was voiced by Don Adams of Get Smart fame should tell you all you need to know, but the cartoon penguin was even more of a bungler). The good stuff should have been taken care of decades ago, the rest is more menace than anything else. "The Federal Reserve will not fail!" If only! I'm starting to think that Peter Sellers is not dead, only in hiding, secretly running the Federal Reserve as Inspector Closeau. It would explain a lot.


Moderately good news for sellers, not so great for buyers.

I wrote a few days ago about the federal government and lenders agreeing to freeze rates.

This isn't a panacea, by any means. It may not help people who had interest only loans, which will still begin to amortize. It won't help those already in default. It certainly won't help those who bought with negative amortization, who never were paying the real payments.

That said, it will give those who could afford the initial cost of money, but have been frustrated by the fact that prices have declined and they're upside-down and therefore cannot refinance into a "normal" loan type because of that fact.

Practical effect on the market: Nothing immediately, as in right this instant. But based upon statistical summaries of who has what loans, at least half of the people who would have been forced into foreclosure in coming months are going to be able to hold on. The vast majority of these, given the five year breathing space given by the government deal, will be able to keep making their payments until such time as they are able to sell or refinance normally. This means the "huge tidal wave of foreclosures" that market doomsday advocates have been going on about becomes a shallow wash.

The statistician and the financial planner in me are actually both in admiration of this move. It not only doesn't cost taxpayers any money directly, I suspect that the longer term effect will be to save us some money, as fewer lenders go down and we have to stand up for fewer government guarantees. It won't help those who couldn't afford their loans in the first place, but it will give aid and comfort to those who suffered solely from price declines. I've said over and over again that the only time the value of a property is important is when it's bought, sold, or refinanced. Unfortunately for those who bought with 2/28s or 3/27s that have now reset higher (or are about to), refinancing is one of those times. They bought with a loan that they really could afford now, just not indefinitely. They knew they were going to need to refinance, and were counting upon their value not to have decreased critically when that time came. However, prices in much of the country have critically decreased. This means that when they needed to refinance because their rate reset, now they were prevented from doing so by the terms on which lenders will extend replacement financing.

Yes, these folks should have limited themselves to properties they could afford on a thirty year fixed rate basis, and I lost a lot of business through preaching about making the situation sustainable. However, I don't have it in me to throw people out of their homes for the (sarcasm on) horrible crime (end sarcasm) of not following my advice. The agents and loan officers who gave such people horrible advice are heaving a huge collective sigh of relief, but my desire for schadenfreude isn't great enough to endure the consequences for all those others, either. Furthermore, the more the market declines, the worse everyone gets hurt. This includes people who were thoroughly blameless as well as people like me, who did our best to avert the disaster. I also suspect that most of the malefactors are still going to get burned, having advised clients to do things which are not covered by the government agreement.

In fact, the government plan helps affected homeowners in direct proportion to how well they really could afford their property in the first place. Also being voluntary on the part of the lenders, it wouldn't have happened if they didn't see it as being in their best interests. The plan gives them cover for doing en masse what they would have had to do for those borrowers individually. All in all, the government has accomplished a noteworthy feat of financial judo.

Furthermore, it carves the heart out of any predictions of coming disaster in the housing market. There is not going to be a huge amount of involuntary supply hitting the market in the coming months. In point of fact, a large percentage of the people who would have lost their homes to foreclosure have already "voluntarily" placed their properties on the market, as the least damaging avenue available to them as individuals. Many of these did not even know they could ask their lender for a modification. Some still don't know that it's true in general, but due to the publicity about this deal, have done so about their loan in particular.

Indeed, I would expect a certain number of people to withdraw their properties from the market, as they contact their lenders and find out they can now afford to stay. They bought these properties because they wanted to live in them, after all. It's only been four days since the announcement as I write this, so I wouldn't expect to see such results of that yet, as it's going to take a while before the homeowners are sure they can take it off the market.

Here's one fact: we've seen a slight uptick in new escrows locally this last week over last, from 450 to 470. The ratio of supply to demand, at 40 to 1, is the lowest I've seen it since the early days of summer. Smack in the middle of Christmas season. You might have seen me write that nobody wants to move the Christmas Tree before, despite it being the best time of year to buy, not only vis a vis sellers but also for tax reasons. Given the market environment, this is indicative of an uptick in demand more than anything having to do with supply. In the middle of Christmas season.

So here we are seeing a small increase in demand as well as the seeds of a decrease in supply. At the time of year when activity is usually at its lowest. What does this tell you?

I've been saying for six months that mass psychology is the only thing keeping this market down. The old Fear and Greed, reversed in their effects from two years ago. People afraid prices are going lower, or greedily betting that they will. But trying to time the market - any market - is a bad idea.

San Diego Area Median Income is now $69,700 per year. For the mathematically challenged, that's a monthly income of $5800 per month. Using standard Fannie and Freddie standards (and A paper lenders have been sitting pretty these last few months), that means that the median family can afford $2613 per month. As I type this, I've got a 6% thirty year fixed rate loan for less than one total point. If someone doesn't have a down payment, add PMI of just under 1%. With $100 per month for insurance, they can afford $320,000. With $200 per month for HOA dues, that's still almost $310,000. There are seventy-five properties on the market in the same zip code as my office where the asking price is that low. If you consider the properties where it could be bargained down that far, it's at least 120 and probably over 150. In one zip code. Median income families without a down payment, and below average (but not putrid) credit. There are over 100 zip codes in the San Diego MLS.

There were 774 sales consummated in the last 30 days, throughout the county. And keep in mind that $69,700 median includes statistics of minimum wage people as well as CEOs. A couple where each earns $15 to $20 per hour can easily afford a starter property, even without a down payment. No, they can't afford the brand new 5 bedroom 4 bath 3000 square foot mini-mansion that advertisers are telling us everyone "needs", but they never could, either. Our parents raised families of five in three bedroom 1200 square foot homes, our grandparents raised families of eight in one and two bedroom 600 and 800 square foot apartments. There's no reason why a family of four can't fit in either one - no reason except envy, that is. For the last decade or so, marketers have been telling people that they didn't have to settle. Well, that was never true, and the loans that enabled people to pretend it was are no longer to be found. I've written before about the long term benefits of home ownership. You can have what you can afford, or you can miss out on the benefits altogether. Matter of fact, as I've said before, the best way to leverage yourself into what you want is to start by buying what you can afford now.

Given these facts, I'm thinking that we're seeing the low point of the market right about now. The horrible part about relying upon mass psychology and using it to try to time the market is that mathematically, at least fifty percent of the people who do so will be left in the dust when the market takes off. All it takes is one good month, and a market turn fueled by the mass psychological phenomenon (or the collapse of such) becomes a positive feedback loop. In fact, if the market does get worse, that only exacerbates the strength of the recovery when it happens. Affordability-wise, we're back where we were four to six years ago. Given the scarcity of new land for development and other constrictions of supply, and the fact that we're not suffering from any shortages of people who want to buy property here, this may be the best opportunity to buy in San Diego we'll see in our lifetime.

Caveat Emptor

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About this Archive

This page is a archive of entries in the Current Market category from December 2007.

Current Market: October 2007 is the previous archive.

Current Market: January 2008 is the next archive.

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