A Mortgage History Lesson & Foreclosure Tax Repercussions

The current mortgage environment has drawn many comparisons with the 1930's, when the government stepped in. It is generally agreed that without those fundamental changes, the Great Depression could have been much worse than it was. In the early part of the last century, most home loans were a 5-yr ARM with a balloon payment. Keeping that in mind, here's a brief summary:

In 1932, the National Association of Real Estate Boards proposed (and Congress created) the Federal Home Loan Bank System, modeled after the Federal Reserve System. Twelve regional banks were created, and a Federal Home Loan Bank Board, like the Federal Reserve board, was set up to oversee them. The Appraisal Institute was also founded in 1932 by the appraisal industry. Bankruptcy and eviction laws were modified and in 1933, Congress created the Home Owners Loan Corporation to help borrowers move from 5-yr balloon loans to 15-year amortizing mortgages.

In 1934, Congress created the Federal Housing Administration (FHA) to insure mortgages and the Federal Deposit Insurance Corporation (FDIC), intended to prevent runs on banks from depleting resources for home mortgages. Lastly, in 1938, Congress created the Federal National Mortgage Association (FNMA or Fanny Mae). Some argue that it is very early in this current business cycle; however it is easy to see the amount of government intervention juxtaposed with today's market, especially at the Federal level.

A plan is nearing fruition on a plan to freeze some subprime rates, but that won't help those already foreclosed upon. As most originators know, in many states (including California), most mortgages that are used to purchase a residence are nonrecourse, but mortgages from refinancing a previous mortgage are usually recourse, based on the note. So, can the lender come after the borrower for the difference? If the loan (Deed of Trust) is a purchase money loan secured by a house that is the borrower's principal residence, the answer is generally "no."

California's anti-deficiency laws [California Code of Civil Procedure Section 580(b)-(d)] protect homeowners by preventing lenders from doing any more than taking back the property. These anti-deficiency laws were enacted during the Depression to give homeowners a fresh start, without a deficiency judgment hanging over their heads. However, the code section is fairly specific. The loan had to be for the purchase of the property and the borrower has to occupy it as his or her principal residence: (No non-owner or vacation homes.) The lender can choose to file a judicial foreclosure against the borrower. For loans involving a refinance or line of credit (technically not purchase money loans) a lender could go after the borrower for the difference.

Regarding tax consequences, here are some sites that may be of help for you:
Questions and Answers on Home Foreclosure and Debt Cancellation -- IRS http://www.irs.gov/newsroom/article/0,,id=174034,00.html

Interest/Dividends/Other Types of Income: 1099 Information Returns (All Other) -- IRS http://www.irs.gov/faqs/faq4-4.html

Foreclosures and Repossessions -- IRS http://www.irs.gov/publications/p544/ch01.html#d0e914
Tax Consequences of a "Short Sale" of Real Estate vs. Foreclosure - CPA's website http://www.realestateinvestingtax.com/shortsale.shtml

Blog worth checking on-- http://dirtlaw.typepad.com/blog/2007/02/preforeclosure.html

In recent weeks jumbo loans have worsened relative to conforming prices, almost back to where they were when they were "bad" a few months ago, and currently have a difference of roughly 1%. So, as usual, headline-grabbing Treasury yields are improving, yet mortgages are plodding along. Conforming rates have improved slightly, jumbo prices hardly at all, while Treasury rates are down. If asked why, the primary reasons are:

1. Continued fear of delinquencies and foreclosures with mortgages (something not present with Treasury securities)


2. Investors nervous about declining property values in many markets (not a factor with Treasury securities)


3. The fear of early pay-offs on current mortgages if rates continue to move down (also not a factor with Treasuries).

The investor perceptions of mortgage companies and FNMA & FHLMC (their stocks are down 50% in recent months) are not helping either.

News today that "The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans, according to people familiar with the negotiations," is helping us somewhat. In fact, financial stocks are up significantly today. But the 10-yr bond continues to dance around 4% and mortgage prices are roughly unchanged.

Oil has dropped into the $89/barrel range for the first time in over a month. The economic news this morning was mixed. Personal Income was +.2 Personal Consumption was +.2%, with no revisions, but the price deflator moved up year-over-year. Unfortunately rates had crept up overnight, given the potential rally in the stock market.

Besides announcing $1.4 billion in HELOC-related write-downs, Wells Fargo engaged in further product changes. Effective today, for all of their nonconforming Verification of Assets loans, the maximum debt-to-income ratio requirement will decrease from 45% to 38%, and non-self-employed borrowers now have reduced eligibility for Limited Doc/VOA. At least one of the borrowers on the loan application must have their income derive from self-employment to be eligible for Limited Doc/VOA documentation option.

Speaking of Wells Fargo, they are absorbing $1.4 billion in losses on home equity loans that borrowers have stopped repaying. Well Fargo's troubled home equity loans, totaling $11.9 billion, represent about 14 percent of the bank's total home equity portfolio of $83.4 billion. The bank has said most of the delinquent loans originated from mortgage brokers or other lenders on the wholesale market. Wells Fargo is now steering clear of virtually all home equity loans made outside its own offices.

FNMA announced changes to their Alt-A program, effective March 1, 2008. (Remember that most, if not all, investors will probably follow suit.) "In light of the continuing deterioration of market conditions," FNMA will no longer purchase No Income/No Assets (NINA) documentation loans, or No Ratio (No Income/Verified Assets [NIVA]) documentation-type loans. Beginning then, FNMA will only purchase Stated Income/Verified Assets (SIVA) and Stated Income/Stated Asset (SISA) loans, with the following eligibility adjustments: for cash-out refinance loans, the maximum LTV/CLTV is reduced to 75% for all except 1-unit primary residence, the minimum FICO score is increased to 660 regardless of LTV/CLTV, and for 3- to 4-unit properties, the minimum FICO score is increased to 700.

Chase, effective today, is changing their risk-based price adjustments for Agency fixed rate products. Needless to say, they are not for the better. This is in reaction to FNMA and FHLMC's loan level pricing adjustments based on LTV and FICO scores. In addition, JP Morgan Chase will be cutting 91 jobs at a Southern California Mortgage Operations Center.

Freddie Mac is offering $6 billion of preferred stock, saying that the capital will be used for their base requirements. Freddie also cut their dividend by 50%.

Quote of the Day: "This time, like all times, is a good one if we but know what to do with it." ~ Ralph Waldo Emerson

Stumble It!

Definitions provided by: U.S. Property Definitions

Actions by the FED & other rumblings

Fed Chairman Ben Bernanke suggested a new idea to fix the troubled market for mortgages too large for Fannie Mae and Freddie Mac to buy: allow the companies to securitize jumbos, but have the federal government guarantee them. Fannie and Freddie currently can buy mortgages only up to $417,000 and so far Congress hasn't acted to lift that. As an alternative, Bernanke suggested that Congress could consider allowing the companies to buy mortgages of as much as $1 million from lenders, pay the government a fee for guaranteeing them, and then turn them into securities to be sold to investors. But is the Federal government willing to take on additional credit risk in addition to FHA, VA, etc?

The House Committee on Financial Services approved the mortgage reform legislation and anti-predatory lending practices by a vote of 45 to 19. H.R. 3915, the "The Mortgage Reform and Anti-Predatory Lending Act of 2007," will create a licensing system for residential mortgage loan originators, establish a minimum standard requiring that borrowers have a reasonable ability to repay a loan, and will attach a limited liability to secondary market securitizers. The legislation will also expand and enhance consumer protections for "high-cost loans," will include protections for renters of foreclosed homes, and will establish an Office of Housing Counseling through the Department of Housing and Urban Development. From here it moves on to the full House . . . .

• E-LOAN, which opened in 1997, laid off 500 employees (out of 950) worldwide. The lay-offs impacted their auto-lending group, programmers overseas, and a few other business lines.
• HSBC withdrew from the mortgage-backed security trading business in the United States. That is not a good thing.
• Trading in Barclays shares, Britain's third-biggest lender, was temporarily suspended from trading after the stock fell 6% in London.
• Edgewater Lending of Clackamas, Oregon announced the closure of their wholesale department but continued their two retail centers. The layoff involves 8 to 10 people.
• California wholesaler ResMae announced that they have ceased accepting locks.
• Indymac reported a net loss of $202.7 million ($2.77 per share) for the third quarter, compared with net earnings of $86.2 million ($1.19 per share) a year earlier.

Bernanke said that there is a host of economic problems which will cause business growth to slow noticeably in coming months. Finally, we actually have some top level government officials recognizing that we have some problems out there. Just as Bill Gross (Bond Guru for PIMCO FUNDS) has come out and stated that if the FED doesn't continue to lower rates over the next several months, the tidal wave will continue to build and we will be in a world of hurt. Not that we're not there already.

Oil Prices, Gas Prices, and Gold all continue to rise which will make consumers pull in their purse strings even more. Foreclosures, Credit Card delinquencies, and Defaults continue to rise. The Dollar continues to weaken. The strong labor /income market, along with the strong global market with demand for US Exports, have kept our economy alive. Builders continue to lower prices to compete and stay alive. Ultimately this hurts the homeowner around the corner. When will this end? When will it get better? No one knows, however, we do need a solution. Lower Rates will help, albeit temporarily.

We have seen some of the biggest institutions come out and waive the white flag. Wamu, Citibank, Morgan Stanley, Merrill Lynch, Goldman Saks, B of A, etc . . . More losses are to follow. Unfortunately, we have not seen the worse of this yet. Traders are starting to price-in another move in December, although we'll need more negative news on the economy before that happens.

Good news? Treasury yields continue to decline, and the 10-yr is down to 4.26% ahead of the three day weekend. (Mortgages, however, are unchanged, primarily because of continued nervousness about that sector, prepayment risk, and money manager's books being set heading into year-end.) We had the September US trade deficit, as expected, and the Import Price Index which rose 9.0% year-over-year! Later we'll see the preliminary University of Michigan Consumer Confidence number. What is the current thinking on another Fed cut in a month? Interest rate futures show a 90% chance that the Fed will lower the Fed Fund rate to 4.25 at the Dec. 11 meeting.

Quote of the Day: "It's never too late to be what you might have been."
~ George Eliot

Let us not forget that Monday is Veteran's Day. Take some time out of your day on Monday to remember those who served our country during time of war and those who gave their lives so that you and your loved ones didn't have to . . . .