From NYC attorneys Crowell Mornig comes the news of a precedent setting court decision involving the rating of a privately placed loan portfolio which failed.
The failure of the rating agencies to maintain prudent underwriting standards in support of their CMBS and RBS ratings has been a key contributor to the low-cost of funds resulting from those ratings and the shrinking subordination levels. For the bonds, the rated portions carry a much lower cost of capital than the unrated portions which results in an overall lower cost of capital much like the cheap mortgage and mezzanine financing which funded up to 95% of the purchase or value of commercial properties reduced the cost of capital to a purchaser and facilitated the low cap rate environment we experienced during the 2-3 years prior to the market meltdown. This law suit may (and should) result in a complete restructuring of the rating process as part of the revitalization of the CMBS market. Check it out:
"In a recent decision, the United States District Court for the Southern District of New York, in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc., et al1 denied a motion to dismiss fraud claims brought by certain noteholders against Moody's and Standard & Poors ("Rating Agencies"), in connection with the defendants' ratings of certain mortgage and asset backed securities. Departing from the general rule, the Court rejected the Ratings Agencies assertion that liability based upon their ratings is prohibited under the First Amendment right to free speech.
BackgroundIn Abu Dhabi Commercial, the Ratings Agencies were hired by Morgan Stanley, the arranger and placement agent for the notes (the "Placement Agent"), to rate notes in connection with the issuance of three categories of notes under a structured investment vehicle. These ratings were included with the knowledge and approval of the Ratings Agencies in information memoranda and other documents distributed to specific potential investors, but not disseminated to the general public.
The Ratings Agencies worked directly with Placement Agent to structure the notes in a manner to ensure that they received the highest ratings. As a part of that structure, the Ratings Agencies were responsible for ensuring certain minimum and maximum percentage requirements of rated assets backing the notes were met. These percentage requirements, however, were not met, resulting in riskier notes than the ratings suggested. In particular, the structured investment vehicle failed meet its guaranteed minimum percentages "AAA" and "AA" collateral assets and exceeded its maximum percentage of residential mortgage backed security investments.
Subsequently, the issuer, not being able to service its debt, filed for bankruptcy. As a result, the notes produced little to no recovery for the noteholders.
Court RulingThe Abu Dhabi Commercial Court denied the portion of the Ratings Agencies motion to dismiss the noteholders' fraud claims finding, among other things, that these ratings were not protected speech under the First Amendment. In reaching this result, the Court held:
the First Amendment protects rating agencies, subject to an 'actual malice' exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern. However, where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is not afforded the same protection.2
Here, the lack of wide spread dissemination of the ratings was pivotal in the Court's finding that the First Amendment protections were in applicable.
Conclusion: In short, this decision steps away from the traditional treatment of ratings as protected First Amendment speech and opens a new avenue for noteholders to seek redress for claims such as fraud. As many similar securities offerings are so targeted, this case may have wide reaching repercussions."
For a full copy of this "noteworthy" decision: Go to: http://www.crowell.com/PDF/Abu-Dhabi-Commercial-Bank_v_Morgan-Stanley.pdf
Tuesday, September 29, 2009
Thursday, September 24, 2009
As the Fed sleeps
Every now and then a columnist has an opinion which is spot-on....this one hits the bulls eye. We need continued action to realize the fruits of our labor....caution does us no good now....there will be time to rest in the future...sooner if we can keep the recovery actions moving now....
By Christopher Swann
NEW YORK (Reuters) – It’s not even October and the Federal Reserve already appears to be going into policy hibernation.
Today’s statement appears intended to attract as little attention as possible. Even the more gradual tailing away of mortgage purchases by the Fed seems calculated to assist the Fed’s quiet retreat.
There will be no further efforts by the Fed to accelerate the pace of growth. Given the grim economic outlook this is a shame. Today’s Fed statement pointed to a pickup in growth, but the Fed’s own economic forecasts still scream out for stronger action.
Even through 2010 unemployment is expected to hover close to 10 percent. Core inflation meanwhile could go below 1 percent in 2011. This is the kind of outlook that would normally prompt the Fed to stamp on the accelerator.
Sadly, the Fed no longer has this option. Ben Bernanke is hemmed in on two fronts.
The first is a political constraint. The doubling of the Fed’s balance sheet during the crisis alarmed many in Congress. As the financial crisis has receded, there seemed less justification for such extraordinary action.
The Fed now badly needs to win back support in Congress. The stakes are high as lawmakers prepare to overhaul the regulatory framework. Not only does the central bank hope to win the new role as systemic regulator, they may need to fight hard to avoid encroachments on their independence by Congress.
They will be particularly keen to prevent oversight by the Government Accountability Office. Such political pressures explain why the Fed’s last significant public announcement was a populist initiative to curb financial sector bonuses.
The second limitation is of their own making. It results from a failure of nerve. The Fed was too quick to sound the retreat on credit easing. Soon after financial conditions started to normalize and fears of depression eased, the Fed indicated that the balance sheet would not expand any more than had already been planned.
This was premature. The Fed could have added another trillion dollars to its holdings without generating inflationary risks or unsettling the markets. By raising the potential ceiling on their asset purchases Fed officials would have given themselves much more room to pursue the goal of full employment.
Now, however, the Fed appears to be locked into its sleepy strategy. To reverse course and expand asset purchases would throw the market into turmoil and undermine Fed credibility. The damage to the Fed’s inflation-fighting credentials could actually push up interest rates — more than offsetting the impact of further credit easing.
Bernanke can claim a good deal of credit for hauling the United States from the brink of disaster. But he swung too swiftly from boldness to caution — putting the Fed on the sidelines. Barring an unexpected downswing, is now powerless to help accelerate recovery and bring down unemployment.
By Christopher Swann
NEW YORK (Reuters) – It’s not even October and the Federal Reserve already appears to be going into policy hibernation.
Today’s statement appears intended to attract as little attention as possible. Even the more gradual tailing away of mortgage purchases by the Fed seems calculated to assist the Fed’s quiet retreat.
There will be no further efforts by the Fed to accelerate the pace of growth. Given the grim economic outlook this is a shame. Today’s Fed statement pointed to a pickup in growth, but the Fed’s own economic forecasts still scream out for stronger action.
Even through 2010 unemployment is expected to hover close to 10 percent. Core inflation meanwhile could go below 1 percent in 2011. This is the kind of outlook that would normally prompt the Fed to stamp on the accelerator.
Sadly, the Fed no longer has this option. Ben Bernanke is hemmed in on two fronts.
The first is a political constraint. The doubling of the Fed’s balance sheet during the crisis alarmed many in Congress. As the financial crisis has receded, there seemed less justification for such extraordinary action.
The Fed now badly needs to win back support in Congress. The stakes are high as lawmakers prepare to overhaul the regulatory framework. Not only does the central bank hope to win the new role as systemic regulator, they may need to fight hard to avoid encroachments on their independence by Congress.
They will be particularly keen to prevent oversight by the Government Accountability Office. Such political pressures explain why the Fed’s last significant public announcement was a populist initiative to curb financial sector bonuses.
The second limitation is of their own making. It results from a failure of nerve. The Fed was too quick to sound the retreat on credit easing. Soon after financial conditions started to normalize and fears of depression eased, the Fed indicated that the balance sheet would not expand any more than had already been planned.
This was premature. The Fed could have added another trillion dollars to its holdings without generating inflationary risks or unsettling the markets. By raising the potential ceiling on their asset purchases Fed officials would have given themselves much more room to pursue the goal of full employment.
Now, however, the Fed appears to be locked into its sleepy strategy. To reverse course and expand asset purchases would throw the market into turmoil and undermine Fed credibility. The damage to the Fed’s inflation-fighting credentials could actually push up interest rates — more than offsetting the impact of further credit easing.
Bernanke can claim a good deal of credit for hauling the United States from the brink of disaster. But he swung too swiftly from boldness to caution — putting the Fed on the sidelines. Barring an unexpected downswing, is now powerless to help accelerate recovery and bring down unemployment.
Wednesday, September 16, 2009
IRS Gives Servicers Flexibility to Modify CMBS Loans
Important update from Commercial Real Estate Direct Staff Report
The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.
Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.
The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.
Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity.
Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.
In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."
In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.
The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.
In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.
"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."
The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.
Comments? E-mail John Covaleski or call him at (215) 504-2860, Ext. 208.
Copyright ©2009 Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.
The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.
Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.
The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.
Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity.
Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.
In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."
In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.
The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.
In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.
"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."
The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.
Comments? E-mail John Covaleski or call him at (215) 504-2860, Ext. 208.
Copyright ©2009 Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.
Monday, September 14, 2009
Stemming the Rising tide of foreclosures plaguing the Middle Class with the Guaranteed Mortgage Assistance Program (gMAP)
In an email blast regarding my blog, I introduced the following proposed solution to the continuing housing crisis which a friend and colleague, Jud Ireland, and two esteemed colleagues, Michael Intrillgator and Kyle Martin, created. The following article regarding this program was published today in the Huffington Post.....it is truly a solution we all need....please tell the President and your representatives in Congress...GET INVOLVED!
A slogan on the White House website states "A Strong Middle-Class = A Strong America."
Vice President Joe Biden, recently gave a speech at the Brookings Institution on the status of the economic stimulus plan and shared several examples of how the American Reinvestment and Recovery Act is starting to benefit the economy, including middle-class Americans.
We applaud the positive points he addressed. However, the truth remains that millions of middle-class Americans are still on a collision course towards losing their homes. The objectives of this paper are three-fold: 1) to put this problem into perspective, 2) to address why the existing program is not working effectively and 3) to propose a bottom-up solution that could be readily implemented for the benefit of not only middle-class America but also the nation as a whole.
The Scope of the Problem:
Recently many articles have expressed optimism that the recession is ending. While we all want this, foreclosures are still an enormous problem with many adverse secondary repercussions. Unless proactive measures are taken quickly, this problem will escalate. The flood of foreclosure filings continues to rise according to the latest data from RealtyTrac. Les Christie of CNN Money recently reported that between June and July of this year, the number of foreclosure filings rose by 179,599 or 9% in one month alone. This foreclosure rate is up 93% above the rate recorded in July of 2006. Right now there are at least 15 million Americans who are out of work. This number is expected to rise and by the end of the year1.3 million Americans will lose their unemployment benefits and tens of thousands of these are destined to lose their homes unless a more effective program is implemented quickly. Twelve percent of mortgages are now delinquent. RealtyTrac's® July 2009 U.S. Foreclosure Market Report™, indicated that in July 360,149 U.S. properties were in default and received foreclosure filings, default notices, or were scheduled for auction and bank repossession.
This represents an increase of 32 percent from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July. "July marks the third time in the last five months where we've seen a new record set for foreclosure activity," noted James J. Saccacio, chief executive officer of RealtyTrac. The problem is acute and, as Biden's speech revealed, is not getting proper attention from the Obama administration. For example, the payroll tax cuts which Biden referenced do very little to prevent unemployed homeowners from losing their homes as they only benefit those who have jobs. The program we propose benefits unemployed homeowners who are striving to become positive contributors to the nation's GDP.Through June of this year, aggregate wages and salaries are down 4.7%. This problem is compounded because 25% of all homes in the U.S. are now worth less than the mortgages against them. Thus there is often little incentive for homeowners to keep their homes when they are struggling just to make their mortgage payments. Coupling this "upside down" status of homes with the employment situation, it is no wonder that over 844,000 homes were foreclosed on by May 2009. Even though the economy may be starting to show signs of a weak recovery the glut of upside-down properties will put a major drag on this recovery. In quantitative terms, the Conference Board Consumer Confidence Index has been rising: From a low of 23.5 in February 2009 to 47.4 in July and now 54.1 in August. So, although the trend looks like it is moving in the right direction, the reality is that it takes a reading of 90 to indicate that economy is on solid footing. A reading of 100 or more means that the economy is growing. This is prima facie evidence that the U.S. economy is not on solid footing and has a long way to go before returning too normal. So, if we are going to end the recession now, we need to do something different.
Deficiencies with the Existing Housing Recovery ActThe Housing Act does not directly address those who have lost their jobs. For example, a job loss may put the homeowner in even more jeopardy of not qualifying for assistance! The applicant must comply with several conditions. Even then, there is no guarantee the applicant will receive assistance since the program is voluntary and lenders are not required to participate in it. The program's scope is also too narrow. Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers who are in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. This number is by no means acceptable. In California alone, foreclosures scheduled for sale in July rose to 124,874, a 10.4 percent increase from June, and a 93.3 percent increase year-over-year from July 2008. Although the American taxpayers bailed out banks, these banks have not reciprocated in a commensurate manner and have been rejecting too many applications for loan modifications. For example there have been incidents where Aurora Loan Services has rejected requests for home loan modifications from clients who are in need of help due to losing their job, but, have tenaciously continued to make all their payments on time. With the proposal we introduce in this paper, such clients would be guaranteed assistance in making their mortgage payments.
Our Proposed Solution to Stemming the Rising Tide of ForeclosuresIn a Financial Times article, Paul Krugman, the most recent Nobel Prize laureate in economics, candidly stated "Damned if I know," in response to an inquiry per what the most promising short-term investments would be for promoting the recovery. We have an answer to this question, which addresses a major subset of the overall macroeconomic problems. Specifically, in this paper we present a solution to the problem of middle-class Americans losing their homes. The primary objectives of this program are to prevent homeowners from losing their primary residence while simultaneously enabling these homeowners to focus their energies on obtaining new jobs and being productive members of society. If not these homeowners will waste productive energy on the hardships of relocation associated with foreclosure. Further, this program will provide homeowners positive incentives and help shore up the balance sheets of the banks and other financial institutions that are holding the mortgages.
We term this program "The Guaranteed Mortgage Assistance Program" (GMAP). The basic concept for this initiative involves guaranteed loans for making mortgage payments in the form of mortgage vouchers. Here we: 1) articulate the framework for the rapid mass implementation of this initiative, 2) provide an example of how this program could benefit a typical middle-class homeowner, 3) estimate in aggregate how much this program would benefit America as a whole, and 4) propose the recommended next steps towards implementing this program. To date, most of the Federal government's initiatives have been of the "top down" variety, which resulted in billions of dollars being pumped into banks, and insurance companies with the hope there would be trickle-down benefits to the middle-class. But hope is not a strategy! These rather startling initiatives included the unprecedented funding of foreign banks, the relaxing of accounting rules and even the funding of private corporations. However, it was the Cash for Clunkers program which worked the best. In magnitude it was miniscule in comparison to the TARP bailout. Specifically, the $3 billion allocated to the Cash for Clunkers program is only 0.381% of the $787 billion TARP bailout. But Cash for Clunkers put approximately 17,000 people back to work on automotive assembly lines. This program worked because it was bottom-up; that is the investment was focused directly on those who were the beneficiaries. It had the triple-benefit of:
* Saving Americans up to $4,500 per vehicle purchased
* Putting thousands of Americans back to work
* Decreasing Greenhouse gas emissionsAmericans have witnessed that bottom-up programs are a much more effective use of capital than top-down programs. In a manner corollary to Cash for Clunkers, our proposed guaranteed mortgage loan voucher program is a triple-benefit "bottom up" approach which would get right to the core of solving the housing crisis while simultaneously helping the banks and stimulating the economy; but at no long-term cost to the government. We now discuss the program in detail.
The Mortgage Payment Voucher ProgramWe propose a fresh new and innovative solution that hasn't yet been tried. This initiative is aimed at benefiting middle-class taxpayers; who for the purpose of this initiative we define as individuals with personal or family incomes of no more than $250,000 with this number selected based on President Obama's definition of the middle-class during his campaign. These loans will be limited to a) primary residences and b) to a maximum of 10% of the mortgage amount of the home. The bottom-line objective of this program is to enable homeowners to be able to make their mortgage payments without losing their homes. This program would have the secondary benefit of enabling the homeowner to focus on finding another job without the stress and dilution of focus caused by the pending loss of one's home. This program would have the immediate benefit of putting a stop to the majority of primary residence foreclosures.
The basic structure of this program is that the government grants 10-year loans to homeowners to help pay their mortgages in the form of a Guaranteed Mortgage Assistance Program (GMAP). These GMAP loans will be fully repaid because they can be secured in the same fashion as a tax lien, so the program is deficit neutral, and hence at no cost to the government.
In terms of specifics, there are three primary time-staged phases to this program, which would work as follows: Phase 1: After successful completion of an application, the government provides a voucher to the homeowner who in turn transfers the voucher to the bank. The homeowner uses this voucher as an equivalent to dollars, which, together with their payment, makes up the total monthly mortgage payment .
Phase 2: The government reimburses the bank for the amount of the vouchers over an extended period of time.
Phase 3: The homeowner reimburses the government for the loan at the end of 10 years as a balloon payment that could be funded either by the homeowner's accrued savings or by taking out a second mortgage against the property or selling the home.For example, if 10 percent of the homeowners elect to participate In this program (roughly correlates with the unemployment rate) at the program limit of 10% of the outstanding mortgage balance, the program will have an upper limit of $100 billion. This number was computed based on the $10 trillion total outstanding residential mortgages. If the government elects to reimburse the banks at the 5% rate then the upper-limit cost to the government is $50 billion over the course of 10 years, which would be fully collateralized and fully repaid by the homeowners. We envision that this program would immediately begin to increase housing equity for the following reasons: When the government announces this program Americans will see that the end of the housing crisis is in sight. With government now backstopping the fall in prices, a large number of potential buyers on the sideline will jump in, driving up demand and leading to further rising prices.
Benefits of the GMAP ProgramThe banks benefit by converting non-performing loans into performing loans, thus shoring up their books. This will significantly contribute to a further thawing of the credit markets by enabling the banks holding GMAP loans to loan against them (like a Treasury asset) at a reasonable multiple of value, thereby further stimulating the economy with new loans. The banks redeem GMAP funds back to the government at a rate of 5 or 10 percent of the principal value per year. Under the 5 percent per year plan, the government would be required to pay the bank a balloon payment of 50% in the tenth year. This is at the same time the homeowner is paying the government the entire loan amount, at the end of the term. The 100% repayment by the homeowner may require taking out a second mortgage. However, after ten years the equity in the home is likely to increase. Thus we have proposed a solution to stem the rising tide of foreclosures at virtually no cost, which would also significantly contribute to stabilizing the banks.Other bottom-up programs should also be considered by the Obama administration. These include small business loans and an initiative for funding pre-school education. For example, University of Chicago Professor of Economics and 2000 Nobel Prize winner Dr. James Heckman states in his prescient paper The Productivity Argument for Investing in Young Children "Enriched pre-kindergarten programs available to disadvantaged children on a voluntary basis, coupled with home visitation programs, have a strong track record of promoting achievement for disadvantaged children, improving their labor market outcomes and reducing involvement with crime." [http://jenni.uchicago.edu/Invest/FILES/dugger_2004-12-02_dvm.pdf] The details associated with implementing these two other programs are beyond the scope of this paper. However, the authors intend to expand on the details of these programs in future papers. Conclusion:This continuing economic disaster can be dramatically mitigated with the GMAP program that serves as a triple catalyst for increased equity in housing, stronger bank balance sheets, and no increase in government debt. This program is based on providing a little short-term reprieve to struggling homeowners while counting on them to have full accountability by fully reimbursing the government. As we see it, it is now time to adopt the GMAP initiative and other such bottom-up economic solutions to address the recession so as to avoid an economic relapse or a prolonged recession like the "lost Decade" in Japan in the 1990's.
Michael D. Intriligator is Professor of Economics, Political Science, and Public Policy at UCLA; Jud Ireland an investor; and R. Kyle Martin Is an accredited investor and a consultant to institutional investors with a focus on companies in the technology sector.
A slogan on the White House website states "A Strong Middle-Class = A Strong America."
Vice President Joe Biden, recently gave a speech at the Brookings Institution on the status of the economic stimulus plan and shared several examples of how the American Reinvestment and Recovery Act is starting to benefit the economy, including middle-class Americans.
We applaud the positive points he addressed. However, the truth remains that millions of middle-class Americans are still on a collision course towards losing their homes. The objectives of this paper are three-fold: 1) to put this problem into perspective, 2) to address why the existing program is not working effectively and 3) to propose a bottom-up solution that could be readily implemented for the benefit of not only middle-class America but also the nation as a whole.
The Scope of the Problem:
Recently many articles have expressed optimism that the recession is ending. While we all want this, foreclosures are still an enormous problem with many adverse secondary repercussions. Unless proactive measures are taken quickly, this problem will escalate. The flood of foreclosure filings continues to rise according to the latest data from RealtyTrac. Les Christie of CNN Money recently reported that between June and July of this year, the number of foreclosure filings rose by 179,599 or 9% in one month alone. This foreclosure rate is up 93% above the rate recorded in July of 2006. Right now there are at least 15 million Americans who are out of work. This number is expected to rise and by the end of the year1.3 million Americans will lose their unemployment benefits and tens of thousands of these are destined to lose their homes unless a more effective program is implemented quickly. Twelve percent of mortgages are now delinquent. RealtyTrac's® July 2009 U.S. Foreclosure Market Report™, indicated that in July 360,149 U.S. properties were in default and received foreclosure filings, default notices, or were scheduled for auction and bank repossession.
This represents an increase of 32 percent from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July. "July marks the third time in the last five months where we've seen a new record set for foreclosure activity," noted James J. Saccacio, chief executive officer of RealtyTrac. The problem is acute and, as Biden's speech revealed, is not getting proper attention from the Obama administration. For example, the payroll tax cuts which Biden referenced do very little to prevent unemployed homeowners from losing their homes as they only benefit those who have jobs. The program we propose benefits unemployed homeowners who are striving to become positive contributors to the nation's GDP.Through June of this year, aggregate wages and salaries are down 4.7%. This problem is compounded because 25% of all homes in the U.S. are now worth less than the mortgages against them. Thus there is often little incentive for homeowners to keep their homes when they are struggling just to make their mortgage payments. Coupling this "upside down" status of homes with the employment situation, it is no wonder that over 844,000 homes were foreclosed on by May 2009. Even though the economy may be starting to show signs of a weak recovery the glut of upside-down properties will put a major drag on this recovery. In quantitative terms, the Conference Board Consumer Confidence Index has been rising: From a low of 23.5 in February 2009 to 47.4 in July and now 54.1 in August. So, although the trend looks like it is moving in the right direction, the reality is that it takes a reading of 90 to indicate that economy is on solid footing. A reading of 100 or more means that the economy is growing. This is prima facie evidence that the U.S. economy is not on solid footing and has a long way to go before returning too normal. So, if we are going to end the recession now, we need to do something different.
Deficiencies with the Existing Housing Recovery ActThe Housing Act does not directly address those who have lost their jobs. For example, a job loss may put the homeowner in even more jeopardy of not qualifying for assistance! The applicant must comply with several conditions. Even then, there is no guarantee the applicant will receive assistance since the program is voluntary and lenders are not required to participate in it. The program's scope is also too narrow. Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers who are in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. This number is by no means acceptable. In California alone, foreclosures scheduled for sale in July rose to 124,874, a 10.4 percent increase from June, and a 93.3 percent increase year-over-year from July 2008. Although the American taxpayers bailed out banks, these banks have not reciprocated in a commensurate manner and have been rejecting too many applications for loan modifications. For example there have been incidents where Aurora Loan Services has rejected requests for home loan modifications from clients who are in need of help due to losing their job, but, have tenaciously continued to make all their payments on time. With the proposal we introduce in this paper, such clients would be guaranteed assistance in making their mortgage payments.
Our Proposed Solution to Stemming the Rising Tide of ForeclosuresIn a Financial Times article, Paul Krugman, the most recent Nobel Prize laureate in economics, candidly stated "Damned if I know," in response to an inquiry per what the most promising short-term investments would be for promoting the recovery. We have an answer to this question, which addresses a major subset of the overall macroeconomic problems. Specifically, in this paper we present a solution to the problem of middle-class Americans losing their homes. The primary objectives of this program are to prevent homeowners from losing their primary residence while simultaneously enabling these homeowners to focus their energies on obtaining new jobs and being productive members of society. If not these homeowners will waste productive energy on the hardships of relocation associated with foreclosure. Further, this program will provide homeowners positive incentives and help shore up the balance sheets of the banks and other financial institutions that are holding the mortgages.
We term this program "The Guaranteed Mortgage Assistance Program" (GMAP). The basic concept for this initiative involves guaranteed loans for making mortgage payments in the form of mortgage vouchers. Here we: 1) articulate the framework for the rapid mass implementation of this initiative, 2) provide an example of how this program could benefit a typical middle-class homeowner, 3) estimate in aggregate how much this program would benefit America as a whole, and 4) propose the recommended next steps towards implementing this program. To date, most of the Federal government's initiatives have been of the "top down" variety, which resulted in billions of dollars being pumped into banks, and insurance companies with the hope there would be trickle-down benefits to the middle-class. But hope is not a strategy! These rather startling initiatives included the unprecedented funding of foreign banks, the relaxing of accounting rules and even the funding of private corporations. However, it was the Cash for Clunkers program which worked the best. In magnitude it was miniscule in comparison to the TARP bailout. Specifically, the $3 billion allocated to the Cash for Clunkers program is only 0.381% of the $787 billion TARP bailout. But Cash for Clunkers put approximately 17,000 people back to work on automotive assembly lines. This program worked because it was bottom-up; that is the investment was focused directly on those who were the beneficiaries. It had the triple-benefit of:
* Saving Americans up to $4,500 per vehicle purchased
* Putting thousands of Americans back to work
* Decreasing Greenhouse gas emissionsAmericans have witnessed that bottom-up programs are a much more effective use of capital than top-down programs. In a manner corollary to Cash for Clunkers, our proposed guaranteed mortgage loan voucher program is a triple-benefit "bottom up" approach which would get right to the core of solving the housing crisis while simultaneously helping the banks and stimulating the economy; but at no long-term cost to the government. We now discuss the program in detail.
The Mortgage Payment Voucher ProgramWe propose a fresh new and innovative solution that hasn't yet been tried. This initiative is aimed at benefiting middle-class taxpayers; who for the purpose of this initiative we define as individuals with personal or family incomes of no more than $250,000 with this number selected based on President Obama's definition of the middle-class during his campaign. These loans will be limited to a) primary residences and b) to a maximum of 10% of the mortgage amount of the home. The bottom-line objective of this program is to enable homeowners to be able to make their mortgage payments without losing their homes. This program would have the secondary benefit of enabling the homeowner to focus on finding another job without the stress and dilution of focus caused by the pending loss of one's home. This program would have the immediate benefit of putting a stop to the majority of primary residence foreclosures.
The basic structure of this program is that the government grants 10-year loans to homeowners to help pay their mortgages in the form of a Guaranteed Mortgage Assistance Program (GMAP). These GMAP loans will be fully repaid because they can be secured in the same fashion as a tax lien, so the program is deficit neutral, and hence at no cost to the government.
In terms of specifics, there are three primary time-staged phases to this program, which would work as follows: Phase 1: After successful completion of an application, the government provides a voucher to the homeowner who in turn transfers the voucher to the bank. The homeowner uses this voucher as an equivalent to dollars, which, together with their payment, makes up the total monthly mortgage payment .
Phase 2: The government reimburses the bank for the amount of the vouchers over an extended period of time.
Phase 3: The homeowner reimburses the government for the loan at the end of 10 years as a balloon payment that could be funded either by the homeowner's accrued savings or by taking out a second mortgage against the property or selling the home.For example, if 10 percent of the homeowners elect to participate In this program (roughly correlates with the unemployment rate) at the program limit of 10% of the outstanding mortgage balance, the program will have an upper limit of $100 billion. This number was computed based on the $10 trillion total outstanding residential mortgages. If the government elects to reimburse the banks at the 5% rate then the upper-limit cost to the government is $50 billion over the course of 10 years, which would be fully collateralized and fully repaid by the homeowners. We envision that this program would immediately begin to increase housing equity for the following reasons: When the government announces this program Americans will see that the end of the housing crisis is in sight. With government now backstopping the fall in prices, a large number of potential buyers on the sideline will jump in, driving up demand and leading to further rising prices.
Benefits of the GMAP ProgramThe banks benefit by converting non-performing loans into performing loans, thus shoring up their books. This will significantly contribute to a further thawing of the credit markets by enabling the banks holding GMAP loans to loan against them (like a Treasury asset) at a reasonable multiple of value, thereby further stimulating the economy with new loans. The banks redeem GMAP funds back to the government at a rate of 5 or 10 percent of the principal value per year. Under the 5 percent per year plan, the government would be required to pay the bank a balloon payment of 50% in the tenth year. This is at the same time the homeowner is paying the government the entire loan amount, at the end of the term. The 100% repayment by the homeowner may require taking out a second mortgage. However, after ten years the equity in the home is likely to increase. Thus we have proposed a solution to stem the rising tide of foreclosures at virtually no cost, which would also significantly contribute to stabilizing the banks.Other bottom-up programs should also be considered by the Obama administration. These include small business loans and an initiative for funding pre-school education. For example, University of Chicago Professor of Economics and 2000 Nobel Prize winner Dr. James Heckman states in his prescient paper The Productivity Argument for Investing in Young Children "Enriched pre-kindergarten programs available to disadvantaged children on a voluntary basis, coupled with home visitation programs, have a strong track record of promoting achievement for disadvantaged children, improving their labor market outcomes and reducing involvement with crime." [http://jenni.uchicago.edu/Invest/FILES/dugger_2004-12-02_dvm.pdf] The details associated with implementing these two other programs are beyond the scope of this paper. However, the authors intend to expand on the details of these programs in future papers. Conclusion:This continuing economic disaster can be dramatically mitigated with the GMAP program that serves as a triple catalyst for increased equity in housing, stronger bank balance sheets, and no increase in government debt. This program is based on providing a little short-term reprieve to struggling homeowners while counting on them to have full accountability by fully reimbursing the government. As we see it, it is now time to adopt the GMAP initiative and other such bottom-up economic solutions to address the recession so as to avoid an economic relapse or a prolonged recession like the "lost Decade" in Japan in the 1990's.
Michael D. Intriligator is Professor of Economics, Political Science, and Public Policy at UCLA; Jud Ireland an investor; and R. Kyle Martin Is an accredited investor and a consultant to institutional investors with a focus on companies in the technology sector.
Thursday, September 10, 2009
Fed's Beige Book offers some positive news reads the headline
The Federal Reserve says it's “cautiously positive” about the economy in its widely watched regular report called the Beige Book.Eleven of the Fed’s 12 regions called economic activity in the area “stable,” “showing sings of stabilization,” or “firmed.”
Analysts said the economy is growing in the third quarter at an annual rate of 3 percent to 4 percent because businesses are spending more.
But the market for homes continues to be weak. In most areas, buyers are first timers and others purchasing the lowest-cost properties. Philadelphia was an exception: Sales there are up even for expensive homes.
In the commercial real estate market, sales were down, and construction was off in all parts of the country.
The Feds are seeing a light when in the depth of the tunnel and think it is daylight...those of us who are living in this environment see the light and know it is someone's candle flickering before going out....In what world can you look at increasing unemployment, significant underemployment a multi-billion dollar commercial mortgage liquidity crisis yet to happen and homes selling for $9,000 (that is not a typo) are things improving?! This is further evidence that the powers that be do not know any more now than they did two years ago when we were told that the sub-prime crisis was contained....in the end, we, the public, will get an education that we will be paying for through taxes for many moons to come....welcome to the 21st century!
Analysts said the economy is growing in the third quarter at an annual rate of 3 percent to 4 percent because businesses are spending more.
But the market for homes continues to be weak. In most areas, buyers are first timers and others purchasing the lowest-cost properties. Philadelphia was an exception: Sales there are up even for expensive homes.
In the commercial real estate market, sales were down, and construction was off in all parts of the country.
The Feds are seeing a light when in the depth of the tunnel and think it is daylight...those of us who are living in this environment see the light and know it is someone's candle flickering before going out....In what world can you look at increasing unemployment, significant underemployment a multi-billion dollar commercial mortgage liquidity crisis yet to happen and homes selling for $9,000 (that is not a typo) are things improving?! This is further evidence that the powers that be do not know any more now than they did two years ago when we were told that the sub-prime crisis was contained....in the end, we, the public, will get an education that we will be paying for through taxes for many moons to come....welcome to the 21st century!
Wednesday, September 2, 2009
US commercial property boom decades away - JLL
The end of summer is always slow...but in the Summer of '09, that is business as usual. If a recent report by Jones Lang LaSalle (JLL) is correct, our summer of discontent will last long into the next decade. Unless and until we are able to restructure and resurrect or replace the CMBS and RBS investment vehicles, liquidity will not return to the market and we will see continued declines in property pricing and no significant momentum in the market.
As reported today by Reuters, JLL recently issued a report that concluded the "level of U.S. commercialreal estate deals seen in the boom years of 2005 through 2007may take a generation to return."
It comes as no surprise to real estate practitioners that US commercial property sales in the first half of 2009 were down 80% from the same period in 2008 to $16 billion which is a whopping 93% decrease in volume from the $231.4 billion recorded in the first half of 2007 according to JLL's US Mid-Year Capital Markets bulletin. Of course, without momentum and cheap debt, prices are off 30 to 55% from prior periods.
- At just $5.2 billion, the second quarter sales activity was the lowest in recent years and down from $30.7 billion in 2Q08 and $114.7 billion in 2Q07 (an incredible 95% reduction in volume - no wonder appraisers are having trouble finding comps). With no CMBS market to turn to for cheap capital -and prospects for a quick recovery not promising, sales or properties are not expected to be robust anytime soon. Jones Lang LaSalle predicts that U.S. investors will slowlybegin to return to the market by mid-2010, though a return tothe boom years of 2005 through 2007 will take a generation orlonger. Instead of $231 billion a year in deals, U.S. commercialreal estate sales are likely to hover around $100 million onaverage for the first several years of the next decade.
JLL reports that cap rates have moved up a full 2.5 percentage points. Based on where cap rates were, this means that a property generating the same NOI could be worth up to one-third less. My opinion is that with increasing expensive capital being the only source and with the on-going perceived risk in the asset class, cap rates can be expected to increase until the rental market shows sign of recovery.
NOTE: the effects of the recession is being felt in the rental market as well as from the peak of the market to the end of the second quarter 2009, U.S. office asking rents fell on average 10% to 25%. Office leasing is down 25% to 50%.
Given all this, JLL predicts that prices for office buildings are not expected to begin to recover until at least 2012 because commercial real estate performance, which is based on job growth, lags the economy. The retail and lodging markets also will need additional time to recover as they depend on consumer spending and business travel.
This is an important point...demand for real estate lags the demand for the goods and services it houses as firms need to expand and employ to fill up their current space which typically is underutilized in a recession before they lease new space....
Be well and God-speed my friends...
As reported today by Reuters, JLL recently issued a report that concluded the "level of U.S. commercialreal estate deals seen in the boom years of 2005 through 2007may take a generation to return."
It comes as no surprise to real estate practitioners that US commercial property sales in the first half of 2009 were down 80% from the same period in 2008 to $16 billion which is a whopping 93% decrease in volume from the $231.4 billion recorded in the first half of 2007 according to JLL's US Mid-Year Capital Markets bulletin. Of course, without momentum and cheap debt, prices are off 30 to 55% from prior periods.
- At just $5.2 billion, the second quarter sales activity was the lowest in recent years and down from $30.7 billion in 2Q08 and $114.7 billion in 2Q07 (an incredible 95% reduction in volume - no wonder appraisers are having trouble finding comps). With no CMBS market to turn to for cheap capital -and prospects for a quick recovery not promising, sales or properties are not expected to be robust anytime soon. Jones Lang LaSalle predicts that U.S. investors will slowlybegin to return to the market by mid-2010, though a return tothe boom years of 2005 through 2007 will take a generation orlonger. Instead of $231 billion a year in deals, U.S. commercialreal estate sales are likely to hover around $100 million onaverage for the first several years of the next decade.
JLL reports that cap rates have moved up a full 2.5 percentage points. Based on where cap rates were, this means that a property generating the same NOI could be worth up to one-third less. My opinion is that with increasing expensive capital being the only source and with the on-going perceived risk in the asset class, cap rates can be expected to increase until the rental market shows sign of recovery.
NOTE: the effects of the recession is being felt in the rental market as well as from the peak of the market to the end of the second quarter 2009, U.S. office asking rents fell on average 10% to 25%. Office leasing is down 25% to 50%.
Given all this, JLL predicts that prices for office buildings are not expected to begin to recover until at least 2012 because commercial real estate performance, which is based on job growth, lags the economy. The retail and lodging markets also will need additional time to recover as they depend on consumer spending and business travel.
This is an important point...demand for real estate lags the demand for the goods and services it houses as firms need to expand and employ to fill up their current space which typically is underutilized in a recession before they lease new space....
Be well and God-speed my friends...
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