By Arthur E. Foulkes
TERRE HAUTE — They are sitting empty all over town.
Foreclosed homes, known as REO (Real Estate Owned) properties, have become a huge part of the housing market in Terre Haute, Indiana and the country as a whole.
“This is a national thing,” said Cy Marlow, principal broker at L.J. Michaels Inc. on Wabash Avenue in Terre Haute. Marlow, who deals only in REO properties, already has listed 63 foreclosed properties in 2007 and sold 248 REO listings last year. The REO market “is huge,” he said.
The growth in the number of people unable to make their house payments in the past few years has been dramatic.
There were more than 430,000 foreclosures nationwide in just the first three months of 2007, according to a report from RealtyTrac.com, an on-line market place for foreclosed property.
That is an increase of 27 percent from the previous quarter and 35 percent from the first quarter of 2006, the report said.
The report ranked Indiana 11th in foreclosures in the nation. Earlier rankings had placed the Hoosier state even worse.
As foreclosures have grown in number, politicians, consumer groups, lenders, government officials and real estate professionals have started pointing the finger of blame in several different directions. They also are calling for different steps to be taken to make sure the problem doesn’t get any worse.
“As more and more Americans are forced into foreclosure, it is time for [Federal Reserve] Chairman [Ben] Bernanke … to take action to crack down on … unfair lending practices,” said Sen. Evan Bayh, D-Indiana, in a media statement issued last month. Bayh and other senators say the Federal Reserve is “looking the other way as irresponsible lenders use aggressive and often abusive tactics to sell borrowers on loans they will never be able to repay.”
Others are pointing a finger of blame at real estate appraisers, saying they are overvaluing properties under pressure from mortgage brokers, homeowners and real estate agents.
If a home loan is based on an appraised value well above the actual market price of the home, the homeowner will find himself “upside down,” meaning he owes more on the mortgage — sometimes considerably more — than the property is worth.
Fully 90 percent of real estate appraisers who responded to the 2007 National Appraisal Survey said they felt pressured to restate, adjust or change appraisal values. Many who said they resisted the pressure to inflate appraised values said it cost them a client or they didn’t get paid for their work, the survey said.
Still others look elsewhere for the cause of the problem.
“It’s not due to predatory lending. It’s not due to over appraisals,” Marlow said. “I think people aren’t living within their means.” The media bombards Americans with the message “buy, buy, buy,” Marlow said. Most of us were never taught to balance our checkbooks in school or to be financially responsible, he said. “You have to be frugal.”
And others say the problem of foreclosures is a result of the bursting of the “housing bubble,” a popular term for several years of rapidly increasing house prices and dramatic increases in new home construction. The end of the “bubble” means more and more people are finding themselves owing more on their homes than the property is worth.
Whatever the reason for the increase in foreclosures, there is no doubt they are a becoming an important factor in the Terre Haute real estate market.
“I’ll bet there are [as many as] 400 [REO properties] in our area,” said a local real estate broker/appraiser who asked not to be named. One home on the north side of Terre Haute that he recently appraised had 12 abandoned or foreclosed homes either next door or very close by, he said.
“How do you think that is going to affect the price of the house?” he asked.
Marlow concurs that the local REO market is getting huge.
Of the 10 real estate brokers in the area with the most listings last year, four of them either handle REO listings exclusively or as a large part of their business, Marlow said.
Beyond the bubble
As the housing “bubble” was inflating, mortgage fraud became more and more common, according to figures released by the Internal Revenue Service.
“Federal investigators have identified an increase in frauds and schemes in the real estate business,” the IRS reported last month. The agency saw a steady increase in cases of real estate fraud beginning in 2001 and growing each year through 2006, it reported.
One local securities trader who deals frequently in mortgage-backed securities said he witnessed first-hand an incident where a home sold for several thousand dollars more than its asking price so that the borrowers could use the extra money to make the required down payment.
“This stinks to high heaven,” the securities broker, who asked not to be named, said. But, he added, “I’ll bet you it happens a lot.”
“Foreclosures are bad for honest Hoosiers,” said Indiana Secretary of State Todd Rokita. Rokita’s office filed a complaint earlier this year against a Terre Haute-based mortgage lender, an area title company and two individual borrowers accused of using incomplete or false mortgage applications to obtain numerous home loans.
“We’re watching the borrowers, the title guys [and] the mortgage brokers,” Rokita said. When borrowers obtain mortgages using false information, foreclosures often result, driving down nearby home values, he said.
Fallout of the subprime market
Mortgage lending and the number of mortgage brokerages grew dramatically during the housing boom, market observer say.
Often these new lenders specialized in what are called “subprime” loans, that is, loans with higher interest rates offered to borrowers with poor or limited credit histories.
“We’re just seeing a totally different attitude about making loans,” said a Terre Haute-based banker and former real estate agent who has worked in the home lending business for more than 30 years. When he started in banking in the 1970s, he said, borrowers needed to have 20 percent of a house payment up front. “That isn’t the case anymore,” he said, asking his name not be used. Many home mortgages today are made with no money down, he said.
The subprime market has been the fastest growing part of the real estate mortgage market for several years. The subprime market grew an average of 25 percent per year from 1994 until 2003. By the time the housing boom reached its peak in 2005, subprime loans made up 20 percent of the mortgage loan market, according to a recent report in The Christian Science Monitor.
One dramatic symbol of the size of the subprime lending industry came in 2004 when Ameriquest, one of the nation’s largest subprime lenders, paid around $15 million to sponsor the Super Bowl half-time show. Now, just three years later, some of the biggest names in the subprime lending business, including industry giant New Century Financial Corp., have closed shop or filed bankruptcy, according to a recent report from the Reuters financial news service.
Subprime mortgages also have seen the highest rate of bad loans.
Foreclosures made up 1.2 percent of the prime mortgage market in the final quarter of 2006, but 4.5 percent of the subprime market, according to a report by the Mortgage Bankers Association, an industry trade group. Additionally, more than 13 percent of subprime borrowers were late with their mortgage payments at the end of 2006.
“We’re almost in a crisis mode in our subprime market,” Rokita said.
The downside of low rates
Practically everyone interviewed for this article agreed that historically low interest rates — which reached 1 percent by 2003 — generated by the Federal Reserve helped fuel the housing bubble.
“All of a sudden we had a lot of people in the [loan] market who couldn’t get there before,” said the Terre Haute banker who asked not to be named.
“The existence of excess [credit created by unusually low interest rates] means that banks must reduce the interest rates they charge, reduce the credit quality requirements of borrowers, or both,” writes economist Mark Thornton in a paper called “The Economics of Housing Bubbles.” During the recent housing boom, interest rates on conventional 30-year mortgages were at their lowest levels in the post-gold standard era, Thornton wrote.
Rokita agreed the low rates helped fuel the growth in mortgage lending and also may have contributed to increased mortgage fraud.
The low interest rates “caused a condition, because it [was] so easy to get a loan, [where] you have people who figured out quite quickly how then can act badly,” he said.
Another aspect of the housing boom was the construction of some substandard housing, said Sharon Dunton, the Indiana representative for Homeowners Against Deficient Dwellings, a consumer group. Many houses were going up too fast, Dunton said. When these homes were later found to have construction flaws, some homeowners found themselves facing enormous repair and maintenance expenses and, in some cases, facing foreclosures, she said.
Effect on the big picture
If the foreclosure picture gets much worse, some observers worry, it could have a negative effect on the national economy as more and more mortgage-backed investments turn sour and more and more people lose their homes.
Investors in bonds that are made up of subprime mortgages could lose as much as $75 billion, according to a recent report on Bloomberg.com.
Banks almost never hold their own bonds, said Auburn University economist Roger Garrison. Mortgages nearly always are sold on the secondary market to entities such as Ginnie Mae, Fannie Mae or Freddie Mac — all either owned by the U.S. government (Ginnie Mae) or implicitly backed by it.
Indeed, part of the mortgage foreclosure problem may have its roots in the existence of these very entities, Garrison said. Because they are implicitly supported by the government, the risk of making bad loans is “externalized” onto taxpayers, who will pick up the bill if these entities fail.
“The risk premium seems to have disappeared,” Garrison said.
Home loss hard to take
A home is still “one of the safest investments you can have,” Marlow said, and while foreclosures are up, economist Alan Reynolds of the Cato Institute notes that more than 95 percent of even subprime homes are not being returned to lenders. He also believes that weak local economies have contributed to the rise in foreclosures, not the other way around.
Still, foreclosures have other costs apart from financial ones, Marlow notes. Many families who lose their homes in foreclosures later end up in divorce court, he said, adding he wishes more people would carefully consider the financial aspects of buying a home before signing their loan papers.
“Owning a home is the American dream,” Marlow said. Losing a home, which often results from other problems such as divorce, drug usage or credit card debt problems, is traumatic, especially for children, he said.
Whether from a natural disaster, a fire or a foreclosure, “losing a home is losing a home,” Marlow said. “It’s devastating.”
Arthur Foulkes can be contacted at (812) 231-4232 or arthur.foulkes@tribstar.com.
