The Real Deal Miami

Only road to housing recovery is stemming tide of owner-occupied foreclosures

By Jack McCabe | October 06, 2009 05:37PM

Simply put, values of real estate, stocks, companies, individuals, and most everything were artificially increased by 100 percent or more the first half of this decade primarily due to increases in real estate values from speculation fueled by leverage and debt.

The painful result of deleveraging is well under way, as the process of devaluation and riddance of debt continues.

Seventy percent of the U.S. gross domestic product is generated by American consumers. I’ve recently heard some pundits say that a “consumer-less recovery” was under way.

There is no such thing.

Stock market increases in recent months are largely due to a reduction of human resources, the selling of existing inventories, and temporary government stimulus of large product purchases like autos and homes.

The American public has witnessed the expenditure of historic sums of taxpayer funds and burden of future debt, but so far has not experienced any of the benefits the financial industry, automakers and other businesses have. Foreclosure and unemployment rates continue to climb.

To be clear… there will be no recovery without the consumer. There will be no consumerism without a healthy housing market. There will be no healthy housing market for years without a stoppage of foreclosures of owner-occupied residences.

In Florida and many other key areas around the country, the tsunami of foreclosures will not only continue, but accelerate in the next three years unless measures to reduce principal balances of inflated debt are finally instituted.

South Florida is an incubator of foreclosures and a laboratory to study the complex variables of the American boom/bust speculative real estate market. Events of the real estate depression that induced and triggered the global recession happened here first, and continue through this unprecedented time in world history.

The area is on target to surpass 200,000 new residential foreclosure filings this year, despite a foreclosure moratorium in the first quarter and recent lender sluggishness to file.

Twenty-three percent of Florida home owners are either currently in foreclosure or default, 10 times the rate just five years ago. The vast majority of adjustable-rate mortgages are nearing first-term rate increases. Unemployment is on the rise.

There’s only one solution to stem the tide of foreclosures — “The McCabe Recovery Plan.”

A combination of the current loan modification program coupled with principal write-downs is required. Reductions and remaining mortgage balances are baselined on loan-to-value ratio at mortgage inception.

An example: A home was purchased in 2004 for $300,000 with a 20 percent downpayment and 80 percent LTV. The property is now worth $150,000. The loan amount is written down to $120,000 and the buyer keeps a 20 percent, or $30,000, equity stake in the home. This is the only way to have a recovery that includes the U.S. consumer, and meaningful increases in the rate of future GDP.

Banks receive loans from the Treasury to cover 100 percent of the principal reduction of mortgage loans. Federal loans have 10- to 20-year terms at 0 to 1 percent annual interest with a one-year exemption of principal and interest, or P & I, payments to those that have recently lost jobs or are “underemployed.”

Banks would be required to loan out 100 percent of federal infused loans for new mortgages and consumer and student loans, with conservative, pre-2000 qualifications and terms.

In essence, banks which originate new loans at 6 to 10 percent interest are able to stay in business, repay the government, and make a profit. The GSEs, or government-sponsored enterprises, will buy the new correctly valued loans in the secondary market. This would also create a healthy group of commercial mortgage-backed securities, or CMBS, instruments in the future with full transparency, accurate values, and minimal risk of future foreclosure losses.

The 200 to 400 banks that most likely will fail in the next three years (411 and increasing quarterly on the Federal Deposit Insurance Corporation’s “at risk” list) from toxic real estate loan portfolios will not only stay in business, but become healthy, without capital infusion at taxpayer expense.

The current conversation amongst Washington politicians and banking interests is a trade-off for lenders to reduce principal amounts while homeowners would share any future profits with the lender. This concept would absolutely fail.

Here’s why:

It dilutes the potential future appreciation and credit availability of the homeowner. Property owners in essence would become “glorified renters,” yet with full responsibility for any future decreases in value. It would ultimately have the effect of creating a class of glorified renters. Another nail in the coffin for the “American Dream.”

With the outlook in many markets of continued price declines and flat prices for at least the next three years, why would any banks and their investors risk almost certain future failure by writing down notes without sufficient loss reserves?

Principal reductions combined with loan modification for primary homeowners funded by federal loans, without a reduction in homeownership benefits is the right plan. The question now is, will the Washington politicians and Wall Street financial institutions listen to the real estate experts?

Next up: The Corus loan portfolio sale and how it affects South Florida.

Jack McCabe is CEO of McCabe Research & Consulting in Deerfield Beach, Fla. He is an independent real estate analyst and consultant to major developers, lenders, and investors.