Affordable Housing Institute : US

After the Allies’ 1943 capture of Tunis ended the North African phase of World War II, they faced another amphibious landing with a vast choice of targets.  To fool the Germans as to the intended landing point, British Intelligence devised Operation Mincemeat, procuring an anonymous cadaver, dressing him as Major William Martin, RM, and releasing his corpse (via submarine torpedo tube) off the cost of Huelva, Spain, where the current would carry him ashore. 

 

Essential to selling the scheme — with fake orders that unmistakably identified Sardinia and Greece as the next invasion targets — was constructing an entire plausible personal history for Major Martin, whose body and uniform were carefully kitted out with letters and personal memorabilia.  Because the Germans believed in Major Martin’s death and life, they believed the orders in a locked briefcase handcuffed to his dead wrist, and they left Sicily unreinforced for two full weeks after the Allies’ invasion.

 

Buried as William Martin, possibly a homeless Welsh alcoholic named Glyndwr Michael

 

Much the same thing takes place in home lending — loans are made because lenders believe that the borrower is genuine.  As I’ve previously posted, owned homes are price-drop resistant, but the same cannot be said for properties that are (1) bought by fraudulent buyers, (2) bought or refinanced by people already deeply in credit-card debt  or (3) bought on pure speculation by investors who hope to flip them.  As documented by The Wall Street Journal, that’s why so many home lenders require the borrower to certify that he or she will use the home as a primary residence:

 

Lenders and builders said they tried to weed out speculators during the boom. To discourage flipping, some builders put clauses into contracts stating that investors who resold their homes soon after they bought had to give up some of their profits.

 

Just keep that equity from going down the drain

 

“We had people at the end signing four-page documents, ‘I am not an investor. I am not an investor. I am not an investor,’ ” Robert Toll, chief executive of luxury builder Toll Brothers Inc., said at a UBS AG conference in 2006. And the person “turned out to be an investor, of course.”

 

Essential to a con is the mark’s desire to believe.  The Nazis who found Martin’s corpse wanted to believe they had scored an intelligence coup; originators want to believe that someone who looks them in the eye is an earnest, deserving buyer:

 

While it is true that occupancy fraud can sometimes be difficult to detect, fraud experts said lenders and builders could have vetted their borrowers more closely. Pulling a borrower’s credit report, for instance, may reveal multiple mortgages. In other cases, appraisal reports will sometimes indicate that a tenant lives in the property, and Internet searches can also turn up indications that a borrower owns multiple homes.

 

“There’s a lot of telltale signs,” said Frank McKenna, chief fraud strategist for BasePoint Analytics, which develops computerized fraud-detection tools. But “the industry was very focused on volume,” he said.

 

We were entirely focused on results

 

Yet, when volume rises and there are fees to be made, fraud rises exponentially, even if it’s of the ‘white-lie’ kind of claiming residency when in fact one is an investor:

 

The temptation to lie can be substantial and may have been encouraged, or at least tolerated, by mortgage brokers and real-estate agents eager to close a home sale. Standards tend to be tougher for borrowers purchasing investment properties, since these loans are considered riskier.

 

Thus we see yet another agency-risk link in an intermediated value chain.  Just as bad lenders make bad loans, originators who are paid at closing have an economic incentive to look the other way.

 

Lenders typically allowed investors to finance no more than 90% of a home’s value, but if borrowers said they planned to live in the property, they could buy a home with no money down, even if they had scuffed credit and didn’t document their income, said Pete Ogilvie, a mortgage broker in Santa Cruz, Calif., and president of the California Association of Mortgage Brokers.

 

100% financing!  No money down!

 

 

It was all too easy to rationalize the white lie, since prices were going up anyway, and you’d be able to flip the home, wouldn’t you?
 

As lenders pore over their defaulted mortgages, they are learning that the number of people who bought homes as investments is much greater than previously believed.

 

Such borrowers turn up frequently in analyses of loans that defaulted within months after origination. In many cases, these speculators lied on loan applications, saying they intended to live in the homes in order to obtain more favorable loan terms or failed to provide the requested information.

 

“Maybe I believed it when I said it?”

 

Roughly 20% of mortgage fraud involved “occupancy fraud,” or borrowers falsely claiming they intended to live in a property, according to an analysis by BasePoint, a provider of fraud-detection solutions in Carlsbad, Calif. Another study, by Fitch Ratings, looked at 45 subprime loans that defaulted within the first 12 months even though the borrowers had good credit scores. In two-thirds of the cases, borrowers said they intended to live in the property but never moved in.

 

The next time you read a sob-story about bilked subprime homeowners, bear in mind these bait-and-switch investors. 

 

“I really intended to live in it if I couldn’t flip it!”

 

If these statistics are any indications, the quick-buck speculators outnumbered the genuinely exploited by three or four to one.

 

Some home builders have come to similar conclusions: They now believe that as many as one in four home buyers in some markets were investors during the boom, up from their earlier estimates of one in 10 buyers.

 

The high number of hidden speculators helps explain some of the problems roiling the housing and mortgage markets. The loans backing these speculator purchases turned out to be riskier than ratings agencies and investors who bought mortgage-backed securities once thought.

 

Investors tend to be more likely than borrowers who live in the homes to walk away from their purchases when home prices fall. “We couldn’t understand what was driving so many borrowers to default so early in the life of their mortgage,” said Glenn Costello, a managing director at Fitch.

 

Much of the occupancy fraud was concentrated in markets such as Florida, Nevada and Arizona, where prices were appreciating by double-digit percentages annually, said Kevin Kanouff, president of Denver-based Clayton Fixed-Income Services, a unit of Clayton Holdings Inc. that reviews about seven million loans a month on behalf of investors.

 

Strong correlation between investor-speculators and foreclosure waves now

 

Unfortunately, markets that were hot with speculator-buyers also swept up first-home aspirant homeowners, and now that the speculators have fled, the foreclosure signs springing up like mushrooms — in places such as Michigan and Ohio — are eroding the collateral of their homes. 

 

In the early years of the housing boom, demand for homes rose because of strong economic fundamentals and low interest rates, which made it more affordable for a large swath of Americans to buy homes. But as home prices began to soar, hordes of investors jumped in.

 

Whee!

 

Once there was a whiff that prices could no longer rise, this speculative demand evaporated, sending prices falling in some markets. The housing boom would eventually have cooled, anyway, but investors amplified the boom and bust.

 

Pump up the prices!

 

Those truthful buyers have been whipsawed, caught in the updraft to pay too much, and now caught in the downdraft unable to sell and escape.

 

Rising defaults among speculators may complicate government efforts to assist home buyers. The Bush administration has said it wants to help only homeowners facing foreclosure, not speculators. But foreclosures of investor-owned properties can create ripple effects in neighborhoods, pushing down prices and making it tougher for people who live in those communities to refinance or sell their homes if they can’t make their mortgage payments.

 

The prevalence, nearly pervasiveness, of speculators in some markets is part of why the mortgage industry’s recapitalization proposal requires homeowners to demonstrate that they are residents.

 

In Las Vegas, as many as 60% of the foreclosures last year involved non-owner-occupied homes, according to Applied Analysis, a real-estate-research firm.

 

Sometimes wisdom is merely applied common sense.

 

But it’s so rare

 

The Las Vegas firm compared the addresses of the borrowers with the locations of their homes. Where the addresses didn’t match likely indicated a speculator.

 

The speculators will have lost their equity, but if they put up very little hard equity, their commitment is modest.  As Sherlock Holmes put it:

 

Hard equity secures the borrower’s undivided attention.  “When you’ve got them by the wallets, their hearts and minds will follow.” — with apologies to John Wayne.

 

“Who you apologizin’ to, pilgrim?”

 

No matter how much economists wish people were rational calculating machines, we are more complex than that.  (It is a weighty economic conundrum why some people walk up escalators.)  Not all money is emotionally equal –

 

 

 “Mine’s bigger than yours, George.”

 

– psychologists have demonstrated that people will work harder to recoup losses than they will to increase gains.  “Having skin in the game” is more than a metaphor, it’s an apt expression of the human subconscious expressing anxiety at having an integral organ hostage to fortune.  Developers will go to the ends of the earth to recover their invested simoleons.

 

“The realization that one is filing Chapter 11 in the morning concentrates the mind wonderfully.” — with apologies to Dr. Samuel Johnson.

 

What do you mean my equity’s upside down?

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