Banks Blocking Way Out Of Foreclosure Crisis
Brett Ellis, a real estate agent in Fort Myers, Fla., was thrilled when he got an offer for a property in Bell Tower Park in May 2008.
"It was a gorgeous property on the corner lot," Ellis told the Huffington Post. The owner, who had lost his job, wanted to sell the apartment for a loss rather than go into foreclosure, a strategy known as a short sale.
The offer was for $350,000, and Ellis, who is a certified distressed property expert trained in executing such sales, knew it was as good an offer as he was going to get in this market. He immediately sent the paperwork into the bank.
He waited for four months. The bank finally told him it wouldn't take anything less than $400,000 -- a price Ellis was sure he could never get. In September, the buyer's agent called to say, "You know what, we gotta move on, we gotta buy something else."
Now the property is sitting vacant as it slides into foreclosure. Its former owner's credit is destroyed, and the house is losing value every day. "God knows what the condition is today," Ellis said, adding he'd be surprised if the property is worth more than $290,000 when it resurfaces on the market. Add in the legal expenses involved in a foreclosure, and the bank cost itself a hundred thousand dollars more that it otherwise would have.
It's a scenario that plays out constantly, everywhere in the United States. In a time of collapsing real estate values, where one in five homes are now under water, a short sale is increasingly the only option before foreclosure. It is less damaging to credit scores and spares the homeowner the shame of foreclosure.
It is also a better option for banks: According to one analysis, short sales resulted in loan losses of only 19 percent, compared with an average loss of 40 percent on homes sold after foreclosure.
So why aren't these sales more widely used?
The broad answer is that the American financial system simply can't handle a collapse of this magnitude. The fates of the banking and real estate industries are intertwined. But they don't work together -- and the result is that they end up working against each other.
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The more precise answer is related to securitization, the method by which banks bundle together different mortgages and slice them up and sell the pieces to various investors. Securitization makes negotiating a real estate sale that results in a loss nearly impossible.
"The most significant aspect is that so many of the banks' mortgages have been securitized, put together and bundled, sold off to Iceland or China or some godforsaken place," said Dave Liniger, founder and chairman of global real estate company Re/Max, in an interview with the Huffington Post. "The bank has to go through all of the various people who are stakeholders and it becomes a very lengthy process, and the bank is turning off the realtors by not even getting answers back to them, sometimes for months."
Banks have little incentive to untie those bundles. Since mortgages are listed on the banks' balance sheets at the value of the original loan, if they complete a short sale they must record a loss on their balance sheets. That would explain why banks drag the process out as long as possible. In Ellis' case, the property is sitting vacant a year after the first offer, allowing the bank to list the original value on its balance sheet all along.
According to research firm Campbell Communications, only 23 percent of short sale transactions are actually completed. "Three out of four potential short sale transactions fail, principally because the mortgage servicer takes too long to respond to the offer," said Tom Popik, author of a February survey of real estate agents. "When these same properties are later sold it further depresses real estate prices."
Congress has had as much success untangling this mess as real estate agents.
"We've been trying to figure out probably for close to two years now why so few mortgages are being modified when it seems to make absolute business sense for the person holding the mortgage to modify rather than foreclose or to take a smaller loss selling it rather than a bigger loss foreclosing on it," said Rep. Brad Miller (D-N.C.).
Miller points his finger at securitization. Once the mortgages are bundled and sliced up into different pieces, known as tranches, the owners of the pieces get paid back according to a certain pecking order. Senior investors get paid back first and if there's a loss, the most junior investors won't get anything. It's those investors who are blocking short sales.
"The people with the least senior tranches have no reason to agree to the modification because they take a complete loss and the people in the most senior tranches don't lose anything. So they've managed to structure their mortgages in a way that makes it almost impossible to modify or sell short," said Miller.
Miller sponsored legislation to reform the bankruptcy code to allow judges to rewrite those contracts, taking away the ability of junior investors to sue and encouraging them to negotiate. But the House-approved measure died in the Senate, 51-45, killed last week by Republicans and 12 Democrats, leaving it 15 votes short of the 60 needed to overcome a filibuster.
Dave Liniger of Re/Max said the provision would have changed the bargaining landscape. Lenders would have had much more of an incentive to take a loss on a short sale rather than see a judge unilaterally change the terms of a mortgage.
"It was a negotiating ploy more than anything," Liniger said.
"It's disappointing," said Financial Services Committee chairman Barney Frank (D-Mass.) of the banks' tendency to foreclose rather than agree to a sale. "I've heard that and I've been trying to press the banks not to do that."
Without bankruptcy reform, the only power the government has is persuasion.
"In the absence of bankruptcy [legislation], you're talking about contracts that we cannot abrogate," he told the Huffington Post. "That's why bankruptcy was so important."
Is there any chance Congress will return to it?
"Excuse me, what planet were you on last week? The vote was 45 to 51. Why would you ask that? Do I think there's a likelihood we could overturn 45-51? No," said Frank.
"I wish it weren't the case," he added. "Maybe there's some kind of compromise."
Sen. Dick Durbin (D-Ill.) isn't confident. "The purpose of the debate last week was to try to create some impetus for the banks to start renegotiating these mortgages in a positive way and the industry fought it," Durbin, who last week concluded banks "frankly own the place," told the Huffington Post. "I think many of the banks have not operated in good faith when it comes to this mortgage foreclosure issue."
Homeowners are the big losers of the banks' battle against the bill. But real estate agents are now losing real money as commissions fall through, making them a potential lobbying counterweight to the banks.
The National Association of Realtors wants the rules changed: "We are advocating measures that would help streamline the process when using FHA, Fannie or Freddie," said NAR spokeswoman Mary Trupo in a statement to the Huffington Post. "We are hoping that new process and regulations are put in place."
Fannie Mae just wrapped up a pilot program to test a process for streamlining short sales by partnering with local listing providers in Arizona and Florida to pre-approve 400 properties for short sales. The government-backed mortgage firm is still evaluating feedback from brokers, but overall the program was a success, and a new short sale initiative is in the works for this year.
"Short sales are one of the tools to avoid foreclosure if all other workout options are exhausted. It's always in the best interest of the homeowner, the community, and the investor to avoid foreclosure," said Fannie Mae spokeswoman Amy Bonitatibus in a statement to the Huffington Post.
Liniger says Re/Max recently trained 5,000 employees in short sales.
Lita Smith-Mines, a lawyer who specializes in real estate on Long Island, told the Huffington Post she and her colleagues often see short sales turn into foreclosures because the bank won't play along--even when losses are as small as $25,000 and the offer is as high as it will get. And much higher, in this market, than the bank will get from a foreclosure auction. The legal costs of foreclosure alone typically run to $50,000.
"There's no common sense when it comes to lenders. They have their paperwork and if you don't slot perfectly in, they just say no," she said.
"A lot was taken on the front end [during the housing boom], but they're not giving anything back on the back end," she said. Smith-Mines, though, said she isn't surprised. "If they actually cared about borrowers, we wouldn't be in this mess in the first place."HuffPost readers: Has the bank foreclosed on your home after dragging its feet on a short sale? Have you given up on a short sale after making an offer and waiting months? Email us your story at email@example.com