Those of you who watched this week’s Democratic Party debate will note that the current foreclosure mess was an oft repeated theme. The candidates are trumpeting what they’ll do if they win in November, but two bills are already before Congress that will impact lenders and consumers.

The somewhat awkwardly named Emergency Home Ownership and Mortgage Equity Protection Act of 2007 and the Foreclosure Protection Act of 2008 are both being debated. Both are focused properties with nontraditional (neg am, interest only, etc) mortgages or subprime mortgages. Mortgage balances and monthly payments would be reduced based on how much a home’s value has decreased.

These won't impact investors directly, since they only applies to owner occupied properties. However, the measures are defiantly of interest to investors since it’s likely that it will impact the cost structure of the entire industry. The measure might decrease the number of underwater owners who walk away from mortgages, but essentially it forces the bank to eat the cost of the market downturn, instead of owners.

This is reform on the cheap, since short term the banks will be shouldering the cost. But the medium/long term effects won’t be good for consumers:

• Banks who are already reeling will be dealt an additional blow. This will lead to a real bail-out, paid for with real taxpayer dollars. The short term “reform on the cheap” won’t stay cheap for long.
• Banks are already recalibrating the way they quantify risk. But the current model assumes that a when a buyer purchases a home then said buyer will both enjoy the benefits of appreciation and the risk of a decrease in value. This assumption no longer holds, and the banks will be justified in charging accordingly. Home ownership will slip further out of reach of an increasingly large segment of the population.

Reform on the cheap doesn't work.  The banks will fix their own messes.  Some should fail - we should let them.  And if the government determines that citizens who are in trouble need help, we shouldn't fool ourselves that this can be accomplished without the government pulling out it's checkbook and spending some tax dollars.  Coercing the business sector to take an altruistic step will backfire in the end. 

Yesterday Massachusetts became the first state to take an aggressive move in blocking foreclosures when Governor Deval Patrick announced measures to protect homeowners facing foreclosure. 

Excerpt from a Commonwealth of Massachusetts press release:  In an ongoing response to the state’s foreclosure crisis, Governor Deval Patrick today directed Commissioner of Banks Steven L. Antonakes to seek delays from mortgage lenders, on a case-by-case basis, for any Massachusetts homeowner who has filed a complaint with the Division of Banks as part of their consumer assistance outreach efforts.

The Massachusetts Attorney General has framed this announcement as a measure to "combat predatory lending practices", but some media outlets have declared the move to be a "moratoriam on foreclosures." 

Note that Governor Patrick's press release emphasizes the "case by case" nature of the measure.  As written it would appear that the measure may be largely symbolic, but in practice placing a new bureaucratic hurdle in the foreclosure process may materially impact the risks that mortgagee banks assume.  This, on top of the ongoing subprime debacle, may continue to pull liquidity out of the market and if left unchecked will have the effect of increasing costs to borrowers and lowering the availability of funds.  This, I'm sure, is not what the government and community groups had in mind. 

The government should move aggressively to identify and prosecute companies that illegally engaged in predatory lending tactics, but new regulations are not the cure for what ails this market. 

There’s a multi-factorial equation brewing out there that is going to impact real estate investors. 

Concerns about flatting property prices tend to get the most press time, along with the ongoing sub-prime lending soap opera. And we’re all keeping an eye on interest rates and hang on Bernanke’s every word. But in my opinion the real story will be how all these factors impact all those risky loans out there, and this is a die that has yet to be cast. 

First American CoreLogic recently released a study on Mortgage Payment Reset and the potential impact that it will have on our economy. Note that First American CoreLogic is an arm of First American – and many visitors will be familiar with First American Title, one of the nation’s largest Title companies. The point being: just like the National Association of Realtors the title industry has a dog in this fight so be careful about taking all of CoreLogic’s conclusions without a bit of scrutiny. But that said, there’s a lot of good data in this report. 

Here’s something that jumped out at me. In 2006 lenders issued $200 billion in ARMs w/ their first reset in 2006. Of that $200 billion worth of quick reset mortgages the vast majority was at super-low teaser rates of less than 2%. Seemed like a good idea at the time: rising prices and brisk home sales made the risks easier to stomach.  Now that market has cooled those 2006 resets are causing problems for many buyers who were overstretched in the first place, and that’s what’s triggering the current wave of foreclosures. 

But, there’s more to come. Most of the ARMS originated in 2006 w/ 2008 resets ranged from 6% to 9% initial rates. Sub-prime territory. And these folks, based on CoreLogic’s assumptions, will be facing increases of from 30% to 50%. The second half of this story is that 23.9% of ARMs originated in 2006 have negative equity, versus only 10.3% of fixed rate loans taken in the same period. 

So not only were ARMS used by the most vulnerable buyers, they were also more than twice as likely to be used for properties in which the owners had no equity. The punchline: during the run-up ARMS were used as an instrument to buy homes that people couldn’t really afford. 

The New York Times ran an interesting article today advising those homeowners who are about to get into trouble to negotiate with their lenders. Many owners don’t realize what we do as real estate investors: the bank doesn’t want your house. Foreclosure is a disaster for the homeowner, but it’s no picnic for the bank. Expect troubled owners to take a page out of the short-seller’s playbook.

RealtyTrends, the monthly newsletter from RealtyTrac.com, reports that foreclosures are up 17 percent in Q3 – 318,355 properties went into some form of foreclosure during the period.  This represents an increase of 17 percent over last quarter, and a year-on-year increase of 43 percent.

Foreclosure levels varied widely across regions, with Colorado, Nevada and Florida leading the pack.  Florida saw a 55% spike in foreclosures to lead the nation with a total of 40,136.  Texas is in second place at 39,363, but in terms of percentage of total properties ranks sixth. 

Increases in foreclosures can be linked to a combination of increasing interest rates, flat property values, and stagnating economic indicators for some regions. 

In addition to paid sites like RealtyTrac.com, information on foreclosures can be found at government sites such as the U.S. Department of Housing and Urban Development website.  They list a number of local programs broken down by state. 

Another indication that the real estate market is starting to turn in some regions is starting to reveal itself.  According to RealtyTrac, foreclosures for the month of August are up 53% over on eyear ago.  Overheated markets are posting some of the largest increases:  Nevada (+255%), California (+160%) and Florida (+62%).  Much of the increase can be attributed to a cooling real estate market, compounded with rising interest rates as adjustable-rate mortages reset and increase the monthly debt burdeon paid by homeowners.