Thoughts on Gordon Gekko, loan modifications and sailing in a boat you never really owned...

By
Real Estate Broker/Owner with Pacific Southland

Well, Gordon Gekko, it seems as it turns out that greed is NOT good. The concept alone is faulted. Greed is not right, greed does not work. Greed does not clarify, and in fact, if anything, it clouds the mind and the situation - it is certainly not evolution, if we allow the human mind to be a part of the process. It isn't even a good war strategy - leave something for your fellow man, and he is less likely to come after you for what you took.

OK, much of this is my opinion only, and in fact let me state that I am not an accountant, an attorney, a certified financial planner, or even a religious advisor. I am a real estate broker, I do loans... so I look at numbers alot, and my degree in architecture has my mindset in a way that thinks all the way around a problem - so this is my take.

Greed did take over in this one, this housing thing. The greed cycle was from top to bottom, and everyone in between. The banks offered products that were geared toward increasing home ownership - which was indeed the mandate right from the top at the federal government. As long as values were continuing to rise, there was no real problem... right? The fact that the programs were based on stated income, and even no documentation of income at all (so you didn't even have to lie!) was of no consequence. The mortgage brokers and bankers were simply selling the products that were given them to sell... it didn't really matter if these people could actually AFFORD the house. And if not, those homeowners could just sell the houses at a profit anyway. Up up up, no worries! The credit card companies jumped into the fray as well, money was loose and we needed to fuel all of that purchase activity and fund the furnishings, and repairs... and cameras to take all of those pictures of the new houses.

Etc. etc. - what a life!

The greed of the homeowners themselves of course had bearing on the situation. It is easy to say, "I was misled!"... or, "I didn't understand those complicated loan documents!" - they understood. They were getting an opportunity to buy something they couldn't afford in a leveraged fashion that they were hoping was going to go up in value and fund their retirement. A common statement at the end of the 1990's : "It is a good thing for my home value because my stocks are tanking!" Everyone felt rich that owned property. What was really going on was somewhat visible although no one wanted to see it... the arrows on the charts were going straight up - and for no real good reason, and they hit the wall, at least one wall around 2000... then "values" went up some more.

When it all burst, the pop was heard all over the world. The folks who provided the monies that were fueling the whole thing with the purchase of blocks of mortgages naturally wanted assurances of their repayment, and had the power to threaten a more serious financial pop - so accommodations were made, so to speak. Numbers thrown around like, 'with the bailouts, we could have given every American $ 24,000..' or some such nonsense, to equal 7.7 Trillion (if none of it gets paid back) ... well, no we couldn't - it seems it wasn't ours to give, and sometimes when the big boss loses, you need to just let them win anyway. Fleets of attacking warships crossing the Pacific... maybe not - but a different world in many other ways was nearer than we are told, I'm betting. Weakness in economy is automatically a weakness in defense - less money to go around, especially when its spread thin.

Let's face it - if this isn't Depression II, then maybe it's D1-A. It's a monster, and it has a lifecycle that we will now have to navigate.

So, what now? How do we reverse this housing mess and fix it?

It seems we need to find a recovery pattern... a system to move forward that will make things progressively better, with a clear, directed path, and improvement with every step. Rebuild everything that is broken. To get anywhere you have to look at where you are now, so let's look at the current situation for homeowners with these thoughts as background to our thinking. Let's first take a quick look at these different types of situations that are out there.

First, there is the guy that never owned a house in this latest rise and fall (1995-2005 / 2006-?). He never participated in the run-up, so never had a chance to sell and profit, to refi and grab the money, or use it for other things. He sees the current situation as somewhat neutral - never got to make any quick cash, but also hasn't plummeted to the depths of debt others have. He may see opportunity in the new situation, with home prices falling down to a level where he can again hope to participate, and whatever kept him out of the market the last time he hopes might now become solved. The reality is that whatever did keep him out likely is still keeping him out - and as unemployment rises that situation gets worse. So hope... but for the hopeful, or the now further hopeless? In an upturning economy, it is a hopeful situation. In a sideways / downturn, it's the opposite. Looks like jobs are the key here.

Then, there is the guy who lost his home before the cavalry arrived. The early foreclosures at the start of this simply were that - the old way of getting that completed. The good news for these guys is that now two years or more have passed, and even if bankruptcy was a part of the foreclosure situation, etc. - time heals all wounds. Again, in an upturning economy, this fellow should be in a good position to move forward. He may not be able to buy quite yet, but he can get involved in lease options, etc. and perhaps lock in a low price at least for the future, although maybe not the great interest rates of today. If the economy continues sluggish to down though, nothing likely changes for him in his ability to get involved. What he really needs is a good job!

Let's talk about the guy who had placed a large enough downpayment in a more "traditional" mortgage, and whether it was a struggle or not, quietly sat there (because he wasn't going out on the town or anything) and made his payments. Value up, value down... he never saw his house as a short term investment, so as long as he's not selling, he hasn't gained or lost anything - he simply trudges along making the required payment. This guy too feels an economic downturn, but it maybe more effects his other investments than his home, as long as he can keep his job. He is not sure what to think about all of these bailouts... personal or corporate, in fact, he might feel that maybe a tax break or something should be there for the guys who did NOT strain the system, and just made their payments. He did have the opportunity if he had enough equity (and this type guy usually does) to refinance to the lowest rates of all time, around 4.375% - 4.500%, and that is his bonus, as others didn't have the equity to get that advantage. So as long as he can keep his job.......

All of the above folks - in an economy that moves forward - have reason to see the glass as half full, with potential opportunities in abundance. These folks should be saving their money and living frugally, because they will want to take advantage of this real estate market at any given opportunity, and they will need cash to take that advantage. An upswing in values of owned properties for them will certainly be one of the biggest opportunities possible to make large gains for their future - maybe the best way to accumulate wealth in their lifetime.

We have two more types to examine, both are currently in trouble in some sense of the word; one can afford to make the payments, and the other cannot, but for both the value has dropped substantially in the home they're in now, and their value is less than what they owe; they are upside down in their mortgage. Whether they can afford to make their payments or not, these two types are really in a very similar overall financial position. Well, they and the bank are upside down, at least in California, and every other state where the property is the sole remedy for recovery in a typical default of the mortgage. Certainly in the case of outright fraud there may be other remedies to the bank, such as judicial foreclosure, whereby they may be awarded a deficiency judgment, if they can collect! Assuming there is no fraud (like almost every "no doc" loan) the borrower / owner is faced with a difficult decision - should I fight to keep something that isn't worth keeping...? And the bank is faced with a decision to try to do their best to lose as little as possible, and also to keep the most value on the books they can for as long as possible in order to remain solvent. So we enter now the world of loan modifications, etc.

The bank 'got in bed' with the borrower on value at the outset - regardless of the specific relationship / type of deed, etc. - as the situation stands, they are in the same position as both have lost. In the event of a foreclosure and no remedy, does it really matter which state we're in or the type of sale? The bank has a certain value on its books as a receivable that they stand not to collect. If they foreclose, that now causes the asset to be valued at its current value, and a loss occurs at resale with the lower value. If they hold off foreclosing, the asset is kept on the books at the higher value, and thus they look more solvent. This is of course looking at any given moment in time, on one side of the line of ownership or the other. As we know, value changes all the time, so one might want to look at a more fluid way of assessing value. One way of doing that is to actually reassign the ownership a little. Now this is just a mental exercise in a way of looking at "ownership", not a specific recommendation, so endure that aspect of the thinking for a minute. From the homeowner's perspective, "Well, this house that was worth (say) $ 400,000 and I borrowed 100% of the purchase price that I owned 100% of is now worth $ 300,000. Well, I'm willing to keep the house and owe $ 300,000 on it, but not $ 400,000. Now, you have lost 1/4 of the loan amount owed to you, so I am happy to give you a 25% ownership in this house for now to replace the value of your lost loan receivable income. I am willing to take my loss in the future value of the home itself because I think the values will eventually come back, and at that time I'll be happy to pay you the other $ 100,000 I owe you." This is a kind of "debt-for-equity" swap. Now the bank, "Well, we're not in the business of owning property, but as an accommodation to the situation, and to keep the value on our books, we'll do this. We'll hold that 25% portion of the property this way - we'll let you pay on the $ 300,000 for now, and you still owe us the other $ 100,000 as a "silent second", but we won't look for that money anytime soon - you can pay no interest or principal payments on that second for the life of the first loan, the second all due at any future sale or when the first loan pays off. Now, we have to keep this "paper" and it is less saleable, which costs us money, but we think it's worth it to make this work out for all parties. Specifically in fact, we believe we lose less money this way than if we foreclose now, which is all we really care about. We'll also reduce the interest rate on your current loan, and even maybe stretch out the term to say 38 1/2 years, to get your debt to income ratio down to the acceptable maximum of 31%. We are doing that because we want to make a situation that you are less likely to default in, and, oh yeah, the government is paying us a little bonus to make this modification in this specific way. Now we'd like to try this out for a period, and if it works out, we'll keep it this way, and make it permanent." Oh yeah... jobs jobs jobs... Again, it's all about jobs.

The Home Affordable Modification Program - sometimes with forgiven debt, sometimes with reduced interest rates... but all some version of this. Might be a good deal for all parties. IF the bank makes this accommodation WITHOUT damaging credit, and if the payments are truly affordable. If they're going to damage the credit - what is the incentive over just giving it back? It isn't worth what you're going to agree to pay - not at this time anyway.

But is this always a good deal? Is saving the hit to the credit worth carrying around this long term ball and chain? If you were a corporation for example, and you had four buildings that were buried in debt relative to value, would you work hard to cut deals to keep it? It is just business to you, and the bank is in business too. They often are not at all working to keep this bad situation hanging around... after all, they can just walk, start a new corporation, and start over again. Well, greed is good... right?

This is called "Strategic Default" and is the relatively new buzzword going around. The question is, why should individuals be held to a higher standard than corporations? We have our personal credit and the damage that will be caused there, yes, but if one is willing to give that up, or if the benefits outweigh the costs, what's wrong with using this tact? I tried two different accountant / personal investors with this question, and neither responded to my emails. One businessman I know is under the full belief that, since the value of money has decreased in this last round of money devaluing / "printing whatever they need" Washington politics, he simply doesn't owe more than his share of the overall value that will ultimately be - time / value of money thinking. While this may be an extreme approach, there seems to be some validity in the theory at least.

What seems to me to be the best approach is to try and consider what will be the best position to be in when we are finally on the other side of this. Wouldn't it be great to emerge from this with clean credit and most of your assets intact? This seems not only the best financial approach, but maybe the best moral approach - the least greedy as it were. One that my Grandparents would be proud of. Taking a look at all of ones financial matters - credit, income, and assets - and try to preserve as much as possible in a fair approach to all that you deal with, but definitely while still in a way that leaves you and your family in a solid position to move forward.

I hear 'ol Gordie Gekko is getting out of jail in the upcoming sequel. I guess we'll see how it all turns out!

Comments (2)

Anonymous
Andrew Powell

Great assessment as to the situations in which American homeowners; both responcible and not, are faced with today. A harsh lesson for many, to live within their means, with the true brunt of the mistakes being passed along to our children.  Thank you for explaining the current options available!

Feb 05, 2010 03:34 AM
#1
Anonymous
David Walker

Excellent, well thought out article.  I am going to share with my friends -- and tout that I have worked with the best broker I know!

Feb 06, 2010 10:08 AM
#2