Friday, March 27, 2009

Lifted from Comments at Washington Monthly

(This started as a comment responding to Hilzoy but grew out of control, so instead of trying to post it there I'll put it here)

You can come up with a scenario to justify even the most exotic loan, particularly if you are a straight out investor. The main problem in my mind was a system that essentially forced real estate investors into fraud.

Because almost all of these products are restricted to owner-occupier borrowers. There is a perfectly good reason for that, traditionally owner-occ are less willing to default and more likely to take actions that preserve the value of the property. So you can't blame the underwriters.

On the other hands the rates for making a commercial loan to buy residential investment property were much higher than an owner-occ loan, enough higher that in many cases you couldn't make your cap rate work, you couldn't get enough cash flow from rent to cover the costs of carrying the loan without tying up all your operating capital.

Not all speculators are flat out gamblers. A lot of people made money buying houses with as little down as possible at the lowest initial rate with the full understanding that exiting the loan in the planned time frame was going to require a new round of financing with associated fees and penalties. For an investor a pre-payment penalty is just part of the cost, in effect it acts exactly like paying points does, it lowers the cost of carrying the loan, with the added advantage of coming at the back end of the total transaction, and hopefully out of the accrued equity.

The only problem is that the loans available that actually make the strategy work are technically and legally not available to the investor no matter how well capitalized he is. There is money just sitting on the table ready to pick up if you can just get someone to write you a loan. And there are or were plenty of lenders ready, willing and able to write you that loan. If you qualified for owner-occupied.

The result was predictable, real estate investors took out whole series of 'owner-occ' loans and often on multiple properties. And yes often with really exotic loan products that make about zero sense for an actual owner-occupier but work for the investor.

Sure it was fraud but in a rising market mostly though not totally a benign fraud. And absent a total freeze-up in credit there was always a way to exit even if appreciation didn't come in the way you expected, because you only lose money on the last round, and maybe not then.

But we had a total freeze-up in credit. And everyone got locked in benigh and malign fraudsters alike. Because Wall Street panicked.

Certainly there was a lot of predatory lending going on, and some people at Countrywide and Washington Mutual are right to be concerned about fooling ACTUAL owner-occupiers into buying houses too big and with too ridiculous terms for what they could afford. Some people need to do some serious jail time.

On the other hand a lot of people were just trying to make a buck buying rentals, managing those rentals for a period of time, and then selling them to a new investor. And a lot of other people were interested to selling those people loans that would pass muster with the underwriter which might require a friendly appraiser. And a certification that you actually planned to live in the house. Oops that was the catch, the obstacle that kept all parties, the seller, the buyer/investor, the lender, the appraiser, the escrow agent from sealing the deal. And people simply agreed to blink.

One last thing. There is some talk about 'liar loans', that is 'stated income/stated assets'. And a lot of this was straight out predation by lenders who might be acting without the knowledge of borrowers, while some of it was people who just wanted more house than they could realistically afford. But not all of it. Because the reason some of our clients and some of our company investments were funded by 'stated/stated' loans with a higher rate than a conventional loan was because ACTUAL assets and ACTUAL income was TOO HIGH to realistically qualify for an owner-occ loan on that particular property. If we had a wealthy out of state investor who wanted to pick up some property for us to manage it would have been kind of difficult to explain why he wanted to relocate from his mansion outside Philly to a three bedroom two bath rambler in a working class neighborhood.

My ex-company was providing a reasonable public service for a reasonable profit. We never to my knowledge put someone in a house they couldn't afford and we were a pretty decent landlord for the multiple properties we managed on our behalf and those of our investors. But in a system where the only way to get a reasonably priced loan for residential investment property is to claim you are an owner-occupier and where there is literally no one tasked to actually check, well investors are going to take the loan.

No comments: