|
|
    |
This week Bruce Norris is joined once again by Robert Hockett. Robert teaches financial and business law subjects at Cornell Law School, where his research and writing focuses on the legal and institutional prerequisites to a just and prosperous economic order. He is also a fellow at the Century Foundation, a commissioned offer for the New America Foundation and consultant to a number of financial institutions, regulators, and legislators. Prior to entering legal academia, he worked at the International Monetary Fund and served as a judicial clerk for the Honorable Deanell Reece Tacha, Chief Judge of the U.S. Court of Appeals for the 10th Circuit. He was educated at the University of Kansas, Oxford University, where he studied as a Rhodes Scholar, and at Yale University. Robert also authored a memorandum entitled It Takes a Village Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification Value Preservation and Economic Recovery.
Robert had just talked about the appraisal issue and how some of it was proprietary. The basic gist is that there is probably going to be a discount on the loan because it is over encumbered. This, however, may be a lot harder to appraise. In an appraisal we think of there being a comparable sale, which may be a little harder to come by on an existing note. The existing home would be pretty easy to appraise. Bruce wondered if Robert feels that for the whole plan to work for the participants on the city side that there has to be a loan purchased at less than the house’s value. Bruce wondered if this would be a fair assessment. Robert, however, disagreed with this in this particular case. However, he said in order to give a detailed answer as to why, he would have to give more details on the valuation model. Robert said they have considered all of this, are concerned about it, and they have tried to use a valuation methodology that avoids that kind of a phenomenon.
It is hard to coin a new phrase after this has been going on for a long time, but Robert has managed to do it. He came up with the term shadow vacancy. The basic idea here is in regards to there being significant danger of actual delinquency defaults and foreclosure in respect to certain homes or neighborhoods. When people make decisions about what to do in the future, whether investing, making lendable funds available, assessing the value of property and collecting taxes on it, moving into or leaving a neighborhood, decisions of that sort will be made almost as if the vacancies were already there. It is similar to saying if you have a 50/50 chance of winning $200, the expected value of that particular winning is $100. In the same sense, you can say an actual vacancy is a vacancy with a 100% probability of occurring. However, in so far that vacancy becomes a possibility, the higher the percentage probability of it occurring, the closer it comes to being an actual vacancy. The notion of a shadow vacancy is a term Robert coined as a way of taking account of the fact that we sometimes view the prospect of possible vacancies as being akin to actual vacancies, even if not quite as serious or certain. The higher the likelihood, the closer to certainty you reach. The decision-making on the basis of vacancy rates is also presumably going to be made on the basis of likely vacancy rates as well, in this case, shadow vacancy rates.
Someone who is current but upside down will be more hesitant to keep the property up. The fuller your stake and the greater degree of your positive equity or your likelihood of having ultimately positive equity and full equity in your house, the more of stakeholder mentality you develop relative to the property. The better care you take of it, the more careful and attentive you are to it and therefore more attentive to your neighbors and their properties. It connects with the broader point that was covered in Section 5 of his big memorandum. We are always talking about more than just the creditors and the debtors. We are also talking about various third parties, often having to do with what economists often refer to as externalities, which can be positive or negative. When you have a lot of vacant properties or prospectively vacant properties, those that are not vacant typically take value hit. Those effects may not be as intense at the moment as they were years ago, but they are still relevant effects that the county will take account of when determining what to do about an ongoing underwater mortgage loan problem.
In referring to the specific type of loan that Robert will be addressing if the plan is implemented, they are current and owner-occupied only. However, Robert said they have to be way underwater, which you really won’t have any trouble finding in San Bernardino. Ultimately it is San Bernardino’s decision, and they are going to come up with their own variation on the basic template of the plan that has been presented to them as a possible way of going. The current understanding is that it would be 10-15% or more underwater, but anyone who wants to be absolutely certain would need to San Bernardino.
Bruce wondered if there is age of property that is being paid attention to, but Robert said this was not the case so far. There is no particular parsing on the basis of the age of the property. Bruce also wondered what is in it for the mortgage resolution partnership. What the mortgage resolution partners would receive is essentially a market-rate fee for the refinance operation in connection with the loan. You receive the acquired loans for which fair market value is paid. If there are market proxies, then it is your market value, and if there are not fair market proxies, then it is valued by some other orthodox method. Once that is done and the mortgage loans are acquired, they are extinguished and replaced by new refinanced principle write-down mortgage loans that will leave the homeowners with an increment of positive equity. Essentially the refinance charges for that are what mortgage resolution partners recoup. The emphasis here is on market rates as they are essentially charging what other refinancers charge when they do these refinancing of mortgage loans when things are permitted or possible.
Bruce gave an analogy of if he was the owner occupant, was over encumbered, and the city uses eminent domain, he wondered who would purchase his loan at some fair number. Robert said it would be the city and by the municipality. The city then owns the loans temporarily. While it owns those loans, the refinancing is done and essentially the old loans are replaced by new loans with principle written down and are essentially more sustainable. While it owns those loans, the refinancing is done and essentially the old loans are replaced by new loans with principle written down that are essentially more sustainable loans. In this case, the lenders here are the private investors who put up money for purposes of paying the awards to those from whom the mortgage loans are purchased. Money has to be spent in order to pay a fair value for the existing mortgage loans. The city does not have this kind of money, and neither does the state. One of the virtues of the plan is it is seen as no tax dollars or public funds being used. The money that is used to pay the fair value for those loans is money that is put up by investors.
Bruce wondered about the creation of the new permanent loan for the occupant. Robert said the creation of the new loan will be done by the cities with the assistance of mortgage resolution partners who specialize in essentially refinancing mortgages. It is essentially going to be whatever happens out in the private market. Some will be FHA-qualifying; others might not, although presumably most will be. The idea is that they are not going to be any different from any other mortgage loans out there as far as FHA coverage and conformability is concerned. They will basically be on all fours with other mortgage loans. If, for example, the city buys a mortgage for $100,000 and the property appraises for $120,000, Bruce wondered what the owner-occupant will be refinancing at. Although this is something the city of San Bernardino or the MRP, Bruce also wondered if there is an intent for there to be a profit-margin on that for either the city or for mortgage-resolution partnerships. However, Robert said there is no such intent. The intent there is simply for a flat fee that is essentially a market rate and equivalent to what you find prevailing in the market for refinancing and earned by MRP in connection with each refinance.
Bruce wondered what is in it for the city. Robert said nothing financial is in it for the city other than two things. One is the avoidance of the cost that would otherwise be entailed to exercise eminent domain. All of that cost is footed by the investors who put out the money that is used to pay fair value for the mortgage loans. The second thing in it for the city is addressing this ongoing urban Blige problem, keeping residents in their homes, and boosting the likelihood that more rather than fewer people will stay in their homes. The idea also is to stabilize property prices so as to prevent any further declines in the property tax base and hence further declines in the city services that can be offered and that are financed out of that property tax base. It is the flip-side of the public purpose that is articulated in this connection with the realization of what is in it for San Bernardino and any other county in California. A lot of other counties and states are looking at this too and have approached MRP to work out arrangements to pursue their own versions of the plan. It may also be worth noting in that connection that every municipality will have its own version because every municipality has its own unique set of property difficulties or other circumstances.
Bruce commented how the market prices are down from the peak but up in Riverside and San Bernardino almost 27% from the bottom. Inventory and time is down, and it seems the market is improving on its own. Bruce wondered if that makes it a much more difficult proposition to sell than it would have been in 2008. Robert said it might make it marginally more difficult, but it does not really make it much more difficult. For one, back in 2008 there was still some skepticism as to whether this was going to turn out to be a really long-term and ongoing debt deflation of the sort that it is turning out to be. There was still some skepticism back in 2008 as to whether this was going to turn out to be a Japan-style indefinitely extended slump. There seems to be a little less skepticism about that now mainly because we have been living with it for so long now and it is still dragging along. A second difference between now and 2008 is back in 2008 there was still some reason to suppose or hope that the federal instrumentalities might do something to help or that the GSEs, FHA, or some other federal instrumentality might help. These programs have been helpful, but they have not turned out to be spectacularly successful.
There are a lot of people who recognize this whereas back then there was a bit more hope that such programs, even from before they were promulgated, might be on the cards and might work. In that respect people might be a little bit more open to the prospect of municipalities or states acting to take control of their own destinies rather than waiting for the Feds. When it comes to the matter of the market and how it compares now to then, it is true that we are above previous lows. However, this is to some extent detracted from the fact that we had a good bit of ups and downs since 2006. The mortgage markets have begun to show signs of coming back before, only to drop yet again. Until we go beyond the two steps forward, or possibly 2-3 steps back, people are going to continue to be concerned that this is another one of those green shoots moments that turns out to be a dead letter where nothing comes of it.
What is interesting about the plan is that it does not deal with anything that is eminently a problem. You are only dealing with things that are current, and probably 40% of the foreclosures are two years in process before they become an eviction or they become a bank-owned property. Talking about pre-emptive, it is pre-emptive by several years whereas it seems the eminent problems will continue unabated in a great number in San Bernardino and Riverside less than in 2008. However, it still seems like this plan is dealing with something that is assuming it is going to be a bigger problem than it would probably turn out to be. When it comes to already delinquent or already defaulted mortgage loans, there is nothing to preclude other solutions being pursued in respect to those mortgages. There is also nothing to preclude some such plan as the present plans being adapted, either now or in the future, to cover those kinds of mortgage loans. The question then is why it does not do that yet.
The first answer to this is in order to avoid any danger of moral hazard at this particular juncture, we start with these mortgage loans and reward people who are staying current against the odds. We avoid adding additional inducements to strategic defaults. This is one reason to begin in this way until nice fine-tuned, moral hazard-avoiding ways of dealing with already eminently delinquent mortgages are developed. Finally, it is worth remembering that we are using private investor funds in order to spare taxpayers and any public expense. Budgets are strapped, and San Bernardino has now voted to file for bankruptcy. The question then relates to you having these private investors, and what you are offering them is a novel new way of addressing a market failure and possibly recouping value. However, it is novel in the sense in that it has not been done before in mortgage loans. This means there is a fairly limited pool of investable funds coming from the private sector. In order to lessen the risk that this will not work or pan out, you deal first with the mortgage loans that are doing best even though the odds are stacked against them. If the plan works, as it is believed it will and prove successful quickly and effectively in dealing with these particular mortgage loans, then presumably people will be a little bit more familiar and find it a little less surprising and therefore willing to invest more. When that comes to pass, it would then be possible to revisit the question or whether more mortgage loans should be looked at in a next wave of such actions pursued by other municipalities other than San Bernardino.
Nobody at the moment is contemplating any such thing, it is rather a prospect Robert is imagining as a possibility in his role as an academic who has been thinking about these kinds of things for 4-5 years. In addition to that, there is a ring sense around this particular exercise of eminent domain authority. Some people out there are worried about slippery slope problems, such as if you can use eminent domain to take one thing, can you use it to take our wives or our children. We acknowledge that eminent domain is legal, but the question is whether or not it is wise. For example, in the case in Hawaii it turned out to be legal but not very wise. This is the biggest problem.
Bruce wondered where the losses go. These lenders are in essence being forced to hit loans that are current. If they already have loans that are in foreclosure; they are probably expecting that. Bruce said he would not think we would be expecting losses if they were current. If we choose the correct mortgage loans, there is no loss and literally a recoupment of value. The only real question is how you distribute that surplus. In some ways you are forcing the action at a market that is still way below even replacement value. You are forcing the lender to take a refi at today’s value when it looks like they will not have to do that even if people did not make a payment for another two years. Robert said he does not believe there is any reason to suppose that they are going to be higher than today.
The valuation model we are using that can be tested once it becomes part of the public domain is essentially to target precisely those mortgage loans which if they were portfolio loans would already have been written down. If they had not been written down owing solely to the fact that they are securitized mortgage loans that are subject to PSAs that prevent those actually financially rational modifications or sales, and if we target solely these mortgage loans, then we are recouping value in the same way that portfolio loan holders recoup value when they voluntarily write down. In that sense, Robert does not think what they are doing is even forcing something. It is only forcing in the sense that we are going around the contract terms that would otherwise prevent servicers from doing on behalf of bondholders what is already in those bondholders’ own interest. It is only true if we have chosen the right mortgage loans, which Robert believes we have.
For more information about The Norris Group’s California hard money loans or our California Trust Deed investments, visit the website or call our office at 951-780-5856 for more information. For upcoming California real estate investor training and events, visit The Norris Group website and our California investor calendar. You’ll also find our award-winning real estate radio show on KTIE 590am at 6pm on Saturdays or you can listen to over 170 podcasts in our free investor radio archive.
