John T. Reed on the Mortgage Meltdown - Sort of

I was curious what my favorite real estate guy, John T. Reed would have to say about the meltdown in the subprime mortgage market. Nothing, as it turns out, at least yet.

Something he wrote about old time "nothing down" huckster Robert Allen reminds me of the last few years of real estate investing.

Author of best-selling books Nothing Down, Creating Wealth, and The Challenge. One-time seminar guru and founder of many Robert Allen Nothing Down clubs around the U.S. Allen’s advice is generally terrible. Although I did like a chapter he wrote on property-wanted ads. Otherwise, he is little more than a financial publicity stunt man.

My book How to Buy Real Estate for Little or No Money Down photographically reproduces documents from his famous “Send me to any city” nothing-down deals. The L.A. Times accepted his “challenge” and made him do them in San Francisco which is near where I live. I went there and got all the documents on each of the seven deals. Some were also done in the county where I live.

On one, which was apparently typical, the documents seem to show that Allen lied to the first-mortgage lender—Bank of America—about whether there was any secondary financing (there was—a seller mortgage) and about his intention to occupy the San Francisco condo as his principal residence (He lived in Provo, UT at the time and never occupied the SF unit). At that time, June, 1981, when home mortgage interest rates were at 18%, Bank of America would only make loans to owner occupants and prohibited all secondary financing. I have their loan policy for the date in question in the book, too. My wife was a loan officer for Bank of America at the time. [Note to bogus gurus: do not brag about deals that you do not want me to look into—especially in the San Francisco area. John T. Reed].

At best, you would have negative cash flow following his books. At worst, you would go bankrupt and wind up in jail. He doesn’t put it this way, but his nothing-down techniques almost all require you to mislead an institutional lender or take advantage of an unsophisticated seller or both. The president of his Atlanta Robert Allen Nothing Down Club literally went to federal prison (at Eglin AFB, FL) for doing illegal nothing-down deals. There is virtually nothing in his material about how to make a profit. Rather he simply assumes that real estate goes up so much every year that you need only buy it to cash in. Click here for a little story about his association with probate guru Jim Banks.

Allen himself got into financial difficulty with the IRS as early as 1984. In 1986, IRS filed a $346,395.79 lien against Allen. In September of 1987, when I wrote an article exposing his financial difficulties, he also had:

* another $65,649.90 IRS lien
* more than $76,000 of delinquent tax warrants filed by the State of Utah
* lawsuits and judgments regarding over $100,000 in unpaid fees to fellow gurus who spoke at his meetings

Allen declared Chapter 7 (total liquidation used when the bankrupt has a negative net worth) bankruptcy in San Diego on July 10, 1996 (Bankruptcy Petition #96-09323-LA). Bankruptcy creditors sometimes get pennies or nickels on the dollar. According toAllen’s bankruptcy papers, his creditors got nothing. The Initial Meeting of Creditors was held on August 9, 1996. A lawyer tells me that Allen would have been asked quesitons under oath about his assets during that meeting. A copy of the transcript of that meeting would be interesting. It would typically be in the case folder. See my 8/96 article.

The Allen’s attorney, Richard V. Vermazen, got $2,000 to handle their bankruptcy according to court papers. The Allen’s were discharged from their debts on 10/17/96. The case was closed with no distribution to the creditors on 10/31/96.

The creditors who were stiffed in the bankruptcy file were:

* American Express Optima Card
* Bank of New York
* Citibank Visa
* Farmers InsuranceGroup (San Diego)
* Ferrette & Slater ALLC (San Diego)
* Franchise Tax Board (California income tax)
* Internal Revenue Service
* John Graff (Highland, UT)
* Mark IV Properties (San Diego)
* McKay, Burton, Thurman (Salt Lake City)
* Neiman Marcus
* Nordstrom
* Robinson-May
* Saks
* Scalley & Reading APC (Salt Lake City)
* Scott Meredith Agency (New York city)
* Shirl and Gail Loveless (Provo, UT)
* Simon & Schuster (New York City)
* The Broadway (Phoenix)

[...]

I think Allen has an interesting story to tell. But it’s not the one he sells. He should speak about real estate investment the way a reformed alcoholic speaks about drinking.

It's 2007 and there is a national wave of guys like Robert Allen who bought overpriced real estate with liar loans, and a bunch of irresponsible mortgage brokers who let them.

Not Just Up the Famous Brown Creek without a Rowing Implement

“We are in a chicken wire boat on Lake Diarrhea with lead oars.”
 -- Out of Work Mortgage Broker

Those guys were raking in the dough while it lasted (I'm assuming AE is "account executive"):

"For those ex employees on this thread that were probably in the 1st round of cuts months ago and are bitter about option one keeping the "best of the best" the details about the severance are that the AE´s will continue with their guarentee and benefits through march at 10k per month and then get a lump sum payment of 10k per year of service. The average AE is getting over 100k in the next 90-120 days.

That's a heck of a lot of severance pay for a division that's going under. I hope taxpayers aren't going to be bailing out H&R Block's bad subprime loans while they're handing out those kinds of lovely parting gifts to laid-off mortgage brokers.

Henry Paulson's Plan to Avert a Mortgage Collapse

There's been a lot of talk about the Bush administration's plan to forestall problems with adjustable rate mortgage resetting. Some blog posts have hinted that Bush planned to use taxpayer money to bail out homeowners or mortgage lenders, but there's been no definite work on that, or much information on the plan until now.

It turns out taxpayer money is not involved in the plan. From The New Yorker:

The Paulson plan is meant to buy borrowers—and, arguably, the economy—some time, by postponing the interest-rate resets for five years.

Not for everyone, though. The plan sets up a system of triage, separating borrowers into three categories: those who will be able to keep paying after the rates reset, or else refinance their loans; those who can pay now but won’t be able to when the rates go higher; and those for whom even the current rates are too high. Only the second group will get help. Also, the plan doesn’t go into effect until next year—if your loan resets on December 31st, you’re out of luck.

In theory, this solution is one that lenders could have arrived at on their own. Lenders often lose less money on a renegotiated loan than on a foreclosure, so they should be well equipped to triage bad loans, separating the workable from the truly hopeless cases. So why did the government need to get involved? One reason is that so many loans are going bad that the companies servicing them don’t have the people or the skills to evaluate them on a case-by-case basis. (A recent study found, for instance, that mortgage servicers renegotiated only one per cent of loans that reset in the first part of this year.) And, because most of these loans have been packaged into securities and sold to outside investors, the process of renegotiating mortgages is now far more complicated than just talking to the loan officer at your local bank. Paulson’s plan streamlines and simplifies the process by creating rough-and-ready definitions of creditworthiness. The Treasury Department’s sponsorship also permits a degree of collusion that might normally be considered illegal—banks aren’t typically allowed to work together to set loan prices. And it reduces, although it certainly doesn’t eliminate, the risk that the investors who actually own these mortgages will sue to prevent the wholesale renegotiation of the loans they own. It’s a powerful example of the way government can shape markets without ever passing a law or a new regulation.

Unfortunately, it’s also an example of the limits of such intervention. Although the plan will provide real relief for at least some homeowners, it’s more like a Band-Aid than like the major surgery that some of the hype makes out. That’s because at this point interest-rate resets are just a small part of the mortgage-market problem.

Mortgage Meltdown Explained

BBC - The US sub-prime crisis in graphics:

The US sub-prime mortgage crisis has lead to plunging property prices, a slowdown in the US economy, and billions in losses by banks. It stems from a fundamental change in the way mortgages are funded.

Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do.

In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing,

But it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue.

Word of the Day: NINJA Loans

From BlownMortgage.com:

But the biggest problem facing subprime borrowers is that lenders now require you to qualify for the financing. Long gone are the NINJA (No Income, No Job or Assets – No Problem!) loans. To get a Fannie/Freddie fixed rate loan you have to have a 620+ FICO score, document your income, assets, do a full appraisal and standard GSE underwriting.

Previous WOTD - HOV Positive

2007 U.S. Home Foreclosures by State and County

Predictably, the foreclosure rates in California and Florida are considerable, along with Arizona and certain metropolitan areas such as Detroit, Atlanta, Denver, Dallas, and Houston.

What surprises me is all of the foreclosures in Tennessee. The Tennessee foreclosure rates aren't as intense as in those states and cities above, but the foreclosure phenomenon seems to be spread throughout the entire state such that Tennessee looks like it was colored in with a bucket of orange paint. From The Atlantic:

Not least, the crisis is harming the neighbors of people in foreclosure, even those who aren’t having trouble making loan payments. According to one academic study, every foreclosure reduces the value of all other houses within an eighth of a mile by about 1 percent, as the sight of vacant property scares off potential buyers. Combine that with a market already in decline, and neighborhoods that begin to have troubles can go off the cliff. On the street pictured, three houses not in foreclosure have been languishing on the market for 72, 97, and 149 days; asking prices along the cul-de-sac vary widely, but average about $40,000 less than the comparable prices in the first two quarters of the year.

TLC, Home of "Flip That House" Debuts "Please Buy My House"

Sign of the times:

Viewers meet three families frantic to escape the real estate trap. Watch as they try one desperate move after another to move their property into the 'sold' column. The stakes are high -- who will succeed?

Tamara on the Housing Crisis

"Isn't trying to get people who couldn't frickin' afford it into home ownership one of the reasons we wound up in our current pickle? Look, people, while owning your own home may be part of the American Dream, it's not part of the Bill of Rights, okay?"
 -- Tamara

Housing Prices Decline: Actors, Musicians Hardest Hit

Forbes - Celebrity Real Estate Losers:

Former Guns N' Roses guitarist Slash (also known as Saul Hudson) feels he overpaid for his Spanish-style Hollywood Hills home, which has a pool, a separate gym and stunning views. He bought the house in January 2006 for $6.2 million. He sold it last December for $5.7 million. Slash is suing his former real estate agent, claiming the house was neither as big nor as private as the agent claimed. The case is ongoing in California Superior Court.

Television star Wilmer Valderrama had to accept $200,000 less for his five-bedroom home in the relatively unfashionable Valley neighborhood of Tarzana. He sold the house in January for $1.75 million.

Johnny Carson sidekick Ed McMahon is also having real estate troubles. He put his 7,000-square-foot Beverly Hills home on the market In July 2006 for $7.7 million. He has since reduced the price three times, and the house is now selling for $5.7 million.

Won't someone think of the celebrities?

Mortgage Fraud Arrests

Associated Press - Hundreds swept up in mortgage fraud arrests:

Across the country, reports of mortgage fraud have soared over the past year as the subprime mortgage market collapsed and defaults and foreclosures soared.

Banks reported nearly 53,000 cases of suspected mortgage fraud last year, up from more than 37,000 a year earlier and about 10 times the level of reports in 2001 and 2002, according to the Treasury Department's Financial Crimes Enforcement Network.

The most common type of mortgage fraud was misstatement of income or assets [AKA liar loans - LJ}, followed by forged documents, inflated appraisals and misrepresentation of a buyer's intent to occupy a property as a primary residence.

Compare this with what real estate adviser John T. Reed has been saying for years:

On one, which was apparently typical, the documents seem to show that Allen lied to the first-mortgage lender—Bank of America—about whether there was any secondary financing (there was—a seller mortgage) and about his intention to occupy the San Francisco condo as his principal residence (He lived in Provo, UT at the time and never occupied the SF unit). At that time, June, 1981, when home mortgage interest rates were at 18%, Bank of America would only make loans to owner occupants and prohibited all secondary financing. I have their loan policy for the date in question in the book, too. My wife was a loan officer for Bank of America at the time. [Note to bogus gurus: do not brag about deals that you do not want me to look into—especially in the San Francisco area. John T. Reed].

Lots of people cheated on mortgage applications in the last decade, and now that things have gone pear-shaped some of them should be worried about receiving a warrant.

John T. Reed Critiques "Flip That House"

Real estate investor and author John T. Reed has an interesting review of the "Flip That House" TV show:

Choice of improvements

The flippers in Flip That House generally make the typical beginner mistakes with regard to what improvements they make to the house. The main mistake is the most common one among beginning flippers. They fix the house up as if the object of the exercise were to impress visitors to the house with their excellent taste and the completeness of their transformation of the property. In short, they make improvement decisions as if they were housewives whose only goal is to make their personal residences look really nice to visitors.

Get the fast buck, not the last buck

In fact, the object of the exercise is to maximize your profit on your investments of money and time. You must get the fast buck, not the last buck. The Flip That House flippers make the common mistake of chasing the unprofitable last buck.

Obviously, each improvement you make to a house has a different profit margin. Furthermore, I suspect most of the improvements made by the Flip That House flippers have a negative profit margin. That is, they cost more than they add in value to the home. They lose money. The flippers would have made more profit if they had not made the improvement in question.

At the end of each episode of "Flip That House" a real estate agent appears and confidently tells the flippers how much their house is worth. One of Reed's readers tracked down the property tax records for one of the houses featured on the show. Result? Instead of being worth $240,000 as the real estate agent claimed the house was listed on the new owners property tax records as being worth $210,000. That just about equaled what the flipper had in the house, not counting transaction costs, interest, insurance, or their time.

"Fannie Mae supplies the critical financial weed and beer to keep our national economic party going"

Over at Iowahawk Dave Burge explains the mortgage crisis in words any moron can understand. America Must Not Allow Me to Fail:

Clearly, in order to avoid a national economic catastrophe, Congress must act now to keep Fannie Mae afloat. But this only addresses part of a greater threat arising from looming financial instability in what I like to call the "Dave Sector." As some of you know, in the last few months I have fallen victim to the subprime mortgage crisis and FEMA's crappy Iowa flood prize packages. Without an immediate infusion of federal cash, Dave will be bunking with Fannie and Freddie at the bankruptcy rehab clinic, and the consequences are almost too terrible to contemplate.

For background on how Dave found himself an innocent victim in the current financial mess read Please Don't Destroy My American Dream:

In August, Linda from the mortgage company called and said that Visa had denied my credit card payment for the mortgage, so I told her to switch it over to my Discover. Then she called back and starts whining that it was denied too. I explained to her that I really couldn't put it on my MasterCard because I maxed that out to convert the basement into a dojo for a new-style martial arts school I'm developing, and that Sensei Dave would have her money after he signs up a few students. I also explained to her that for a older plus-size gal, she totally had it "goin' on," and that maybe we should get together at TGI Fridays for Happy Hour to discuss it, my treat, because my AmEx card was still good.

After five or six margaritas Linda seemed to calm down, and came up with another great financial plan: a home equity ARM. It turns out that in only three months the appraised value of my new house had risen by $50,000, and that First Coralville would lend me the difference! That would be enough to cover all my missed mortgage payments, with plenty left over for a sweet Yamaha dirt bike I had my eye on. We toasted to new beginnings, and my new $200,000 per year income.

Zillow: Many homeowners upside-down on their mortgages

Bloomberg - One Third of New Owners Owe More Than House Is Worth:

The highest percentages of homeowners with negative equity were located in California. In four of the state's metropolitan areas -- Stockton, Modesto, Merced and Vallejo-Fairfield -- the number of homeowners whose mortgage debts exceeded the values of their properties topped 90 percent, Zillow said. In five more California areas -- the Inland Empire (Riverside-San Bernardino), Bakersfield, Yuba City, El Centro and Madera -- the percentages were more than 80 percent.

Dang. That's a bad situation to be in. Even if you owe exactly what your house is worth you're really upside down once you consider the standard 6% realtor's fee and closing costs. That's assuming you can even sell in a soft market. If you're actually upside-down on your mortgage you're pretty much stuck in the house waiting for the market to rebound. If you lose your job and have to move to another location you'll lose your house and all the equity unless you have a big cash reserve to settle the mortgage.

I won't go into Housing Panic-style histrionics, but this portends a tough road in some areas and particularly in California.