Banks and Republicans are blocking short-sales of homes

May 10, 2009 | By | 6 Replies More

A middle-aged couple who bought a home in my neighborhood are in a terrible situation.   They paid too much for their new house, which needed a lot of repairs, and they failed to aggressively work to sell their existing home.  Therefore, they now have two houses.

Image by Erich Vieth

Image by Erich Vieth

They continue to live in their original home while their new house (two houses away from where I live) has been vacant for three years and it is falling apart.  I’m not talking about chipped paint.  There are huge holes in the roof that are causing the house to rot out.

Check out the garage roof too:

Image by Erich Vieth

Image by Erich Vieth

People who know a lot about rehabbing houses tell me that if this house and garage don’t get immediate attention, they will need to be completely torn down.

What can the owners do?  They paid $240,000 for a house that was worth $180,000, and now it’s probably only worth $90,000 (because the water pouring in through the roof after every rainstorm is rotting out the house).   They probably have a big mortgage on the house (I’d guess that it’s in excess of $200,000).   They seem to be current on their real estate taxes and their mortgage, but they are frozen, apparently panicked, and this inaction is destroying their investment.  If this goes on for another year, their house will be worth nothing at all.

The question, then, is what can they do about the situation?   Conventional thinking is that they should “sell short.”  Go to the bank and agree to sell the house for $90,000.  Get something rather than nothing.   This would also be better for the bank to get something rather than nothing, right?  But not so fast.

In our complex mortgage system, the banks (and other mortgage companies) “securitize” home loans as soon as they are made, as explained by Arthur Delaney and Ryan Grim:

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 [Rep. Brad Miller (D-N.C.)].

Therefore, if the owners of the house down the street could ever get over their panic and decide that they wanted to “sell short,” the bank would be likely to choke.    That’s because the low-echelon tranch owners of the note have nothing to lose.   Or at least, that’s how they often see it.   What is the net effect?

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.”

Therefore, I’m concerned that I’m going to see that nearby house, which was a well-maintained beautiful house merely 10 years ago, collapse into a pile of rubble.   Multiply that situation by several million and you can see a national crisis developing.  First, let me make it clear that many of these people exercised terrible judgment in buying houses they couldn’t afford and yes, that was not smart of them.  But here’s the bottom line: Not only are the banks going to kick millions of people out of these houses; they are also going to saddle the neighbors with decrepit housing, which breeds crime and health hazards.  See here and here:

Many houses in Slavic Village have had their siding stripped up to the roof lines. A few criminal masterminds even stripped vinyl siding, apparently unaware of the difference in wholesale scrap prices between plastic and metal.  When a house is derelict, people will dump garbage in the yard, rather than pay for haulage. Windows are broken, and doors are stolen, opening up the interior to the elements. In Cleveland’s cold and damp climate, the houses deteriorate quickly. But some not badly enough to keep drug dealers out.

Miller sponsored legislation to address this problem, but it was recently shot down, mostly by Republicans, according to Delaney and Grim:

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.

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Category: American Culture, Economy, ignorance, Law, Politics, Psychology Cognition, Science

About the Author ()

Erich Vieth is an attorney focusing on consumer law litigation and appellate practice. He is also a working musician and a writer, having founded Dangerous Intersection in 2006. Erich lives in the Shaw Neighborhood of St. Louis, Missouri, where he lives half-time with his two extraordinary daughters.

Comments (6)

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  1. Tony Coyle says:

    And we dare to call ourselves intelligent.

    Intelligence implies an ability to plan, and to determine the least damaging course of action.

    Banks (or the investors) may consider that they would not wish to short sell, since they would lose RIGHT NOW. However, as you so rightly point out, absent a short sale all of the investors will lose a little later.

    This is not even self interest, it's plain and simple stupidity.

    I'm ashamed of every senator who voted against this measure. Venal self interest, showing absolutely no concern for their constituents. Their concern is reserved entirely for their lobbyists.

  2. Ben says:

    It may not be enough, but I just heard about a tax-loophole where you can replace half the roof and deduct the entire amount. However, if you replace the whole roof, you cannot deduct anything. So theoretically you can replace half the roof each year and deduct the entire amount. Something about improvements vs. repairs.

  3. Erich Vieth says:

    Ben, thanks for the tip. I'm afraid that if this house doesn't get an entire new roof this year, the whole structure will fall down.

  4. Tony Coyle says:

    maybe replace the half of the roof above the shingles this year, then the half underneath next year?

  5. Erich Vieth says:

    Arianna Huffington is focusing quite a bit of her attention on financial issues these days. Here's a recent example:

    [T]he people were watching when the Senate voted on cramdown legislation that would have given relief to the millions of Americans who are, or soon will be, facing foreclosure — and the lobbyists won. As a Times editorial put it: "When the time came to stand up to the banking lobbies and cajole yes votes from reluctant senators — the White House didn't. When the measure failed, there wasn't even a statement of regret."

    http://www.huffingtonpost.com/arianna-huffington/

  6. Interesting article. I've read lots of your stuff, but I had to comment on this one.

    The reason this legislation failed was the bankruptcy cram down provision. This would allow judges to rewrite mortgage contracts during bankruptcy proceedings. What is ironic is investor loans can be rewritten. One important difference is that investor loans are normally a point to a point and a half higher than what a normal mortgage is! So all you liberals, do gooders and uniformed think about this. You could have this provision but everyones mortgage would need to go up 1 1/2 percent. Including yours. All to help the irresponsible homeowner (at least they currently are a homeowner).

    Christopher Dodd, Democrat. Recently financed a home, within the past few years. He got a sweatheart deal from a special department in Countrywide. Rates that you and I couldn't get. Shouldn't he of known that?

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