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Minyan Mailbag: Bizarro World

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.

Prof. Succo,

Record Foreclosures...Record New Home Sales...is this Bizarro Jerry?

Large well financed tract homebuilders with their own mortgage companies have moved into several areas in our region over the past 10 years.

They can and have purchased bare farm ground on the cheap ($3-5,000 per acre), converted it and developed it into a vinyl sided, subdivision/city popping out of a corn field complete with playgrounds, pool, clubhouse, ponds, walking paths, etc.

Using abundant and relatively cheap Hispanic sub-contractors/labor. They can build a home within 30-60 days.

Once specs homes are built they advertise NO DOWN PAYMENT, 3.125% Rate, 3/1 ARM. etc.

They take a buyer who has no savings and has been employed less than a year and put him into a home that costs $134,500. They put him in this home with a multitude of 100% mortgage products including 80/20's, 100% Conventionals, and my favorite 97% FHA's with a downpayment gift of 3% from a non-profit organization. They use FHA because the DTI ratios are more flexible, bankruptcies only have to be discharged 2 years, and credit scores only have to be 600-620 depending on the situation. However, FHA does not allow 100% financing, but they do allow a gift from a non-profit organizaiton. The builder can pay closing costs up to 6% (which is used by the builder to pay down the already low 3/1ARM to a lower level), but the builder cannot give the buyer the 3% downpayment that FHA requires that would be fraudulent. SO what does the builder do? They make a donation to a non-profit organization in the amount of 3% plus $250-$500 handling cost. The non-profit than gifts the 3% to the buyer for the downpayment out of their already established pool of funds and keeps the handling cost. Believe it or not this is completely legal according to HUD.

The builder's mortgage company qualifies this buyer on a 3/1 ARM telling them that the rate will rise and fall with the interest rate environment and overall economy. They don't tell them that the adjusted rate is figured by adding a margin to an indexed rate which automatically means the payment will adjust at the very least the maximum capped amount for the first three adjustment periods. At the end of the 3 year fixed rate period a new payment is figured at the new rate. The borrower cannot afford the new higher payment and the property ends up in foreclosure. The builder is in and out of the subdivision before the first wave of foreclosures hit as this would dramatically cut profit due to the 20-45% cut in overall values caused by the high number of foreclosures in the subdivision. I know this because I have recently purchased a home at $90,000 when the original price 3 years ago was $134,000 in one of these subdivisions.

The large well financed tract builder moves on to construct a new subdivision.

If the market is so strong then please tell me why the values in these sudivisions drop by 20-45% while the builder moves on to a new subdivision and starts the same process/game all over again selling homes for $135,000-136,000. My best guess is that the existing homeowners (suckers) are not as sophisticated as the builder. In other words the homeowner cannot offer a 6% closing cost concession, 3% gift for downpayment, and pay a 5-7% commission to the real estate agent on top of a loss of value of 20-45%.

Near as I can tell our Federal Government, from the FMOC to HUD, is nurturing this type of situation where these supposedly new breed, consolidating, Wall Street homebuilders are enriching themselves at the expense of U.S. taxpayers and the poor souls they prey on, and I forgot to mention the sub-par or below average workmanship and materials these homebuilders offer.

In my opinion this is how we get record new home sales while we have record foreclosures. Is this the Bizarro world or what?

How good a juggler is/was Greenspan? I never thought he'd be able to keep all the balls in the air this long. Maybe his arms are starting to tire. Maybe he senses something coming. Maybe that is why he is no longer interested in the job. Maybe this is why he is just now starting to get real vocal about Fannie Mae (FNM) and Freddie Mac (FRE). Maybe he is setting the stage for, "It wasn't my fault."...."It was those damn GSE's."

The house of cards is starting to wobble.

Minyan John

John,

We have noticed that those defending ARMs are those that sell them. You point out the real risk of ARMs (a financial product like any other; just like a gun, it is how one uses them that is the danger): the proliferation of loose credit by inexperienced lenders bringing leverage to those that will ultimately not be able to manage it.

We don't dispute that 5/1 ARMs make loans cheaper and "match" cash flows for homewoners that have a short time horizon (although this fact is what creates pandoras box). We do understand, however, that they cause people to borrow a principal amount (the full purchase price of a house since there is a very low or no down-payment) that will ultimately not be supported by collateral value (the price that they will be able to sell the house at in five years).

Mr. Greenspan is not juggling anything, nor is he particularly talented in such. Mr. Greenspan has a very powerful tool: he is able to print money. He is the chief of the fire department and he has the biggest hose. He can douse the burning building and it seems there are no flames left, but tons of water is not the solution, although to the bystanders they don't know that. Water won't put out the electrical fire that is about to explode within.

Regards,
Prof. Succo

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