Taxpayers Supporting Freddie's Gambling Addiction

Caution: This will make you angry.

Yesterday it was reported that Freddie Mac lost $4.7 billion in the second quarter and needs another $1.8 billion injection from the government to keep operating. We expect Freddie and Fannie to be losing money due to all of the mortgage defaults that are still taking place. But let's dig a little deeper into the losses.

Buried in the report are the details of the losses for the 2nd quarter (which are actually improved from the first quarter) and you will see the following:

• net interest income of $4.1 billion
• minus credit losses of $5 billion
  
• minus derivative losses of $3.8 billion
• Net Loss = $4.7 billion
  

How did Freddie lose so much in derivatives? They made massive bets on rising interest rates and lost billions as rates fell from April 1 through June 30. We the taxpayers continue to fund their losses every quarter and gives them $$$ to play the interest rate market and lose more $$$.

If they were a public (or private) company they would be out of business. But now they are in control of the federal government and go to the casino with an unlimited piggy bank, thanks to the American Taxpayer and our elected officials who allow it to continue.

Warning: Trial Loan Modifications can be Hazardous

The failure of the government's loan modification program, Home Affordable, has made a lot of news lately. Only a fraction of the anticipated number of homeowners have truly benefited from the program. Why do so many people start the mortgage modification process and end up getting denied or canceled? What are the hazards of getting involved in a trial modification?

Trial Modifications
About a year ago, under tremendous pressure from the government and consumer groups, home loan servicers (primarily the big banks) started using trial modifications in order to get more homeowners started in the loan modification process. Because of the mammoth volume of requests for modifications (Bank of America was receiving over 80,000 calls a day at the peak) servicers started homeowners on trial modifications, or temporary modifications, while they began processing and underwriting the homeowners qualifications for a permanent modification.

Often times the processing time to determine if a homeowner takes many months, up to a year. Meanwhile the homeowner continues to make trial modification payments at an amount lower than the payment on their mortgage note. The homeowner assumes if they make their trial payment on time, they will be approved for the permanent modification. They don't realize that homeowners are often denied a permanent modification regardless if they make all of their trial payments on time. Most of the time the reasons for denying a modification relate to the borrower making too much, or too little income.

Something has been happening as they have been making those lower, trial payments. The homeowner has been accumulating a past due balance for the difference between the note payment and the trial payment. The longer the trial period, the bigger that past due balance becomes.

Putting Homeowners in a Hole
Take the example of Stacey. She started a trial modification with Wells Fargo in August of 2009. She was told it would be a three month trial. She made all three months on time, but Wells Fargo was behind, presumably dealing with hundreds of thousands of other homeowners. So Stacey continued to make the trial payments as directed by Wells Fargo. Finally in July of 2010 she received notice that her modification request was declined because she didn't make enough money. We'll ignore the point at this time that Wells Fargo did not calculate her income correctly. So they sent her a letter letting her know she has to start making her note payment again. They also mentioned in the letter that Stacey had to immediately pay the past due balance of over $8,000. "Past due? But I made all of my payments on time," Stacey thought. Yes, but now she owes the difference between the trial modification payments and her note payments over the past 11 months. And she owes it now. According to the letter she must pay it now or face foreclosure.

Be Careful with Trial Modifications
The servicers need to be aware of the hole they are putting homeowners in when they start them on a trial modification. Likewise, homeowners that are on trial modifications need to take advantage of the lower payment and save some money each month so that if their request for modification is denied, they can pay the past due balance.

Immigration Policy & Real Estate

Nothing has been in the news more in Arizona recently than SB1070. In case you have been living in a cave, I am referring to an immigration enforcement law recently passed in Arizona that goes into effect on July 29. The law requires local law enforcement authorities to question individuals who have been stopped for an infraction and are suspected of being in the country illegally to show identification authorizing them to be in the country. This article will not debate the politics, the effectiveness, or the constitutionality of the law. My interest is in how the law will affect (or not affect) real estate in Arizona. So I will let others argue whether the law is racist and unconstitutional, or whether it is simply the state trying to enforce what the feds have failed to enforce.

What Drives Real Estate Growth?
Growth in real estate, whether in the form of increased home sales or rising values, necessitates a growing population. Arizona real estate has benefitted over several decades from the domestic migration from colder U.S. climates to the Sunbelt. That growth led to spectacular new home starts and rising home values from the early nineties through 2006. The overall economy sailed on a wind driven much by the real estate market.

A great deal of that growth took place beginning in 2000. From 2000 to 2007 the illegal immigrant population in Arizona is estimated to have grown by 70% according to a study by the Department of Homeland Security, while nationally that figure was only 37%. Illegal immigrants have to live somewhere, so they must also contribute to the real estate market. Many rent homes or apartments, which drove up rents and consequently increased property values. Many also purchased homes and even obtained mortgages with falsified identification. While illegal immigrants can’t claim to be the primary source for the rise (and eventual fall) of the real estate market, their impact shouldn’t be ignored.

This impact is more apparent in neighborhoods that are primarily Latino like the Maryvale neighborhood of west Phoenix and Glendale. Many illegal residence simply abandoned homes that they rented or had purchased when they made a decision to leave Arizona.

Why Are Illegal Immigrants Leaving?
Immigrants have been leaving Arizona for a couple of years. It started well before SB1070 was signed into law. In fact that law isn’t scheduled to go into effect until later this month. In 2008 about 100,000 illegal immigrants (18%) left Arizona according to DHS. If most of the illegal immigrants came across the border for higher paying jobs, it only makes sense that they leave when those jobs are no longer available.

The decline of a real estate and construction dependent economy began in late 2006, and was free-falling into 2007 and 2008. The result, the jobs held by many illegal immigrants simply vanished. Compounding the issue was another law that was passed in 2007, the Legal Arizona Workers Act. This law focused on employers that were hiring illegal workers. It placed very stiff penalties, including the loss of a business license, for those employers that knowingly hired illegal workers. While very few companies have been prosecuted under the law, it appears that employers have decided not to take the risk of losing their business.

One would think that Arizona’s dependence on real estate would result in a higher unemployment rate than the rest of the nation. Instead Arizona has been at or below the national unemployment rate in this recession. In fact the Phoenix metro area had 8.7% unemployment in May while the U.S. unemployment rate was a full point higher at 9.7%. I can only speculate that is because the Arizona workforce has shrunk as illegal immigrants choose to leave as their jobs disappeared.

SB 1070’s Impact
The most recent immigration legislation in Arizona does not appear to contribute to any population increase, nor is it designed to. It is designed to do exactly the opposite, at least in the short term. Proponents believe it will lower entitlements, thereby lowering government spending and keep tax rates low. That should provide a fertile ground for business growth and population, a longer term view.

The national and international attention for Arizona and this debate is extraordinary. The attention however has been mostly negative. The opponents of the law focus on racism to make the debate appear Anglo versus Latino. Not a good image for Arizona. Proponents of the law focus on the problems and crime associated with illegal immigration: drug and human smuggling, kidnapping, and executions. Also not a good image for Arizona. This recent immigration debate is not helping the cause to persuade people to move to Arizona.

Conclusion
In the short term it appears that SB1017 is hurting our real estate market. Immigrants that haven’t already left may choose to, creating more vacancies. In addition, a poor image of Arizona is being portrayed by both sides of the debate.

The long term consequences depend on what happens next. We will have to wait and see if Congress will pass any meaningful legislation for immigration reform. The law also faces court challenges including a suit from the U.S. Department of Justice. Interestingly, in this lawsuit my federal tax dollars will be applied to the plaintiff side while my state tax dollars will contribute to the defense.

How can immigration policy help the Arizona real estate market? Real estate growth needs population growth. Therfore it can be positively impacted by policy that allows for an increase in LEGAL immigration, specifically legal immigration from Mexico.

Oh Canada! Let's Not Get Carried Away

A couple of weeks ago an article in the Wall Street Journal compared Canada's mortgage market to the U.S. The point of the article was that home loans for our neighbors to the north are more conservative than in the U.S. which is why they did not experience the bursting of the housing bubble.

The same conclusion was reached by reporters on CNBC this morning as they praised Canada's home loan system for a variety of reasons (CLICK HERE for a link to the story). Why do people believe Canada is superior to the U.S. when it comes to mortgage lending?

The Numbers

While 9.5% of U.S. homeowners were 3 months or more delinquent as of March, in Canada the ratio is only 0.44%. The latter number is superior, but not surprising when in is noted that subprime lending hardly even existed in Canada. Even though it was (and still is) tougher to qualify for a mortgage in Canada, the homeownership rate is roughly the same as ours, 68%.

The Lenders

Who is doing the lending in Canada makes a difference. In the U.S. most mortgages are originated by mortgage bankers, securitized and sold on the secondary market. Government guarantees on most mortgages add to the liquidity of our markets. In Canada most home loans are originated by banks and kept in the banks' portfolios. The bank makes the loan and retains the risk. Therefore the banks are very cautious about the loans they will approve.

The conclusion one may take from the story is that traditional bank lending is good, and securitization of mortgages is bad. That is an under-informed conclusion.

Consequences

Another important factor is that all of Canada's home loans are recourse loans. This means that in the event of a default, the borrower is accountable to the bank for any losses incurred as a result of the default. In the U.S. laws related to recourse vary by state. For example in Arizona, the lender may only sue the borrower for a deficiency in a select set of circumstances.

Since Canadians know they are on the hook if they default, they are more apt to find a way to make their payments on time.

Other Side of the Coin

So are Canadian mortgages better than U.S. mortgages in every way? Absolutely not. There is a major downside that was not even mentioned in the CNBC story - There are no fixed rate home loans in Canada.

With all of the negative talk about the securitization of mortgages, it is often overlooked that with securitization comes fixed rates. With fixed rates comes stability and financial security for a homeowner.

Banks do not like to lend fixed rates with their portfolio. Why? Because 30 years (and even 15 years) is a long time, and they don't want to be committed to earning a fixed level of interest over that long period of time. A bank's cost of funds (the rate paid on deposits) will vary over time, so the revenue they earn (rate earned on loans) must also vary. That is why bank portfolio loans are almost always carry adjustable rates.

Risk of the Canadian System

Therefore in Canada, since banks provide most of the home loans with their own funds, the most common loan program is a 5 year adjustable rate mortgage (ARM). ARMs are great when rates are as low as they are today. My ARM is under 3%, so my payment is relatively low. But what will happen when rates increase? Mortgage payments in Canada will increase and I suspect more Canadian homeowners will find it difficult to make their payments.

Yes, Canada is better today based on their low level of defaults, but I suspect their mortgage issues may be masked by low rates.

Chaos in Europe = Low Mortgage Rates for Americans

Stock market turmoil and chaos in Europe are helping Americans get low interest rates on their mortgages. How and why is this happening?

Flight to Quality
Over the past several months, expectations have been for higher interest rates. The end of the Federal Reserve’s $1.25 trillion mortgage-backed security purchase program suggested that rates would have to rise to attract more investors to purchase mortgages. But with all of the chaos in Europe, investors from around the globe are flocking to American bonds, including mortgage-backed securities.

The financial instability is not contained to just Greece. One of Spain’s largest banks, CajaSur, failed and had to be taken over by the Bank of Spain (Spain’s central bank). This news feeds the flight to quality by investors.

U.S. Treasuries and other “safe,” fixed-income investments are the beneficiaries. Mortgage-backed securities are included in the “safe” category because they have real collateral in the form of real estate. Real estate values have already taken major price hits over the past few years, and the worst of the devaluation appears to be over. In addition, underwriting standards are much more stringent than they were a few years ago, so investors understand that owning mortgages today is a sound investment.

Opportunities for Homeowners
The low fixed interest rates today represent opportunities for homeowners to refinance and lock in a low, fixed payment. In general, a 1% reduction in rate represents a 10% reduction in payment. Reducing a payment isn’t the only benefit. Some homeowners are choosing to shorten the term of their mortgage from 30 years to 15 years so that they can own their home “free and clear” sooner, and reduce the amount of interest they pay over the life of their mortgage.

Long Term View on Interest Rates

In the long run there are some factors that do not bode well for interest rates. Most notable is the growing federal deficit. In the first 220 years of recorded financial records of the United States (i.e., 1789-2008), the nation had cumulative deficits of $5.3 trillion (i.e., outlays in excess of receipts). The combined deficits in the 3 years of 2009-10-11 (i.e., the actual deficit of $1.4 trillion in 2009 plus the government's projected deficits in 2010 and 2011) are estimated to reach $4.2 trillion (source: White House, 5/10).

Twitter and Facebook and Linked In, Oh My!

A few weeks ago I was in Lake Tahoe for some meetings. One of our sessions was a presentation about using social media to market business. They were over a hundred mortgage loan originators in the room, but when the speaker asked how many had a Facebook page, or used Twitter specifically for business, less than a dozen people raised their hand. This surprised me. What didn't surprise me was that all of the people that raised their hand were under 45.

Most people have found the benefits of using Facebook to find old classmates or share photos with family and friends. Likewise, scores have discovered that Linked In helps to connect with business associates, clients, or aids in a job search. I have some friends and family members that love Twitter. I have to admit, I have yet to find my love for this medium. I'm still working on it, but so far I find there is too much noise.

If you work, you should have a Linked In page. That includes working for a company, yourself, or even volunteer work. It is a great venue for networking and there are seemingly infinite numbers of "Groups" to join to generate discussions and connect with like-minded folks.

Facebook isn't just for sharing photos of your family or announcing your mood to the entire globe. It is a phenomenon how many millions of people use Facebook. Many of them are your customers, or potential customers. The most annoying thing about Facebook are some of the games like Farmville or Mafia Wars. My news feed will sometimes get clogged up with my "friends" progress on one of these games. I'm sure there is a way to block that stuff, I just need to figure it out. Also here is a bit of advice, do not post anything on Facebook that you don't want EVERYONE to know. Employer background checks often include visits to Facebook to find out more about the candidate.

Twitter is a beautiful idea. Short and sweet announcements that get shot out to all of your "followers." My advice is to be discriminatory in who you follow so that you aren't tweeted with too much nonsense. Likewise, don't tweet a bunch of gobbily-gook like, "Life is a beautiful gift so treasure each day." That may be true, but I will probably stop following you if that is the depth of tweets I receive. I (and your followers) want useful information.

More people are getting on board with social media for business, even the over-50 crowd. Click the links on the right for my Facebook and Twitter pages. I promise not to publish any gobbily-gook.

Taking Off the Training Wheels

Pedaling Toward Independence from Government

If the mortgage industry were a kid on a bicycle, it just got its training wheels taken off. Although the Federal Government is our dad that is still holding on to the back of the bike, running along as the kid pedals down the sidewalk.

Turn the clock back a few years, and the mortgage industry was riding a unicycle... while juggling chainsaws... blind-folded... and drunk. Well, there was a terrible accident. Now the mortgage industry has to learn to ride again.

The training wheels came in the form of increased government intervention. The Federal Reserve purchased the bulk of mortgage backed securities for a full year. This pushed interest rates lower and help more people afford new mortgage payments. That program ended on March 31. Without the Fed buying up all of those mortgages, rates rose a bit. They are up from the all time lows, but they are still very attractive.

In addition, the home-buyer tax credit is going away. To be eligible, buyers must have an executed purchase contract by April 30, and close by June 30. This was a way for the government to stimulate the housing market. It was successful in encouraging people to buy homes. Going forward people will buy homes if they need them, not for a tax credit, and it is important that the market show it can survive without the extra government support.

But the mortgage industry still has a lot of government support. Dad is still holding on to the back of the bike, running by its side. The only mortgages that are being securitized and sold in the secondary market have some sort of government backing. Fannie Mae, Freddie Mac, FHA, and VA compose almost all of the market. Private label mortgage -backed securities haven't been issued for over two years. However, there are reports that they may be making a come-back. These private-label mortgage-backed securities would be primarily for jumbo loans. Jumbo loans today are primarily being held in banks' loan portfolios.

Re-emergence of securitation of non-government backed mortgages would be another big step for the mortgage industry to ride the bike again, without dad holding on. The true test will be seen with the reform of Fannie Mae and Freddie Mac. That may be a long and painful process. The industry isn't there yet, but at least the training wheels are off.