hRUBIK's hRAMBLINGS

So Prove Me Wrong

2011-08-04T23:03:00.003-04:00

On Tuesday, after the nefarious Beltway Bozos passed the largest debt increase in American history -- a 16.78% increase which the greedy spenders will utilize to its fullest extent -- the stock market reacted with its sharpest loss in months. I said then that worse was to come; that the Asian markets at midday were down about 2%, foreshadowing a continuing Wall Street decline.

Wednesday morning the slide from Tuesday afternoon continued until the afternoon, when the tide turned and the market began to rise. The Dow clawed its way back to +26 for the day, and I began to wonder what had happened. I think I know.

Wednesday afternoon the heaviest volume came from heavy buying of Standard & Poor's industrial fund. That fund deals mainly in the 500 top industrial stocks on the exchange (most people have at least heard of the S&P 500). When money is pumped into the S&P 500, the fund managers must deal with it; they buy industrial stocks. This creates a feedback mechanism, driving the market ever higher. This feedback is enhanced by computer trading, since the computers are not programmed for fear.

All you need is a catalyst, and it is my belief that the catalyst was the Fed's private member banks -- a sinking stock market was the opposite of what their political masters needed, so they began buying to shore up the market. Without doubt, the need for a "sucker rally" was also a powerful motivator. The industrials rose on the coattails of that buying.

This morning the outlook was a bit bleaker. The Asian markets did not follow Wall Street; they continued to drop. Standard & Poors was the top loser of the day in terms of volume. Apparently the rallyers from Wednesday also got cold feet, and the sell-off began again in earnest. Traders wanting to retain relative liquidity are moving to cash in anticipation of rising interest rates. This is putting a strain on the banks, which, while paying minimal interest, are still being hurt by having to hold funds which they dare not place in the market.

It is no wonder that instead of paying interest, banks are starting to charge large depositors a fee for holding their cash, as announced by BNY Mellon today. "The northern lights have seen strange sights...", but we are about to fall down the rabbit hole.

I have digressed. Today, the Dow dropped over 500 points, down 4.31% in a single day. At this writing (10:30 PM Thursday here, 10:30 AM Friday in Hong Kong), the Hang Seng is down over 4%. It could rebound, but the threat of a weekend, and worries over the U.S. unemployment figures pointing upward, make an Asian rebound very tentative.

So, to the geniuses in Washington, I say, the worst possible thing you could have done to our economy was to increase the President's credit card limit. Prove me wrong. I'm waiting.

WHAT? No UP?

2011-08-02T21:52:00.004-04:00

There are some stunned people this evening who were jubilant that the House and Senate and President came together on a deal that would hopefully avert default. They were expecting that the stock market would rise and everyone would be cheerful about the wonderful new future we faced.

But -- the market tanked. It lost 265 points, over 2%, for the day. This may seem counterintuitive to government figures, public employees, and newscasters, but there is a very logical reason for what happened. Unless I have misread what appears to be an obvious reaction, I predict that the next few days may show that it will continue to happen. In fact, as I write this, the Asian markets (on which the sun has risen and which are already in tomorrowland)are down over 2% -- a harbinger of tomorrow's Wall Street adventure.

What the Washington Klutzes have done over the past several decades has been the steady erosion of the worth of the US dollar. In order to score political points by artificially generating an "economic recovery", the gummint, through the evil genies at the Federal Reserve, has held interest rates at levels that are artificially low. My question for some time has been, "If it costs nearly nothing to borrow a dollar, then what is that dollar really worth?"

The panic over possible default was engineered by the Administration, the Fed, and the lapdog press, with the overt participation of the folks who make their living through usury -- the bond traders. In the last hours of the panic, there were those who moaned that if the US gummints credit limit was not increased, the gummint would not be able to pay its creditors.

That fiction ignored the fact that the President, via the Secretary of the Treasury, has the responsibility of prioritizing spending. He has put a high priority lately on bombing Libya, but such a low priority on such things as Social Security and Medicare as to threaten that those latter checks might not go out if he didn't get his way.

The usurious bond traders were particularly worried. If the credit limit were capped at the current rate, there could be no new borrowing. Because they make their money on the commissions from bond sales, capping the credit limit might cap their incomes. They needed an influx of new borrowing.

There are unintended consequences to every evil under the sun. The US dollar, already weakened by the stupid Quantitative Easing policies of the Fed, is about to get even weaker. Currency inflation has one side effect that the markets understand, and that is, that when money is devalued through printing, interest rates must rise.

When interest rates are held artificially low, and stock dividend yields outpace bond interest, stock prices rise due to higher demand. That was the scenario during the rounds of Quantitative Easing, and the reason for the interest in the stock market over the past year. I expect that this scenario is ending. Cheap money is risky money. Risk-takers demand higher compensation for higher risk, and interest rates are about to rise.

Classically, when interest rates rise, and their rate of return begins to exceed the rate of return for stocks, the market flees stocks and buys bonds. When savvy investors realize that everyone else in the marketplace will sooner or later get the same idea, panic selling sets in. Nobody wants to be the last guy to trade before the market hits bottom.

I have been wrong before, and am willing to concede that I may not be entirely on the right track. I will, however, predict that the stock market is in for a decline to a sustainable level, at say around 8500, maybe a little lower. That will be caused by an expectation that cheaper money will be seen as higher risk with higher returns, with the gummint selling economic snake oil in an effort to charm bond buyers. This will lead to a drawdown in capital invested in plans to expand operations and payrolls, with an accompanying depression of the employment figures.

The American people elected new Representatives who promised to hold to Tea Party principles. Instead, those Representatives appear to have been eating the Washington Establishment's magic mushrooms.

The Rosy Crystal Ball

2010-10-15T08:34:00.002-04:00

I've been too busy to publicly express my perspective on the economy lately but several items are making me curious as to how much manipulation the markets can handle before they correct themselves. The future, as presented by the US government and its monetary master, the Federal Reserve, appears quite well, and "market analysts" seem to be predicting a gradual strengthening which supposedly began when the "recession" ended over a year ago.

I have often spoken out against the use of statistical correlation with regard to attempting proof of a concept. Correlation, however, allows visualization of a composite picture of events. Such correlation helps to avoid tunnel vision, where fixation on a particular goal blinds the observer to other inputs. The analysis of correlated events will then provide a view with more depth perspective, and add "color" to a "black and white" picture.

The Fed has embarked on a course of Quantitative Easing (QE). QE is another term for printing money without increasing its backing. It "eases" the ability of member banks to lend money at low interest rates, and consequently, devalues the currency in which the money is issued.

I have a question for the wizards : if interest rates are at a historic low, and yet the lenders are having difficulty interesting businesses in borrowing more (because the businesses appear wary of overextending themselves), what are the banks going to do with the additional currency? Will they, themselves, take the opportunity to purchase additional assets at low interest rates?

A related area is the trend in consumer prices. If the Consumer Price Index has risen for the past 3 months at only fractions of a percent, this is perceived as a sign that inflation of the currency is under control. However, when the index rate for July and August combined was only 0.3 percent, yet the increase in August alone for fruits and vegetables (at the peak of harvest when prices should fall) was 0.4 percent, does this indicate that the composite index is understating the inflation of the core items which affect the largest numbers of consumers?

Another area being watched is the trend in retail sales. One prediction which I saw, credited to JP Morgan Chase, was that retail sales would be up 0.6 percent in September, but if autos are excluded, would be up only 0.4 percent. Question : if retail sales are measured by dollar expenditures, and they roughly parallel the rise in consumer prices, does this indicate that they are in reality flat or even slightly negative?

A third area being considered is the report on business inventories. The prediction (again attributed to JP Morgan Chase) is that the government will announce business inventories up 0.6 percent in August. This has been interpreted to mean that confidence is increasing. In view of the rise in consumer prices, coupled with the increase in retail sales roughly paralleling the price increases, could it also mean that perhaps people have stopped or slowed their buying?

I don't know. I confess to being an amateur in matters of complex macrofinances. Nevertheless, there is something smelly that the newspaper has been wrapped around. Looking at only one part of the data could make me hopeful. Correlating the data makes me skeptical.

Change in Operations

2010-05-21T18:52:00.002-04:00

To my readers : I had to make a change in comment moderation due to a comment being placed which could have redirected readers to a website with questionable content. Sorry, but there are skunks in every woodpile, I suppose.

Calling All Lollipops?

2010-04-10T00:07:00.002-04:00

My famous pessimism (OK, infamous, if you will) with regard to things economic when they just don't make sense got a jolt today with a FOX News article The Dow's up but trades are scarce, worrying bulls which pointed out that the DJIA has been rising while the trading volume has been declining. So I jumped into Yahoo! and pulled a graph:

Yup. The prices are up about 70% from last year, while the number of trades is down about 25%. You would think that if the market is recovering and prices are rising, there would be an increase in the number of players trying to expand their holdings.

Do you smell something burning?

A few commenters on the article want to pin the scam (yes, I do think there is an attempt being made to create a sucker rally) on the Administration, but I hesitate to go that far. Invoking Occam, I would tend to say that some of the major banks and fund managers are behind this phenomenon, hoping to draw broad enough support in the market to allow them to dump their more toxic assets on the unwary.

The NYSE volume today was 4,511,569,000, of which 995,307,699 shares (22%) were Citibank (662,164,923), Ambac Financial (195,367,197), and Bank of America (134,825,884) -- the top 3 issues traded. This makes me deeply suspicious when almost 1/4 of the trades involved stocks which have negative P/E ratios and which are anticipated to pay no dividends. Remember that someone has to sell in order for someone else to buy, and it is the selling that first makes the buying possible; who is dumping these stocks? (I won't bother myself with who might be stupid enough to be buying them.)

Open letter to Tim Crawford

2010-03-21T16:28:00.003-04:00

The following email was sent to the listed recipients. It seems that failure to listen to constituents is not a unique feature of the Beltway Gang.

March 20, 2010
Open letter to Tim Crawford,
Summit County Council District 7

Dear Tim,

As a fellow campaigner in the past for addressing problems of representation in local government, I am appealing for your attention in the matter of the hostility that exists between the government of Summit County and the Barberton-Norton Mosquito Abatement District.

As you are probably aware, the Barberton-Norton Mosquito Abatement District (MAD), organized under Chapter 6115 of the Ohio Revised Code, came into existence after the Barberton City Health Department (BCHD) ended its long-standing mosquito control program. Nuisance control of mosquitoes is not a mandated function of health districts, and the regular spraying for mosquitoes was considered a luxury that could not be maintained under the BCHD's limited budget.

Both the Barberton and Norton City Councils were approached with the idea of forming a special sanitary district to reduce the population of biting arthropods under Chapter 6115. When neither council took action to form such a district, citizens from both communities circulated petitions and presented them to the Summit County Common Pleas Court as required by the statute. The Court agreed that formation of the special sanitary district would "be conducive to the public health, safety, comfort, convenience, or welfare" of the affected communities, and ordered that the Barberton-Norton Mosquito Abatement District be established.

There have been complaints by certain disaffected persons that the organization and operation of the MAD, with assessments levied by the Board of Directors (BOD), is an example of "taxation without representation". Such an accusation is no more true than one which would state that levies by the State Legislature are also "taxation without representation". This is so because the landowners in the district are represented by the BOD, who are appointed by their elected officials. Those Directors are required to be residents of the MAD, and can be contacted by any landowner; the meetings of the MAD Board of Directors are also open public meetings at which the public can address the Board directly with its concerns.

At the request of residents in surrounding areas, the MAD undertook efforts to expand. This expansion was opposed by the Summit County Health District (SCHD), which took the position that the activities of the MAD were an unnecessary duplication of the sporadic spraying done by the SCHD. In fact, the activities of the MAD are directed at nuisance control for the comfort and convenience of the residents; possible control of arthropod-vectored diseases are a secondary benefit from the standpoint of the MAD. The SCHD mosquito control program is oriented toward preventing outbreaks of arthropod-vectored diseases; the "comfort and convenience" of the residents is not emphasized by their program.

Despite the different goals of these two entities, SCHD has actively and aggressively worked to eliminate the MAD. In the summer of 2009, the MAD sent out a survey to the landowners of Norton, and nearly a thousand of the recipients replied (22%) with postcards to Norton City Council, the vast majority of which were supportive of the MAD. They did not want their mosquito abatement program to end.

As mentioned above, the landowners of Barberton and Norton are represented by the BOD. The political subdivisions in which the MAD is located (Barberton, BCHD, Norton, Summit County Executive, SCHD) are represented by the District Advisory Council (DAC). The Summit County Executive had a representative on the DAC from the beginning, and upon the City of Norton ending its agreement with the BCHD and contracting with the SCHD, the SCHD was entitled to choose a DAC member.

It is my concern that neither of the DAC members representing Summit County are residents of the MAD. This situation, coupled with the antagonism of the SCHD toward the MAD, is a recipe for mischief. The citizens of Barberton and Norton are looking to you, our representative on the Summit County Council, and a resident of Norton who benefits from the work of the MAD, to protect our right to enjoy our property comfortably.

Thanks for listening to an old Norton Neighbor.

--Jim Hrubik

cc: Dave Koontz, Mike Zita, Scott Pelot, Todd Bergstrom, Don Nicolard, Bill Mowery, Ken Braman, Brenda Hlas, Bob Genet, Kevin Coughlin, Tom Sawyer, Brian G. Williams, John Otterman, various Internet sites.

Repeal 17 : Restore I-3
-------------------------------
http://www.linkedin.com/pub/james-c-hrubik-sr/12/7a4/a58

The MAD website is Barberton-Norton Mosquito Abatement District

Angry messages can be sent to:

Tim Crawford, Summit County Council, District 7

Bob Genet, Mayor of Barberton

Dave Koontz, Mayor of Norton

Todd Bergstrom, Norton Ward 1

Don Nicolard, Norton Ward 2

Bill Mowery, Norton Ward 3

Ken Braman, Norton Ward 4

Mike Zita, Norton At-Large

Scott Pelot, Norton At-Large

Brenda Hlas, Norton At-Large

Let them know how you feel about spending City tax dollars to oppose the Mosquito Abatement District.

The Peter Principle is for Real

2010-02-18T20:28:00.003-05:00

Hmmm.

The head of the UN Framework Convention on Climate Change, Yvo De Boer, is resigning that position to go to work for KPMG.

KPMG. The company that was auditor for New Century Financial.

You remember New Century? They went bankrupt because of their practices with respect to subprime mortgage lending. Then the bankruptcy court examiner accused KPMG of helping hide the accounting irregularities. To quote directly from Final Report of Michael J. Missal, Bankruptcy Court Examiner in re: United States Bankruptcy Court for the District Delaware, Chapter 11, Case No. 07-10416(KJC),
"The increasingly risky nature of New Century's loan originations created a ticking time bomb that detonated in 2007. Subprime loans can be appropriate for a large number of borrowers. New Century, however, layered the risks of loan products upon the risks of loose underwriting standards in its loan originations to high risk borrowers. For example, more than 70% of the loans originated by the Company had low initial 'teaser rates' that were highly likely to increase significantly over time. A senior New Century officer noted in 2004 that borrowers would experience 'sticker shock' after the teaser rates expired. More than 40% of the loans originated by New Century were underwritten on a stated income basis. These loans are sometimes referred to as 'liars' loans' because borrowers are not required to provide verification of claimed income, leading a New Century employee to tell certain members of Senior Management in 2004 that 'we are unable to actually determine the borrowers' ability to afford a loan.' Another common loan product offered by New Century that had a high degree of risk was the '80/20' loan, which involved two separate loans for the same transaction: a first lien mortgage loan with an 80% loan to value ratio and a second lien loan with a 20% loan to value ratio, resulting in a combined financing of 100% of the value of the mortgaged property. One Senior Officer of New Century noted in early 2006 that the performance of these 80/20 loans in 2005 was 'horrendous.'"

"The Examiner has completed his investigation and files this Final Report, The Examiner recognizes that the subprime mortgage market collapsed with great speed and unprecedented severity, resulting in all of the largest subprime lenders either ceasing operations or being absorbed by larger financial institutions. Taking these events into consideration and attempting to avoid inappropriate hindsight, the Examiner concludes that New Century engaged in a number of significant improper and imprudent practices related to its loan originations, operations, accounting and financial reporting processes. KPMG contributed to certain of these accounting and financial reporting deficiencies by enabling them to persist and, in some instances, precipitating the Company's departures from applicable accounting standards."

"KPMG contributed to these failings in critical ways. Among other inadequacies, KPMG failed to question or test certain important assumptions in a rigorous manner. The KPMG management team acquiesced in New Century's departures from prescribed accounting methodologies and often resisted or ignored valid recommendations from specialists within KPMG. At times, the engagement team acted more as advocates for New Century, even when its practices were questioned by KPMG specialists who had greater knowledge of relevant accounting guidelines and industry practice. When one KPMG specialist persisted in objecting to a particular accounting practice on the eve of the Company's 2005 Form 10-K filing -- an objection that was well-founded and later led to a change in the Company's practice -- the lead KPMG engagement partner told him in an email: 'I am very disappointed we are still discussing this. As far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off.'"

Somehow that last paragraph seems like it could fit the whole Climategate fiasco with just a minor tweaking. According to Fox News, "De Boer's resignation comes in the wake of the continuing Climate-gate scandal -- a story that began with the leak of stolen e-mails from top climate scientists and led to revelations of sloppy science, efforts to suppress dissenting opinions and ultimately flaws in the U.N.'s top climate policy document. "

The article concludes with, "De Boer said he will be a consultant on climate and sustainability issues for KPMG, a global accounting firm, and will be associated with several universities."

Fitting.

By the way -- those 80/20 loans that were made in 2007 and 2008 (and there were quite a few of them) -- are now resetting. Look for foreclosures to jump again toward mid-2010.

How much is a dollar worth if ...

2010-01-31T20:52:00.003-05:00

As I write this (January 31, 2010), the media are reporting that the special inspector general at the Treasury Department, Neil Barofsky, who has been assigned to monitor the Troubled Asset Relief Program (TARP, aka The Bank Bailout), has today warned Congress that the problems within the financial system that created the market collapse are worse now than before the TARP began.

Part of the reason for the alarm is the fact that the government has been borrowing to prop up the housing market, and, with the collusion of the Federal Reserve, has been holding interest rates at artificially low levels. A point will soon be reached at which the borrowing will have to cease, since the foreign lenders will realize that the risk levels have risen, and the subsidization will end. This will initiate another collapse in housing prices.

I have a question : How much is a dollar worth if it doesn't cost anything to borrow it?

We can see that government intervention in the marketplace is rapidly leading the United States to bankruptcy. Rather than trying to expand spending, Congress needs to concentrate on how to best avoid foreclosure by the nation's creditors.

If anyone thinks that the Chinese government (our major creditor) will simply roll over and forgive our debt, they need to study the tactics of the Tongs. The future of our country looks bleak, not because the people lack the willingness to work and pay their debts, but because the Congress has used the nation's credit card and gone over the limit.

The spending on bailouts, foreign aid, and domestic programs must stop.

Calling Sancho Panza...

2010-01-25T22:52:00.004-05:00

On January 22, 2010, the Akron Beacon Journal ran a story put together by staff writer Marilyn Miller which told of the request by a local man, Michael Karder, for government help to build wind turbines. In the article there is an implication -- "some companies inherit patents that create walls that stop new people from promoting their products" -- that his business cannot gain traction because someone else owns the technology.

Just a bit over a week earlier (January 13), Beacon staff writer Bob Downing wrote a column about Karder's agreement with a European firm to assemble and market its wind turbines in the US. The windmill parts would come from China, the generators from Korea, and the assembly would be done in the Akron area. The major drawback, he claimed, was lack of financing, which he blamed on a tight credit market.

All he needs is $60,000,000 to build the plant. (Ever hear the Kingston Trio song, "Tijuana Jail"?) The January 13 story states that there are 7 competing factories in the United States, with several more under construction and which are to open soon. Ultimately, he anticipates producing 600 wind turbines per year, with installation of about 1,700 of them offshore in Lake Erie.

The articles paint glowing pictures of a future filled with new jobs for the Akron area, but as is typical of such populist fodder, they are light on details. Let's explore some rabbit trails.

At 600 per year, and a reasonable lifespan for the project of 30 years (we will not at this point go into the details of why businesses are allowed to depreciate their assets, but suffice it to say that most of the time, when a factory is sold, it requires extensive renovations and modifications before the new owner can use it), the lifetime output of the factory can be anticipated to be about 18,000 windmills. One tenth of them are to go in Lake Erie, if various governments approve. Of course, Mr. Karder expects that he will also be able to manufacture parts for smaller wind turbines for the home electric generation market. Realistically, though, one would think the market for such turbines is limited, not because people don't want to try them out, but because of the layer of restrictions that exist now and will exist into the future. Try going to your local building department with a request to put one in your back yard and you will get a quick lesson in local government.

Mr. Karder would like to borrow $60 million. For the sale of argument, let us say that he is allowed by a generous lender to amortize and pay off the loan over 30 years, like a home loan. Let us also assume that he would be able to borrow the money at 4% (current large portfolio 30 year commercial mortgages amortized at 30 years are at about 8.25%, but we will assume a green investor...). The total cost of the factory would then be about $103 million (and if he actually has to pay the market rate, $162 million).

One other thing : Mr. Karder has purchased the patent rights for the wind turbines designed by his European partner -- "I have patent rights in North America, primarily the Great Lakes area." Does that mean that someone else owns the distribution rights in other parts of the country, and he is limited to the Great Lakes region? If so, his market is truly limited.

If Mr. Karder's factory can actually produce the large turbines he envisions (2.5mW and up), he will face competition which ranges in price from $1 million to $2 million per mW installed. If he cannot successfully break into that market, and instead has to compete in the residential or small commercial market with the 100kW-900kW machines he plans to begin with, he will be competing at about $1,000 - $2,000 per kW installed.

[It can be argued that the return on a wind turbine currently is somewhat better than break-even, with generation running in the neighborhood of $0.10/kW, and my current electric bill at just over $0.11/kW delivered. At that price, with an average annual consumption of 9800kW, I could save $98/year by buying a $25,000 wind turbine (I could probably get by with 25kW/day, but then I don't have an all-electric home). Some people prefer to concentrate on how much they will save regardless how much they spend.]

There are some other factors which will also come into play -- the NIMBY factor (why don't the Kennedy's want a nice, clean, green windfarm blocking their view of Cape Cod?), licensing and zoning restrictions, air rights (if my windmill blocks your windmill and devalues your property, can you sue me?), and so on.

The articles do not mention these things. They simply bring to the fore the fact that an entrepreneur wants the government to step in and help him set up a business. The POTUS, as reported by Ms. Miller, blamed the banks and the patent laws.

What would really be helpful would be an explanation, by a banker, of the reasons why Mr. Karder, with $60,000 down, cannot get a $60,000,000 loan to build his factory. Is it that the bankers have examined the costs and determined that the risk is too great? Is that why he needs Federal dollars?

For my part, I'd go nuclear. Our Navy has had nuclear powered ships cruising the globe for a half-century now, and each ship's power plant can easily provide enough electricity for a small city. At Las Alamos, the Hyperion Power Module was developed and will soon be deployed in Third-World communities around the world. Why Third-World? I will let you guess why Americans will not get the benefit of American technology.

A year ago, I posted in another place,

Hyperion Fast Facts

Small -1.5 meters across, approx size of a residential “hot tub”
Produces 70 MWt or 25 MWe, enough to power 20,000 average American homes or the equivalent
Buried underground out of sight and harm’s way
Transportable by train, ship, truck
Sealed module, never opened on site
Enough power for 5+ years
After 5 years, removed & refueled at original factory
Uniquely safe, self-moderating using a natural chemical reaction discovered 50 years ago
No mechanical parts in the core to malfunction
Water not used as coolant; cannot go “supercritical” or get too hot
No greenhouse gases or global warming emissions
Think: Large Battery!

Think nuclear. (Nucular in some parts of the country.)

I would be willing to bet that any American city, or even a savvy investor, who wanted to borrow $60,000,000 to set up two power plants that would power 40,000 homes for $300/year would find a lender. Crunch the numbers. Reporters don't seem to know how to use calculators.

Steady As She Goes

2009-12-08T00:09:00.002-05:00

While there has been some expectation that the Federal Reserve would have to begin raising interest rates to prevent inflation, the comments today by Ben Bernanke throw some cold water on that idea :

"Though we have begun to see some improvement in economic activity, we still have some way to go before we can be assured that the recovery will be self-sustaining. Also at issue is whether the recovery will be strong enough to create the large number of jobs that will be needed to materially bring down the unemployment rate. Economic forecasts are subject to great uncertainty, but my best guess at this point is that we will continue to see modest economic growth next year--sufficient to bring down the unemployment rate, but at a pace slower than we would like.

A number of factors support the view that the recovery will continue next year. Importantly, financial conditions continue to improve: Corporations are having relatively little difficulty raising funds in the bond and stock markets, stock prices and other asset values have recovered significantly from their lows, and a variety of indicators suggest that fears of systemic collapse have receded substantially. Monetary and fiscal policies are supportive. And I have already mentioned what appear to be improving conditions in housing, consumer expenditure, business investment, and global economic activity.

On the other hand, the economy confronts some formidable headwinds that seem likely to keep the pace of expansion moderate. Despite the general improvement in financial conditions, credit remains tight for many borrowers, particularly bank-dependent borrowers such as households and small businesses. And the job market, though no longer contracting at the pace we saw in 2008 and earlier this year, remains weak. Household spending is unlikely to grow rapidly when people remain worried about job security and have limited access to credit. " Ben S. Bernanke, December 7, 2009.

Several weeks ago the Federal Open Market Committee issued the following 3rd quarter statement :

"Investor sentiment toward the banking sector appeared to deteriorate over the intermeeting period. Bank share prices fell, with equity prices for large banks declining more than those for regional and smaller banks. Credit default swap spreads for large bank holding companies were about flat, but they widened for regional and smaller banking organizations. Market participants reportedly remained concerned about the earnings prospects for banks in an environment of weak economic activity and rising loan losses.

Debt of the private domestic nonfinancial sector appeared to have declined again in the third quarter, as estimates suggested that household debt edged down and nonfinancial business debt decreased. Consumer credit contracted for the seventh consecutive month in August, reflecting declines in both revolving and nonrevolving credit; issuance of consumer credit asset-backed securities also fell."

"The recovery appeared to be continuing and was expected to gradually strengthen over time. Still, most members projected that over the next couple of years, the unemployment rate would remain quite elevated and the level of inflation would remain below rates consistent over the longer run with the Federal Reserve's objectives. Based on this outlook, members decided to maintain the federal funds target range at 0 to 1/4 percent and to continue to state their expectation that economic conditions were likely to warrant exceptionally low rates for an extended period. Low levels of resource utilization, subdued inflation trends, and stable inflation expectations were among the important factors underlying their expectation for monetary policy, and members agreed that policy communications would be enhanced by citing these conditions in the policy statement. Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations. While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks."

"The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period." FOMC Minutes, November 3-4, 2009.

The information presented by the Fed seems to be that (1) interest rates will remain low for the foreseeable future, (2) despite the addition of significant amounts of cash (stimulus money) into the banking system, banks are still reluctant to loan the money, and (3) there is an "underutilization" of available financial resources. I believe the Fed is well aware of the danger to the banking system that is posed by these conditions.

Money is a tool of commerce, and like any other tool, is also a commodity. It is necessary to provide a conduit for exchange of goods and services. The value of those goods and services are subject to relative supply and demand. Rapid communications, enhanced transportation facilities, and better education have opened the way for competition in US domestic markets for goods and services produced in developing countries. Workers in those countries are likely to have lower demands for wages and benefits, and production in the marketplace shifts toward lowest cost and highest profit.

Consumption of goods and services in the US has changed. Prior to the financial market collapse, most American economic activity was undergirded by credit extended, to a large degree, on real estate, in markets which had been overdeveloped. The housing supply in the United States still exceeds demand; this is the reason for the decline in real estate prices and the large numbers of vacant dwellings that can be found in every major American city. To give an example, Census 1990 tables show that Summit County, OH had a 1990 population of about 515,000 with 211,500 housing units. The 2006-2008 projection tables indicate a population of 543,600 (up 5.6%) with 242,700 housing units (up 14.8%). Housing unit growth outstripped population growth in the county by nearly 3:1 over a decade and a half. When the smoke cleared, there were 8% fewer people per house in 2006-2008 than in 1990. Despite the increase in supply, predominant prices had risen from $60-75K to $100-150K in that time period. While this appears to fly in the face of the law of supply and demand, the underlying cause of the anomaly was the availability of easy credit and lax underwriting guidelines, coupled with a change in behavior whereby homeowners borrowed against anticipated future increases in home value in order to subsidize lifestyles that were beyond the means of their ordinary incomes.

Mr. Bernanke's concern about underutilization of the available financial resources is valid. It needs to be recognized, though, that no matter how one might want to demonize the bankers for not making credit more readily available to consumers when the rates are so low and the cash is so plentiful, they are being prudent. In fact, considering the current excessive overcompensation of American workers (by developing world standards), they are also being prudent in not lending to commercial enterprises to stimulate production, since the market for overpriced American goods is shrinking (and this despite the contraction in our balance of payments ratios).

The Fed's concern with respect to their policy possibly leading to "excessive risk-taking in financial markets" is valid. Supply and demand drives lending as well as buying (alas, how many times people have been warned that when they mortgage their home, they are selling it to the lender for the term of the mortgage!) and a shortage of mortgage funds in the conventional market always seems to bring out the unconventional lenders with a correspondingly higher interest rate to compensate for the increased risk. While the "official" interest rates promulgated by the Fed may be low, desperate borrowers may be willing to pay a premium for the use of money provided by unconventional lenders willing to gamble, a situation which could lead to an even more serious economic, or possibly even social, collapse further down the road.

Another serious consequence has to do with the nature of the banking business itself. Banks do not make money on deposits, they make money on loans. The wild profitability of banks during the period 2001-2005 was related to their profligate lending practices. If they do not lend money, they make no profit, and investors shun unproductive assets. The banks themselves may raise interest rates -- this is seen already in the credit card industry -- and once again expose themselves to inordinate risk-taking. Or, they may be replaced by other institutions. I would be willing to guess that in some parts of the country Islamic banks are starting to take up the slack. When reinforced by the power of money, Sharia Law puts on a very attractive face. But be aware; the situation in Dubai is instructive. There is a reason why slavery and debtors' prisons still exist in lands that utilize that type of economic structure.

Dumping Workfiles

2009-12-02T22:33:00.003-05:00

Visitors to my basement at one time were treated to the sight of dozens of file storage boxes stacked there. The majority of those appraisal workfiles dated from my tenure as a staff appraiser from 2003 - 2004. USPAP requires that a copy of the appraisal and the workfile be retained for 5 years from the effective date of the valuation. After that the files can be discarded, but the rules governing client confidentiality have to be followed. As a result, when the files reach their fifth birthday, I use them to heat the house.

While going through the boxes (yes, I do glance at the reports to make sure I do not inadvertently destroy something which should be retained) I found the following peer review done by a third appraiser regarding my appraisal of a home and the value opinion provided by another appraiser retained by a litigious borrower:

"November 4, 2004

I have been asked to review two appraisal reports that were completed on this property. The first report was completed by James Hrubik based on an interior viewing of the home on February 12, 2004 and the indicated opinion of value was stated as $33,000. A second report was completed for a different client by Appraiser X based on an interior viewing of the home on August 18, 2004 and the indicated opinion of value is stated as $70,000. For this review I viewed the exterior of the subject property and all comparable sales used and have attached photos of these properties and a location map to this review. Please note that approximately six months have transpired between the effective dates of these reports and I am therefore unable to confirm if the condition of the home had changed in this period of time.

For this review, I surveyed the Akron Area MLS and public record information. The MLS describes this neighborhood as Southwest Akron and is Area SUM34. Per the MLS there had been a total of 93 sales of single family homes of all property ages and styles in the twelve months preceding the effective date of Mr. Hrubik’s report. The price range was $3,000 to $134,900 with nearly 2/3 of all sales ranging between $3,000 to $30,000, and many were described as being ‘Bank Owned’. The median price was $21,500 and virtually every sale between $71,900 to $134,900 was described as being a ‘New’ home.

The report completed by Mr. Hrubik provides a neighborhood description that states this is an urban neighborhood with property price ranges between $10,000 and $125,000 with a predominant price of $40,000. The age range is described as being from New to 100+ years with a predominant age of 80 years, which is reasonable and consistent with MLS data. Mr. Hrubik selected three sales for his analysis that were offered in the MLS and I was able to verify the sale price and property features as reported based on the MLS descriptions and public record information as follows:

Comparable #1: 643 W. Thornton sold in 9-2003 at $30,000 after being listed at $32,000 for 54 days. The property descriptions are consistent though Mr. Hrubik fails to report that this home was reported to have a finished basement rec room with wet bar and a negative adjustment could have been included. There was no prior sale or listing of this home in the previous 36 months.

Comparable #2: 987 Laurel Avenue sold in 10-2003 at $29,500 after being listed at $32,900 for 119 days. The property descriptions are consistent with the data sources noted. Though there was no prior sale of this home in the 36 months prior to the date of value, the home had been offered for sale in the MLS on two previous occasions, once at $49,900 for 184 days until the listing expired on 2-14-2002 and again at $39,900 for 92 days until the listing expired on 7-31-2002.

Comparable #3: 994 Celina Avenue sold in 10-2003 at $33,530 after being listed at $34,900 for 122 days. The property descriptions are consistent with the data sources noted. There was no prior sale or listing of this home in the 36 months prior to the date of value.

All three sales are in close proximity, similar in age and living area, and were within six months of the effective date of value and are therefore considered relevant and reasonable. Each was listed for sale with a professional Realtor and had adequate market exposure in the MLS.

As noted, I was also provided an appraisal report completed by Appraiser X for a different client and have found a number of significant deficiencies with the report. The neighborhood is described as being ‘Suburban’ rather than ‘Urban’. The neighborhood price range is stated as $50,000 to $90,000+ with a predominant price of $60-75,000 which clearly contradicts MLS data for this neighborhood. In addition the age range is 60 to 100 years which does not include a significant number of homes in this market that are much less than 60 years old. Appraiser X fails to provide the FEMA flood zone information which leads me to question if she had adequate data sources for this community. The land value estimate of $15,000 is not reasonable for a site of 32’ x 132’ in this urban setting as this is more than 50% of the total sale price of nearly 2/3 of the reported sales in the MLS as noted above. Finally, Appraiser X provided three sales in the market analysis that were non-MLS transactions. The data source stated (Auditor’s Office/Exterior Inspection) does not provide information regarding any terms of sale, property condition, or if the transaction was at market and arm’s length. Other concerns regarding these sales are as follows:

Comparable #1: 817 Raymond is reported to have sold in 4-2004 at $72,000 per public record information. Appraiser X states that there was no prior sale of this home in the preceding 36 months. However, this home was offered in the MLS at $20,000 in 1-2004 and transferred to SMB & A LLC in 1-2004 at $14,000. The home then was sold in 4-2004 at $72,000 with terms and conditions of the transaction not known nor is there verification that the home had been restored for this purchase. Appraiser X’s failure to disclose the previous recent sale is a violation of USPAP and leads me to question if this was actually a ‘flip’ transaction.

Comparable #2: 1006 Nathan is reported to have sold in 11-2003 at $67,000 per public record and seller. Appraiser X fails to disclose that the [n.b. - I deleted this buyer-seller relationship disclosure for retention of confidentiality] and is likely biased toward the transaction. Failure to disclose this relevant information regarding the seller is considered misleading as a typical reader would assume this was a verified and unbiased transaction. There was no prior sale or listing of this home in the 36 months prior to the effective date of value.

Comparable #3: 640 W. Thornton is reported to have sold in 2-2004 at $75,000 per public record, The data source can not be used to verify the terms and conditions of this transaction nor the condition of the home at the time of its sale. However, upon my exterior viewing on November 3, 2004 this home appears to have been vacated and at least one window is broken which again leads me to question the reliability of this sale. No other sale or listing in the preceding 36 months was found in data sources for this property.

It is highly unusual for a qualified appraiser to not utilize the MLS as a primary data source for this established urban neighborhood in the city of Akron, which leads me to question if Appraiser X had adequate experience or resources to have accepted this appraisal request.

For the purposes of this review, I also surveyed the MLS for active listings in the subject’s neighborhood to help establish a reasonable upper limit of value for homes of similar vintage.

Currently, a property at 388 Raasch Avenue is offered for sale at $45,000. This home is described in the MLS as being completely renovated including newer drywall, carpet, furnace, A/C, windows, roof, kitchen with oak cabinets, newer bathroom. The home is reported to have been built in 1925 and offers 1128 sq ft living area, which would be competitive with the subject. As noted, this home has yet to sell and has been on the market for over 200 days. It is my opinion that this active listing provides some helpful insight into this neighborhood for homes that are renovated to this degree.

For these reasons I am of the opinion that the value as reported by Appraiser X is without merit or support. The neighborhood description does not accurately reflect the reality of the predominant sales activity in this market area. The use of questionable or unreliable sales data without utilizing the MLS in this market, or seeking assistance from someone with access to the MLS, leads the reader of the report to unreasonable conclusions and for this reason the report is misleading."

I remember that incident well, as I was required to sit beside my client's attorney as we faced the borrower and his counsel. That is how I managed to get a copy of the review. Also, because the report was involved in litigation, it and all pertinent files need to be retained an additional five years beyond the settlement of the dispute.

The rest of the story? The borrower (who wanted to borrow about $60,000) claimed my client would have made the loan had the borrower been a member of a protected group. Appraiser X, whose office was 60 miles away, was brought in to make the case that I had significantly undervalued the home and that my client had utilized it in an attempt to prevent the loan. It is of interest that I was not named in the suit; there was nothing in my report which could have been interpreted as bias. I just had not come up with the correct number, and my client trusted my judgment.

No mention was made anywhere in the proceedings that the tax appraised value of the home was only $30,750. My client settled out of court by agreeing to hire a fourth appraiser who managed to appraise the subject property for about $45,000, thereby allowing the client to loan the borrower the tax appraisal amount and still stay within Federal guidelines.

To my knowledge the second appraisal was never submitted to the Ohio Division of Real Estate for review; protection of Appraiser X was possibly a part of the settlement. Now you may have a bit more insight into why the banking industry was in need of a stimulus in 2008.

Time Flies

2009-11-26T17:19:00.007-05:00

It has been several very busy months since the last post. I have been busy gathering and verifying tax card information for the Geauga County Auditor in order to provide an updated database for the 2011 reappraisal in that county. In doing so, I have been logging experience hours in non-residential appraisal work, to be applied toward my application to sit for the General Appraiser certification exam.

Meanwhile, while not intending to do so, I have failed to provide a follow-up on the query that was the subject of the last post. I received the following reply (in part) to the information I sent to the troubled borrower:
Jim,

Thank you for the information and your thoughts. I will certainly take your advise [sic]. I noticed that remodeling averages are from 65%-77% depending on the project which certainly shows the appraisal was estimated much lower. I understand what the auditor's records show but they came in here and documented 4 bdrm and 3 full baths. Are we paying for an accurate appraisal? Two more questions 1) how is land value figured? And replacement cost per sq ft? Our insurance company has it much much higher. I'm just trying to wrap my mind around this as to why it came in so low. We had this same thing happen before were [sic] the first appraisal came in much lower 50-60000. We spoke with Chase and explained everything and they issued another appraisal. The appraiser who came out has intimate knowledge of our area in fact he explained the his mother is a Realtor in this area and he knows the value. It came in at $399,000.

I never did email the man back, but my notes on my thoughts have been cluttering my desk for the past 5 months, so here goes.

First off, the last few sentences of his email are very troubling to me. If, during the original loan's appraisal process, the value came in $50-60K less than what was "needed", and the bank sent out a second appraiser who "knows the value", I, as a very suspicious, untrusting, and experienced reviewer tend to immediately class the second appraiser as one who could also "hit the value", whatever it took. Sorry, I have not just one noid, but a paranoid where these matters fall.

Is the borrower "paying for an accurate appraisal"? I suppose that is a very nuanced question. By law, the client is the bank. The borrower pays for the appraisal, but the bank is the intended user. Certainly the bank should be interested in a well reasoned and factually supported opinion of value, but the words "accurate" and "opinion" do not belong in the same sentence without some other explanatory verbiage. The facts should be accurate, and the opinion should be unbiased.

Certifications 1, 4, 7, 9, 11, and 12 of the FMNA Form 1004 (3/2005) address the accuracy and adequacy of the data used in the analysis. Adjustments may be difficult in a declining market with a scarcity of sales, and the appraiser must use his best judgment. Much more attention is also being paid now by lenders to geographic competency (Certification 11) -- where does the appraiser live and normally work, and is he truly familiar with the market? n.b. -- it should be recognized that an appraiser can become extremely competent in a market at some distance from his normal base, but the onus is on the appraiser to prove such competency in both his choice of data and the resulting reasoning.

As to the value of the land, there are three normally accepted methods for determining land value (the value of the land as vacant and unimproved). The first is market sales comparison. Examination of recent sales of vacant buildable parcels should provide the appraiser with information to form an opinion of value for the subject parcel. The subject parcel had 2.65 acres; the borrower cited a 1 acre lot selling for $78,000. That would be a very poor comparable in a built-up area like the City of Solon; more comparable sales would be vacant residential lots between 2.5 and 3 acres in size, and such sales would be extremely rare. The $5750 adjustment for site size would be the appraiser's opinion of the contributory value of the site size difference; the important thing there is support for the site value which the appraiser is supposed to detail on page 3 of the Form 1004. That support is required by FNMA, regardless whether the Cost Approach is completed. (We'll discuss that a little further on.)

The other two commonly used methods for determining site value are extraction and allocation. Allocation is fairly simple and is built into most models for AVMs and CAMA. In its simplest form, when the cost to build the house, new, is calculated, a percentage figure is multiplied by the cost to give a land value. In its most reliable form, the percentage is derived from market studies of builder costs, and is adjusted internally for positive and negative land features. In practice, however, it is often a "pluck from air" (PFA) figure and, within assessment records, frequently produces hilarious results. (Sorry, but I have in mind a lot in the City of Akron which had an old house on it. The year the house was demolished, the lot was valued by the Auditor at $8,000. The next year, with a new house -- built with government grant money and not at all a market-driven project -- on the lot, the tax appraisal land value had jumped to $20,000. The mean and median price of housing in the neighborhood was unchanged. Such is the magic of carelessly applied allocation.)

Within built-up areas with few vacant land sales, extraction is the third commonly used method for determining site value. To properly do a land value extraction, sales comparisons must be run on a number of recent sales of homes where significant details of their quality and condition are known to the appraiser. The appraiser must do a Cost Approach appraisal of each of the comparable homes (comparable in this context being more applicable to the characteristics of the land than the houses), with great care taken to account for all forms of depreciation that might have affected those homes. The resultant depreciated cost of the improvements is then subtracted from the raw sales price to indicate the contributory value of the land under the home. Unfortunately, while many appraisers cite extraction as their method for determining site value, it is my experience from looking at their reports that a good many of them either have no idea what they are about, or they are incredibly lazy.

In general, FNMA does not require the Cost Approach to be completed on the Form 1004 unless it is the appraiser's opinion that it is needed to provide support for the reasoning behind the value opinion. Appraisers generally use cost tables to determine the cost to construct the home using current methods and materials, and then apply estimates of depreciation (physical, functional, and external) to arrive at a depreciated cost of the improvements. This is then added to the site value figure to indicate a market value for the home. In theory, it works if an honest site value is used and if all three forms of depreciation are properly accounted for. Lenders want to see the Cost Approach used because they feel it is a shortcut to providing a figure for which they can require the borrower to supply an insurance policy. Most appraisers are now including a disclaimer that the costs "are not to be considered indicative of insurance replacement costs", this despite the fact that the form requires them to check that the costs are either for reproduction or replacement.

An insurance appraisal is generally not a market value appraisal. Insurance policies are written to allow property owners to recover the utility of their asset if it is fully or partially destroyed. Replacement cost per square foot, for insurance purposes, must include the costs involved in removing any debris from a damaged home, and then reconstructing it to its former usefullness. This means that no depreciation can be entered into the process, since the home, when the owner again takes up residence in it, will be restored to "new" condition. The replacement cost may be, and usually is, far more than the market value of the home. If the home is purchased for $100,000, but is of such age and design and condition that to rebuild it to modern standards would cost $200,000, the borrower may only be required by the lender to insure it for the purchase price. If it burns to the ground and must be rebuilt, the insurance company will only pay the policy amount. The borrower will have to come up with the rest. If he cannot qualify for the additional loan amount, or does not have the cash, he may have to default on the original loan. Consequently, homeowners should have their houses independently appraised for insurance purposes, and under no conditions should they rely on a market value appraisal for insurance value uses.

There is one final thing cloesly related to the above which needs to be mentioned and which will make me persona non grata in some circles. The gentleman who originally wrote to me acknowledged in his rejoinder that "I noticed that remodeling averages are from 65%-77% depending on the project". A dirty little secret is that this also applies to new construction, albeit to a lesser degree. Just like a new car, which loses value the instant it is driven off the dealer's lot, in a stable market, a new house depreciates, possibly 5% - 15% depending on where it is located, the instant the buyer signs the contract with the builder. The practice of selling new homes with 100% financing is still occurring, but it is not politically expedient to suggest to FNMA that new home buyers should be required to put down 20-25% of the purchase price in cash. Especially not with the government trying to stimulate the economy by offering tax incentives in a market that is in significant oversupply.

Hi-yo, Silver! Away!

Comparing Oranges to Oranges

2009-06-12T13:32:00.004-04:00

I get some interesting questions from time to time. While I cannot directly address the concerns some people have about home value (the instant I utter my opinion of value, even orally and/or "off the cuff", I have done a certified appraisal and am required to submit to the person receiving the opinion (even though a client relationship may not exist) a signed certification. So, I have to be careful. Still, as I said, some of these things are interesting and bear a little research.

Here is a sample, dated today:

Jim,

We just had an appraisal completed, which feel $105,000 short of the appraisal completed 11/07 KeyBank. We understand the market trend in today's economy. However we live in an area that is still maintaining a good home value- Orange Village. The appraiser used comps that are 3 bdrm 2 to 1 full baths 2 car garage and the homes are 48, 53 & 35 years old which our is 30. Also our home sits on 2.65 acres heavily wood lot and the comps are 1.65, 1.48 & .35 not on wood lots. We have put 62,000+ in home improvement in the last 2 years, Pella windows & all entry doors & sliding door, new boiler, new hot water tank, new roof, remodeled kitchen, new built in appliances, porcelain floor, 2 full baths taken down to the studs granite & silestone vanity tops porcelain tile floor and shower, all new interior doors, closet doors, all new light fixtures interior & exterior, new carpet, baseboard, interior paint through out.

With all that said he noted $15,000 in home improvements and a few windows replaced all but 5 windows have been replaced. He adjusted the replacement sq. ft @ $79. The acres he gave $5,750 for adjustment, 1 acres lot in Solon is selling for $78,000.
He appraised our property @ $291,000 which we needed $347,000. Why didn't he use comps that are apples to apples not apples to zucchini ? QuickenLoans will not order a second appraisal even through I was able to give them comps that just sold last month @ $380,000 which was built the same year close to the acreage and 4 bdrms & 3 full baths. We have lost our 4.375% rate lock and have no recourse. And our $500 lock rate deposit. What happened????? Can you shed any light on this and suggestions?

Thanks for your time.

Curious George being a monkey, I did a little look-see in the MLS and sent the following reply :

Thanks for the query.

I assume that you are referring to the home at --- Road, 44022. The Cuyahoga County Auditor shows that the home is a 2436 sf ranch, on about 2.65 acres, built about 1979 with 3 bedrooms, 2 full baths, a half bath, full basement, and a 3-car garage. The tax appraised value for 2008 was $292,400, including the tax appraised land value of $68,400.

You need to realize that the lender will be looking at the same public records information, and underwriters are currently being very conservative.

I cannot address specifics in your question since I do not appraise in Cuyahoga County and cannot claim competence in that market area. There are, however, some very general items that you might want to look at.

You imply that only three comparables were used. I am finding that I have to use from 5-9 comps on the grid, including 1 or 2 active listings to show the market trend. Because of the scarcity of sales, the first three comps may be "ugly" due to the need to keep their sales dates within 6 months; it is not always easy to "bracket" under tough market conditions.

You also need to remember that cost is not the same as value. You may want to take a look at Remodeling Magazine's Cost vs Value Report .

I performed a search of the MLS looking for sales only in Orange. In 2006, there were 33 sales with a median price of $307,000, in 2007 there were 24 sales with a median price of $348,875, in 2008 there were 27 sales with a median price of $260,000, and for the first five months of 2009, there were only 5 sales with a median price of $165,600. While the MLS does not show all the sales that have taken place, it does show the brokered sales that most likely have occurred with adequate market exposure and can be used to form a value opinion which meets the FNMA definition of "market value". The statistics show the actual trend in prices for brokered sales in the Orange market.

I would suggest that you examine the appraisal report done in November 2007. You have implied that the value opinion was $396,000, or about $162/sf. There was a home which sold at 28700 Jackson Road on 4/26/2007 for $290,000 ($120/sf). That home was a 2413 sf ranch on 2.55 acres built in 1962. While it did not have a basement, in my opinion it would be a logical candidate as a comparable sale even though it might have to be heavily adjusted for that feature. In fact, examination of the MLS sales data shows that even in 2007, with a much higher median price than now, there were very few single-story homes in Orange that sold for more than $130/sf.

You may want to write a letter to the Ohio Division of Real Estate expressing your concerns, and forward to them copies of both appraisals for their review.

Sincerely,

Without a doubt this homeowner is feeling the pain of current market conditions on his financial situation. He may be under the impression that all is well in his neighborhood, but there are very few locales where real estate prices have not dipped. I have been tracking the MLS statistical reports for the entire state since 2003 (via the updates published in Ohio Realtor) and for the first 4 months of 2009, the median sales price across the entire NEOHREX MLS area is down more than 21% from the same period in 2008. I don't think we have hit bottom yet, either. My opinion.

Oy! Such Enthusiasm!

2009-04-02T19:23:00.002-04:00

On November 23rd I wrote,

"I have several very bitter disagreements with the tax thieves. One has to do with their desire to strangle the taxpayer. The term "mark to market" is now getting some attention, but it is an old IRS tactic that was adopted by the people who invent accounting rules. According to the IRS, if the market interest rate is 5%, and I loan you money at 1%, you must pay income tax on the 4% I did not charge you. The accountants were forced by this tactic to come up with a definition of "fair value" that relies on the current market price, even for assets which a taxpayer does not intend to sell. If I buy stock at $1/share on December 30, 2008, and it goes to $2/share on December 31, 2008, and back down to $1/share on January 2, 2009, I have a gain of $1/share for the 2008 tax year, even if it was not realized. For a cash basis taxpayer, there is no effect, but for an accrual basis taxpayer, there is an imaginary taxable gain of 100%. This is the result of "marking the value of the asset at current market price". The tax must be paid in 2009, and you can take a write-off for the imaginary January 2 loss in 2010. IRS will use your money, interest free, in the meantime.

When "mark to market" is applied to assets that are being held for income generating purposes, the decline in the market price of those assets can cause catastrophic effects in the credit ratings of companies. That is why so many lenders and insurance companies are now in a credit crisis. That is why throwing money at the problem will not help. The rules have to change. I advocate that "mark to market" be used only for assets actually traded, and "value in use" be given more emphasis where accrual accounting is utilized. IRS will not be happy with such a concept."

Note that I qualified the conditions for change; that "mark to market" be used only for assets actually traded.

Yesterday (April Fools' Day), bowing to pressure from the banks and the politicians, the Financial Accounting Standards Board (FASB Issues Staff Position 141(R)-1) revised the rules regarding "mark to market". It is a lengthy read. The market has reacted quite positively today to the release of the statement. I have very strong doubts that many of the market participants have read anything beyond the news headlines about the statement.

Of interest to an appraiser is the following :

"8. If the acquisition-date fair value of an asset acquired or a liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, an asset or a liability shall be recognized at the acquisition date if both of the following criteria are met:

a. Information available before the end of the measurement period indicates that it is probable that an asset existed or that a liability had been incurred at the acquisition date. It is implicit in this condition that it must be probable at the acquisition date that one or more future events confirming the existence of the asset or liability will occur.

b. The amount of the asset or liability can be reasonably estimated.

Criteria (a) and (b) shall be applied using the guidance in Statement 5 and in FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss, for application of similar criteria in paragraph 8 of Statement 5."

Remember, an appraiser is one who provides an opinion of market value, while an accountant (or a computer program) provides an estimate of market value. Estimates can be prepared in the complete absence of consideration of the market participants, but opinions must consider what the market participants are actually reacting to.

The following disclaimer was also of interest [my bolds for emphasis]:

"This FSP was adopted by the affirmative votes of four members of the Financial Accounting Standards Board. Mr. Linsmeier dissented.

Mr. Linsmeier dissents from issuance of this FSP because it fails to provide guidance in two key areas, and, therefore, he does not believe the FSP will be operational. First, this FSP requires that an acquirer recognize at fair value an asset acquired or a liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period without providing guidance as to how to make this assessment. This assessment drives the key differences in the accounting prescribed by this FSP and, if not clear, is likely to raise significant application and comparability issues. Statement 157 provides guidance on how to determine fair value in active and inactive markets and in the presence of both observable inputs and unobservable inputs, which might suggest that fair value should be able to be determined in many, if not most, circumstances. Mr. Linsmeier is concerned that without providing guidance on how to make this determination assessment the Board is being unclear about its intentions, introducing significant judgment in the application of this FSP that will not result in consistent reporting across enterprises.

Second, this FSP does not prescribe in detail how an asset or a liability arising from a contingency initially recognized at fair value in a business combination would be measured subsequent to its initial recognition. This FSP only requires that an acquirer develop a systematic and rational basis for subsequently measuring and accounting for such assets and liabilities depending on their nature, suggesting in the basis for conclusions to this FSP that methods be developed similar to those prescribed in Interpretation 45. While not stated in this FSP, the Board in its deliberations leading to this FSP generally agreed that Statement 5 does not provide appropriate guidance for the subsequent accounting for an asset or a liability arising from a contingency initially recognized at fair value in a business combination. In addition, the majority of the Board did not support subsequent accounting at fair value for those assets and liabilities. The failure to make these tentative decisions authoritative in this FSP and the failure to provide further guidance on the subsequent accounting similar to Interpretation 45 are likely to result in multiple methods for accounting and reporting for identical assets acquired and liabilities assumed in a business combination subsequent to their initial recognition at fair value, causing significant comparability issues for financial statement users across enterprises. As a consequence, Mr. Linsmeier believes this FSP fails to provide sufficient guidance to permit financial statement issuers and their auditors to consistently apply the guidance in this FSP and, as a result, financial statement users will not be provided useful and comparable information about the financial statement effects of assets acquired and liabilities assumed in a business combination that arise from contingencies. "

The Appendix to the statement includes the following items:

"B28. The Board acknowledges that this FSP does not provide investors, creditors, and other users of financial statements with some information that would have been provided had Statement 141(R) not been amended. However, because this FSP will continue to require that an acquirer disclose the amount of the asset or liability recognized at the acquisition date and the nature of the contingency, investors, creditors, and other users of financial statements will receive more information than they received under Statement 141. The Board believes the changes to Statement 141(R) made by this FSP were necessary to address operational issues raised by various constituents that could have resulted in significant costs to preparers.

B32. Differences also exist between the disclosures required by Statement 141(R), as amended by this FSP, and revised IFRS 3. For an asset or liability arising from a contingency recognized at the acquisition date, this FSP requires that the acquirer disclose the amount recognized and the nature of the contingency. For contingencies that are not recognized at the acquisition date, this FSP requires that the acquirer include the disclosures required by Statement 5 in the footnote that describes the business combination. For contingencies in which there is at least a reasonable possibility that a loss will be incurred, Statement 5 requires that an entity disclose the nature of the contingency and give an estimate of the possible loss or range of loss or state that such an estimate cannot be made. Revised IFRS 3 carries forward the existing disclosure requirements in IAS 37 and requires an acquirer to disclose the reasons that the fair value of a contingent liability cannot be measured reliably, if applicable. For recognized contingencies, the acquirer is required to disclose (a) a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits, (b) an indication of the uncertainties about the amount or timing of those outflows, including major assumptions made about future events, where necessary, to provide adequate information, and (c) the amount of any expected reimbursement and the amount of any asset that has been recognized for that expected reimbursement. For unrecognized contingencies, unless the possibility of any outflow in settlement is remote, the acquirer is required to disclose the nature of the contingency and, where practicable, (1) an estimate of its financial effect, (2) an indication of the uncertainties relating to the amount or timing of any outflow, and (3) the possibility of any reimbursement. Under IAS 37, entities also are required to disclose changes in the carrying amount of a contingent liability, including the reasons for those changes. "

The market rally today was said to be a result of investors hoping to see financial stocks show improved profit conditions as a result of application of this rule. While this rule will help in situations where assets held for income production are being analyzed, I would have to agree with Mr. Linsmeier that there is insufficient guidance with respect to supplying investors with information where assets which have defaulted or are in danger of default are being valued. In particular, the downward price pressure on the housing market has, I believe, been understated because the statistics being analyzed have not been adequately filtered to reflect market value as perceived by buyers.

Once the idea sinks in that this is not a cure for the mortgage portfolio devaluation problem, we may see some "morning after" regrets. Choking on furballs is always a danger when one partakes of the hair of the dog which bit him.

If Congress Were Serious... Or Even Semi-Intelligent...

2009-01-27T23:54:00.008-05:00

Is there intelligent life on Capitol Hill? How many fingers do those weird politicians have, and can they use them to count? Has the concept of a zero made it into their culture?

First they conjured a few hundred million to bail out some banks. Then they had seven hundred billion added to the pot. Let us write that on the blackboard, students.

$700,000,000,000. Seven hundred billion. The number of seconds that have elapsed since Julius Caesar was assassinated (44 BC - 2009 AD, 2052 years): 60 seconds/minute x 60 minutes/hour x 24 hours/day x 365.3 days/year x 2052 years = 64,765,059,840. If you spent $10/second for 2052 years, you would still not have spent $700,000,000,000!

The Honorable Lunatics voted in October 2008 to spend up to $700,000,000,000 to bail out the failing banks. $350,000,000,000 remains unspent, and there is a strong push by the Obama Regime to have Congress add another $850,000,000,000 to that. Because there is no way the Loyal Opposition can halt this juggernaut, within a short time there may be $1,200,000,000,000 in the pig-trough (that is $100/second for over 380 years, or since the time the Pilgrims landed here).

Let us do this another way. We all remember story problems from high school math. According to the US Census Bureau estimates for 2005-2007 (Table B25087) there are just over 51,000,000 US housing units with a mortgage. Of those, about 23,639,036 (46.2%) had mortgage payments over $1500 per month. The data from the Census Bureau is tabulated below; the upper mortgage payment amount was assigned at $6000/month for calculation purposes. I added the fourth column to arrive at the estimated mean monthly mortgage payment for each category. The final figure of $88,531,316,700 is taken to represent the average monthly US mortgage payment total.

(Sorry about the formatting. I am still trying to figure out why Blogger screws up simple html formatting)

TABLE B25087.
MORTGAGE STATUS AND SELECTED MONTHLY OWNER COSTS
Universe: OWNER-OCCUPIED HOUSING UNITS
Data Set: 2005-2007 American Community Survey 3-Year Estimates
Survey: American Community Survey

United States
	Estimate	Margin of Error	Mean Payment Subtotal
Total:	75,072,666	+/-172,605
Housing units with a mortgage:	51,164,197	+/-123,611
Less than $200	25,783	+/-1,536	$2,578,300
$200 to $299	126,355	+/-2,860	$31,588,750
$300 to $399	381,877	+/-5,296	$133,656,950
$400 to $499	822,717	+/-7,688	$370,222,650
$500 to $599	1,376,810	+/-10,365	$757,245,500
$600 to $699	1,947,454	+/-12,985	$1,265,845,100
$700 to $799	2,462,599	+/-12,073	$1,846,949,250
$800 to $899	2,855,941	+/-15,590	$2,427,549,850
$900 to $999	3,069,593	+/-16,378	$2,916,113,350
$1,000 to $1,249	7,679,899	+/-30,119	$8,639,886,375
$1,250 to $1,499	6,809,133	+/-24,825	$9,362,557,875
$1,500 to $1,999	9,848,125	+/-36,793	$17,234,218,750
$2,000 to $2,499	5,648,279	+/-21,249	$12,708,627,750
$2,500 to $2,999	3,233,753	+/-16,491	$8,892,820,750
$3,000 or more	4,875,879	+/-16,814	$21,941,455,500
Mean Total Payment			$88,531,316,700

Based on the above, $1,200,000,000,000 would pay all of the mortgage payments for everyone in the USofA for about 13.5 months. However, it has been projected that only 10% of the mortgages in the country are likely to default. Since the depression is gathering steam, that is likely an underestimate, but if one could assume that a successful solution could be applied within, say, 6 months time, the default rate might be held to no more than 25%.

The current economic crisis was begun by a collapse of the sub-prime loan market, and spread to the prime market due to fear in the investment arena that further lending would not be secure. IF the government were to somehow guarantee that NO mortgage would be allowed to go into default (in effect, guaranteeing that the investor would be paid for his risk, mortgage lending would once again be viewed as relatively safe and profitable.

As much as the above plan would sell every man, woman, and child in the country into slavery to the off-shore lenders who would once more be emboldened to loan in the American housing market, it would be far more sensible than the current balloons being floated that have to do with judges being able to re-write the terms of loans. It would also lend itself to being implemented as a refundable tax credit, paid in advance, and as such, would offer almost immediate relief (at least as soon as the rules could be drawn and the forms printed). Finally, while it would not deliver any pots of money to the scum-bag bankers that got us into this mess, it would directly benefit the general population, and, in restoring confidence to the money markets, would ultimately create jobs, allowing people to work themselves off the program over time.

Details would have to be hammered out; cut-off dates (I would suggest rescuing only loans made prior to 1-20-2009), tax refund rules, possible upper limits to payments (the current regime made a big campaign point of not giving tax breaks to the RICH), and restrictions on passing the bailout to third parties, are items that would have to be fought over.

If a worst case scenario of 25% potential default (25% of all mortgages needing such insurance), the bill would come to roughly $265,593,950,100 per year. There would be enough in the pig-trough to pay one-fourth of all USofA mortgages for about 4.5 years. That should be sufficient time to get over our economic sniffles, and would guarantee a resounding re-election for BO & Company.

How Much is that Dollar in the Window?

2009-01-16T16:06:00.004-05:00

Some more wizardry by those who flunked Econ 101. There is a sense of panic out in the vast, snow-covered American hinterland (yes, I am including New Yawk, Warshington, and Lost Angels in hick country) with regard to what "money" is currently able to buy. This Reuters article is an interesting read, just for the nit-picking possibilities : Inflation slows to half-century low in 2008

"WASHINGTON (Reuters) - Inflation slowed to a half-century low this past year and industrial output fell for the first time since 2002, data showed on Friday, as the recession deepened toward year-end, raising the specter of deflation." ...

"Weakening activity worldwide has depressed commodity prices, pulling headline inflation down sharply. However, core U.S. inflation, which strips out volatile food and energy costs, is also slowing increasing the risk of deflation." ...

[Notice the blurb about food and energy costs? Are we talking industrial commodities, like steel? Today, on the Chicago Exchange, July 2011 wheat is up 19% over March 2009 wheat. December 2011 corn is up 21% over March 2009 corn. December 2009 lean hogs are up 13% over March 2009 lean hogs.]

"'Deflation is just around the corner,' said Meny Grauman, an economist at CIBC World Markets in Toronto. 'With the U.S. economy roughly one full year into a deep recession, the prospect of deflation is a concern for another time, especially on a day when the U.S. government has decided to inject billions more into the U.S. banking system.'" ...

[Huh? Run that past Barney Frank again...]

"Deflation is usually described as a dangerous spiral of falling prices causing economic contraction as consumers hold off purchases in the hopes of even lower prices. Mounting job losses, falling household wealth and tight credit conditions have forced consumers to hold back on spending, limiting businesses' ability to raise prices and encouraging some to offer heavy discounts to lure customers." ...

[ummm -- whose description? A politician's or an economist's?...]

"Analysts said the data illustrated the urgent need for a massive fiscal injection to turnaround the economy. President-elect Barack Obama and Congress are working on a package of spending and tax-cut measures to stimulate demand." ...

[Analysts? Banking analysts?...]

"'There is little hope of a near-term revival in manufacturing without a huge fiscal stimulus program implemented with a sense of urgency,' said Roger Kubarych, an economist at Unicredit Markets and Investment Banking in New York." ...

[Ah. Question answered.]

"The Fed has dropped benchmark interest rates virtually to zero and with little firepower left on that front, is concentrating on pumping money into troubled credit markets to try to restore lending, hoping to spur activity and beat back incipient deflation risks." ...

[Yes. We must borrow until we are back on a sound economic footing. Just trust them, don't think about it.]

"Core prices, which exclude food and energy items, were flat for the second month in a row in December. On a year-over-year basis, core inflation rose 1.8 percent, the smallest increase since December 2003 and still within a range Fed officials would be comfortable with." ...

[Lets see : spending is down, prices are still rising (but not as slowly), and we are ignoring the rapidly increasing cost of (food commodities) what people are still buying. Makes sense to reporters, I guess.]

I have a question. Is there anyone in these "think tanks" that is not politically motivated? We have a period in time in which the Federal Reserve, at the urging of the government, has gone berserk printing money backed only by the 'full faith and credit of the United States'. This is a Wizard of Oz moment in time, or maybe the emperor's parade is passing and I'm the little kid. (Do fairy tales have a basis in reality?)

Congress, please stop the nonsensical pretense at solving the current economic woes. The explanation for the problem is simple : if you eat too many plums, you get diarrhea. If you are sitting on the toilet, suffering from diarrhea, and feeding yourself plums as a means of curing yourself... do I paint an understandable picture?

Tim Harford (of Undercover Economist fame) has written an interesting post : The $10,000 Light Bulb … ; he states, "The official inflation rate tries to compare the price of a typical bundle of goods today with that of a typical bundle of goods in the past. But we do not consume the same goods today as we did in the past. How many Walkmans in an iPod? The question has no sensible answer, but an answer, nevertheless, is codified in the official inflation rate."

The sad truth is that measures of inflation or deflation [note measures!] may have no real impact on people other than the political necessity to tie increases in entitlement programs to some fictional explanation; the need to exclude food and energy costs arose when the need to limit the costs of government handouts became apparent. That is why you have an "official inflation rate", and why it is important to politicians and the bankers who pull their strings.

Actual inflation or deflation has an impact on real people, but mostly when it affects precisely the items excluded from the most prominent measures -- staple items like food and energy. The new $100 trillion Zimbabwe note (released today) is a case in point; in a country where a loaf of bread cost $30 billion (last week, anyway), and $10 billion, $20 billion, and $50 billion notes (released last week) are no longer enough, you have to make the bill bigger to sucker somebody into accepting it. Would you spend $22 million for a single sheet of toilet paper? (Oops -- last week's price, more expensive this week. Actually, if I were a Zimbabwean with Internet access and a Swiss bank account, I would try selling some of that money on e-Bay -- accepting payment only in Swiss francs -- to collectors in other countries!!!)

I will reiterate. Inflation of currency is the deflation of its value caused by printing more of it without any material backing. Declining prices of goods is not deflation; it is the refusal of buyers to spend inflated money on items for which they have no perceived need. As a result of the criminally profligate printing activities of the Federal Reserve as abetted by the government, we should begin to see, within a 3-6 month period, astronomical increases in the costs of food and other staple goods. Buy your garden seeds early. The only deflation 'real Americans' have to worry about is in the purchasing power of their dollars.

Now for our story problem. Senator Boozhwa has economic diarrhea from eating too many political plums. If poo-paper is $22 million per sheet (last week), how much will it cost the Senator to flush America down the toilet before the next election? [Hint : $800 billion will not be the final number.]

Commercial Break

2008-11-23T00:08:00.002-05:00

This past week I was prompted by Mickey Axlebender Thirdson to pontificate on deflation, since people were talking about it but did not seem to know what it meant. Of course, if one is speaking of pneumatic tires, deflation causes a "flat", and if one is talking about a bore (as in, politician who won't shut up) the term has no meaning since the bore is a boor and cannot be embarrassed sufficiently to become deflated. However, when one is speaking about economics, then the common sentiment is that deflation is when prices go down.

It is a bit more complicated than that, though. Perhaps we need to look first at "inflation", which everyone thinks they understand. We will need a place to stand on if we are going to move the Earth, saith Archimedes, and that place in economics will be a standard medium of exchange. Gold comes to mind quickly, as does the cost of a loaf of bread. The USBuck has been taken to be the standard for the past half century (yes, Virginia, there was a time when other currencies were considered the standard -- see "pieces of eight", for example) and the rise of the Euro notwithstanding, foreign investors have rallied back to the dollar recently because, relative to what is happening in the rest of the world, and in spite of US economic woes, the USBuck is still the most confidence-inspiring piece of paper afloat.

Inflation is generally seen to be a process whereby prices are rising. There is a need to understand why prices rise. In a rational economic world, prices rise due to a rise in demand relative to a decline in supply. In other words, people are bidding for something, and the competition drives up the price. There are multiple intertwining factors in action, however. One factor is the item being purchased, and another is the perceived value of the currency used. In other words, the USBuck is a commodity in trade. In general, the more USBucks there are in circulation, the less valuable they become, and the more of them are required to barter for the item being purchased. When the government creates more USBucks, to the buyer, the USBuck has become less valuable, and to the seller, the item being sold has become more valuable. Inflation in the price of the commodity being sold, where the demand for the commodity has not increased, is actually caused by deflation of the value of the currency used in trade.

So, we flashback to Jimmy Stewart in "It's A Wonderful Life", and we see him instructing Momma Dollar and Poppa Dollar to hide in the safe and create lots of little dollars. Unwittingly, Frank Capra was commenting on the reason why FDR was unable to solve the problem of the Great Depression with all of his programs. They all tended to create little dollars.

Entrepreneurial buzz is full of the concept of "creating wealth". Wealth is "created" when a product, for which there is a demand, is produced. Too much of the "wealth creation" that has taken place has simply been fabricated through artificial accounting constructs. One popular method has been to provide seller financing of a piece of real estate. The seller needs money and is looking for a buyer, and the buyer has no money and wants the property, so the seller "creates" the money by allowing the buyer to make payments over the life of the contract. There is risk involved, and the seller compensates for the risk and charges interest (the time value of the money) to make up for the fact that he cannot use all of the sales price right away (opportunity cost has to be compensated for). The money used to make the payments (USBucks printed by the Federal Reserve) was originally intended to be used in direct exchange for goods and services without any adjustment for lost opportunity costs. Because the terms of the contract are now competing directly with the interests of the private banking system (the Federal Reserve), feedback in the economy forces the Federal Reserve to print additional USBucks to protect its own position. Money has been "created". This does not necessarily lead to a decline in the value of the USBuck IF there has been a corresponding increase in the total goods and services being traded and in the number of buyers of those things. Unfortunately, as has been pointed out in prior posts, there is a huge oversupply of housing (the most common wealth creation venue under the above scenario) and the net effect of the increase in USBucks has been to lower their value in trade.

Deflation is commonly taken to be the situation when prices are falling. Why do prices fall? Prices fall either because there is too much "stuff" for sale -- no demand for the "stuff" -- or because the number of USBucks available has declined. If there are fewer USBucks, then the demand for USBucks rises, and the buyer is entitled to get more "stuff" for fewer USBucks because of the relative value. To look at the backside of it, deflation caused by a reduction of the number of USBucks in circulation is actually inflation in the buying power of the USBuck. My opinion -- William Jennings Bryan, with his "Cross of Gold" speech, was a blithering populist idiot who did not seem to realize that the alternative to crucifying the farmer with the gold standard was to suffocate the rest of the country with worthless paper.

Sad to say, it appears that just now the deflation in the worth of the dollar is coinciding with a deflation in the worth of the goods and services in some sectors of the economy. There are too many houses; about 10% of the total housing stock should be bulldozed and returned to cropland or some other productive use. There are too many cars (particularly cheaply made, breakdown-prone, high-priced, gas-guzzling ones) -- a fact easily illustrated by the lack of car sales having very little impact on whether or not Americans are still getting to wherever they want to go. There are too many mortgages that were made at below-market teaser rates and which will default as the rates reset to market and the borrowers can no longer afford to pay.

The government response has been fantastically stupid. Instead of listening to economists, the Congress and Senate chose to listen to every plaintiff whose ox had been gored, especially the Federal Reserve bankers. In the blink of an eye, the Federal Reserve was allowed to create $700,000,000,000 of new BailoutBucks, a move which cheapened the money in everyone's pocket overnight. Prices should have shot upwards, but one other factor was at work -- the machinations of the Infernal Revenue Service.

I have several very bitter disagreements with the tax thieves. One has to do with their desire to strangle the taxpayer. The term "mark to market" is now getting some attention, but it is an old IRS tactic that was adopted by the people who invent accounting rules. According to the IRS, if the market interest rate is 5%, and I loan you money at 1%, you must pay income tax on the 4% I did not charge you. The accountants were forced by this tactic to come up with a definition of "fair value" that relies on the current market price, even for assets which a taxpayer does not intend to sell. If I buy stock at $1/share on December 30, 2008, and it goes to $2/share on December 31, 2008, and back down to $1/share on January 2, 2009, I have a gain of $1/share for the 2008 tax year, even if it was not realized. For a cash basis taxpayer, there is no effect, but for an accrual basis taxpayer, there is an imaginary taxable gain of 100%. This is the result of "marking the value of the asset at current market price". The tax must be paid in 2009, and you can take a write-off for the imaginary January 2 loss in 2010. IRS will use your money, interest free, in the meantime.

When "mark to market" is applied to assets that are being held for income generating purposes, the decline in the market price of those assets can cause catastrophic effects in the credit ratings of companies. That is why so many lenders and insurance companies are now in a credit crisis. That is why throwing money at the problem will not help. The rules have to change. I advocate that "mark to market" be used only for assets actually traded, and "value in use" be given more emphasis where accrual accounting is utilized. IRS will not be happy with such a concept. It is not an accident that a recent Federal tax court decision (10/30/2008) ended in a ruling that disallowed a value for the cost of a historic facade restoration in New Orleans. IRS argued that only sales comparison should be used, and that cost and lost income should not be considered. "Judge James S. Halpern ruled that the court would not supplant its responsibility to assess an expert appraiser's reliability by accepting USPAP as the defining standard of reliability, stating that federal rules of evidence only require that expert testimony be based on reliable principles and methods." (Appraiser News Online, November 19, 2008, Vol. 9, No. 21/22). In short, the IRS can ignore Congress and make things up as it goes along.

Deflation? The horse is out of the barn, but it's a mule. There are too many USBucks running around out there. The politicians are planning to print more in an attempt to "stimulate" the economy. There is too much "stuff" for sale, and the only way out of the rabbit hole is to either reduce the amount of "stuff", or reduce the number of USBucks. Meanwhile, back at the ranch, prices will continue to go down, and the country will suffocate in excess USBucks.

Too simplistic? If I have to cut my throat, I would rather do it with Occam's Razor.

A Rent Survey

2008-11-21T02:11:00.003-05:00

Well, I guess I'd better get started on this.

First, we need to do a rent survey, to see what investors are asking in the Akron area. Checking the Akron Beacon Journal for November 20, 2008, we find 241 rental ads running and 43 single-family homes for rent that we can identify by address. Using the Auditor's website, we fill in the missing data -- sometimes the bath count, always the GLA, separating out attic finish (which may contain a room used as a bedroom, but which many investors seal off as a liability concern), and checking for a garage.

The rent survey follows:
It appears that on average, there is a $37/bedroom difference between a 4-bedroom rental and a 3-bedroom rental, and about a $92/bedroom difference between a 3-bedroom rental and a 2-bedroom rental. It also appears that the 2-bedroom rentals, being smaller and possibly easier to maintain, return a higher rent/square foot ($0.63) than the others.

Our investor may possibly want to concentrate on 2-bedroom homes, which will likely fit his purchase budget more easily as well.

Second Base

2008-05-08T21:06:00.004-04:00

Realizing that improved real estate is a depreciable asset (have you ever filled out Form 1040, Schedule E?), an honest investor who truly wishes to get a return on an investment in rental real estate should first get a handle on the meaning of capitalization. In case you were wondering, that has a good deal to do with the term capitalism, which is a dirty word to some people who think that failing to properly capitalize a venture is a virtue.

Capitalization refers to the ability to reasonably compare the costs of an asset to the benefits that derive from owning it. Accountants are familiar with the concept, but most amateur real estate investors, sad to say, are not. Even Jesus warned about the dangers of failing to capitalize ventures. I won't tell you where He said that; you have to look it up for yourself, but it is there and He was very clear about it.

An investor who has no start-up capital is on shaky ground. I know, having started several businesses on shoestrings and losing my shirt because I was undercapitalized. Therefore, we will give our hypothetical investor the tidy sum of $10,000, and see what he could (maybe should) do with it.

There is a basic formula for calculating the income produced by an investment : Income = Rate * Value. If we consider putting the $10,000 in the bank at 0.2% interest (which is about what some banks are paying right now on savings accounts and CDs), then the annual income (simple interest) on $10,000 would be R * V = 0.002 * 10,000 = $20. That is not much of an incentive for saving. It is one of the reasons why intervention by the Federal Reserve, lowering interest rates to stimulate the economy, will ultimately have disastrous effects. The only people who will win that one are the bankers, who get to use every one else's capital virtually for free.

Our investor could put the money into the stock market. There are many solid mutual funds that have been paying 8%-12% per year. What is important to look at, though, is the mix of the annual return from those funds. How much is due to dividends paid by the companies that the fund invested in, and how much is due to capital gains that the fund earned through stock speculation? If the latter has been a very high percentage of the annual gain, the new market economics may soon make that fund much less appealing than one which derives a higher percentage of its gains through dividends paid on annual production.

In the end, all solid gains come from the production of goods and services. Rental real estate is a service which produces places in which people can live. The rates of gain from those things are regularly published. For real estate investors, the Appraisal Institute publishes the Korpacz Real Estate Investor Survey© National Market Indicators, which is a gold mine of data on current capitalization rates for various types of real estate.

An example would be the Overall Cap Rate for Apartments for the 4th quarter of 2007 (3.5%-8%, with a mean rate of 5.75%), or the Residual Cap Rate for Apartments for the 4th quarter of 2007 (4.5%-8.5%, with a mean rate of 6.58%). These are rates obtained by surveys of market participants; they are the rates that are being reported by serious investors in this field. They are also bellweathers for the economy in general, since any inflation rate (driven by artificially low interest rates) that exceeds the mean cap rates for a class of investment makes it economically foolish to hold that investment class.

Our investor also must study the care and feeding of his investment. We will assume he wants to buy a house and rent it out to generate income. He would like to have the largest gains possible, but he is a young sprout of 35 years, and would like to make an investment that he can still be drawing income from 30 years from now, when he retires. For this reason he prudently seeks a rate of return that appears supported by professional investors in his investment class.

Our investor will buy a house. Out of the gross rent, he will pay a mortgage, taxes, insurance, and anything that is needed in the way of maintenance. When he is ready to pass on, he will have not only earned an income over a lifetime, but will also have built an equity position. That equity position, however, should be considered a windfall bonus if it turns out to be a gain that beats the inflation rate, because in order to maintain the property, he will have to make further capital improvements over the life of the investment lest it depreciate through negligence to the point where it would be worth less than the original purchase price and also possibly lose its income generation potential.

Our investor will start with $10,000, and hope to match the Overall Cap Rate for Apartments (about 6%, or $600 in annual net gain). For the sake of simplicity, we will stick with the short term implications, fully realizing that as his equity position increases, the theoretical yield should also rise. The fact that the monthly payments on the loan will remain constant (we will assume he goes the full 30 years without refinancing) make a short-term analysis more realistic.

Next time we will help our investor choose his investment property.

Finding the First Corner

2008-04-02T17:35:00.002-04:00

Fable of the Day

An old man watched a young boy tease a bear that was tied to a tree with a rope. Each time the bear would rise, the boy would back off. Each time the bear would sink back down, the boy would poke it with a long stick. The old man asked, "Sonny, what do you think you are doing? If that bear gets loose, it will tear you and everybody else in the neighborhood to shreds."

"No worry, old man." says the boy. "I'm just playing the stock market."

.........................................

We proceed with my underlying claim that an investment whose value is based solely on the ability to "flip" an asset is on shaky ground.

The Fannie Mae Form 216 (Aug '88), Operating Income Statement, is a frequently neglected tool that should be included with any appraisal of a 1-4 family income residence and critically scrutinized. The biggest problems (at least from my perspective) center around the facts that:
most appraisers have no real-world experience or training in the maintenance and operation of a residential rental
most appraisers lack the experience to adequately address the need for periodic repairs to real property, and,
as a result, appraisers using the 216 generally accept borrower estimates or simply PFA to fill in the blanks.
When this is followed by a reviewer or an underwriter who may not have been adequately trained to spot inconsistencies between the appraisal report and the 216, the Monthly Operating Income developed on the 216 will provide an unrealistic or even fraudulent indication of the property's net income generation potential. Fannie Mae requires this form to be properly filled out and submitted with every Fannie Mae 1025, Small Residential Income Property Appraisal.

The 216 should also be completed for every single-family appraisal (Fannie Mae Form 1004) where the home is to be used as a rental. It usually is not, however, because loan officers do not want to pay the additional fee most appraisers charge to do extra work, and in any event, it is easy to get around by simply claiming that the home is to be owner occupied. Unfortunately, there is no space on the forms to indicate whether the borrower already owns a dozen single-family homes within the county. (Such information is embarrassingly easy to find and is sometimes very difficult to hide, but has nothing to do with the valuation of the subject property. The amount of fraud seen by the average appraiser is incredible, but reporting it can be hazardous to his business. Maybe I should post a few war stories?)

If the subject property is a single-family residence that will be used as a rental, the Fannie Mae 1007 (8/88), Single Family Comparable Rent Schedule should also be filled out. This will provide an estimate of the subject's gross income potential, as of the appraisal date. In general, the rent comparables used in the Fannie Mae 1025 will be used for the same purpose if the property is a 2-4 family rental.

The front of the 216 is used to project the anticipated income and expenses for the next 12 months. It is sometimes necessary to survey income property owners to get a feel for what is typical in a given neighborhood; quite often the subject property's owner will underestimate his actual expenses. The form carries this statement :

"If the appraiser is retained to complete the form instead of the applicant, the lender must provide to the appraiser the aforementioned operating statements (n.b ' actual year-end operating statements for the past two years'), mortgage insurance premium, HOA dues, leasehold payments, subordinate financing, and/or any other relevant information as to the income and expenses of the subject property received from the applicant to substantiate the projections."

In over 20 years of residential appraisal practice, I have never had a lender provide that information. I always had to acquire it from the applicant, the property owner (if it was a sale), or market surveys. Many borrowers treat a request for such information with an attitude of offense, and market surveys are time-consuming because the competition in the rental market makes landlords treat such information as proprietary. It is, nevertheless, critical data, and on more than one occasion I have had to conclude that the projected Net Operating Income shows that the landlord's business is not viable. Once that happens, you have a very unhappy investor, who will never again willingly give you data about his investment plan. You also will have a very unhappy loan officer, who will try to guarantee that you never again get an appraisal order from his company.

So, what is so difficult about this Form 216? For one thing, is asks for items like projected vacancy and the "customary expenses that a professional management company would charge to manage the property". Those two items alone can sink the NOI. The second page, though, is the real killer. On page 2 is the Replacement Reserve Schedule. Many investors will ask, "What is THAT?". THAT is what causes many of the investors in my market to lose their investment.

Even assuming that the rental is unfurnished, and the tenant must supply stove and refrigerator, items like dishwashers, furnaces, central air units, and water heaters need periodic replacement. It is not unusual to see an appraiser indicate on a form that a home has a Remaining Economic Life of 40-50 years (hey - would you make a 30 year loan if the REL was 30 years or less?). Let us suppose you are talking about a duplex, with two of each. Assuming the equipment is brand spanking new the day of the appraisal, in a 50 year period the investor will need to buy and install two furnaces, four central air units, eight water heaters, and eight dishwashers. That is based on average life expectancies for those items. He will also need to re-roof the building at least once, and, based on my experience and the experiences related to me by local investors, will need to totally replace the flooring -- carpet and vinyl -- about nine times. Assuming he sells it at the end of the fifty year period, on that schedule, all of the replacement items would be needing to be replaced at that point, and he would be selling a building in need of updating.

The Replacement Reserve Schedule provides an amount that should be set aside each month to have money in reserve to complete the repairs that will be required over time. A wise lender would require an escrow account for those items, but using that criterion, I have never done business with a wise lender. Those figures are totaled and transferred to page 1 and added to all the other expenses to give the Total Operating Expenses. The numbers are then reconciled: the Total Operating Expenses are subtracted from the Effective Gross Income and divided by 12 to give a Monthly Operating Income. The Monthly Operating Income is then reduced by the Monthly Housing Expense (P & I on the mortgage, hazard insurance, property taxes, MIP, etc) to give a Net Cash Flow. If this form were completed honestly and properly, the percentage of loans made on residential rental real estate would plummet. In most cases, the only way to generate a positive cash flow is to reduce the amount that is to be borrowed, since that is usually the largest single monthly expense. This calls for a bigger down payment, and would spell the end of cash-out refinancing of most rental properties.

Next time we will look into the case of the honest investor who wants to actually get an income from real estate rental property, and expects to hold the property for a lengthy period of time.

Cornering a Market

2008-04-01T11:36:00.001-04:00

As a review appraiser, one of the biggest problems with appraisals of residential investment properties -- rental homes -- has been the lack of careful attention by the appraiser to the actual return on investment anticipated by the investor. If the investor were putting money into a stock, he would surely be interested in whether that stock was likely to earn money and pay dividends. The investor would look at the money in hand, examine the alternate choices (i.e., bank interest, other stocks, bonds, state lottery, etc) and see what rate of return could be expected. That caution has been lacking in recent decades, as investors look at stocks from the standpoint of their possible resale value (buy low, sell high) rather than their income generation potential (long term gain through dividends).

When it is realized that the entire rationale for the existence of the stock market is the generation of capital for start-up and expansion of a business enterprise, the prostitution of the market by those who use the change in stock price as their sole reason for participation should give shareholders and directors reason to very seriously consider the potential negative consequences of going public with the stock, for, at that point, the financial stability of the company becomes hostage to the perceived profit-taking ability by the market at large.

The real estate industry has been taken over by this same mind-set. It was the anticipation of a quick profit by the property "flippers" that drove the real estate bubble, much the same way that stock "flippers" have driven other "bubbles" in financial markets. The "flippers" made their money by buying low and selling high. Just as the stock market attracted non-traditional investors, the real estate market attracted "flippers" across the spectrum. It was not unusual during the bubble years for Average Joe to buy a house, live in it for a year or so, then sell and buy another, making a small (sometimes large) profit and moving up in the world. Indeed, there is nothing wrong with that kind of approach to real estate. The problem arises when Other Peoples' Money (OPM) enters the equation.

If you have a few spare shekels of your own, what you do with them is your own business. You can engage in risky economic behavior because it is YOUR money. If you went to the local bank and said, "I would like a personal loan so I can buy some lottery tickets, and I will offer the tickets as collateral", any rational banker would either throw you out or die from laughter. (That is not to say that if you looked hard enough, you could find an irrational banker.)

The basic underpinning of the study of economics is an understanding of the relationship between supply and demand. That relationship is never perfect; it is always in flux. Today I demand eggs for breakfast, tomorrow I demand cereal. What I pay for breakfast today is determined by how many eggs there are to be had, and how many other people want eggs. If eggs are scarce, and many people want them today, I may have to pay the California Gold Rush price of $100 per egg today, and if everybody wants cereal tomorrow, the guy who wants to sell a dozen eggs tomorrow may not get $1 for the whole dozen. Supply and demand; the market works in cycles and despite the claims of experts, is unpredictable because it involves the perceived wants and needs of people, and every day brings a new itch to be scratched.

Therefore, if I go to the bank to borrow money for an investment, the banker wants to know what the value of that investment will be over the life of the loan. He wants to know if it will be a winner or a loser. If I want to invest in Pet Rocks, he wants to know if they produce dividend income, or if they have good resale potential. For that reason, few sane bankers will loan money for an investment in a day at the horse races, or even an investment in the stock market. Such gambles are heavily regulated.

When the public fell for the canard that residential real estate was a good investment, most people failed to recognize that what they were falling for was a property flipping scheme, and not a dividend stream investment. The mantra was that real estate never goes down in value, therefore it was "safe". It was thus felt that using OPM was legitimate for property "flipping", whether done by investors who had that as their sole objective, or by Average Joe, who just wanted to make a profit when he sold his house.

Enter government social engineering. Very few economists are elected to Congress. This is also a result of the Law of Supply and Demand, but I will leave the reader to figure out what I mean by that. Official government policy for several decades has tried to maximize home ownership, without regard to whether the new homeowners understood their responsibilities. This has resulted in lowering the equity barrier for entry into the real estate market, and the lowered requirements have been extended even to non-owner-occupied dwellings.

In previous years, it was believed that a loan to value ratio of 80% was a reasonable risk, and borrowers with less than 20% down were required to purchase mortgage insurance, either through a GSE (FHA insurance) or through private mortgage insurance (PMI) companies. The insurance was then used to guarantee the repayment to the lender in the event of default.

Because of the common belief that values were increasing (based partly on government indexes that measure the buying power of the dollar) the property "flipping" could continue as long as a higher resale price could be obtained by the investor. Little real attention was paid to the actual return earned on the investment. This was where the Operating Income Statement -- the Form 216 -- should have been of greater concern. It is also where the use of Gross Rent Multipliers (GRMs) lead to false impressions of value.

Enough for now, I have other things that must be done at the moment. The investment idea that I am toying with will be developed over the next few posts.

Sad Stories Abound

2008-03-27T19:20:00.005-04:00

I read today a story about a woman in Southern California who, in February, lost her $70,000 per year job, and less than two months later, is obtaining food for herself and her two children from a food bank because she did not qualify for Food Stamps. She was uncertain of her future, with a $2500/month interest only loan on her home. Comments to the news story were mostly sympathetic, but there were a number of people who could not see how someone making $70,000 a year could go broke so quickly. It seems that a huge number of Americans never make anywhere near that kind of money and have learned to live on less than half that amount.

So here's my sad story. Yesterday I went out on an appraisal assignment for a refinance. The house was an older dwelling, straddling two parcels. The front parcel was zoned commercial, and the rear parcel residential. The property does not conform to zoning. The home had a new roof, and the windows had been replaced a while ago with insulated glass units, and the basement had just been waterproofed. It still had a septic sewage system, even though the city sewer line was stubbed out to the property at the street.

The gentleman wanted to talk, and I let him. He showed me the front property pin, which was under his driveway; part of the drive was on the neighbor's property. He showed me the septic tank lids, which were right on the property line. Worse yet, the septic tank had a spruce tree growing on top of it, and there was no way of telling which way the effluent drained, if it drained at all. He showed me the basement, with its new, professionally done waterproofing, and also the missing basement steps (we had to climb down a step ladder) that the contractor had removed and not replaced, and the partially removed partition wall that he said the contractor had not completely removed because he was afraid the floor above would sag. He showed me the crumbling and collapsing plaster on an upstairs ceiling, where water had been leaking in for some time before he had the roof reshingled.

Not quite a slam-dunk as a valuation problem.

He told me his story. He once had a good paying job, years ago, but the company closed up shop in the northern part of the state. It seems that the union was based in Cleveland, and insisted on Cuyahoga County wages for workers in Summit County, where things just were not as expensive as they were further north. For years he had worked at odd jobs, and was now drawing his Social Security. His wife was bringing in most of the current income, working as a waitress, and she seemed very displeased with life. She shut herself in the bathroom, and it was with great difficulty that he was able to persuade her to come out and allow me to examine that room. With poverty there is often familial distress.

It seems that easy money was part of the problem. He had refinanced the house in 2004, and if it was an 80% refinance, then the appraisal at that time was probably close to the actual market value. But, in 2005, he needed to fix the roof, and he took out a home equity loan. That brought him close to 100% financing. He was also paying a very high interest rate for his car, and last August, refinanced his home equity loan to roll the balance that he owed on the car into the second mortgage. Bad move. The HELOC is adjustable, and he is upside-down on his mortgage. He was trying to refinance to roll it all into one lower interest fixed rate loan, but based on the fact that prices in his neighborhood have been falling at about 1%/month since 2006, and the needed repairs, I think he is stuck right where he is.

He told me where he needed to have the value come in (and I doubt that he realized he was engaging in a criminal act by doing so); it would have been far better from the standpoint of making the loan if the appraiser who had appraised it last August had been there yesterday instead of me. Had that appraiser accurately reported in August the problems with the site alone, I doubt the loan would have been made. Then again, it was a different bank, and we are in a different economic world than we were in just a few months ago. I have a feeling that my opinion of value is going to contribute to greater marital discord.

I wish I could help, but I think the solution is to be found only by squeezing through the tunnel. How did we, as a nation, get in such a fix? It may be simple human insecurity. We are herd animals, afraid of judgment and always seeking peer approval. People live beyond their means because they need to put up a public front. Just like the people who will speed up on the highway because somebody is tailgating them, rather than sticking to their convictions about obeying the law, we somehow rationalize that it is OK to engage in risky economic activity because "everyone else is doing it". We think that safety lies in numbers, and delude ourselves about the virtues of democracy. It is not a virtue to collectively go broke.

A Simple Misunderstanding

2008-03-20T00:27:00.001-04:00

That friendly couple in Washington DC, Freddie Mac and Fannie Mae, have become household words lately. The way people talk, you would think they are part of the Gummint. That is because they have the word "Federal" in their names, just like "Federal" Reserve.

Freddie and Fannie, though, like the Fed, are NOT part of the Gummint. They are GSEs -- Government Sponsored Enterprises -- that are private corporations operating under the regulation of the Office of Federal Housing Enterprise Oversight (OFHEO). OFHEO, you might want to know, is the organization that publishes phony statistics on how well the nation's real estate industry is doing.

Anyway, the game is this. Sharkey the Lender loans Average Joe the money to buy or refinance his house. Joe gives Sharkey a Mortgage Deed as collateral. Sharkey sells the Mortgage Deed to Fannie or Freddie, who then package it with other Mortgage Deeds in a bundle -- a mortgage backed security -- and sell shares of it to investors.

OFHEO has required that Fannie and Freddie maintain a cash reserve, of roughly $82 billion between the two, because sometimes people stop paying on their loan and the house has to be foreclosed and sold to make sure the investors get their money back. Most of the time, the price Freddie or Fannie get for the house is less than what is owed. Then they have to pony up the balance out of their cash reserve.

Things are not too good in the mortgage securities business right now because a lot of people are finding out that they can't make their payments, and Freddie and Fannie have had to make things right with the investors. In fact, things are so bad, that Fannie lost $2.1 billion and Freddie lost $3.1 billion in the last quarter of 2007.

Today it was announced (the rumor was circulating for a while, since there was pressure from both Congress and the President to make the move) that OFHEO will allow Freddie and Fannie to reduce their reserves by about 10%, allowing them to put themselves at risk for approximately $200 billion in additional home loans. The current $82 billion was there to guarantee about $2.7 trillion in loans. God help the American taxpayer if they have to pay out more than the $82 billion.

HEY!! WAIT A MINUTE!! Didn't Big Ben last week just say that the Fed was going to loan an additional $200 billion to the mortgage industry to keep it afloat, and they could use their shaky loans including Fannie and Freddie debt as collateral? Anybody still know how to use a calculator? Count on fingers and toes, even?

This follows another move by Congress, which allowed Fannie to begin loaning on higher priced housing; the limits were raised from $417,000 to $730,000, which meant that a 20% down buyer of a $912,500 house could now have the loan held and guaranteed by Fannie Mae instead of a private sub-prime securities bundler. Congress shamelessly did that to bail out its fat-cat contributors who were facing resets in their adjustable jumbo loans. They did it while mouthing platitudes about helping the poor.

Remember Econ 101. Investors expect to be paid more if they take bigger risks. If real estate prices are falling, and interest rates are falling, and Fannie and Freddie have obligations that are going to come due because of bad lending policies in the past, who will buy shares in Fannie and Freddie if the risk is seen to be increasing and the rate of return is going down?

As late as September of last year, Big Ben was saying that increasing the risk to Fannie and Freddie was not a good idea, and OFHEO was strongly resisting the idea of having them enlarge their portfolio. As late as last week, the chairman of Fannie said that any move to increase Fannie's capital could harm its shareholders, but today we see Fannie being told to do just that.

That the politicians are pandering to the fear in their constituencies by playing with the market is clear. That they have no concept of basic economic principles is also clear. That they control the nation's purse is downright diarrhea-causing.

Some folks point to the great accomplishments of FDR in taming the Great Depression by interfering in the market. What they fail to understand is that the Great Depression was not cured by the New Deal. The Great Depression officially ended on September 1, 1939, after which time America's factories and farms went back into full production.

There is only one solution to the economic mess that America finds itself in. That solution is the complete restructuring of the tax system; the removal of all taxes on production and replacement with a national consumption tax. In a sense, it would mean economic war with the rest of the world, since they would either have to play along, or see their goods priced out of reach of Americans.

The current financial debacle was not caused by deficiencies in the marketplace but by the marketplace reacting in a healthy manner to the situation it found itself in. We will not kill the cancer by handcuffing the doctors. We must excise the beast that actually caused the disease.

Let's Hope She Still Has Her Voice

2008-03-19T01:03:00.003-04:00

I am glad I am not Ben Bernanke. Or George W. Bush. Or the head of the OTC, Fannie, Freddie, or Ginnie, or the Secretary of the Treasury. Or a CEO of any of the major lenders.

One reason is that I do not at all understand the machinations occurring in the financial markets right now. I do understand a few basic themes :

when supply is low and demand is high, prices go up

when supply is high and demand is low, prices go down

when people cannot afford to pay their debts, they default

when risk is high, investors look for high yields

when a man is broke and his credit is bad, he goes without

I also see the following things in the marketplace :

incomes have not kept pace with expenses for the majority of Americans

residential real estate lending provided much of the means for consumption in the past decade

there are far more houses in the market than there are buyers who can afford them

the loans that were made in 2005-2006 are at their peak for their first reset

For a decade I have been warning that the use of Home Equity Lines of Credit are not only dangerous, but have the effect of robbing the Average Joe's piggy bank. Most Joes have no idea that when they borrow against their home, they sell an interest to the lender. They do not stop to consider that when Sharkey loans them the money, he expects to make a profit. Therefore, the interest he takes in the home is ALWAYS greater than the amount of money lent. In good times, this fact is difficult to visualize. Joe rarely thinks about his home as a savings account; he is often told that it is an investment. Nothing could be farther from the truth.

An investment is a vehicle for providing a return on capital. An investment that does not keep pace with inflation is a bad deal. A home is a place to live. No matter where Joe wants to live, he must pay rent. If the price of houses goes up, the landlord will raise the rent. If Joe buys the house, and sells an interest to Sharkey at a fixed rate, he has purchased a form of rent control. Then, if the price of houses goes up, Joe's monthly rent stays the same, and the equity he builds in the house becomes a hedge against future rent inflation. The hedge is usually not very high, because while land does not suffer from obsolescence, the improvements (der hut?) will depreciate (translation : deteriorate) and will need repairs from time to time. Joe will normally pay for those repairs out of his pocket.

Over time -- the life of the improvement or the life of the owner, whichever comes to an end first -- it is almost certain that the cost of maintaining and repairing the improvement will, with any inflation, equal the total equity Joe has in his home. New roofing, siding, windows, furnaces, water heaters, paint, carpeting, cabinets, etc. will have to be purchased and installed at least once (and maybe more -- figure three times for a water heater) during the typical 30 year amortization period. Joe will also need to address the cost of taxes and insurance. If Joe does not need to touch his equity in that time period, he will indeed have a lump-sum amount available if he would sell his home. But --

What if Joe borrows against that equity? For one thing, it is almost certain that the interest rate charged for a second mortgage or a line of credit will be higher than the rate on the first mortgage. If it is not, then Joe has been sleeping at the wheel and should have already refinanced his principal balance at a lower fixed rate. By borrowing against his equity, Joe has just raised his own rent. If he uses the money to repair his home, he might have made a wise move, especially if the cost could not be paid out of pocket and the repair was essential for maintaining the structure or systems and preventing further deterioration. Use of the equity for any other purpose is foolish unless Joe is fully willing to surrender to Sharkey (who is really his landlord, you see) control over the monthly rent.

What if Joe does not borrow against the equity, but sells the house he now owns free and clear and buys another? If he pays the same amount for his new home that he got for his old home, he will have actually gotten a raw deal unless his intent was only to move to a new location. If he moved up in the world and bought a more expensive home, he will borrow again; the cost of fancy digs is higher rent. A home is not an investment; at best it is a forced savings account and rent control device.

Alas, Joe has been suckered by Sharkey into a cash-out refinancing or a HELOC. Worse yet, Sharkey has convinced Joe that since house prices are rising, the value of Joe's house must be increasing, and therefore Joe can borrow MORE than the difference between what he originally paid and what he still owes. And, even worse, Sharkey has talked Joe into an adjustable rate loan -- a loan which Joe is qualified to take on at its lowest increment, but which he has no hope of keeping up the payments on after it resets a time or two.

By now we see that Average Joe has no idea what he is doing. (But if you ask him, he will tell you how good a deal he got from Sharkey. At least until the first reset of his loan.) Joe sells Sharkey the rest of his interest in his house, and spends the money on a new pickup and a bassboat and a cute car for the wife; they also go to Disney World and watch the Pirates of the Caribbean without catching the joke underneath. And, guess what? His neighbors, Harry and Sam and Bebop (have to be multi-cultural in this neighborhood, you know) do exactly the same thing. Twenty-four months later they each get a letter from Sharkey. Sharkey is raising their rent by 2% of the total amount they each owe.

Joe and Harry and Sam and Bebop each get together with their wives to discuss this new development. Harry's wife, Zelda Sue, tells him he was stupid, walks out, gets a divorce, and the house has to be sold for the settlement. Joe's wife and Bebop's wife agree with them that they had better sell their houses; the signs go up the next day. Sam has a heart attack over the whole matter and his widow is forced to sell to settle the estate. Suddenly, there are four houses for sale on Joe's block.

Think : when supply is high and demand is low, prices go down. Three months later, all four houses are still on the market, and the four neighbors (OK, so they do miss old Sam) are now busy trying to undercut each other with the prices. Sam's widow gets desperate, and sells the house for the loan balance just to get out from under it.

Think : when people cannot afford to pay their debts, they default. Harry gets fed up with the situation and disappears; he does send Joe a postcard from Ecuador where he has a new job with a pharmaceutical company.

Think : when risk is high, investors look for high yields. Bebop finally gets a buyer, but has to do a short sale. His credit is no good, but he does manage to get another house in a poorer section of town, buying it on Land Contract at 15% interest (but look at the bright side -- it's a fixed rate!).

Think : when a man is broke and his credit is bad, he goes without. Joe? Joe is evicted by the foreclosure order. He and his wife are living in the pickup, and they aren't planning any vacations for a while.

Wait a minute, you say. You forgot the first one : when supply is low and demand is high, prices go up. No, I didn't forget the first one. Sharkey convinced Joe that prices were going up. Sharkey had an appraiser who would hit his numbers. Sharkey quoted government figures that painted a rosy economic picture. Sharkey lied; he didn't tell Joe that the neighborhood was overbuilt and that there were lots of empty houses to go around.

So here is a snapshot of the economy. For a decade it was buoyed by consumer spending while American industrial production fell and imports rose. For a decade the Sharkeys convinced people that they could borrow their way to prosperity. For a decade the economy was based on mortgage fraud and government economic deceit. For a decade, the money supply was artificially inflated by low interest rates, and foreign investors were suckered into buying overvalued mortgage backed securities.

All good things (and all bad things) come to an end. When the money supply could no longer be stretched because the foreign balance of payments was causing imported goods to rise in cost, interest rates were raised. At the same time, the adjustable rate mortgages began to reset, and the borrowers could no longer afford their rent. As they began to default in large numbers, sales prices on existing homes began to drop in a competitive spiral. As the money supply tightened, new constructions became harder to sell, their prices also declined, and defaults among the buyers of more recent new homes rose, again dragging prices downward.

When it became apparent that the margin of profit on the adjustable rate mortgages was declining, the investors began to look for more profitable venues, and as they sold their securities, first the sub-prime lenders, and then the mainstream lenders began to suffer from a lack of cash to continue lending, even to good credit risks.

We are now in the second full year of this debacle. The peak number of first-time resets is now occurring. That means that the peak number of foreclosures from default will begin in about six months. Through this entire time period, some real estate sales have been occurring. As I examine the lending data, it is appalling to see the high percentage of 100% finances; a huge number of homes in the past two years, in the face of the subprime melt-down, have been financed with 80% conventional fixed first mortgages and 20% adjustable second mortgages to make the down payment. I can easily see strong foreclosure activity occurring as far along as three years from now, short of draconian measures on the order of nationalization of the lending industry and restructuring of the loans.

America has been cash poor for some time now. Foreign investors, lured by the seeming stability of the mortgage backed securities, provided a significant portion of the cash that fueled residential real estate finance and consumer spending, all the while piling up an imbalance in foreign debt. The recent forced buyout of Bear Stearns at the command of the Federal Reserve did little but lower foreign confidence in the securities. There are other brokerages just as upside down in their portfolios; an investor needs to ask whether the risk of losing equity in a fire sale such as the Bear sale is worth taking on.

Remember that it was the oversupply of money created by the Fed's low interest rate policy that drove the consumer spending and foreign payment imbalance. The willingness of the Fed to lend money to the troubled lenders by allowing them to borrow against shaky securities cannot make our foreign trading partners see the dollar as a currency worth holding. The lowering of the discount rate will make taking on additional debt backed by US assets even less palatable. It could even be that lowing the discount rate could make mortgage lending more difficult since there would be fewer foreign investors willing to risk such a low-paying venture. And what will Big Ben do if lowering the discount rate does not cure the problem? Lower it to 0%? Offer to PAY investors to take Fed money?

We are living in interesting times. As I said above I do not understand what is happening in the financial markets. I only know one little saying that might fit the situation.

"it ain't over until the Fat Lady sings."

Cannibals on the Street?

2008-03-17T13:20:00.002-04:00

Sometimes the things that are under the surface take a long time to finish growing and finally come up to show off their real faces. The American people are about to get a peek at what they have been growing under the rug for the past century or so.

The first little fungus to erupt is the Federal Reserve Banking System. Most Americans are under the impression that the Federal Reserve is a part of the government -- an extension, if you will, of the Treasury Department. They do not realize that it is a private bank for bankers, given special privileges by the government. It has a monopoly position on the issuance of currency, and can "create" money at its whim.

Part of the lure of the Federal Reserve System has been the ability of the Fed to loan money to its member banks, and to set the interest rate privately. Thus, while the politicians pride themselves in having maintained a "free market" in our economy, the roots of the market have been captivated by the governors of the Federal Reserve. To control the level of public confidence in the currency printed by the Fed (you know, those green things in your wallet that say "Federal Reserve Note"?), interest rates have been manipulated outside the market.

Thus, to slow inflation, the Fed has traditionally raised interest rates to its member banks, and since they are bound to the Fed (they own shares), they will not borrow money in the world market at interest rates that actually reflect the value (buying power) of the little green certificates. To spur the economy, the Fed would lower interest rates, making it easier for consumers to borrow -- the member banks set the rates for mortgage and credit card loans -- regardless what the open market would say about the money supply.

It was all an elaborate shell game, and worked quite well, as long as people continued to believe in the Tooth Fairy, and ignored the impact of social engineering on spending.

The Great Depression provided the first opportunity for the Fed to exercise its muscle. Under the policies of FDR, the national banking system coalesced around the idea that the government would guarantee the safety of private depositors; the FDIC was born. Further, the national currency was divorced from the "gold standard"; gold became an illegal substance for private citizens, and the dollar bill began to bear the words "Silver Certificate". Fort Knox, however, remained the repository of the nation's wealth, as the gold stored there encouraged the world citizen to have confidence that if they accepted payment in US dollars, at least their government could in some way collect in gold what was owed them. The rest of the world never left the "gold standard", even if Americans believed the fairy tale.

As a result of a World War from which the US emerged victorious with its industrial capacity intact, the fiction was sustainable. Americans grew to expect the prosperity that came from being the only (for a while) provider of industrial goods for the world market. In the decade following World War 2, as the German and Japanese economies began to recover, there was little competitive pressure on American industry. The German industrial heartland had been given to the Soviets to rule, and under their socialist regime, there was no danger of a resurgence to compete with the US. Western Germany was forced to rebuild what little industrial capacity it had, and develop new industries. Japan had never had a consumer-oriented industrial base -- most of its industrial production had been at the command of its imperialists and warlords -- and as it went through its new metamorphosis, the standard joke in the US was "Made in Japan".

In the second decade following World War 2, the emerging manufacturies of Japan and Germany began to address their weaknesses in the American market. Japan attacked quality control, and Germany worked at luxury market share. The Germans had a slight advantage, since they had been known for high-quality goods prior to their defeat and division, but the Japanese quietly mimicked the best German designs and undersold their American competitors, since their labor costs were substantially less. The American worker had enjoyed a monopolistic advantage for almost a generation, and demanded from the capitalist bosses ever larger wages and benefits. Had the increase in costs been re-spent on domestic production, the "trickle-down" might have been more uniform, but with American markets opening to the much less expensive foreign products, the increased American wages and benefits tended to trickle down to foreign economies.

Toward the end of the 1960's, America became preoccupied with long-overdue social justice issues. Not only was racial equality pushed to the front of the domestic political agenda, but the industrial heartland felt the guilt of rural poverty -- the hardscrabble farmers and miners who had provided the raw materials for the industrial growth had been left behind in the race to national prosperity. In addition, the plight of the urban poor, largely at that time Black Americans who had suffered discrimination in so many ways, was exposed to the national conscience.

Had the equality sought by Martin Luther King, Jr. sufficed, the Civil Rights Movement would have triumphed, since there was a large and relatively prosperous Black middle class that had grown up within that segregated society. Guilt, however. is a powerful motivator, and LBJ, with his Great Society, was able to sell to Middle America the socialism that would create central government entitlement programs which would ultimately dwarf all other government costs. That would create a permanent underclass, with no respect to race, color, or national origin, depending on government handouts and market manipulation.

Nixon restored to the American citizen the right to own gold, but the "Silver Certificate" had gone out of print in 1963, under JFK, and redemption of the certificates for silver ended in 1968 under LBJ. Inflation had caused the price of silver to exceed the official backing price of the dollar because the total outflows of dollars to other countries, partly due to trade, and partly due to foreign aid, had exceeded the inflows. In short, America was buying more foreign made goods than it was selling back to foreign markets. Nixon recognized the problem, saw the rift between China and the Soviet Union as a tool, and opened China to US trade as a means of correcting the imbalance.

The rise of OPEC, however, caught the American economy off-guard. Never before had a cartel been large enough to impact the cost of American living overall. With the sudden rise in energy costs, inflation jumped, and the political answer seemed to lie in wage and price controls. The Fed raised interest rates to try to control inflation, and the economy staggered. By 1980, under Carter, the prime rate had been raised to over 21%. The Savings and Loan portion of the banking industry suffered severely, and under Carter the caps that had hindered S&L mortgage lending were lifted.

With the Reagan presidency, the economy recovered through the stimulation that was provided investment via the Reagan tax cuts. However, the S&Ls were also allowed to begin borrowing from the Federal Reserve to augment their deposit income. Because they were not under the same kind of regulatory oversight as the Federally chartered banks, risky and imprudent lending brought about the S&L collapse. It was at this time, also, that the S&Ls were allowed to sell their mortgages and have them transformed into securities.

Under GHW Bush, FIRREA was passed, and Fannie Mae and Freddie Mac were encouraged to increase the availability of low-cost mortgages to lower income families. Because the S&Ls had declined in number, there were competitive openings for other private lenders to get involved. Mortgage brokerage became a very viable alternative to traditional mortgage lending, since a pool of mortgages could be combined and sold as securities by GNMA. During most of the Clinton presidency, interest rates remained relatively high -- above 8% -- as the Fed worked to keep inflation down under the growing ability of private mortgage companies to "create" money.

After September 11, 2001, the US economy stumbled, and the Fed was called upon to reduce interest rates in order to raise confidence in the economy. The lowered interest rates made it attractive to refinance existing mortgages, and, in the refinancing, to extend the debt. This worked to further the social engineering aspect; a primary focus of "compassionate conservatism" was affordable housing, and the boast of increased homeownership was heard. Unfortunately, the effects of supply and demand were ignored; growth was fueled by new construction and in many areas of the country, the supply of housing was greater than the number of households to occupy it.

Also, in order to enlarge the pool of new homeowners, requirements for down payments were reduced; whereas normal lending practice in more conservative times called for a 10%-20% down payment, with mortgage insurance required to underwrite any down payment of less than 20% (FHA mortgages are mortgages with the lower down payment insured by HUD). Private mortgage insurers became very profitable businesses.

It became apparent to some participants in the market that the cost of PMI was a hindrance to the mortgage boom. There appeared to be a rise in mean sales prices (a factor which was probably a result of the higher prices of new homes rather than an actual increase in the value of the existing stock, since the supply was outpacing the demand), and an unregulated cottage industry arose in which mortgage brokers encouraged refinancing to eliminate the PMI premium on the mortgages which had little homeowner equity behind them.

Pressure was applied to appraisers to "hit the number" needed to make the loan. In many cases, this was as little as a 5%-10% increase in perceived value, which could be accomplished by skillfully manipulating comparable sales data. It was further assisted by published government and trade association statistics which made sweeping generalizations as to the rate of increase in "value". Appraisers who failed to go along with the program found their business volume declining. Hordes of new appraisers were trained, most often by the value-inflating appraisers who were swamped with business, and speed and low cost, rather than quality of analysis, became the hallmark of a successful appraisal practice. Such qualities were demanded by the clients. It was even argued by some appraisers that their upper end value opinions were justifiable, since the increases sought were so small, as a percentage, and, after all, government-supplied statistics backed their opinions.

The mortgages generated by such practices, sold as securities on the secondary mortgage market by such players as Bear Stearns, reached their peak volume in 2005. At that point, the Fed determined that inflation was beginning to increase, and minor moves upward were made in the Federal discount rate. This had the effect of slowing, almost imperceptibly, the refinance boom. The larger effect was on the lending products that had been pushed to the marginal borrowers. Many of those loans had been made as adjustable-rate mortgages, with low or no interest teaser periods. Some had been made as interest-only loans, also with adjustable rate structures.

These products had been sold to investors with the understanding that by making the loan now, at below-market rates, the returns later, after the resets, would cause the loans to be profitable in the long run. Because they were securities, traded on the world market, they were purchased by investors world-wide. Banks in Europe, in particular, found these securities attractive.

European investors, stymied by slow growth in their industrial sectors because they were also facing competition from emerging Third World producers, turned to American mortgage-backed securities rather than investing their money in the socialistically restrictive economies of their own countries. It would prove to be their undoing.

As the resets began to occur in 2005, the borrowers for those mortgages were faced with either accepting the higher payment amounts, refinancing at current rates (which had also increased), or defaulting. A small percentage began defaulting. As 2006 wore on, the volume of new construction sales declined, since it became harder to finance those homes under the liberal rates that had been available before. The decline in new construction sales, which had driven the upward trend of the market, caused the overall mean sales prices to begin to decline. As the mean sales prices began to decline in most markets, it became just a bit harder to obtain a loan at what was viewed as the upper end of the range; resale prices then began to decline a bit as existing stocks of housing on the market were enlarged. Because the comparable sales no longer existed to justify lending at the levels that previously existed, borrowers whose mortgages were resetting found it harder to refinance, even at the higher rates. The number of defaults began to climb precipitously.

By mid-2007 serious questions were being asked about the quality of collateral backing some of the securities handled by Bear Stearns and other financial houses. The ratings of such companies were reduced, and investors began to sell off their securities. In a climate of doubt over their value (and it should be remembered that value is a perception, not a fact), the values naturally declined. With a decline in the confidence in the backing of those securities, the entire credit marketplace underwent a transition. Creditors -- the major banks behind both mortgages and credit cards -- tightened their criteria and actually became punitive toward otherwise good credit risks (all the while continuing to try to lure borrowers with introductory "0%" interest rates). Industrial borrowers found it more difficult to borrow to meet ordinary operations, driving up their costs and reducing their profitability. The stock market has reacted accordingly, seeking investments that are either seen as "safer" or "more profitable".

Behind the scenes, the Federal Reserve has been manipulating the rates. We now see a situation in which a financial company, Bear Stearns, has been purchased by a Federal Reserve member bank, JP Morgan Chase, at a fraction of its book value, under direct duress from the Federal Reserve (a threat to the Bear Stearns management do the deal NOW, at an unrealistically low price, because the backing for it may not exist later). This smacks of cannibalism, one bank eating another, to the benefit of the Federal Reserve governors. The spring rains have brought the mushroom out in the open.

It is easy to blame the Federal Reserve. That bank, however, is doing what comes naturally. Big loan sharks eat little loan sharks. For the ordinary investor, the question now is, "Whenever the DOW rises, is that a fake come-on by the big players to encourage the less wary to buy their worthless assets? Are the big boys simply seeding the marketplace and pulling back once the less wary step in and buy their overpriced holdings?" If you are a little shark, be careful that your eyes are not bigger than your stomach.

Project Wrapup

2008-03-12T23:11:00.004-04:00

Just out of curiosity (bad character trait, that) I decided to take a look at the median prices for brokered sales in the Kenmore (North) and Summit Lake markets, then compare those figures with the data drawn from the foreclosure/REO sales studied and the public records data available in the MLS from Realist.com.

Several things need to be kept in mind. The public record data in Realist.com has some quirks. Not all sales are to be found there, since the search was done by using the 510 Land Use Code on the Auditor's Card, and that information is not entirely accurate. It is not unusual to find single family homes mis-filed under LUCs 520 and 530, and to also find 2- and 3-family homes showing up under LUC 510. This is one of those little caveats to keep in the back of the noodle when thinking about Automated Valuation Models (AVMs) that have become favorite tools of the banks and which are used by the mass appraisal folks (gummint fellers, fer the most part). I will say it once more : I think a lot of the statistics blown our way by the government are economically incorrect even though they may be politically correct.

Also, the public records data in Realist.com, as reported for the end of a calendar year, will only show the final transfer of a parcel. If it was foreclosed and sold at Sheriff Sale, then sold by the bank as an REO, and then "flipped" by the REO buyer, all in the same year, only the last sale will show. This has a tendency to skew the statistics in Realist.com upward. Theoretically, it should all even out in the end, but it never seems to work that way.

Finally, the MLS sales include only brokered transactions by MLS members -- Realtors. Sales brokered by members of the Realtist organization do not show up there unless the Realtist broker is also a Realtor (most are).

OK. Here comes the data table.

Appraisal: Auditor Appraisal: Sheriff Realist.com SP REO SP MLS Non-REO SP
Kenmore (N) Mean $65,031.78 $67,931.51 $64,581.00 $29,929.19 $71,789.00
Kenmore (N) Median $61,860.00 $69,000.00 $66,454.00 $30,000.00 $71,000.00
Summit Lake Mean $39,802.00 $44,700.00 $46,074.00 $11,218.03 $21,125.00
Summit Lake Median $38,720.00 $48,000.00 $43,553.00 $7,587.50 $22,750.00

Cute, isn't it? I see some very interesting correlations that could lead to some questions. However, I'm not going to beat this horse any more. The entire spreadsheet is available for download from my website, www.hrubikappraisal.com/, as
February 2008 Blog Project Data
Excel Spreadsheet, 60kB.

WARNING!! Correlation Does Not Prove Causation!!

2008-02-28T11:36:00.005-05:00

Just thought I'd throw that out, since there could be some misconceptions about the data I am presenting and the correlations that appear.

This warning is brought to you courtesy of the on-going Global Warming controversy. Like most controversies involving science, that controversy exists because people forget that correlation does not prove cause. It has now occasioned a lawsuit by an Eskimo village in Alaska, which is suing Exxon for causing the sea level to rise and wash away part of the village.

The danger here is similar to that posed by the Dow Corning silicone implant lawsuit. Lawyers realize that in civil suits, all they need to do is convince the jury that the defendant needs to be punished. The typical jurist has no idea that correlation and causation are two completely different things. American jurisprudence thrives on circumstantial evidence, which is another way of saying that it is based in superstition.

Correlation is created by relationships in statistical data giving a probability that something could or could not occur, and is useless without a statement setting out the level at which the correlation would be considered significant. That statement is based on a purely subjective decision.

Causation is shown when witnesses can prove that a particular action resulted in a particular effect. It is a statement of fact, and has no subjective component.

Unfortunately, the American legal system is intoxicated with the concept of correlation implying causation. From a purely scientific standpoint, circumstantial evidence NEVER proves innocence or guilt beyond the level of confidence predetermined by the trier. Defense in civil suits is primarily a matter of proving one's innocence, with the same kind of intelligence and reasoning as pervaded the Salem Witchcraft Trials.

The Dow case resulted in a judgment against Dow Corning that was so large the company filed for bankruptcy. The lawyers got their fees, the class action members got their piddly awards, and lots of people lost their jobs, because the legal system allows pseudoscience in the courtroom. The fact that it was later shown that the Dow product was not the cause of the problems was simply too bad for common sense and justice.

My data does not imply causation of any kind.

Project Results

2008-02-26T14:56:00.004-05:00

The hypothesis : there is a correlation between either the Auditor's appraised value (which is not market value) and the foreclosure appraisal value (which is supposed to be at market value), or between the outstanding loan balance and the foreclosure appraisal value.

The procedure : both the Kenmore (North) and Summit Lake neighborhoods were searched via a polygon map search for REO sales which took place in 2007. The sales were cross-checked with the Summit County Common Pleas Court Records and the Summit Count Sheriff's Sales data. The data was entered in an Excel spreadsheet, and included the names of the appraisers used by the Sheriff, and also included pre- and post REO sales data where it was deemed pertinent. The ratios of appraisal:auditor's appraisal for the prior tax year, the appraisal:judgment amount, and the appraisal:REO sales price were calculated, along with the range of ratios, the mean, median, and mode values for the ratios, and one standard deviation from the mean of the ratios.

Unfortunately, before the project began, no confidence level was chosen for rejecting the null hypotheses, namely, that no correlation would be found. The following items must be considered :
standard practice allows for a variation of +/- 5% between the value opinions provided by two or more individual appraisers before serious questions about the methodolgy or data are raised

no standard ratio exists for determining the amount of a loan to be made relative to the appraised value (underwriting guidelines which allow 100% financing have made such determinations impossible)

the REO sales price does not meet the definition of market value as set forth in 12 CFR Part 34, but because all of the REO sales had open market exposure in the MLS, there is some reason to treat those sales as though they approximate the market value for REO sales as a class
With these things in mind, the percentage data was tabulated as follows :

Appraisal: Auditor Appraisal: Judgment Appraisal: REO SP
Minimum Ratio 56.26 31.36 114.62
Maximum Ratio 165.12 247.81 1500.00
Mean Ratio 107.56 101.96 366.34
Median Ratio 104.12 98.63 276.00
Standard Deviation 15.92 28.29 238.74
Conclusion : The range of the ratios was quite wide, and only the median ratio of the appraisal:judgment amount was below 100%. There does, however, seem to be a very close correlation in the median ratio of the appraisal to the judgment amount (within 2% either direction). It would thus be interesting to know if the appraisers had knowledge of the judgment amount prior to providing their analysis.

The fact that the mean and median ratios for the appraisal to the eventual REO sales price are 366% and 276% respectively is an area of concern. It can be accepted that the appraised value prior to the foreclosure would be higher than the REO sales price, since there would be both effects present regarding the condition of the foreclosed home, and the fact that the REO sale would take place under conditions of duress.

Because it was possible to separate REO sales from non-REO sales in the analysis, there was some other very interesting stuff that came out of this exercise. More Later.

Progress Report -- of sorts

2008-02-22T21:41:00.004-05:00

My little project is not so little. I have finally gone through all the sales and located the case numbers and court dockets for them. This allowed me to identify the Sheriff's appraisers for each property, the appraised value used to set the minimum bid (2/3) at the Sheriff Sale, and the sale date (which is different from the date the sale was recorded).

The Appraisal Subcommittee National Registry was used to check whether the appraisers used by the Sheriff were licensed. The appraisers used were Jon Poda (Licensed Residential), William Wilcox, Robert Campbell, James Yocum, David Waddell (Certified Residential), John Cunningham, Tom Robinson, Al Wilkinson, David Troutman, James Buie, Ed Abdulla, and Phil Leonard.

The "Rules of Practice and Procedure of the Court of Common Pleas, General Division of Summit County, Ohio" were consulted; Section 11, "Foreclosures", deals with appraisers' fees. There is no specification in the Common Pleas Court Rules as to form of the appraisal report. ORC 2329.17 and 2329.18 specify that the appraisal must be done by three disinterested freeholders of the county, and that their report must be deposited with the Clerk of Courts; it does not specify any form for the appraisal to follow.

Here is where it gets interesting. Two of the appraisers are licensed by the state. Because they are licensed, the USPAP holds them to a higher standard than the other, unlicensed appraisers. ORC 4763.17 (A) states that "A certificate holder, registrant, and licensee also shall comply with the uniform standards of professional appraisal practice, as adopted by the appraisal standards board of the appraisal foundation and such other standards adopted by the real estate appraiser board, to the extent that those standards do not conflict with applicable federal standards in connection with a particular federally related transaction." Standards Rule 2-3 requires a signed certification for each written property appraisal report. The reports deposited with the Clerk of Courts do not contain the required certification.

While the Jurisdictional Exception Rule can and must be cited in the certification to maintain compliance with the Ethics Rule, there is no court rule, i.e., jurisdictional exception, for violating the requirement for a certification to be attached to every report submitted by one of the licensed appraisers.

I have no idea what an attorney might do with that kind of information, if his client felt he had gotten a raw deal in a foreclosure action. I wonder what would happen if such an attorney would simply subpoena their workfiles?

'nuther thing. After all the weeding, I have 103 sales; 73 in Kenmore (North) and 30 in Summit Lake. Twelve of the Kenmore REO sales have already been "flipped". Ten of the Summit Lake sales have been "flipped", at least one of them for more than ten times the REO sale price. A number of "flip" sales have been identified where the real estate agents handling the listing have ended up owning the property; a "strawman" was used to buy the REO and then "flip" it to the agent. I'm not going to name names here. I think what I will do is make the whole spreadsheet available for download somewhere after I get done with it. The spreadsheet contains the dates and prices of the "flips", as well as the sellers' names. It is all public records stuff; nobody has bothered to compile and analyze the data until now.

and 'nuther thing more. I got curious about one of the Federal foreclosures I appraised last summer. The house was refinanced in 2005 with a $50,000 mortgage. I appraised the home for $19,000. The bank bought it at the foreclosure sale for $32,000. MLS shows it was then put on the market for $13,900 and came under contract in 6 days. Does that make sense?

The idea of packing up and going to Korea as a teacher of English as a second language is looking more attractive every day.

Oooof!

2008-02-14T20:33:00.003-05:00

Just a quicky update. Grabbed all the MLS REO sales I could locate for the Kenmore (North) and Summit Lake neighborhoods in Akron, for the 2007 calendar year. This is some interesting stuff.

75 of the 125 sales in Kenmore (North) were REOs (60%); 37 of the 43 sales (86%) in the Summit Lake neighborhood were REOs. Thus I have a sample size of 118 sales.

For some I will not be able to get the foreclosure sale price, or the foreclosure appraisal amount (unless I can find a way to access the data for the Federal Court sales). Still, it is the county sheriff sale information I am interested in, and I now have the names of all the defendants in the foreclosure cases for these properties.

I also have the seller names and sales prices for some really spectacular post-REO flip sales!! (And here we thought the lenders were becoming cautious because of the sub-prime meltdown. They seem as stupid as ever. And there appear to be some really clueless appraisers out there yet as well -- maybe they are coming to appraise in Akron from Cleveland and Columbus and Upstate New York.)

This project will take some time, but I have already laid out the Excel spreadsheet for the project. Stay tuned!

US-less PAP?

2008-02-14T13:54:00.004-05:00

A recent article in the Cincinnati Enquirer, Sheriff's appraisers cash in, serves generally to irritate, and is illustrative of a problem that exists in the appraisal world. That problem is the total misunderstanding of the appraisal profession by the legal profession and the public at-large. It is partly a result of the "double-dipping" that attorneys are allowed; when an appraisal is needed for a legal reason, the attorney handling the case is legally permitted to do the valuation himself. He can then pocket the fee for both the appraisal and the legal work.

Further, the courts are able to alter the rules under which appraisals are performed; the Jurisdictional Exception Rule of the USPAP was specifically designed to step around any possible conflict between legal and appraisal ethics. (Normally, what is not ethical for an appraiser -- charging for an appraisal based on the amount of value opined -- is completely ethical for the legal profession, and those "ethics" are extended by court rules even to licensed and certified appraisers working for the courts.)

The passage of SB 185 by the Ohio Legislature in 2006 was supposed to tighten up protections for consumers and reduce the pressure by lenders on appraisers to perform unethically. It is simply too bad that the rules are still as full of holes as a block of Swiss cheese. The holes begin at the Federal level and worm their way down to the local courts.

Prior to the passage of FIRREA there was no requirement for appraisers to be licensed or regulated to do business with regard to Federally Related Transactions (FRTs). Those transactions are defined in the Code of Federal Regulations (CFR) as:

12 CFR § 34.42 (OCC), § 225.62 (Federal Reserve), § 323.2 (FDIC), and § 564.2 (OTS),
(f) Federally related transaction means any real estate-related financial transaction entered into on or after August 9, 1990, that:
(1) The Board or any regulated institution engages in or contracts for; and
(2) Requires the services of an appraiser.
(Also for NCUA, CFR § 722.2 (e))

FIRREA required that appraisers for FRTs be licensed. The licensing requirements were to be drawn up by the states, but had to meet the minimum requirements set by the Appraiser Qualifications Board of the Appraisal Foundation, which was under the oversight of the Appraisal Subcommittee.

Title XI of FIRREA (1989) - aka the Savings and Loan Bailout -- in Section 1113 (1) stated, "a State certified appraiser shall be required for all federally related transactions having a value of $100,000 or more ..." It was quickly realized by the banking industry that certified appraisers were in short supply and not only were appraisals somewhat costly, but that when done correctly, created a time lag in the closing process. In 1994, the regulations were modified to require appraisals only for FRTs that exceeded the de minimus amount of $250,000.

Thus, a Federally Related Transaction does not necessarily require an appraisal. (It has always been good business practice when lending money, however, to have some idea what sort of collateral might be backing the loan, and provides a type of legal defense for the bank -- blame it on the appraiser! -- if the loan goes bad.)

But then we come to the "holes in the cheese". First, of course, at the Federal level, is the de minimus. The vast majority of mortgage loans are under $250,000. That meant that the vast majority of appraisals for those loans could be done by unlicensed -- potentially incompetent -- individuals. This is not to imply that all unlicensed appraisers are incompetent. Nor does it establish that all licensed and certified appraisers exercise competence as defined by the USPAP. It simply points out that any valuation for a FRT under the de minimus amount does not necessarily have to be done under the USPAP. It can be an estimate based on an AVM, it can be performed by a real estate agent doing a simple CMA, or it can be a PFA number supplied by anybody. FIRREA leaves up to the states, individually, to determine who can do business as an appraiser.

Ohio is not a mandatory licensure state. That means that if someone decides one day to be an appraiser, he is one. It is that easy. I am not an advocate for mandatory licensure. That is how I got my start; I simply started doing appraisal work as a real estate agent. That does not mean that prior to obtaining my certification, I did not try to comply with the USPAP. I did try. I even performed appraisals for FRTs, and conscientiously attempted to provide credible value opinions for my clients. Fortunately, I was not faced with any complex appraisal problems during that time.

Under SB 185, the Ohio Revised Code was changed to read,
"Sec. 4763.13. (F) Except as otherwise provided in section 4763.19 of the Revised Code, nothing in this chapter shall preclude a person who is not licensed or certified under this chapter from appraising real estate for compensation.

Sec. 4763.19. (A) Subject to division (B) of this section, no person shall perform a real estate appraisal for a mortgage loan if the person is not licensed or certified under this chapter to do the appraisal. [my bolds]

(B) Division (A) of this section does not apply to a lender using a market analysis or price opinion, an internal valuation analysis, or an automated valuation model or report based on an automated valuation model, and any person providing that report to the lender, in performing a valuation for purposes of a loan application, as long as the lender does both of the following:

(1) Gives the consumer loan applicant a copy of any written market analysis or price opinion or valuation report based on an automated valuation model;

(2) Includes a disclaimer on the consumer's copy specifying that the valuation used for purposes of the application was obtained from a market analysis or price opinion or automated valuation model report and not from a person licensed or certified under this chapter."
Despite all the hullabaloo about consumer protection in SB 185, it simply gave the Attorney General a tool with which to beat on licensed and certified appraisers, and loan officers who were stupid enough to use such people, if they stepped out of line.

This brings us to the problem illustrated by the Cinci Enquirer article. There is no state requirement anywhere that appraisals done for foreclosure sales be done by competent people. The statute simply says that the appraisers must be "freeholders" and residents of the county. (At least the Federal District Court has required that the appraisers for its foreclosure suits be state certified appraisers and residents of that county.)

The article does state, however, that three of the six appraisers are licensed. Those three, under the USPAP, are not permitted to waive the requirements under Standards 1 and 2, since the Hamilton County Court of Common Pleas does not appear to have made any rulings that permit them to do so! At the very least, the certifications required by Standard 2 must be attached to their appraisal reports, and must be submitted even if the reports themselves are not in writing!

Some questions :

(1) Why have none of the licensed or certified appraisers in Hamilton County filed any complaints with the Division of Real Estate against the sheriff's licensed appraisers regarding violations of the USPAP? The appraisals are public records and part of the court documents (at least they are here in Summit County).

(2) Why have no attorneys for the people being foreclosed on grasped the opportunity to take any action?

My curiosity is piqued. I am going to do some research into some of the Summit County foreclosure sales, the appraisals done prior to foreclosure, and the actual prices obtained for the properties on the REO market. I have a hypothesis : there is a correlation between either the Auditor's appraised value (which is not market value) and the foreclosure appraisal value (which is supposed to be at market value), or between the outstanding loan balance and the foreclosure appraisal value. This may take some time, but stay tuned!!

Heinlein and Mosquitoes

2008-02-06T23:39:00.000-05:00

When, in the course of human events, it becomes necessary to levy an assessment for services rendered, the question always arises as to the value of the services, the morality of assessing for them, and who should be allowed to participate in the decision.

"'Value' has no meaning other than in relation to living beings. The value of a thing is always relative to a particular person, is completely personal, and different in quantity for each living human -- 'market value' is a fiction, merely a rough guess at the average of personal values, all of which must be quantitatively different or trade would be impossible."

"This very personal relationship, 'value', has two factors for a human being : first, what he can do with a thing, its use to him...and second, what he must do to get it, its cost to him. There is an old song which asserts 'the best things in life are free.' Not true! Utterly false! This was the tragic fallacy of which brought on the decadence and collapse of the democracies of the twentieth century; those noble experiments failed because the people had been led to believe that they could simply vote for whatever they wanted...and get it, without toil, without sweat, without tears.

Nothing of value is free. Even the breath of life is purchased at birth only through gasping effort and pain."

"I fancy that the poet who wrote that song meant to imply that the best things in life must be purchased other than with money -- which is true -- just as the literal meaning of his words is false. The best things in life are beyond money; their price is agony and sweat and devotion...and the price demanded for the most precious of all things in life is life itself - ultimate cost for perfect value."
Jean V. Dubois, Lt. Col. (ret), Mobile Infantry, in Starship Troopers by Robert A. Heinlein.

Heinlein argued that moral values were not inherent in human nature, but that they were developed by exercising the ability to protect those who were defenseless. It is because people have equated the will of the majority with the "rightness" of an action that we have people who argue that the franchise should be open to all, without any qualification. There is some resistance to the idea that only those who pay for the improvement have the right to determine that the improvement be made.

In the instance of the formation of a Sanitary District (and particularly, a Sanitary District Organized Wholly for Reduction of Populations of Biting Arthropods, i.e. a Mosquito Abatement District) according to Ohio Revised Code 6115, the district may be established by petition under the conditions (6115.05) that it be signed by at least 500 freeholders of the proposed district and "The petition shall set forth the proposed name of said district, the necessity for the proposed work and that it will be conducive to the public health, safety, comfort, convenience, or welfare, and a general description of the purpose of the contemplated improvement, and of the territory to be included in the proposed district." It is the function of the Board of Appraisers to determine the value of the service provided. It must be further recognized that any appraisal performed by the Board of Appraisers, if they fall under the Uniform Standards of Professional Appraisal Practice, is defined as an "opinion of value".

Such an "opinion of value" may not necessarily take the form of a monetary quantity (since no "market value" can reasonably be determined); the statute states (6115.29) "The board of appraisers shall appraise the lands or other property within and without the district to be acquired for rights of way, reservoirs, and other works of the district, and shall appraise all benefits and damages accruing to all lands within or without the district by reason of the execution of the official plan." In the case of a Mosquito Abatement District, the benefits to the freeholders of the district include not only the reduced potential for disease transmission, but also the increased ability to enjoy the property without the nuisance factor which attends the presence of biting mosquitoes. Such a value fits the criteria, "completely personal, and different in quantity for each living human"; there is, moreover, no way to accurately measure a market reaction to such value.

The benefits to the freeholders with respect to the reduction of potential disease transmission must be related to the value which they place on human life and the quality of that life. It is a given within our system that a freeholder is responsible for nuisances and dangers associated with his freehold, otherwise, he would have no inducement to procure liability iinsurance. It is therefore only necessary to establish that a danger exists to then state that the freeholder must exercise responsibility for that condition.

"Both for practical reasons and for mathematically verifiable moral reasons, authority and responsibility must be equal -- else a balancing takes place as surely as current flows between points of unequal potential. To permit irresponsible authority is to sow disaster; to hold a man responsible for anything he does not control is to behave with blind idiocy."
Major Reid, in Starship Troopers by Robert A. Heinlein.

Does a danger exist with regard to mosquitoes in the territory subscribed by the Mosquito Abatement District? The mosquitoes (and common diseases they vector) which are found in Northeastern Ohio include varieties of the species Aedes (LaCrosse, Equine, and St. Louis Encephalitis, Dog Heartworm), Anopheles (Malaria), and Culex (St. Louis Encephalitis, West Nile). There are those, even among local health professionals, who argue that discussion of these diseases with the general public amounts to "fear mongering".

What is the actual incidence of these mosquito-vectored diseases in Ohio? While malaria is not considered to be an important disease in modern-day Ohio, there was a time when it was significant. The City of Lima was named after the place whence it obtained cinchona bark for the production of quinine, a very important commodity in mid-19th Century Ohio. The Ohio Historical Society (Ohio History, v34, pp113-114) quotes a source stating (with regard to malaria along the Ohio Canal) "The victims were numbered by the thousands, many being buried in shallow graves along the canal,...".

In another place, (ibid., v54, pp413-416), the Society reviews Malaria in the Upper Mississippi Valley, 1760-1790 by Dr. E. H. Ackerknecht (1945) in which he states that at the end of WW2, there were, annually, still about 5,000 deaths nationwide from malaria, and commenting on the disease's decline, says, "One of the mysteries of medicine is why malaria disappeared. After having been once very prevalent, it disappeared spontaneously long before the introduction of systematic anti-malarial measures. Here in Ohio and in the other northern states the decrease came about quite independently of any conscious effort on the part of the various health agencies."

The Ohio Department of Health reported 30 human cases of malaria in 2005, and 10 cases of dengue hemorrhagic fever. All cases were assumed to have been brought into the state by travellers from overseas. However, historically, malaria is a local disease, and dengue is vectored by the Aedes species. In addition, the CDC is aware that persons who have not travelled overseas can be infected by mosquitoes which have vectored the disease from "recent immigrants, migrant workers, and travelers from malaria-endemic countries". (Mosquito-Transmitted Malaria -- Michigan, 1995)

The OSU Extension Service, in its Factsheet HYG-2058-98, states,

"Mosquitoes may transmit diseases such as dengue, yellow fever, and malaria to humans. Mosquito-borne encephalitis is a viral inflammation of the brain. Encephalitis can infect humans, horses, and a variety of other mammals and birds. Eastern equine encephalomyelitis (EEE), although very rare is frequently fatal. A small rural outbreak in late 1991 resulted in more than 20 farm animal fatalities, most of which were horses. Transmission of the disease occurs when an infected mosquito takes a blood meal. Birds serve as natural hosts for EEE and St. Louis encephalitis (SLE). St. Louis encephalitis, like EEE is an epidemic disease, meaning that it is usually rare. It can be absent from an area for several years and then reoccur suddenly without warning. LaCrosse encephalitis (LAC) is the third type found in Ohio. It is considered endemic to Ohio and occurs year after year at low levels. Ohio has more recorded cases of this disease than my other state. LaCrosse encephalitis is the least severe of the three types of mosquito-borne encephalitis that are found in Ohio, and occurs most often in children. Small woodland mammals, such as chipmunks and squirrels serve as the natural host for the virus, however LAC virus can also be passed, transovarially, from mother mosquito to her offspring.

Mosquitoes can also transmit filariasis (heartworm) to animals. Dog heartworm is the most significant of these, however in some areas, veterinarians are beginning to see more heartworm in cats."

West Nile was unknown (or at least unreported) in this country before 1999. In 2002, Ohio had 31 deaths from WND, and while there were only 3 fatalities from WND in Ohio in 2007, it must be noted that Cuyahoga County had the highest number of cases (6) in that year. While Summit County has not had a reported human case of WND since 2002 (5 cases that year), the surrounding counties have reported cases almost every year.

While the data for the past decade seems to indicate that the danger of human infection by these diseases is very low, the danger exists. Further, there does not seem to be any specific reason why some of these diseases wax and wane over the years. There is no guarantee that something will not happen to trigger outbreaks of epidemic proportions. The only reasonable way to short-circuit the disease cycle is to eliminate the vector. The questions become, "What is the value of one human life?" and "What cost is reasonable to meet that opinion of value?"

In these questions, the Board of Appraisers has a ready answer in the form of the petition submitted to the court. The freeholders have determined that the value exists; a value which cannot possibly be expressed in monetary terms. The statute then directs the Board of Appraisers to base the assessment on the cost of attaining that value, i.e., the budget for the program. With respect to the basis for assessment, the statute is clear (6115.43): "In the case of a district organized wholly for the reduction of populations of biting arthropods, if the board of appraisers determines that each parcel of real property in the district receives a portion of the benefits received by the entire district in the same proportion that its taxable value bears to the taxable value of all the real property in the district, and the court confirms the determination of the board, the assessments for the reduction of such populations shall be uniformly apportioned throughout the district on that basis." Since, by reason of the arguments put forward in the deposition of Dr. Richard Berry (7-27-2005), larviciding and adulticiding are done by the District over all areas in its subdivision, the rate of application is the same regardless the property size, and the goal is to protect public health through prevention and control, the benefits justify uniform assessment.

The MAD was formed by freeholders petitioning the court for establishment of the district. Not all freeholders signed the petition. The statute allows (6115.08) individual freeholders who did not sign to present objections to the district, but limits the objections to a "denial of the statements in the petition".

If, indeed, authority and responsibility go hand in hand, the authority any freeholder exercises over his freehold is equal to the responsibility he bears for conditions on that land. If the necessity for the exercise of authority has been established in the minds of the petitioners, they have the moral responsibility to act, regardless the cost to themselves. Those who are not freeholders have no responsibility or liability for the freehold, and no moral authority to participate in the decisions involving the assessment.

Geographic Competence as a Function of Location

2008-01-29T18:32:00.000-05:00

The oldest saw in real estate is that "location, location, and location" are the three most important factors in the value of real property. That is, of course, a bit of an exaggeration, but it is true enough that the URAR grid has, among the top factors on the grid, "location", "site", and "view". Those items are located toward the top of the grid because they have been shown to be significant reasons why a buyer might pick a particular home. In the middle of the grid are "condition", "room count", and "GLA", which have been deemed, by those who study buyer psychology, to be lesser factors. What strikes the reviewer who is cognizant of these things is that the majority of appraisal reports will have the bulk of adjustments in the mid-section of the grid, with few at the top.

"Ah-ha!" says the reader as he leaps to a hasty conclusion that I am about to say that the adjustments are up-side down. Not really. The best arguments for a preponderance of adjustments in the mid-section are that (1) they are quantitatively easy to develop, and, (2) if the appraiser has followed common sense and the guidelines set down by FNMA for choosing comparable sales, all of the sales used will be nearby and locationally similar. There should be no need for substantial adjustments for location if all the sales are within a half mile of each other and in the same Census Tract. There should be no reason to make an adjustment for lot size when all of the lots have the same frontage and about the same area. If the subject and comparables are all on quiet residential streets, why should a view adjustment be needed?

When the market is active and there are plenty of sales to choose from, there is generally little difficulty in providing a credible opinion of value for a home in a given neighborhood. In that situation, difficulties typically arise when the lender says, "I need $xxx to make this deal go." (According to Ohio Attorney General Mark Dann, such a statement is prima facie evidence of appraiser coercion -- a misdemeanor under the Ohio Revised Code -- and he has urged appraisers who receive faxes or emails with such statements to forward those items to him for prosecution of the senders!!) An appraiser who would prostitute his or her services under such a condition might well choose sales in locations beyond the recommended distance guidelines, ignore differences in appeal (and thus value) due to location, and "hit the number." This is, too often, a problem where a local appraiser is involved, but is almost always a problem where an appraiser who is based some distance away commutes a long way to the subject neighborhood.

This is not to say that such a commuter cannot learn the nuances of the subject's neighborhood and proceed to do a credible job of valuation. The difficulty lies in the time and effort needed to become competent, and the very little amount of money that most lenders are willing to pay for an appraisal (although it has been my experience that the more times a lender has been told a particular number is not feasible, the higher the price they are willing to offer for the appraisal, and conversely, if the appraiser does not "hit the number", the greater the likelihood that the lender will ignore the appraiser's invoice).

In a "down" market, the use of an appraiser who is not very familiar with the subject's neighborhood is a prequel to appraisal fraud. In a declining market, good sales comparables become hard to come by. As data in the immediate neighborhood of the subject becomes scarce, it is necessary to reach out to other, "competitive", neighborhoods in order to bracket the subject for all features. It is highly unlikely, however, that even "competitive" neighborhoods will have exactly equivalent features and appeal. Especially in suburban or rural neighborhoods, use of a sale from an adjacent town or township may become necessary, and if a location adjustment is NOT made in such cases, the appraiser has some explaining to do.

A geographically competent appraiser will be able to make appropriate adjustments, and explain why they were made. The problem, again, is that the appraiser is faced with a changing market, it takes time and effort to dig out and analyze the sales statistics, and the fee for the appraisal is usually not worth the work involved, unless the appraiser needs simply update his files with the most recent data. Many appraisers, however, are still using neighborhood descriptions that were cooked up (or copied from somebody else) by their supervisory appraiser when they were trainees. Relatively few appraisers have actually taken the time to compile their own neighborhood statistics.

Even those appraisers who use data from the MLS may be fooled into using statistics generated by Realtor associations, without thinking that those figures may be biased in favor of convincing buyers and sellers to enter the market. There are other appraisers who buy their statistics from national services without bothering to consider the underlying assumptions that need to be made to properly interpret that data. The dangers are manifold.

So what triggered this rant? I had two recent phone calls, one from a lender, and one from a salesman hoping to sell me a listing at an appraisal directory. The loan officer asked if I could tell him whether a particular value for a home on Roslyn Avenue in Akron would be feasible. I told him that in order to make such a determination, I would have to do an appraisal. He then asked what the market was like in Akron; I told him that we had an increasing number of foreclosures, and that there were quite a few more listings in the MLS than there were sales. He thanked me and hung up. If I were to buy a lottery ticket, my odds of winning something would be smaller than the odds that he promptly called another appraiser, hoping he could find someone who would be willing to violate USPAP for him. If it were legal to record phone conversations, and Mark Dann paid a bounty for violations submitted, I could make more money doing that than appraising.

As to the second call, the salesman directed me to the web page for his directory. In order to be listed there, his company charges a fee. All you need to do, if you are looking for an appraiser, is click on the county and a list of appraisers with their contact information comes up. There are directories such as that which also offer free listings, and I am on about a half-dozen of those. The biggest problem with all of these directories is the deception inherent in all of them. The potential client is usually looking for an appraiser who is local to the subject's neighborhood. This salesman said that he was looking for an appraiser in Kansas City, and my web page came up. While I may travel up to 20 miles west to the rural Wayne and Medina County portions of my service area, I have no desire whatsoever to go outside the areas in which I feel competent. However, if you bother to click on his directory's map of Summit County, you will find that of the 14 firms that are listed, four are in Summit County, four are in Cuyahoga County, one is in Lorain County, two are near Columbus and Dayton, and the remainder are out-of-state management companies. Another directory lists appraisers by ZIP code; there are out-of-county appraisers who have several listings, each of which has a fraudulent ZIP so that they are shown as being "local" to the ZIP code a client may be searching. So much for truth in advertising.

So why is there a credibility problem with the appraisal profession? I submit that it has to do with the marketing of appraisal services, and the choosing of appraisers for the assignment by the very people who are paid a bigger commission if the loan amount is higher. If lenders were forced to be liable for the quality of the loans they made, they might be more careful about who they hired to evaluate the collateral. That is a problem that was created by Congress. If that is too hot a potato for the pols, they should consider setting up a Federal agency that would dole out the appraisal work on a rotational basis, just as the VA Fee Panel does, without any say by the lender as to who the appraiser might be. Part of the criteria might be a requirement that the appraiser's office be located within a certain distance of the subject property. A variation on such a scheme is used right now by the U. S. District Court, Northern Ohio Division, for foreclosure appraisals; the Master Commissioners are required to use a state certified appraiser whose address in the Federal registry is in the same county as the property being foreclosed.

Over twenty years of licensing has not solved the problem of appraisal fraud. The politicians created the environment for the current mortgage lending crisis. It is time the denizens of the Capitol tried a different approach to clean up the mess they made.

The Dow(n) Jones

2008-01-23T09:54:00.000-05:00

It is a little after 10AM, the Dow has been open almost half an hour and is bouncing. It fell nearly 200 at opening and is now down only about 100. The ASX and TSE both ended their Wednesday sessions without coming back up to the level of Monday's losses. The European exchanges are about to close for the day, and are down as well. Looks like Benny's 3/4 percent panic rate cut had little effect on overall market sentiment.

In musing over the problem of trying to find out how much of the economy had been funded by entrepreneurs flying under the radar of the unemployment managers, it struck me that the impact of the alien invaders from south of the border has not been mentioned much in the mainstream media. They seem to be fixated at this point on which primary candidate put which foot in his/her mouth on a given day.

Does it seem like a coincidence that the banks (read : lenders) who were so eager to accept the Mexican Matricula card as ID for loans and credit cards are the ones that appear to be having a huge share of the current difficulty? Could it be that as things sort of ran out of steam, the alien invaders found work harder to get and are now simply walking away from the obligations they have incurred? After all, if you can go back to Mexico, where your credit report is irrelevant ... (wait a minute -- no SSN, no credit report!!! -- but they were acceptable credit risks according to BofA and CITI and WaMu and so many others!!). The plus side for the government is that they will never show up as "unemployed", either. Makes for a rosy economic picture, to the bureaucratic way of thinking, I suppose.

Just like the Great Depression (which may have to be named the period Formerly Known as the Great Depression), this little bump in the economic road will generate plenty of graduate papers and scholarly studies.

Irrational Exuberance?

2008-01-22T21:04:00.000-05:00

Having kept an eye on the markets all day, I have observed some interesting things. Benny and Co. dropped the discount rate by 3/4 percent just before the NYSE opened. This was a panic move on the Fed's part due to the stunning losses all over the rest of the world on Monday, while America's markets slept. Aside from Monday's huge declines overseas, the ASX (which is 16 hours ahead of us here -- they closed on Tuesday afternoon at 4PM while it was still 2AM in New York) dropped again on Tuesday, as did the TSE in Tokyo. Benny and his boys probably did not sleep well last night.

The NYSE opened with a bang. Out of the gate, despite the rate cut, it lost roughly 450 points, then recovered to close 128 points down for the day. I observed something that piqued my curiosity. Bank of America announced a write-down due to its mortgage losses, and a reduction in its projected dividend. Its stock rose nearly 4% during the day. Citigroup, which is showing a higher P/E ratio, declined. When asked about this phenomenon, one who once worked for a brokerage stated that the people who made the buying and selling decisions were the guys who went to college, got C's, and spent their time drinking beer.

Then, today, I got another letter from BofA begging me to borrow some money from them. Just 1.9% through December 2008. Then it would reset to 25.24%. Unless I was a second late with a payment, in which case it would default to 32.24%, immediately. Go suck eggs, Bank of America. You and your predatory shareholders deserve to lose your shorts, and any government idiot that wants to bail you out should be tarred, feathered, and ridden out of town on a rail.

Why so sour? I had some input from two widely divergent sources today. One was Neal Cavuto, explaining why the government should let the market correct itself without any outside help. I could agree to that, but his reasoning was off. He pointed to the figures that show 3% growth in the economy and only 5% unemployment as evidence the economy was healthy enough to take care of itself. The other source made no reference to bailouts, but pointed out that huge numbers of people who were unemployed would never be visible to the unemployment bean counters. Again, on target, but there is a different reason for it in my mind.

Current tax law with lax immigration enforcement drove many of the tradespeople into "self employment", operating as "contract labor". The cost of employment taxes has been a burden for the small business person, and competition from the "paperless workforce" has driven down wages. Those self employed people in construction and all other aspects of real estate are now looking for work. They cannot collect unemployment. Their numbers are larger than the government can admit, because they never made it onto the radar in the first place -- they were skillfully evading the tax laws.

However, they were a substantial part of the consumer economy. While they exercised as many loopholes as possible to avoid taxes, their deductible expenditures were accounting for a significant chunk of consumer spending. They are no longer generating income to deduct against; they are not buying the cars and trucks and services they previously needed to buy in order to keep down their FICA "contributions", and that, in turn, is causing layoffs in other segments of the economy.

Mind you, I have no figures to prove this. I am going on gut feeling, and observations over the "back fence" of the economy. But I think Cavuto is very wrong in his assessment of the health of the economy, despite being right in his understanding that government tinkering with markets will do nothing but work greater hardship in the long run. It might make a good graduate thesis in economics, however. Yoo-hoo, Axlebender -- are you listening?

Meanwhile, in the Far East, it is Wednesday morning. Both the ASX and TSE are up from yesterday, and have almost gained back Tuesday's losses, but they are still below their Monday closing!. When I get up in the morning, I'll have to check on how they did overnight. If they cannot gain back some of Monday's losses, it could foreshadow a Wicked Wednesday in New York.

Get a Bigger Fan...

2008-01-22T08:46:00.000-05:00

... because it is starting to hit and there is lots more where this came from :

Suing the Buyer's Agent

Looking at the results of Black Monday in Asia and Europe, followed by Grey Tuesday and the Fed rate cut early this morning (which immediately caused a rise in the FTSE), I'm curious as to the effect in ten minutes when the NYSE opens.

While it may seem like a kindness for the Fed to lower rates and stave off total chaos for the moment, there is little doubt in my mind that any relief to the market will only last long enough for some of the bigger and higher rollers to cover their positions.

As my youngest said last night, "Somebody is buying..."; that is true. But I doubt there are any genuine "bargains" in the market today. If you didn't unload the risky stuff two months ago, this morning will be too late.

Five minutes to the bell. This is going to be instructive.

Musings on Market Collapse Disorder

2008-01-14T18:27:00.000-05:00

Value is a personal concept. To the extent that we are ego-centric, that statement may be easy or difficult to grasp. Each person observes his world and ranks the objects and ideas within his understanding in a hierarchy; every thing and object, including life itself, has a "value" which is assigned according to perceived importance.

Further, the position in the ranking is subject to change, based on the person's perceived needs. Thus, value is merely a perception, and it is common for items which are more easily obtainable to be substituted for scarcer items whenever they are in close proximity on the hierarchy.

An example in the ethical realm would be the conflict between self-preservation and self-esteem. If a choice must be made between going hungry and stealing food, or between lying and dying, the closer together the choices are in importance to the person, the easier it is to substitute one for the other.

In the realm of currency exchange, the closer to parity two currencies are, the more equal their value appears, and the less resistance there is to trading one for the other. When real property is considered, the principle of substitution drives the appraisal process.

Whenever real property is appraised, the object of the assignment is to locate the subject within a universe of other "things" which can be substituted for it without causing cognitive distress. The "things" may be a sum of money, other real property, security, or the potential to profit in some other way via the asset. For this reason it is critical that the "value" be defined prior to any attempt to give an opinion of value (appraisal) of the property.

"Market Value" has been defined by agencies of the U.S Government (12 CFR Part 34, Office of the Comptroller of Currency) as:

34.42 (g) Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
Buyer and seller are typically motivated;
Both parties are well informed or well advised, and acting in what they consider their own best interests;
A reasonable time is allowed for exposure in the open market;
Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
The price represents the normal consideration for the property sold unaffected by special or creative financing or
sales concessions granted by anyone associated with the sale.

As we go further into this discussion, it is essential to note that 12 CFR 34.44 (d) requires that for any Federally Related Transaction, i.e., a transaction as defined in 34.42 (f), the appraisal must "Be based upon the definition of market value as set forth in this subpart".

The tricky part is meeting all the requirements of 12 CFR 34.42 (g). If the predominant buyers and sellers in a market are not owner occupants, are they "typically motivated" from the standpoint of residential mortgage lending? If there is no way to judge the exposure time on the open market because the majority of sales are private transactions, can statistical data from such sales be used to describe the market for the purpose of informing the residential mortgage underwriter of "typical" market conditions?

There is no question in my mind that the reliance of many lenders on AVMs, the failure of appraisers to understand 12 CFR 34 and the characteristics of their own markets, and the willful disregard of 12 CFR 34 by the residential lenders has resulted in extension of inadequately secured credit to borrowers.

The "collapse" of many real estate markets around the country has not been due to a decline in market value of the homes. It has been due to a phony inflation of prices based on the ability to obtain undersecured financing. We are simply finding out that the emperor has no clothes.

Incompetence Corrupts...

2008-01-11T11:47:00.000-05:00

and just a little incompetence can corrupt absolutely.

Lord Acton may not have considered the above twist, but my new analysis of market areas in the City of Akron is raising some significant questions in my mind about the whole process of determining a "market value" for residential property in some markets. Conventional practice relies upon the Sales Comparison Approach to provide a means of forming an opinion of value. The data I am finding, however, seems to imply that sales comparison may be entirely inappropriate in some markets, and the insistence by lenders on the use of the technique may be an important contributor to the current difficulties in the mortgage lending arena.

Most appraisers are familiar with the "big three" approaches to deriving a value opinion : cost, income, and sales comparison. In residential mortgage lending, underwriting doctrine insists that sales comparison is most appropriate. Lenders (as well as most appraisers) have believed that by comparing a subject property to the market experience of other nearby homes of the same age, size, type, and condition, it is possible to predict the reaction of "typical" buyers to an attempt to market the subject. What has been ignored are the basic assumptions that must be present in developing an opinion regarding "what if we tried to sell it?".

The market area I was researching was the Summit Lake Neighborhood in the City of Akron. The city's official neighborhood data sheet for that neighborhood gives a year 2000 owner-occupancy statistic for "South Akron" as 57.3%, but also has a note that "Slightly over one-third of housing units are owner-occupied, significantly less than 55% in the City." My research from the Census 2000 data shows an average tenant-occupancy rate in the Summit Lake Neighborhood of about 70%. Consequently, the most probable buyer for a single-family home in that neighborhood, at any given time, would be an investor.

In examining the statistics from brokered MLS sales and the public records data for all sales in that area, a serious discrepancy was evident. The mean sales price for brokered sales declined from $27,167 in 2001 to $13,741 in 2007, with the median declining from $24,000 to $10,000. In complete contrast, the mean for all sales increased from $44,347 in 2001 to $63, 509 in 2006, and the median for all sales increased from $42,700 to $70,000.

What is not evident from the raw stats is the fact that the MLS sales are mostly REO sales -- the banks have been hiring agents to dispose of their foreclosed properties -- whereas the public records stats only include the final transaction price for a given home at the end of the calendar year. The private sales by the investors, who are dealing both among themselves and also with owner-occupant buyers, involve numerous "flip" sales where the REO homes have been purchased, "rehabbed", and resold. There is no ready information with regard to marketing times or seller concessions and incentives. Further, if one looks closely at the major players in the high-end sales, one finds that at the end of 2007, a number of them were either under indictment or already in jail for mortgage fraud.

Even if all the transactions taking place were honest deals, there is still a problem with trying to determine what the typical buyer and seller would be willing to agree on in this market. An owner-occupant is usually looking for a house that is ready to move in to. An investor who wishes to be a landlord will be looking for a home that will be able to generate an income stream with minimal repairs and maintenance. The investor who is rehabbing to resell will be picking up the sales at the bottom of the pile. The "market value" of the home should not differ much between each category of buyer, since open market competition for the property should drive the final sales price. However, the appropriate method of arriving at the "market value" may be something other than simple sales comparison as anticipated by the standard appraisal forms.

Out-of-town appraisers, who may be relying on public records sales data without understanding the owner/tenant composition of the neighborhood, may be providing value opinions that do not really meet the needs of the intended users or their intended use. Users of AVMs in such a neighborhood run the risk of developing value estimates completely out of line with the reality of the marketplace. This situation warrants further exploration.

New USPAP

2008-01-07T08:55:00.000-05:00

On January 1, 2008, the 2008-2009 revision of USPAP became the effective law of the land ("The Financial Institutions Reform, Recovery and Enforcement Act of 1989 recognizes USPAP as the generally accepted appraisal standards and requires USPAP compliance for appraisers in federally related transactions. State Appraiser Certification and Licensing Boards; federal, state, and local agencies, appraisal services; and appraisal trade associations require compliance with USPAP.") with regard to standards for appraisers in the USofA. It can be found at:

Table of Contents

Skimming through it, there have been a number of changes. The DEFINITIONS section drops the terms "advocacy" and "supplemental standards". The Conduct section of the ETHICS RULE now simply states, "An appraiser must not advocate the cause or interest of any party or issue.", and the comment that "An appraiser may be an advocate only in support of his or her assignment results." has been removed.

The SUPPLEMENTAL STANDARDS RULE has been removed. We will undoubtedly see many interpretations of this action. The Supplemental Standards Rule allowed "government agencies, government sponsored enterprises, or other entities that establish public policy" to add to (but never take away from) the requirements of USPAP. This requirement is now wrapped into the "Problem Identification" portion of the SCOPE OF WORK RULE. The phrase "supplemental standards" has been replaced with the phrase "laws and rules". The Second Exposure Draft (March 5, 2007) for the change shows the rationale :

"Today in USPAP, because Fannie Mae is a GSE, portions of the Fannie Mae guidelines are Supplemental Standards. Conversely, the guidelines of the Employee Relocation Council (ERC) are not Supplemental Standards simply because the ERC is not a GSE. Although both guidelines are recognized as part of competent performance when they apply, Fannie Mae’s guidelines are currently looked at differently because they are identified as Supplemental Standards under the current definition.

The guidelines of Fannie Mae are not laws or regulations. However, the proposed edits will not change: 1) the necessity for an appraiser acting in compliance with USPAP to follow Fannie Mae guidelines where applicable; and 2) the enforcement of USPAP, including those items necessary for competent performance and meaningful reporting. The appraisal guidelines of GSE’s such as Fannie Mae and Freddie Mac will remain part of proper development and reporting when they are applicable to a given assignment.

Eminent domain appraisal assignments are commonly subject to laws and regulations. The requirement to recognize and comply with such an assignment condition is part of competent performance in USPAP, but also has a clear and obvious basis outside of USPAP.

In both examples compliance with USPAP (today or under the proposed edits) requires adherence to those assignment conditions that are necessary for proper development and reporting. The appraiser’s identification of the intended use and intended users drives the applicable assignment conditions, such as the appraisal guidelines of Fannie Mae, the ERC, or the laws of eminent domain."

Other changes include:

Advisory Opinion 5, "Assistance in the Preparation of an Appraisal" has been retired and replaced by Advisory Opinion 31, "Assignments Involving More Than One Appraiser".
Advisory Opinion 30, "Appraisals for Use by a Federally Regulated Financial Institution" has been added, outlining the appraiser's obligations to understand the rules made by the Office of the Comptroller of the Currency, Federal Reserve Board, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration. (What may be interesting for non-appraisers is that the statement of the legal definition of market value promulgated by the Federal agencies is specifically quoted here).
Advisory Opinion 32, "Ad Valorem Property Tax Appraisal and Mass Appraisal Assignments" has been added, outlining the applicability of USPAP to such people as county assessors. Individual jurisdictions need to specify whether or not their assessors must adhere to the Standards. The individual jurisdictions also need to specify the Intended User(s) of the mass appraisal report. There is a statement that in mass appraisal assignments, individual tax record cards for a particular property are not appraisal reports since the mass appraisal assignment takes in a universe of properties and not any specific property.

Interesting stuff, but not particularly easy reading. I am looking forward to my next 7-hour USPAP Update class, though.

New Year, Old Concerns

2008-01-04T15:07:00.000-05:00

Well, I started off the new year with an update to my web page, to make it look more professional. It seems that with all the loss of confidence in the financials markets, it would be a better idea to have a "serious" web page rather than one which indicated a greater sense of humor. Nothing much humorous about loans going south in large flocks. We shall see if springtime sees the migration turn around. With all the financial climate change, though, a meltdown could be in the cards.

Which leads to the old business. It seems that borrowers are not the only entities going into default. Lenders who have ordered appraisals also appear to be defaulting on payment for the reports. If the the borrower has tapped out all his equity and the appraised value is so low that the lender can't make the loan at an appropriate loan-to-value ratio, the lenders are simply ignoring the appraisal invoices.

I've sent off a request for the Ohio Attorney General's office to look into this phenomenon. The O.R.C. provides for criminal penalties for appraiser coercion, and the AG's office issued a clarification (109:4-3-24) which states in part,

"Division (B)(10) of section 1345.031 of the Revised Code states that in connection with a consumer transaction, a supplier is prohibited from knowingly compensating, instructing, inducing, coercing, or intimidating, or attempting to compensate, instruct, induce, coerce, or intimidate, a person licensed or certified under Chapter 4763. of the Revised Code for the purpose of corrupting or improperly influencing the independent judgment of the person with respect to the value of the dwelling offered as security for repayment of a mortgage loan."

My question to the AG's office is whether they consider withholding payment for the report because the loan couldn't be closed an attempt to influence the judgment of the appraiser. I think it is.

Business is so slow right now that to start requiring payment in advance might cause any clients to look for suckers elsewhere. That may, however, be the only way to survive in this market.

Pop Go the Weasels!

2007-12-22T22:52:00.000-05:00

The wheels of justice roll very slowly, but sometimes they find traction. The recent fraud indictments against a rehabber/flipper, a bank, appraisers, and a title company, acting in collusion, had tongues wagging in Akron. Unfortunately, the people whose houses are in foreclosure probably will not get much comfort from this. The story is at:

http://www.ohio.com/news/top_stories/12665796.html

and pictures of the indicted are here :

http://media.ohio.com/documents/Evergreen.pdf

Back in my May 7, 2007 post, I mentioned some of the appraiser discipline notices in the Ohio Division of Real Estate Newsletter (Winter 2007). It appears that the Division has only published two of the quarterly newsletters this year, but they have been busy. The Summer 2007 issue describes the penalties handed out to 27 appraisers who were allowed to stay in business, and three others who were forced to surrender their licenses because of misconduct. It used to be a rare occurrence when an appraiser lost his license, but the Division is working with the Ohio Attorney General, and I don't doubt that there may also be some criminal charges associated with some of these cases.

The Division Newsletter is at:

http://www.com.state.oh.us/real/documents/2007Summer.pdf

What Judge Boyko Actually Said

2007-12-02T22:08:00.001-05:00

The best part are Judge Boyko's comments in the footnotes. He does have a sense of humor!!

UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF OHIO
EASTERN DIVISION
IN RE FORECLOSURE CASES	)	CASE NO. NO.1:07CV2282
	)	07CV2532
	)	07CV2560
	)	07CV2602
	)	07CV2631
	)	07CV2638
	)	07CV2681
	)	07CV2695
	)	07CV2920
	)	07CV2930
	)	07CV2949
	)	07CV2950
	)	07CV3000
	)	07CV3029
	)
	)	JUDGE CHRISTOPHER A. BOYKO
	)
	)
	)
	)	OPINION AND ORDER
	)
	)

CHRISTOPHER A. BOYKO, J.:

On October 10, 2007, this Court issued an Order requiring Plaintiff-Lenders in a number of pending foreclosure cases to file a copy of the executed Assignment demonstrating Plaintiff was the holder and owner of the Note and Mortgage as of the date the Complaint was filed, or the Court would enter a dismissal. After considering the submissions, along with all the documents filed of record, the Court dismisses the captioned cases without prejudice. The Court has reached today’s determination after a thorough review of all the relevant law and the briefs and arguments recently presented by the parties, including oral arguments heard on Plaintiff Deutsche Bank’s Motion for Reconsideration. The decision, therefore, is applicable from this date forward, and shall not have retroactive effect.

LAW AND ANALYSIS

    A party seeking to bring a case into federal court on grounds of diversity carries the burden of establishing diversity jurisdiction.  Coyne v. American Tobacco Company, 183 F. 3d 488 6^th Cir. 1999).  Further, the plaintiff “bears the burden of demonstrating standing and must plead its components with specificity.” Coyne, 183 F. 3d at 494; Valley Forge Christian College v. Americans United for Separation of Church & State, Inc., 454 U.S. 464 (1982).  The minimum constitutional requirements for standing are: proof of injury in fact, causation, and redressability. Valley Forge, 454 U.S. at 472.  In addition, “the plaintiff must be a proper proponent, and the action a proper vehicle, to vindicate the rights asserted.” Coyne, 183 F. 3d at 494 (quoting Pestrak v. Ohio Elections Comm’n, 926 F. 2d 573, 576 (6^th Cir. 1991)).  To satisfy the requirements of Article III of the United States Constitution, the plaintiff must show he has personally suffered some actual injury as a result of the illegal conduct of the defendant.  (Emphasis added).  Coyne, 183 F. 3d at 494; Valley Forge, 454 U.S. at 472.

    In each of the above-captioned Complaints, the named Plaintiff alleges it is the holder and owner of the Note and Mortgage.  However, the attached Note and Mortgage identify the mortgagee and promisee as the original lending institution — one other than the named Plaintiff.  Further, the Preliminary Judicial Report attached as an exhibit to the Complaint makes no reference to the named Plaintiff in the recorded chain of title/interest.  The Court’s Amended General Order No. 2006-16 requires Plaintiff to submit an affidavit along with the Complaint, which identifies Plaintiff either as the original mortgage holder, or as an assignee, trustee or successor-in-interest.  Once again, the affidavits submitted in all these cases recite the averment that Plaintiff is the owner of the Note and Mortgage, without any mention of an assignment or trust or successor interest.  Consequently, the very filings and submissions of the Plaintiff create a conflict.  In every instance, then, Plaintiff has not satisfied its burden of demonstrating standing at the time of the filing of the Complaint.

    Understandably, the Court requested clarification by requiring each Plaintiff to submit a copy of the Assignment of the Note and Mortgage, executed as of the date of the Foreclosure Complaint.  In the above-captioned cases, none of the Assignments show the named Plaintiff to be the owner of the rights, title and interest under the Mortgage at issue as of the date of the Foreclosure Complaint.  The Assignments, in every instance, express a present intent to convey all rights, title and interest in the Mortgage and the accompanying Note to the Plaintiff named in the caption of the Foreclosure Complaint upon receipt of sufficient consideration on the date the Assignment was signed and notarized.  Further, the Assignment documents are all prepared by counsel for the named Plaintiffs. These proffered documents belie Plaintiffs’ assertion they own the Note and Mortgage by means of a purchase which pre-dated the Complaint by days, months or years.

    Plaintiff-Lenders shall take note, furthermore, that prior to the issuance of its October 10, 2007 Order, the Court considered the principles of “real party in interest,” and examined Fed. R. Civ. P. 17 — “Parties Plaintiff and Defendant; Capacity” and its associated Commentary.  The Rule is not apropos to the situation raised by these Foreclosure Complaints.  The Rule’s Commentary offers this explanation: “The provision should not be misunderstood or distorted.  It is intended to prevent forfeiture when determination of the proper party to sue is difficult or when an understandable mistake has been made. ... It is, in cases of this sort, intended to insure against forfeiture and injustice ...”  Plaintiff-Lenders do not allege mistake or that a party cannot be identified.  Nor will Plaintiff-Lenders suffer forfeiture or injustice by the dismissal of these defective complaints otherwise than on the merits.

    Moreover, this Court is obligated to carefully scrutinize all filings and pleadings in foreclosure actions, since the unique nature of real property requires contracts and transactions concerning real property to be in writing.  R.C. § 1335.04.  Ohio law holds that when a mortgage is assigned, moreover, the assignment is subject to the recording requirements of R.C. § 5301.25.  Creager v. Anderson (1934), 16 Ohio Law Abs. 400 (interpreting the former statute, G.C. § 8543).  “Thus, with regards to real property, before an entity assigned an interest in that property would be entitled to receive a distribution from the sale of the property, their interest therein must have been recorded in accordance with Ohio law.”  In re Ochmanek, 266 B.R. 114, 120 (Bkrtcy.N.D. Ohio 2000) (citing Pinney v. Merchants’ National Bank of Defiance, 71 Ohio St. 173, 177 (1904).¹

    This Court acknowledges the right of banks, holding valid mortgages, to receive timely payments.  And, if they do not receive timely payments, banks have the right to properly file actions on the defaulted notes — seeking foreclosure on the property securing the notes.  Yet, this Court possesses the independent obligations to preserve the judicial integrity of the federal court and to jealously guard federal jurisdiction.  Neither the fluidity of the secondary mortgage market, nor monetary or economic considerations of the parties, nor the convenience of the litigants supersede those obligations.

    Despite Plaintiffs’ counsel’s belief that “there appears to be some level of disagreement and/or misunderstanding amongst professionals, borrowers, attorneys and members of the judiciary,” the Court does not require instruction and is not operating under any misapprehension.  The “real party in interest” rule, to which the Plaintiff-Lenders continually refer in their responses or motions, is clearly comprehended by the Court and is not intended to assist banks in avoiding traditional federal diversity requirements.²  Unlike Ohio State law and procedure, as Plaintiffs perceive it, the federal judicial system need not, and will not, be “forgiving in this regard.”³

CONCLUSION

    For all the foregoing reasons, the above-captioned Foreclosure Complaints are dismissed without prejudice.

IT IS SO ORDERED.

DATE: October 31, 2007

S/Christopher A. Boyko

CHRISTOPHER A. BOYKO

United States District Judge

¹ Astoundingly, counsel at oral argument stated that his client, the purchaser from the original mortgagee, acquired complete legal and equitable interest in land when money changed hands, even before the purchase agreement, let alone a proper assignment, made its way into his client’s possession.

² Plaintiff’s reliance on Ohio’s “real party in interest rule” (ORCP 17) and on any Ohio case citations is misplaced. Although Ohio law guides federal courts on substantive issues, state procedural law cannot be used to explain, modify or contradict a federal rule of procedure, which purpose is clearly spelled out in the Commentary. “In federal diversity actions, state law governs substantive issues and federal law governs procedural issues.” Erie R.R. Co. v. Tompkins, 304 U.S. 63 (1938); Legg v. Chopra, 286 F. 3d 286, 289 (6^th Cir. 2002); Gafford v. General Electric Company, 997 F. 2d 150, 165-6 (6^th Cir. 1993).

³  Plaintiff’s, “Judge, you just don’t understand how things work,” argument reveals a condescending mindset and quasi-monopolistic system where financial institutions have traditionally controlled, and still control, the foreclosure process.  Typically, the homeowner who finds himself/herself in financial straits, fails to make the required mortgage payments and faces a foreclosure suit, is not interested in testing state or federal jurisdictional requirements, either pro se or through counsel.  Their focus is either, “how do I save my home,” or “if I have to give it up, I’ll simply leave and find somewhere else to live.”

    In the meantime, the financial institutions or successors/assignees rush to foreclose, obtain a default judgment and then sit on the deed, avoiding responsibility for maintaining the property while reaping the financial benefits of interest running on a judgment. The financial institutions know the law charges the one with title (still the homeowner) with maintaining the property.

    There is no doubt every decision made by a financial institution in the foreclosure process is driven by money. And the legal work which flows from winning the financial institution’s favor is highly lucrative. There is nothing improper or wrong with financial institutions or law firms making a profit — to the contrary , they should be rewarded for sound business and legal practices.  However, unchallenged by underfinanced opponents, the institutions worry less about jurisdictional requirements and more about maximizing returns. Unlike the focus of financial institutions, the federal courts must act as gatekeepers, assuring that only those who meet diversity and standing requirements are allowed to pass through.  Counsel for the institutions are not without legal argument to support their position, but their arguments fall woefully short of justifying their premature filings, and utterly fail to satisfy their standing and jurisdictional burdens.  The institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance.  Finally put to the test, their weak legal arguments compel the Court to stop them at the gate.

    The Court will illustrate in simple terms its decision:

“Fluidity of the market” — “X” dollars,

“contractual arrangements between institutions and counsel” — “X” dollars,

“purchasing mortgages in bulk and securitizing” — “X” dollars,

“rush to file, slow to record after judgment” — “X” dollars,

“the jurisdictional integrity of United States District Court” — “Priceless.”

On Being Boyko-ed

2007-11-26T12:59:00.000-05:00

The ruling by Judge Christopher Boyko (US District Court, Northern District of Ohio), on October 31, 2007, that Deutsche Bank could not proceed with the foreclosure of 14 Cleveland homes unless it could prove that it owned the mortgages at the time foreclosure began, has been a source of numerous questions, one of which was "Does that mean the homeowners now own their homes free and clear?".

Unfortunately for the homeowners, the answer is "No". Somebody still owns the mortgage deed to their property. What Judge Boyko addressed was the fact that Deutsche Bank had been named the trustee for the mortgage pool (the "derivatives" sold to investors), and could not show that the actual mortgage had been sold to them.

What is critical to understand is that the homeowners DID borrow the money, and they DID sell an interest in their homes (via the mortgage deed) to a lender. However, under Ohio law, all real estate transfers must be matters of public record, and the interest in those mortgage deeds, wherever they are, were never transferred to Deutsche Bank. Thus, the investors, for whom Deutsche Bank is the trustee, may not actually own anything other than a paper promise to repay issued by the mortgage originator. Sort of a play on Federal Reserve notes being a promise to pay but not being backed by anything but faith in the US Treasury (which faith appears to be evaporating).

What Judge Boyko verified was that only the entity that had a recorded interest in the property (i.e., was an owner of the actual mortgage deed, and not just somebody who had loaned money to the owner of the mortgage deed) had any standing in the foreclosure suit.

The unmentioned possible ramifications are a herd of different colored horses. Deutsche Bank's attorneys complained to the judge that nobody had ever asked them to prove ownership before. Deutsche Bank, moreover, has been the leader in foreclosing Cleveland homes. As foreclosure orders went out to hundreds of other homes without proof the plaintiff owned the mortgage, the homes were abandoned, vandalism destroyed much of the equity, and the homeowners and mortgage deed holders suffered some severe losses.

So now an important question : were all those uncontested foreclosures legal? If not, who is liable for the damages? I can think of some interesting possibilities.

The holder of the actual mortgage deed sues Deutsche Bank for the damages caused by fraudulently foreclosing on its property. (Deutsche Bank may be in a bad position for countersuing over any amounts it might claim the mortgagee owes its investors because it initiated the foreclosures without legal standing.)

The homeowners sue Deutsche bank for fraudulently forcing them out of their homes.

The mortgagors and/or mortagees band together in class action and petition the court to void the foreclosures and Sheriff sales of the properties (and any subsequent REO sales) because the foreclosure suits were fraudulent. This could cause a cascade of losses to the lenders who loaned on the REO purchases.

Angry citizens petition their legislators to remove the judges that allowed the foreclosures to take place without requiring proof of ownership.

et cetera.

Indeed we live in interesting times. I foresee a need for hordes of new attorneys, and a doubling or tripling of the number of courts at all levels. As an owner of options for Royal Bank stock (option value = 517.67 pence, current market value 413 pence, down from over 600 pence last summer), I am certainly happy to not be holding options for or stock in Deutsche Bank. I have no problem seeing why bank stocks are being eyed with suspicion, especially those banks that have boldly sought to be trustees for mortgage derivative products.

Mining for Data - Part 9 : The Finale

2007-11-21T23:37:00.000-05:00

We began with the recognition that understanding trends in a real estate market involves data collected not only over a historic time period, but that also the most current data may be several months out of date. We also stated that knowledge of current listings, their marketing histories, and the typical exposure time in the market helps us interpret current market pressures. Such information is important to investors in order for them to make sound financial decisions.

In the second installment, we pointed out that an accurate neighborhood description is critical to maintaining the credibility of an appraisal report that has come under scrutiny. The third installment pointed out some of the general difficulties that would be encountered in trying to nail down an accurate neighborhood description. It also outlined some sources that can be used to help build a good neighborhood description; one that lends itself to gathering sales data on an objective basis and without ambiguity.

Session four dealt with the mechanics of searching the public records section of Realist.com in the CRIS MLS system for the recorded sales and exporting the data to a file for later analysis. Installment five walked us through the process of converting the Realist.com data exports into Excel spreadsheets and formatting the spreadsheet into a more useable tool.

Session six dealt with making certain the data in the spreadsheet fit some basic assumptions, and then presented the mechanics of finding the measures of central tendency for the data. The seventh installment tabulated and compared six years' worth of statistics from Realist.com and the CRIS MLS, for the same neighborhood, and session eight discussed the discrepancies in the two statistical sets.

The sad truth is that all of this has been tedious work. It has been an exercise that would be totally unappreciated (and possibly resented) by the loan officers who order the appraisals, and the findings would possibly be an irritant or inconvenience for the administrative reviewer or underwriter who had to deal with the appraisal report containing them. In most cases, the appraiser doing this kind of analysis would find that if he were searching out and using truly comparable sales for the appraisal of his subject, the neighborhood description would make no difference whatsoever in his opinion of value. Why, then, go to all this trouble?

Value is a subjective matter. The appraiser renders an opinion of value that is uniquely his own. The client then relies on that opinion to make a decision. It must be assumed that the decision is significant enough that the client has required an unbiased opinion of value. The credibility of the opinion rests on the trust that the client places in the appraiser, and in a modern marketplace, it is not usual that the client personally knows and trusts the appraiser. The appraiser's credibility is established in the truthfulness and internal consistency of his appraisal report.

The appraiser may say, "I know this neighborhood. Houses sell for $X,000 - $Z,000 and I believe my subject is worth $Y,000." He may have a well reasoned value opinion -- but what if the rest of his report was "Plucked From Air" to suit the comfort of his client?

We have reached a point in history where irresponsible lending practices, founded in the greed and carelessness of both investors and borrowers, are generating widespread economic tragedy. Homeowners are losing their homes to foreclosure, and investors are losing their hope of long-term gain. Litigation to fix the blame for this tragedy will drag many appraisers into the courtroom to testify in their own defense. The simple fact is that the data existed all along to establish the characteristics of a neighborhood with acceptable accuracy, and yet many appraisers bungled that part of their job.

Even if the appraiser in litigation can show that his comparable sales were valid, and can explain his reasoning for making adjustments to those sales, a clever attorney for the plaintiff can avail himself of the true neighborhood description for the subject property. It will come down to the heart-wrenching plight of a destitute borrower, who has become homeless, against the appraiser who was relied upon to be accurate in his reporting of the facts. Then, if the appraiser has no factual basis for the neighborhood description in his report, even though his value opinion may have been reasonable when viewed against the comparables, his credibility before a jury will have been diminished and he may be seen as a contributor to the plaintiff's woes.

Set against this, taking a bit of time to find the facts and report them, distasteful as they may be to the loan officer or real estate agent who simply wants a quick close to the sale or refinance at "whatever number it takes", is cheap insurance.

Mining for Data - Part 8

2007-11-12T08:27:00.000-05:00

Looking at the sales statistics from Realist.com, and the statistics from the same neighborhood, over the same time period, from the CRIS MLS, reveals some startling discrepancies. The mean sales price rose from $60,600 in 2001 to $73,000 (rounded) in 2006, according to the Realist.com figures -- a 20% increase. The MLS data, however, shows a decline from a mean sales price of $57,000 in 2001 to $39,300 in 2006, a 32% decrease. The Realist.com data shows an increase in the predominant (mode) sales price from $62,000 to $80,000; the MLS shows a decrease in the predominant price range. How could there be such a discrepancy?

Remember our assumptions from Part 6? We assumed that each transfer shown by Realist.com was the only transfer of the home that year. When we look at the MLS data and cross-check with the Auditor's sales histories, we find that a large number of the sales that are in the Realist data set are "flip" sales -- homes that sold earlier in the year as foreclosure and REO sales, and which were then resold at a much higher price by the investors who initially bought them.

The "flip" sales, for the most part, do not show up in the MLS because of a simple law of economics : real estate agents work on a commission basis and do not take on listings which they cannot sell on the open market. The majority of the "flip" sales are private sales made to buyers who do not understand the market, do not understand the terms of the financing that they are undertaking, and are not getting their money's worth in the deal. You can sometimes see these homes in the MLS as expired listings that failed to sell at their list price and went on to be sold for MORE THAN their open market list price.

If somebody offered to sell a home for $60,000 and nobody would buy it in a 60 or 90 day marketing period, would you pay $75,000 for that house? There seem to be people who are that stupid. There seem to be appraisers who are willing to value the real estate at the contract price regardless what the market as a whole is doing. There seem to be lenders who are willing to finance such deals. There seem to be securities investors who are willing to put such mortgages in the portfolios of 401(k) plans. Would you buy a stock or mutual fund that was based on such securities?

The situation is ready-made for a bookie. It is possible to examine the sales histories of many of these homes, drive by them to examine their physical condition, and then make a bet as to how long it will be before they are in foreclosure again. In fact, as I sorted through the sales data (and you probably saw it as well, if you did this exercise), some of these homes have been foreclosed two to three times in the past six years!! Some of the investors have bought a home from the bank, "flipped" it to a gullible buyer, and within the six year period, bought it back from another bank and "flipped" it again!

Maybe it is time for the Kingston Trio to redo "Tijuana Jail" with new lyrics?

Government statistics for real estate sales generally follow the path of the stats derived from the Realist.com data. To be sure, Realist.com DOES include all the sales, including the foreclosure/REO transactions, in the full report sheet for each property. It is the cumulative sales search that only reports the final price for the year in the search results. That is only logical; there is no practical way to report the multiple sales in a search which has fixed start and end time parameters. It is the negligence of the statistician, however, whether he be a bureaucrat or an appraiser, that is responsible for the misreporting and/or misinterpretation of the data.

Next -- finally -- a recap and conclusion.

Mining for Data - Part 7

2007-11-07T20:09:00.000-05:00

We have gone to a lot of trouble to this point to gather sales data and massage it to provide some statistical picture of how the neighborhood market has been performing. The data from Realist.com can be summarized like this [apology for the massive white space]:

Summary of Data from Realist.com
Year	# Sold	Min SP	Max SP	Mean SP	Median SP	Mode	Std. Dev.
2001	39	$30,000	$129,000	$60,619.23	$59,000	$62,000	$17,967.33
2002	42	$23,000	$118,500	$62,476.19	$59,550	$35,000	$20,502.13
2003	56	$12,003	$157,500	$67,249.98	$67,100	$55,000	$23,168.68
2004	84	$15,000	$175,000	$72,363.56	$75,000	$80,000	$30,403.45
2005	71	$8,900	$147,700	$74,739.11	$75,500	$75,000	$27,609.10
2006	89	$21,525	$116,500	$72,970.78	$75,000	$80,000	$19,934.08

So what does this seem to tell us? It appears that the mean and median sales prices in this neighborhood have increased by roughly 25% over a six year period. This fits the general trend that has been trumpeted through the land with respect to rising property values. The data from the MLS needs to be added to provide some information about average market times :

Summary of Data from CRIS MLS
Year	# Sold	Avg DOM	Min SP	Max SP	Mean SP	Median SP	Pred. Price Range
2001	42	62	$19,000	$129,000	$56,957	$50,200	$30,000-$39,999 (8)
2002	42	86	$20,000	$131,000	$53,146	$39,500	$20,000-$29,999 (11)
2003	60	75	$7,000	$157,500	$42,365	$31,550	$30,000-$39.999 (18)
2004	66	77	$8,000	$130,880	$49,339	$35,125	$20,000-$29,999 (19)
2005	69	83	$11,000	$139,900	$40,506	$32,000	$20,000-$39,999 (18)
2006	80	85	$9,500	$109,900	$39,343	$30,500	$20,000-$29,999 (24)

WAIT A MINUTE!! THAT CAN'T BE RIGHT!!!!

Tune in next time for another exciting adventure with Top-Notch Appraiser, and we will try to make some sense of this. In the meantime, go back and think about those assumptions that had to be made with respect to the data from Realist.com.

Mining for Data - Part 6

2007-11-06T08:33:00.001-05:00

Spreadsheets were designed with number junkies in mind. They can do all kinds of wizardry with their built-in mathematical functions. Once you learn one of them, all the other spreadsheets are easy to adapt to, since they seem to have all been designed after the pattern of their grand-daddy, VisiCalc. We begin by opening the file "2001 sales data.xls" in the spreadsheet; I am using OpenOffice's Calc.

We have already set up columns A, B, and C to hold the information about Tax ID, Recording Date, and Sales Price, and the rows were ordered by ascending street number and street name. There are some assumptions we have to make at this point if we are not going to be going back and checking the Auditor's web site for every property on the list.

The first assumption is that the recording date shown is the only transfer for that property in that year. In the event the home transferred more than once (e.g., a foreclosure followed by REO sale followed by investor flip), only the final transfer will be shown. The second assumption is that the transfer is an actual arm's-length sale; this cannot be guaranteed since Realist sometimes reports as sales the sale of partial interests, transfers into revocable trusts, land contract agreements, and multi-parcel transfers by investors. It is worth the effort to scan down the list to see any "sales" that do not have a sales price and check the Auditor's web site; if those transfers need to be removed, simply click on the row header to the left of column A and delete the row. A third assumption is that Realist will not always have the entire data set; they sometimes miss a transaction. While the data is good, it will not be perfect.

One other consideration : beginning with the 2003 data, it seems that Realist is reporting a transfer having occurred in that year, but any subsequent transfer shows up with its more recent recording date and sales price. In the event such transfers show up, the Auditor's site must be visited to obtain and extract the correct data for the year under consideration. Example : 931 Bloomfield shows up in the list of 2003 transfers with a 10/11/2007 recording date and sale price of $50,000. That transfer is actually the second transfer in 2007 (a foreclosure sale) following an investor sale 6/21/2007 for $54,350. The 2003 sale occurred on 3/3/2003 for $69,900 (which, incidentally, was a "flip" after a sale 8/19/2002 for $22,500; a sale that did not show up in the 2002 Realist sales search).

An even better example is 438 Beechwood, which sold in foreclosure 1/15/03 for $25,000, as an REO on 1/31/2003 for $18,000, and then as a "flip" on 9/29/2003 for $69,900. To be as consistent with my data as possible, the latter is the information I will use for 2003. What will not show up is the fact that the home at 438 Beechwood was subsequently foreclosed again on 9/22/2005 for $36,000, sold as an REO 3/8/2006 for $24,000, and again as a "flip" on 5/15/2006 for $80,000. Any appraisal done on those sales was required by Federal law (USPAP) to have all prior sales within 36 months disclosed. Was the law broken? Did an underwriter ignore the facts presented? Did a loan officer somewhere alter the appraisal without the appraiser's knowledge? Only a jury can determine if fraud was committed.

Scrolling down to the bottom of my spreadsheet, I find that the final transfer is in row 40. Since row 1 contains the column headings, this means that Realist.com picked up 39 recorded sales in the neighborhood in 2001. In column A, I move to row 42 and type "Min", in row 43 "Max", in row 44 "Mean", in row 45 "Median", in row 46 "Mode", and in row 47 "SD". We will use the spreadsheet's math functions to find the range and measures of central tendency, as well as one standard deviation from the mean.

For those who just got lost, I recommend reading Conceptual Statistics for Beginners by Newman and Newman (1994). Dr. Isadore Newman is the man who opened my eyes to how statistics can be used and misused, and introduced me to the concept of the Null Hypothesis (the Type 1 Error), forever changing my view of how scientific research ought to be conducted and reported. Just a plug for a great teacher.

Moving to column C, row 42, type "=min(c2:c40)". This will find the lowest sales price for the data set in column C from rows 2 through 40. When you press "ENTER", the number $30,000.00 appears. You are now in row 43 of column C. Type "=max(c2:c4)"; the high sales price of $129,000.00 appears when you press "ENTER". In row 44 of column C, type "=average(c2:c40)" and press "ENTER"; the mean sales price for 2001 was $60,619.23. In row 45 type "=median(c2:c40)" to get the median sales price of $59,000.00, and in row 46 type "=mode(c2:c40)" to get what we can take to be the predominant sales price of about $62,000.00. In column C and row 47 type "=stdev(c2:c40)" and the spreadsheet will calculate the amount of one standard deviation from the mean, which comes out as $17,967.33.

This information tells us that the measures of central tendency -- the mean, median, and mode -- are all very close to each other; the average sales price was about $60,600, there were the same number of sales above $59,000 as there were below $59,000, and the most commonly occurring sales price was $62,000. If we were to graph the data we might expect a normal bell curve, and the standard deviation of about $18,000 tells us that 68% of all the sales in this neighborhood in 2001 occurred within the range of roughly $43,000 to $79,000.

An underwriter presented with this kind of information might ask a few more questions before granting a loan for more than the mean neighborhood sales price on a home in this neighborhood. As I mentioned in Part 2 of this series, however, he is not likely to get this kind of information because (1) appraisers have learned that in order to keep appraisal orders coming in, they should not report information that causes the value opinion to vary from the stated neighborhood predominant price by more than 10%, and, (2) nobody is paying them enough to take the trouble to do this kind of analysis; in fact, there is constant pressure to reduce the price for an appraisal and consequently to reduce the quality of the work. Had this kind of information been sought out and presented, we might not now be in the midst of a housing market melt-down.

Next : Summarizing some findings.

Keep them buckets movin', Ben...

2007-11-02T10:09:00.001-04:00

So yesterday the Fed pumped another $41 BILLION dollars into the bailout. $70 billion from the Fed before, $100+ billion by the banks themselves, and another $41 billion -- this is starting to make the S&L bailout look like chicken feed. At least Congress hasn't put any tax money into it yet.

BUT -- I predict that they will. The banks are taking heavy hits on their earnings (and bankers pay lots of money to political campaigns), the dollar is sinking, foreclosures are still increasing, and despite the seeming good news with respect to economic growth, the price of fuel and all other commodities is also going up. It has only been optimism (and denial of reality) that has kept things going this far.

Henry H. Harrison (editor of REV magazine) has predicted that the downturn in housing prices will continue for years. I think he may be right. We are overbuilt and overpriced and overborrowed.

Mining for Data - Part 5

2007-11-02T10:00:00.000-04:00

There are a number of ways to manipulate data. Since I am an old hacker from way back -- my first spreadsheet was DynaCalc, running under Microware OS-9 back in 1986 -- I tend to prefer spreadsheets over databases. They may not be as pretty sometimes, but they get the job done. Excel seems to be the spreadsheet of choice, but many people balk at the price of Microsoft Office, which does not normally come bundled with their computer, so an excellent alternative is OpenOffice's Calc application ("scalc"). Calc looks like Excel, behaves like Excel, and it is free.

We have downloaded our data reports in .csv format, so they are comma delimited text files. They also have funny file names, courtesy of Realist, such as "1856407_39153.csv", which can be a pain to keep track of. We need to organize our data. With the right mouse button, click on the .csv file name, and "Open With..." scalc (or Excel, or whatever your spreadsheet is called). Once the file is open, you can see from the data just what kind of fish you have caught. In this case, we see 2001 sales data for the 44302 ZIP Code. I saved that as "2001 44302 raw.xls" in a folder called "Realist Raw Data".

The full report starts out with tax mailing information, which I don't need for anything, so I simply highlight all those columns by holding down the Control ("CTRL") key and clicking on each column header, and then delete. That leaves the Tax ID field in column A. By clicking on the column B header, all of column B is highlighted, and a new column can be inserted. This is done twice, to make two new empty columns. I then go across the top of the spreadsheet, reformatting the column widths to whatever I find comfortable. Because both columns B and C are now empty -- the whole sheet has been shifted right by two columns -- I have room to move the "Recording Date" and "Sales Price" fields.

Click the header cell directly above "Recording Date". The entire column will highlight. Position the cursor over the "Recording Date" cell, press and hold down the mouse button, and drag the entire column to the left, into column B. Do the same thing with the "Sales Price" column, dragging it to column C. You now have the Tax ID number in Column A, the Recording Date in column B, and the Sales Price in column C. This will be handy for doing the stats later. Don't forget to save your spreadsheet early and often.

The 44302 ZIP Code has addresses from several Census Tracts. Click on cell A1 to park the cursor in a handy spot, then from the Data menu, choose Sort. A Sort Criteria window will open. At this point we will sort by Census Tract; the second sort criterion can be set to Carrier Route ( a little trick that will make it easier to fine tune the Census Tract Block Numbers, which are not a provided sort criterion). When the sort is done, we find that we can highlight all the data for Census Tract 5064 and 5065, copy it, and paste it into a new spreadsheet. I named the new spreadsheet "2001 sales data.xls" and saved it in a folder called "Realist Stats".

The file "2001 44302 raw.xls" can now be closed. I repeated the process of creating .xls files from the .csv files for each of the downloaded reports; there were 18 altogether. The files that I had named "2001 44313 raw.xls" and "2001 44320 raw.xls" were manipulated in the same way as I had manipulated "2001 44302 raw.xls", and the data for Census Tracts 5064 Carrier Route C053 and Census Tract 5065 copied from each and pasted into "2001 sales data.xls". At that point, I had a spreadsheet with all the recorded sales for 2001 within the neighborhood bounded north by Amelia, east by West Exchange, south by Copley, and west by Storer.

The whole process was then repeated for each of the years 2002, 2003, 2004, 2005, and 2006. As each "200x sales data.xls" sheet was completed, it was resorted using as the criteria (1) Census Tract", (2) Street Name, and (3) House Number. The data was scanned to make sure that properties located on the northeast side of Exchange Street were not accidentally included, and the files were then ready for a year-by-year analysis of the sales data.

Next : Crunch Time

Mining for Data - Part 4

2007-10-31T10:43:00.000-04:00

Having decided on a neighborhood -- in this case, the portion of CRIS MLS Market Area 21 that lies east of Storer and south of Amelia, and which just happens to take in Census Tracts 5065 and Tract 5064, Blocks 4 and 5, it is time to collect all the transactions in a given time period. A quick peek at a ZIP Code map of the area reveals that three separate ZIPs are found there : 44302, 44313, and 44320.

We will use Realist.com for the data source, since it is one of the tools supplied to Realtors in the CRIS system. This tool is accessed by clicking the "TAX" button in the main CRIS menu bar. We will do a General Search of the tax data.

The General Search window for Realist.com is used for setting our search parameters. Searches can be done in Realist by ZIP Code and by Municipality. If there are multiple Census Tracts in a given ZIP Code (as there will be with this search), the data can be sorted by Census Tract later as needed.

First, the general search criteria. We are looking for single family market data. The "State Code" portion of the Land Use menu should be set to "Sort Numerically"; this allows you to easily pick LUC 510. Then we choose "Akron City" and ZIP "44302". The recording date fields are now set; we are going to gather all the sales data since January 1, 2001, but in order to do this in a manageable way, we will take the data one year at a time. The starting and ending dates for this search are set at "1/1/2001" and "12/31/2001", and the "SEARCH" button is clicked. In short order the "Property List" records are presented. For my purposes, I prefer the "Single Line View".

Now to extract the information so that we can save it and not worry about having to do this search again. Click the "EXPORT" button. You will be taken to the "Export Builder". Be sure you check "Select All" for the fields to be printed in "Full Records". That will give you more information than you will need (or want), but again, the data can be fine-tuned later.

Set the "Full Records" export choice to "Excel", and click the "EXPORT" button. The Export Status window will soon appear. From there you can go to the Export Manager to download the report, back to the Property List, or back to the General Query for a new search. The exported data will wait in the Export Manager until you are ready to save the report to your hard drive. It will be in the form of a comma-delimited text file, or .csv format.

We will go back to the General Search pane and follow this procedure for ZIP Codes 44313 and 44320 as well. When that information is gathered for 2001, we repeat the process for 2002, 2003, 2004, 2005, and 2006. If we were updating our information for a current appraisal assignment in 2007, we would also draw the information from 1/1/2007 through the current date, but until that information is needed, it is best to pull data sets for complete years. Realist allows CRIS users to download only 5000 records per month under their CRIS account, and this kind of information is too valuable to waste. Of course, you can always buy the data separately from First American, but part of the reason for this tutorial is to teach utilization of existing resources.

Finally, in the Export Manager, we will download each of the reports to the hard drive. We are ready to sort and crunch some numbers.

Mining for Data - Part 3

2007-10-29T13:21:00.000-04:00

Reporting the market characteristics of a neighborhood is not always an easy matter. There are some states which are non-disclosure states; the actual sales price of a property does not become a public record. Ohio requires disclosure of the final sales price, partly because the counties levy transfer taxes based on the amount of the transaction. To fail to record the actual sales price of a property is a matter of tax fraud, and thus the sales price for any non-exempt transaction is readily available in the public records. There are many exempt transactions, such as some foreclosure sales, which may not show a recorded sales price. It is because of those cases that multiple sources of data are handy.

For the Realtor (and every appraiser should belong to his local Board of Realtors simply to gain access to the MLS), the MLS is the primary source of sales data. It is probably the only reliable source of listing data as well. The MLS has come a long way from the days of paper books and stats charts compiled once a month; today, the appraiser can specifically define a search for a type of property, refine the search, and create meaningful statistical interpretations of the market over varying time periods.

Within the CRIS MLS system used in the Akron area, neighborhood searches can be performed by either specifying the subject's MLS market area, by specifying a radius around the subject, or by a "rubber band" map search using up to ten way-points. I prefer the latter, because the agents, who are responsible for the data being input into the system, sometimes deliberately put the property into an adjacent market area which has slightly better appeal. It is not uncommon, for example, to find homes located in the East Akron (East) area listed as being in Ellet, because they are in the area served by Ellet High School. The "rubber band" search uses GIS information from the public records, and if the neighborhood boundaries have been properly defined to include homes with the most similar age, size, design, and location characteristics, those properties will be included regardless which MLS area the agent indicated.

As an example, let us say that our subject is located on Noble Avenue, north of Copley Road, in what has been designated as the West Akron (South) MLS Area (Area 21). Area 21 is bounded generally on the north by Frank Boulevard, east by West Exchange Street, south by Copley Road, and west by Copley Township. The subject is in a submarket that can be described as primarily average quality two story homes built between WWI and WWII, in the region east of Storer Avenue and south of Amelia Avenue. To be sure, there are some newer Capes and ranches, and some older (and higher construction quality) two story homes in that area, but the predominant housing stock was built in the Roaring 20's (my grandfather built such a home on Noble Avenue).

It just turns out that the submarket described above includes all of Census Tract 5065 and most of Blocks 4 and 5 of Census Tract 5064 (the homes on Amelia and northward are of generally better quality and more like the homes east of Exchange Street in Blocks 1-3 of CT 5064, part of the Northwest Akron MLS area, Area 23). It is a neighborhood marked by a relatively high number of investor-owned, tenant occupied dwellings, and also has had a relatively high percentage of foreclosure and REO sales in the past several years. On the positive side, the city has invested heavily in upgrading the infrastructure in an attempt to increase the overall appeal of the area.

When a "rubber band" search of this region is done, all of the sales in a given time period will fall into the net, and using the different MLS reporting options, the sales data can be sorted so as to include all sales, or to exclude sales which obviously have not occurred at arm's length because they were REO. From there, a statistical report can be generated which will provide the number of sales, the average market time for the final listing period, the low, high, mean, and median sales prices, and a means of determining the predominant sales price range. The sales of homes which were obviously owner-occupied can be identified and studied. Armed with such data, the appraiser now has one way of supporting his statements about the market characteristics of the subject neighborhood.

You can bet your little red booties that the average appraiser has not gone to this trouble, because it is time-intensive, because the typical client doesn't care unless there happens to be a problem with default down the road, and because the results most likely would not make an underwriter comfortable when dealing with a refinance transaction where the opinion of value was high enough to meet the ratios but also high enough to warrant a detailed explanation as to why the appraiser thought the subject was an obvious overimprovement for its neighborhood. In the end the borrowers suffer, the lenders suffer, the neighborhood suffers, and the credibility of the appraisal profession suffers.

Mining for Data - Part 2

2007-10-24T18:51:00.000-04:00

A knowledge of the subject property's market area is essential to providing a credible opinion of value for the property. The second section of the 1996 URAR Form and the third section of the 2005 FNMA URAR Form deal with the characteristics of the neighborhood. It is sad but also a bit amusing, when reviewing appraisal reports, to see how frequently appraisers appear to use PFA (Pluck From Air) as their primary data source for neighborhood information. Much of this nonsense is lender-driven, because underwriters set guidelines for neighborhoods and housing that is acceptable for their lending portfolio, and the loan officers then pressure appraisers to make sure the report does not contain information that would cause a loan application to be rejected.

It is uproariously funny to read an appraisal report for a house in the City of Akron (a major metropolitan area), done by an appraiser from Cleveland, which states that a home in central Akron is in a "suburban" neighborhood. This helps allow the appraiser to explain why he used comparables located more than a mile away to support a value opinion that nearby sales of similar homes would simply not support. It is also good for a chuckle to see an appraiser from just about anywhere, (for example -- I have reviewed work from Texas and Montana where the population density was perhaps 10 people per square mile, and even from Wayne County, Ohio, the second largest dairy county in the US in terms of milk production), describe a rural neighborhood as "suburban" simply because there are lenders who shy away from lending in rural areas. Because some lenders require a specific explanation when the subject's value is more than 10% above or below the predominant neighborhood sales price, some appraisers will simply plug in their final value opinion for the subject as the predominant price. Whatever makes the client happy (and generates repeat business), or whatever is fastest (because the pressure is on to provide speedy turnaround) has been the prevailing business model for many appraisers.

There are several places to get neighborhood information, and census.gov is a good one, albeit in 2007 the data collected in 2000 is somewhat old. The appraiser simply needs to take care in disclosing where he got the information, especially if change is taking place in the neighborhood. Land use patterns can be developed by accessing regional planning commissions, or local municipal planners, or, if databases like Metroscan or Realist.com are available, through searches based on land use codes.

The process of developing accurate descriptions of neighborhood characteristics is often tedious, and will consume much time for which the appraiser will not be paid by any client. Lazy appraisers may simply copy from other appraisers' reports without verifying the information, or may simply guess at what they hope will pass scrutiny. The chance that the appraiser will be held accountable for the neighborhood description is very small, since most of the emphasis in review and litigation centers around the description of the subject and the sales comparables. There is, however, that old saying in real estate that the three most important factors are location, location, and location; inaccuracy in describing the neighborhood will result in a deceptive value opinion. Further, if the appraisal is challenged in court, the credibility of the entire report may suffer if the neighborhood data section can be shown to have insupportable information.

The neighborhood boundaries must be well defined. FNMA prefers that they be defined by physical characteristics, such as streets, bodies of water, land uses, or even types of dwellings. Every real state agent knows that buyers are strongly influenced by school system boundaries, and a good example is the Ellet market in Akron. Traditionally, the area served by Ellet High School has been highly regarded, and a portion of the East Akron (East) CRIS MLS market area is within the Ellet district. It can be shown, statistically, that homes in that portion of the market tend to sell for more than homes of similar age, size, and design in the portion of the market served by East High School. The boundaries for the high school districts are readily available from the Akron Public School system.

However, there is a strong possibility that use of a school system boundary can open the appraiser to a charge of violating civil rights laws, since schools are associated with children and children are associated with familial status, which is a protected class. It is fortunate that in the case of the Ellet district, the boundaries also very closely correspond to census tract boundaries, and if those are used as search criteria, there is much less chance of a civil rights violation being charged as long as the demographic data does not enter into the description. Because the Ellet area is so prominent, mention of the school system cannot be avoided, but the use of the school boundaries alone is probably not defensible.

With some data services, the number of search parameters is limited, but the data provided can be further sorted by using spreadsheets and then analyzed via the built in statistical procedures. In the end, however, the appraiser must have a grasp of what is statistically significant and what is not, and that generally means that he must be familiar with his target market area.

Again, the time consumed in building a neighborhood description means that it is best to build a good one and stick with it, regardless whether the subject property "fits" the client's guidelines. It is safer to provide an explanation for a property that is not "typical" than it is to redefine "typical" in terms of the subject simply to provide a quick turnaround time or make an underwriter happy. It may not be good for business -- clients tend to shoot the messenger when they get bad news -- but it is legal and ethical and if your bills can be paid somehow, you will sleep better at night.

Mining for Data - Part 1

2007-10-22T19:12:00.000-04:00

The appraiser's opinion of the value of a property on a given date is always subject to certain assumptions. If I am an investor trying to maximize my gain through trading of stocks or securities, I want the most up-to-date information about the market, including both the current price quote and some information on trends not only with respect to the price itself, but also the number of shares being traded in a given trading session. If the price is rising with large numbers of shares being traded, it is a different market than one where the price is rising with few shares being traded. Supply and demand always has an impact on price and value.

Real estate sales reports are victims of much longer time lags than stock trading reports. It is for that reason that so many people were caught by surprise when the national real estate market began its decline in late 2005. While technology has allowed us to close the information gap somewhat by speeding up certain processes, the real estate sales cycle does not normally operate very quickly (at least not from the perspective of a stock trader). Let us examine the process, first.

When a real property owner decides to sell his property, he does not simply submit a "sell" order to his broker and wait for the notice to arrive in his e-mail that the sale has taken place. He needs to determine what asking price should be attached to the property, and that entails a valuation of some sort. He may do it himself by looking at advertisements for other properties along with public data about sales of other properties near his. Or, he may hire an appraiser to do the work for him.

Of course, I recommend the latter -- that is my business -- but it is going to cost the property owner about $350 in this area for a good residential appraisal (one that is more than a simple "CMA" done for free by a real estate agent hoping for a listing). In actuality, that price for an appraisal may be a very cheap investment tool, when the time value of money is considered. A $100,000 mortgage for 30 years at 6.5% has a $632/month payment; if the appraisal helps to sell the home only two weeks faster, it has paid for itself in saved house payments. Relocation companies, which buy a house from the employee as an incentive to the move and then hope to resell the home and break even, generally contract for at least two separate appraisals, which must have values within 5% of each other; if they are not, a third appraisal is sometimes ordered. Relocation appraisals are more complex, and rather than providing "market value" provide an anticipated sales price involving a forecast of the next 90-120 days in the market; they are also more expensive (about $500 each) and yet the relocation companies consider them to be important investment tools because they save money in the long run.

There are some limitations to the ordinary property owner doing his own research and valuation. The first is a lack of objectivity; the fact that anything a person owns is automatically going to be seen as being "better" or more valuable than most other properties competing with it. The second is a restricted data pool from which to draw information; a professional should have access to subscription data sources which are much more extensive than those an ordinary consumer can access. A third is general knowledge about market trends, both long and short term, since the most available data is always that which tells of the success of other participants in the market, and downplays their failures and mistakes.

I need to inject a caveat here which may sound like I am up on my soapbox again, but government statistics are notoriously untrustworthy. They tend to be compiled by agencies having a vested interest in the outcome, whether it be the increased ability to collect taxes, or the need to trumpet the success of a government program and ensure the employment of the bureaucrats involved. Further, the expansion of on-line information sources, many compiled by individuals motivated by "causes", tends to increase the possibility that any data obtained could be tainted by prejudicial effects. Care must be exercised in choosing data sources.

The data used in an ordinary appraisal for marketing purposes should be as recent as possible, and if older data is used, sales prices of the comparables may need to be adjusted for the effect of market change over time. Six months is normally considered to be a reasonable parameter for the date of sale, but it should be kept in mind that the closing date alone may not be the only time factor involved. If a person puts his property on the market today, he will do so at what he thinks is a proper asking price. If the property is priced correctly, it can be expected that a certain "exposure time" will elapse before an agreement with a buyer will occur. That information is hard to come by, unless the listing history of the comparable, including all price reductions, is available, because a "reasonable exposure time" may not be the same as the total market time of the property. Further, after a sales agreement is executed, there is usually a delay between the time of agreement and the actual recording of the sale (the closing date). Thus, if a typical marketing time (based on a reasonable exposure period) is 60-90 days, and a typical time to closing is 3-4 weeks, use of a six month old sale without the additional marketing information can give a very deceptive indication of value depending on whether the market is rising, stable, or falling.

I'm going to keep these posts as short as I can, so this novella will be in installments.

Slap my forehead! Deja vu!

2007-10-18T20:39:00.000-04:00

I was just looking back at some of my earlier posts and the one on August 8 caught my eye. There I reported that the Fed had pumped over $70 billion into the banking system, but that the S&L Bailout in the 1980's had cost the taxpayers over $150 billion.

Then, earlier today, I updated and republished my post for September 21. In a note at the beginning, I commented on the $100 billion fund some of the banks are setting up to bail out the bad loans.

Quick -- what is 70 + 100 ? Does $170+ billion injected into this mess to date cause any alarm bells to ring when compared to the $150 billion mess of the 1980's? What exactly did the Congress fix when they changed the banking regulations back then?

Let ME make a few suggestions:

1. Require PMI for all loans that exceed the 80% LTV ratio, and amortize that insurance premium into the life of the loan. If the borrower pre-pays, fine, but he should not expect to recover that insurance premium. If he takes out a real estate collateralized line of credit or second mortgage, either of those options should carry PMI if the total LTV on the property exceeds 80%.

2. Require that all securitized (essentially all Federally related) real estate transactions based on a collateral valuation be underwritten using a real appraisal, and that the appraiser be at minimum state licensed and chosen through a central clearinghouse in the same way that VA appraisers are assigned their appraisals. This would take the loan officers competely out of the loop as far as ordering appraisals, would do away with the de minimus loophole currently in place.

Those two items alone would put the home mortage industry back on a solid foundation. The opposition will come mainly from three groups -- the mortgage bankers themselves (they do not want to give up their power over the appraisers), the civil rights lobby (which will see the insurance requirement as a hindrance to minority home ownership because it would increase the cost to the no-down-payment buyer), and the Realtor associations, which are opposed to removing the de minimus loophole (and thus closing off a source of income to unlicensed valuators).

Maybe Congress can sneak it through in a bill giving themselves a raise.

Bernanke Bites the Bullet

2007-09-21T22:14:00.000-04:00

***This is long, I originally wrote it for 9-21-07, but discovered that I had UNDERestimated some of the figures and have just now gotten it fixed for human consumption. In hindsight, I may have been too optimistic, considering the $100 BILLION slush fund that CitiBank, JP Morgan, and Bank of America are putting together to buy up bad loans...***

BBB may not stand for Better Business, Buster as much as Bungling Boogers in the the Boardroom.

The U.S. American consumer is getting the closest haircut in quite a while. What generally goes unsaid is that the Federal Reserve System is a private banking group which exists for the benefit of its member banks. The Fed regulates borrowing between banks, and in doing so, adjusts the availability of credit for commerce throughout the country.

Ben Bernancke's recent move to lower the discount rate is going to have some serious repercussions for the consumer. A major market for bonds has been foreign investment, and American buying habits have created a huge imbalance in the flow of dollars. Foreign governments now hold a significant share of our currency, and they have been watching our credit market woes.

The lenders (read investors in mortgage securities, with heavy emphasis on banks as the primary conduits for lending) are beginning to have trouble with their cash flow. In order to keep the economy running strongly in the aftermath of 9/11, the Fed reduced the discount rate to its member banks and they in turn were able to loan money at lower than what should have been market rates. To cover their potential future earnings, the lenders strongly emphasized adjustable rate mortgages, and in the race to compete with one another, added incentives to borrowing such as interest-only balloon loans with 5-7 year terms and adjustables with teaser interest rates that were far below market. In those crazy days it was not unusual to see a lender that could, itself, borrow at 5%, turning around and loaning the money at 2%.

While this may leave the ordinary person scratching his head over what appears like a losing scenario, the lenders had a plan. They were counting on the rates to increase in the future; the adjustables were set to begin increasing at 1%-2% increments per year after the 12-24 month teaser period ended, and the adjustments would follow the market rates current at the time of adjustment. To be sure, there were caps on the rates, but let us take a look at what is and will be happening.

Let's create a fictitious homeowner, Danny Dumkopf. (No offense to anyone named Danny, I just like the alliteration.) Danny has a house in Anytown, which he bought in June 1990 for $100,000. He put 20% down, and borrowed $80,000 at 10% for 30 years (which was an acceptable interest rate back then since we were just recovering from the Savings and Loan bailout.) His monthly payment was $702 and a few cents. In June 2005 Danny was feeling like buying a new car and taking a vacation and doing some remodeling around the house. He was offered a chance to refinance his home with a 30 year adjustable rate mortgage at 2% introductory rate with a 6% cap and 2% increments; the adjustments would begin in 24 months. He understood that the maximum interest rate he could possibly pay was 8% by 2009. That seemed like a good idea in 2005, when he was still thinking about the 10% rate he had gotten in 1990.

He had already been paying for 15 years, and he had significant equity -- but he still owed about $65,000 and had 15 years to go at $702/month. The new car would cost $25,000, the vacation $10,000, and the new kitchen and bath and carpet and windows and siding would cost another $60,000. Average sales prices were up, there was data to indicate the house was worth way more than the $100,000 he had paid for it, (the refinance appraisal said the house was worth $206,000, which was what was needed by the lender to make the loan) and Danny was approved for a $165,000 refinance, including the closing costs. His monthly payment would drop to about $610, a savings of almost $100/month!! No-brainer, dude!!

It is now June 2007. His mortgage is about to reset. Rates are hovering at about 5.5%; Danny's rate will increase by 2%, to 4% for the next year. In two years' time he has paid back about $8,200 of the loan and his principle is now $156,800. His monthly payment will go to $776 for July 2007. Ooops. He goes back to the bank to refinance, at 30 years again and a 5.5% rate, and the appraisal on his house comes back at $200,000 (the market is down, but even this appraisal was tailored to "hit the number"). And he finds that his monthly payment would jump to $890, which he cannot afford. He sticks with the $776/month payment, in the hope that the market will come back up and rates will go down.

The Fed knows we are now in trouble, and will attempt to manipulate the rates. However, they can only do so much, because such huge chunks of our currency are in foreign hands. The foreigners are already shying away from our bond markets because they are worried about the stability of our currency. Ultimately, either our interest rates must rise, or inflation must increase. Rates will have to gradually rise, and an 8%-10% discount rate is more than reasonable. In fact, it is what the lenders were counting on in the first place when they loaned that money at the teaser rates.

Back to Danny. It is June 2008. He has another reset to face, and still owes $153,700. The Fed has held the line on the rates as best it can, but they are still at about 6.5% and Danny's rate will reset to 6%, or a payment of $959/month.

Some other things to consider. Danny bought the house in 1990. He put $20,000 down. It is very likely that a buyer of a $100,000 home at that time, who had $20,000 cash to put down, was probably in his early to mid-30's. Let's say Danny was 35 then. He is 62 today. He may even be retired already. His pension or Social Security could handle the $610 per month payment, and maybe that is what he was looking at when he made his stupid move. However, it may not be able to cover a $959 per month payment. He will have to sell his house.

That could be a problem. While mean and median sales prices have certainly increased since 1990, those figures have been skewed upward by new constructions and resales of the newer homes. In terms of actual appreciation, there are very few places in the country where existing homes have appreciated by more than 25%-40% over the last 25 years. Danny's home may actually have a market value far less than what the refinance appraisal said, even if that was supposed to be market value at the time.

If the market is still soft (and the projection is, that with so many people in the same boat as Danny, it will be) the sale plus closing costs may allow him to break even, at which case he is without a home on his retirement income, or worse, still owing money on his refinance. His other option is to walk away from the home and let the lender foreclose. There will be many Dannys who do that, and the foreclosures will add to the depression of the market. If you do not like the word depression, I advise you to learn it and get used to it.

Back to the foreigners. They are the investors who bought so heavily into our mortgage securities and government bonds. The mortgage securities are now causing havoc in the credit market, and credit is tight because investors are hard to find (they don't want to increase their risk, and the mounting foreclosures are telling them the risk is real.) Mr. Bernancke is trying to keep the funds flowing and bail out his member banks, and to do that, he has lowered the discount rate so they can borrow from the government more cheaply. This causes inflation to increase; the government basically has to print more money to feed the banks, and the foreigners, seeing the devaluation of the dollar, are now shying away from U. S. government bonds and securities and selling their U. S. dollars to buy Euros and gold, which they think are now more stable. The Loonie is now at parity with the USBuck, and a 2x4 which formerly cost $2CDN and thus perhaps $1.80US will now cost $2US; the price of new construction, remodeling, and repair is about to go through the roof.

I hope Danny enjoyed his car and his vacation.

FHA Relaxing Standards?

2007-09-18T23:30:00.000-04:00

One of the interesting ideas flown at the FHA Update Seminar I attended in Cincinnati on September 6 was the one where FHA is planning to do away with testing appraisers on FHA requirements before they are added to the FHA Roster. While that may add a LOT of appraisers to the roster, it may ultimately create some additional risk to FHA when appraisals are submitted which do not properly identify problem areas in homes.

At one time, an FHA buyer could fairly well assume that the house he was buying had no significant defects, because the FHA appraiser was to submit the value opinion subject to the Valuation Conditions addendum. The Valuation Conditions addendum no longer is part of an FHA appraisal. FHA relies on the appraiser to use his own judgement in calling for repairs. That is not a bad idea, but if the appraiser has not been tested to find out if he actually understands the criteria, it may not be a very good idea, either.

FHASecure - a cautious attempt to help

2007-09-03T09:53:00.000-04:00

Having been on the HUD roster as an FHA appraiser since 2000, the following HUD news release is of special interest, because it will probably spur a greater demand for FHA appraisals.

It should be noted, however, that the proposed program is not a panacea. The homeowner must have at least 3% equity in the home, and there are huge numbers of borrowers who were put into no-down-payment mortgages, and whose homes were over-appraised in order to meet the underwriting requirements. Coupled with falling home prices (and values), those borrowers may be beyond help unless the lender can find an appraiser who will commit appraisal fraud on their behalf.

I predict that the FHASecure program will help that segment of the population that resisted the popular HELOCs and merely refinanced their existing mortgage with an adjustable in order to reduce their monthly payment. I further predict that we will see more programs being designed to bail out the HELOC crowd, since the caps on the FHA mortgages were not increased. The FHASecure program is truly tailored to lower income, lower priced housing borrowers. The high rollers will soon come begging to the Feds for similar assistance.

**********
from http://www.hud.gov/news/release.cfm?content=pr07-123.cfm
**********

BUSH ADMINISTRATION TO HELP NEARLY ONE-QUARTER OF A MILLION HOMEOWNERS REFINANCE, KEEP THEIR HOMES
FHA to implement new “FHASecure” refinancing product

WASHINGTON - President George W. Bush today announced that HUD's Federal Housing Administration (FHA) will help an estimated 240,000 families avoid foreclosure by enhancing its refinancing program effective immediately. Under the new FHASecure plan, FHA will allow families with strong credit histories who had been making timely mortgage payments before their loans reset-but are now in default-to qualify for refinancing.

In addition, FHA will implement risk-based premiums that match the borrower's credit profile with the insurance premium they pay-i.e., riskier borrowers pay more. This common-sense, risk-based pricing structure will begin on January 1, 2008.

"Many hard-working American families who were able to make their mortgage payments under the initial teaser terms of the exotic loan are now struggling to make ends meet because their rates have doubled or tripled," said HUD Secretary Alphonso Jackson. "FHASecure will bring stability to the housing market and give eligible families who were in good financial standing before their loans reset a chance to keep their homes."

The combination of FHASecure and risk-based premium pricing will permit FHA to return to the role it was originally designed to play, bringing stability to the real estate market by helping break today's cycle of foreclosures and price depreciation and creating much needed liquidity in the now-constricted mortgage market.

FHA has recently experienced a substantial increase in the number of conventional borrowers refinancing into FHA products. With FHASecure, it can help even more. The number of these refinancing transactions has tripled since the start of 2006. FHA's transactions are projected to surpass 100,000 loans by the end of the fiscal year. To date, these figures do not include refinances for delinquent borrowers.

The FHASecure initiative will operate under the same safe guidelines as the FHA's existing mortgage insurance program without affecting FHA's financial health. Eligible homeowners will be required to meet strict underwriting guidelines and pay a mortgage insurance premium, which offsets the risk to FHA's insurance fund at no cost to the taxpayer.

The risk-based insurance premium structure will further expand FHA's reach to additional underserved borrowers, particularly minorities and first-time homebuyers who have been disproportionately lured into exotic mortgages, and enhance the FHA's overall risk management. The move to risk-based premiums ensures that FHA remains on solid financial footing as a self-financed agency for the long-term.

FHASecure, like all FHA products, will be underwritten to ensure the borrowers have the ability to repay the loan, will require escrow for taxes and insurance, and will continue to offer unprecedented foreclosure prevention assistance. The FHA has never permitted and will not include pre-payment penalties or teaser rates that are common in exotic mortgages and have caused much of the current market troubles.

To qualify for FHASecure, eligible homeowners must meet the following five criteria:

A history of on-time mortgage payments before the borrower's teaser rates expired and loans reset;
Interest rates must have or will reset between June 2005 and December 2009;
Three percent cash or equity in the home;
A sustained history of employment; and
Sufficient income to make the mortgage payment.

"FHASecure is designed for families who are good borrowers but were steered into high-cost loans with teaser rates," said Assistant Secretary for Housing-FHA Commissioner Brian Montgomery. "These homeowners, many of whom are minorities, need a safe, affordable mortgage product that will help build wealth. All FHA borrowers pay mortgage insurance premiums to offset claims to the FHA insurance fund and ultimately prevent risk to the taxpayer."

FHASecure will also bring much-needed liquidity to the mortgage market. FHA anticipates more lenders will offer FHA-insured loans, pool them, and securitize them with the Government National Mortgage Association (Ginnie Mae), which has the full faith and credit of the U.S. government. This guarantee makes Ginnie Mae's mortgage-backed securities the safest on the market and helps to channel greater capital into the housing market, benefiting U.S. homeowners.

Since its inception in 1934, FHA has helped almost 35 million people become homeowners, making it the largest insurer of mortgages in the world. The 109th Congress introduced the Expanding American Homeownership Act in June 2006 which would enable FHA to be a safe option for more underserved low- and moderate-income and minority families so they can achieve the American Dream of homeownership. Today, President Bush also urged Congress to quickly pass the Administration's FHA modernization proposal to help more families in need.

For more information about FHASecure and other FHA products, please call 1-800-CALL-FHA or visit www.fha.gov or www.hud.gov. For a list of your local homeownership center or a HUD-approved housing counseling center, go to www.hud.gov/offices/hsg/sfh/hcc/hcs.cfm

-###-

Questions .. and an attempt at answers.

2007-08-22T14:32:00.000-04:00

The Harris Poll group surveyed 2225 adult USians the week of July 6-13 to learn that about 2/3 of them knew little about world politics, and, seemingly, from the way the results were reported on Breitbart.com, about the same percentage don't know what is going on in USian politics, either. That is a scary set of statistics, and one can only hope that the ignorant stay home at election time. Of course, they could get off their soap opera channel and do some work reading what candidates have to say, what the issues are really about, and study a bit of US and world history. Just as likely, the height-challenged emergency substitute childhood careperson (We do need to maintain our political correctness, do we not? I wonder how they say that in Spanish?) could drop about $100 million in my checking account, tax free, also.

I am throwing out an unsubstantiated guess that roughly the same percentage of USians have no working understanding of economics. An even smaller proportion have any clue as to why there is turmoil on Wall Street over interest rates. I fielded two questions today that no one had asked me before.

The first had to do with the reason home values for insurance purposes have continued to rise when market values for the same homes are in decline. This is addressed by looking at the fact that there are several kinds of value. The market value of a home, as defined on the FNMA appraisal forms, has to do with the most probable price a willing seller and willing buyer, neither acting under duress, can agree upon for the home. When there is a lot of unsold inventory, for whatever reason (high interest rates keeping people from borrowing, overbuilding by developers, etc.), the seller must reduce his price to get the buyer to choose the seller's home over a competitor's home.

Insurance values, on the other hand, have less to do with the resale value of a home and are almost enirely concerned with the replacement value. As inflation increases (which can be done through lowered interest rates, by the way), the cost of rebuilding goes up with the cost of the materials and labor. The costs can also be artificially manipulated, as happened when the US restricted the import of Canadian softwood lumber in an attempt to protect US lumber workers, or in the case when a competitor begins buying up all of the surplus lumber (As happened when the Canadians turned to the Japanese as an alternative market, and the Japanese continued to buy even after the US lifted the import restrictions. Keep a sharp eye on the Chinese, who are competing with us for petroleum.). Also, insurance values have to include the cost of cleaning up the damage and hauling away the debris. Most insurance companies will only replace up to 80% of the value, figuring that they won't have to replace a foundation if the house burns to the ground. On a new construction, at 80% replacement, the insurance company is near a break-even point when market value and insurable value are compared.

The second question had to do with why so many mortgage lenders were downsizing or closing down their operations. Most people think they go to the bank for a loan, and Jimmy Stewart is on the job. What they do not realize is that Congress and the regulators changed the rules of the game a quarter century ago when they had to bail out the savings and loan companies. When the rules changed, mortgage brokerage came into its own.

Let's say you want to be a mortgage broker (OK, don't shoot me, I'm going to simplify this a great deal). You get a license (now required most places, but only in the past few years) and round up 100 people (Investor A) to provide seed capital. They are your shareholders, and at $10,000 per share, put up a million dollars. You find five customers who want to borrow $200,000 each, and loan out the million dollars at 7% for ten years. Over the 10 years, they will pay $393,308 in interest. You package the loans as securities, and by the end of the second week sell the package to Investor B. You have to discount the package so Investor B will pay you right now, so you charge him only 6% ($60,000) simple interest. You pay a loan servicing company 2.5% ($25,000) for collecting the monthly payment and passing it on to Investor B. You get a 1% commission ($10,000) for your two weeks' work. The $1,000,000 has earned $25,000, or $250 per share. You do this 25 times in a year. At the end of the year (simple math) your shareholders have dividends of $6,250 each. You have made $250,000. The borrowers are happy to have 7% mortgages. But...

What if some of those borrowers default? Both the servicing company and Investor B will lose money. If the loans were not insured (which most sub-prime loans are not), they may come to you to make good on the default. What's that? You bought a big house, a new Lexus, and took several cruises and spent the money?

Suddenly Investor B no longer wants to buy your loan packages. With little prospect of quick gains, Investor(s) A rush out to sell their shares. With some bad publicity, suddenly no one wants to buy the shares. Wall Street notices. You have no more money to loan. You are out of business.

You will have to Pass GO without collecting $100. If you were careful, you may be able to avoid having to look for the Get Out Of Jail Free card. If you were putting pressure on appraisers to hit inflated numbers in their appraisals, both you and they MAY go to jail for bank fraud. If you were careless in qualifying borrowers and sold them loans they could not reasonably pay back, you MAY end up under the bright lights of a Senate hearing. You MAY end up in consumer lawsuits.

It was a good thing (from one perspective) while it lasted. To every thing there is a season...

Catch 22 ?

2007-08-16T10:12:00.001-04:00

In an attempt to settle the markets, the Federal Reserve has injected about $71 Billion into the banking system in the past week. The effort has been made to instill confidence in the liquidity of financial institutions holding mortgage portfolios because the number of defaults has been rising so sharply. Interest rates have not been lowered since 2004, because the Fed has been worried that a drop in interest rates would fuel inflation.

Most Americans are blithely unaware that the Fed is a PRIVATE banking system -- a clearinghouse for its member banks. The money it has made over the past few years has been at the expense of homeowners who have refinanced their homes through the member banks. It would be a type of justice if the Fed, which did not raise rates sharply enough during the housing boom to slow it and create a more cautious approach to borrowing, would now be bitten by its own creation.

Efforts by the Fed to try to slow the sagging of the economy may be counterproductive. Americans have funded our economic expansion in the past decade by borrowing and spending more than they have earned. The current crunch is the result of running out of equity to borrow against. The lenders have become frightened and are tightening their criteria.

Many analysts are now saying that the Fed must lower the discount rate so that the adjustable rates can drop back. This presupposes that those who are now in economic distress over their outstanding loans will be able to refinance at lower, and hopefully, fixed rates. However, if the Fed's fears about rising inflation come true (and they may regardless, because the rise in inflation has been driven more by events outside the US than events inside the US), the increases in the cost of living may well create a situation where people still have to choose between paying their mortgage and buying food and gasoline. They are going to have to cope with rising utility prices, rising food prices, and devaluation of the dollar due to the increases in deficit spending by the government that are just around the corner.

What? Didn't lowering tax rates increase the flow of money into the treasuries? Yes it did, but only because the increased revenues were made possible by increased capital gains created by increased spending. When the spending declines from the pressure on the wallets of the people, there will be a decline in fiscal intake, which will either require the raising of taxes, the decline of government spending, or the weakening of the dollar. Political realities in view of the coming election cycle make the latter most probable.

Americans have been living high on the hog for some time. That is not bad in itself, but when it is funded by a tax system that punishes production and rewards spending, there is death in the pot. Free markets are essential to prosperity and the welfare of the people, but they cannot long co-exist under our present socialistic tax system.

Sloggin' Along

2007-08-10T13:44:00.000-04:00

Having just spent about 3 hours on-line running stats in CRIS and updating my neighborhood description and market conditions for the new City of New Franklin, I decided to check the news and caught this article about consumer debt :

http://www.foxnews.com/printer_friendly_story/0,3566,292872,00.html

I have to say, the efforts of the Dems in regard to credit and personal finance way outshine anything that is being reported about Rep efforts. Waiting for Congress to act in a responsible manner on this, however, is like waiting for latex-based paint to dry on the bottom of the ocean.

Article I, Section 10 of the Constitution prohibits any State from making any "Law impairing the Obligation of Contracts" as well as "lay[ing] any Imposts or Duties on Import or Exports", but is silent on the regulation and licensing of commerce within the individual states. If state legislators had any sense of responsibility toward the people, they would consider limitations on the usurious practices of the credit card companies. In particular, when an entity does business within a jurisdiction, it should be required to file all legal claims within that jurisdiction. The clauses which creditors use to require action against them in the jurisdiction of other states effectively shields them from many small (and VERY irritating) complaints regarding their abusive practices.

SB 185 in Ohio ( http://www.legislature.state.oh.us/bills.cfm?ID=126_SB_185 ) , Section 1321.57, contains some restrictions on abusive lending practices. Of particular interest is :

"Sec. 1345.031. (A) No supplier shall commit an unconscionable act or practice concerning a consumer transaction in connection with a residential mortgage. Such an unconscionable act or practice by a supplier violates this section whether it occurs before, during, or after the transaction.

(B) For purposes of division (A) of this section, the following acts or practices of a supplier in connection with such a transaction are unconscionable:

(1) Arranging for or making a mortgage loan that provides for an interest rate applicable after default that is higher than the interest rate that applies before default, excluding rates of interest for judgments applicable to the mortgage loan under section 1343.02 or 1343.03 of the Revised Code and also excluding interest rate changes in a variable rate loan transaction otherwise consistent with the provisions of the loan documents;"

Why can this not be extended to apply to consumer credit as well?

FOOTNOTE: A few days ago I asked an attorney whether the practice by lenders of using a Broker Price Opinion instead of an appraisal to provide a value opinion in a foreclosure action was allowed by SB 185. It clearly is ... a big loophole:

"Sec. 4763.19. (A) Subject to division (B) of this section, no person shall perform a real estate appraisal for a mortgage loan if the person is not licensed or certified under this chapter to do the appraisal.

(B) Division (A) of this section does not apply to a lender using a market analysis or price opinion, an internal valuation analysis, or an automated valuation model or report based on an automated valuation model, and any person providing that report to the lender, in performing a valuation for purposes of a loan application, as long as the lender does both of the following:

(1) Gives the consumer loan applicant a copy of any written market analysis or price opinion or valuation report based on an automated valuation model;

(2) Includes a disclaimer on the consumer's copy specifying that the valuation used for purposes of the application was obtained from a market analysis or price opinion or automated valuation model report and not from a person licensed or certified under this chapter."

I was concerned that I might have wandered into a grey area by doing work for the courts that sets the fee based on the value amount (which is unethical according to USPAP, but allowed under the Jurisdictional Exception Rule). I find that SB 185 also says, :

"Sec. 4763.12. (A) A person licensed or certified under this chapter may be retained or employed to act as a disinterested third party in rendering an unbiased valuation or analysis of real estate or to provide specialized services to facilitate the client or employer's objectives. An appraisal or appraisal report rendered by a certificate holder or licensee shall comply with this chapter. A certified appraisal or certified appraisal report represents to the public that it satisfies the standards set forth in this chapter.

(B) No certificate holder or licensee shall accept a fee for an appraisal assignment that is contingent, in whole or in part, upon the reporting of a predetermined estimate, analysis, or opinion or upon the opinion, conclusion, or valuation reached, or upon consequences resulting from the appraisal assignment. A certificate holder or licensee who enters into an agreement to provide specialized services may charge a fixed fee or a fee that is contingent upon the results achieved by the specialized services, provided that this fact is clearly stated in each oral report rendered pursuant to the agreement, and the existence of the contingent fee arrangement is clearly stated in a prominent place on each written report and in each letter of transmittal and certification statement made by the certificate holder or licensee within that report." (my bolds)

So it is legal for me to work for the court under the court's rules. Whew! For a while there I was afraid I had been committing a first degree misdemeanor.

They are waking up in Washington... on drugs maybe?

2007-08-08T09:12:00.000-04:00

Why is it that when the high rollers feel a pinch, the politicos step in and throw a bone to the little guys as an afterthought?

The foreclosure and sub-prime meltdown problem is bad. It is affecting the poor, especially those who were put into loan packages with low interest teaser rates (just about anybody can qualify for a loan at a 2% interest entry level) and adjustable rates after the teaser wore off (usually 18-24 months, which is why the loans that were taken out in 2005 are just now priming for default).

BUT ... the poor were not the only people who got sucked into the whirlpool. You see, the two giants of the secondary mortgage market, Fannie and Freddie (both GSEs), have CAPS on the amount of loan they will insure. Currently that is at $417,000. An 80% loan under those caps will allow you to buy a $521,250 house. This reduces the risk for F/F and the possibility that Uncle Sam will have to ride to the rescue to bail them out.

If you need to borrow more than the Fannie/Freddie cap amount, you can play a little moneymagic game. Get the first mortgage under the cap, and have that one insured by F/F at prime rates for 30 years, with the second mortgage secured by a sub-prime loan with a low initial rate and adjustments as prescribed. Millions of Americans have done this. Many of them bought homes in New York and New England; in fact, the main reason why the high end housing market is so slow is that the sub-prime lenders are now starting to require that their underwriters look at the deal more like F/F's underwriters do. The cost of sub-prime borrowing is skyrocketing, and it is hurting the high rollers (who are really middle managers who want to live like royalty).

Or, maybe you are not such a high roller, but you want to buy a house with no money down. F/F like to see 20% down. That is easy, too. Borrow the 80% from F/F, and borrow the 20% down payment from a sub-prime lender. Maybe this helps to explain how our housing market got into this mess.

The problem is the second mortgage. When that loan's rates increase, and the borrower defaults, the whole project goes in the dumper with both loans being called.

What about the 90%, 95%, or 99% 30-year fixed conventional mortgages that were out there? Many of those were prime, but not insured by F/F and required that Private Mortgage Insurance be purchased for the loan amount over 80%. PMI is expensive (yeah, I would charge a high premium if I were the insurer, too). The borrower had to be qualified at the time of closing to be able to afford the whole ball of wax; these people generally do not hit trouble unless they have job loss problems. OR -- they had a government grant that helped them qualify but later left them in the lurch.

Seems like Mr. Chris Dodd (D-CT) wants some action in the mortgage arena. He would like to lift the caps on Fannie and Freddie. That would allow his high dollar buddies to continue their lifestyle with government insurance.

Mr. Charles Shumer (D-NY) would like to have about $1 BILLION set aside to help bail out the sub-prime lenders. The idea there is that investors would then look upon sub-prime as favorable again, pump their money into buying those securities, and, behold!, the interest rates would drop again to where millionaires and paupers alike could afford them. Unfortunately, the estimates for the cost of the bailout are now running in excess of $120 BILLION (don't gasp, honey, the S&L bailout cost over $150 BILLION).

And, Mrs. Hilary Clinton (D-NY) would like to have $1 BILLION set aside to help low income buyers fund their home purchases. (As if that would somehow help them buy a house like hers??? Naaaa. The po' need to feel like they are getting equal treatment with the rich, or they won't vote properly.)

Where will the money for this come from? Mr. Shumer and Mr. Sherrod Brown (D-OH) want to amend the Truth in Lending Act , SB 1299 (129-A-4), requiring appraisers to be bonded --

" (4) the term `qualifying bond' means a bond equal to not less than 1 percent of the aggregate value of all homes appraised by an appraiser of real property in connection with a home mortgage loan in the calendar year preceding the date of the transaction, with respect to which--

(A) the bond shall inure first to the benefit of the homeowners who have claims against the appraiser under this title or any other applicable provision of law, and second to the benefit of originating creditors that complied with their duty of good faith and fair dealing in accordance with this title; and

(B) any assignee or subsequent transferee or trustee shall be a beneficiary of the bond, only if the originating creditor qualified for such treatment; and for 1% of their gross valuation total each year."

Let's do some math. Suppose an appraiser appraises five $100,000 homes per week, with 2 weeks off for vacation per year. His aggregate valuation amount is $25,000,000. One percent of that is $250,000. Let us assume that he gets paid $500 per appraisal (California Dreamin!!!!). His gross income is then $125,000 per year. Does anybody have a problem with this math, senators excepted? By my numbers, he would have to charge $1,000 per appraisal just to be able to renew his license each year, and more if he wanted to eat. Please remember that it is unethical for appraisers to charge for their work based on the amount of the valuation.

The cost of the bonds would then be used for bail-out purposes. The appraiser will be the goat if the borrower loses the home in foreclosure. While appraisers usually carry E&O insurance, the insurers generally make every effort to settle without trial. Once the appraiser's deductible has been used, he rarely has a chance to defend his appraisal without the insurer walking away.

Oh, yeah, under that bill, the lender gets an additional set of instructions for qualifying borrowers. That's all.

I have a better idea. Actually two of them. One, require all home mortgage lenders to conform to the Fannie/Freddie requirements and then require ALL borrowers that exceed the 80% LTV ratio to purchase PMI. Two, make the HUD-1 settlement statement a public record, disclosing to all the world exactly who got paid what in the real estate transaction, and require that the actual appraiser who did the appraisal be named on the HUD-1, with the appraised value. It wouldn't solve all the problems, but it would be a step in the right direction.

Don't tell me it won't happen. I know that already. It's too simple, and it would keep people too honest.

Today's Perspective

2007-08-07T17:01:00.001-04:00

Checking in on CRIS at about 4:55 PM, the home page contained these stats:

It looks as though new listings are still running at about 3:1 over closed sales and new contracts. Not a good situation if you are in the "gotta sell" crowd.

I watched the video clip of Jim Cramer having a meltdown over the drop in the market due to the loss of confidence in the mortgage backed securities. He made some sense, from the viewpoint of an investor who knows that the market will ultimately be unable to sustain its growth rate and must subside for a time, and who doesn't want to get caught with a portfolio that he cannot sell for a profit or at break-even.

Unfortunately, markets must rise and fall periodically. My Prudential stock has taken a 20% hit in the past month, and while it is up some since the reaction to last week's announcement that the company now thinks the sub-prime market is undervalued, I am questioning my own wisdom in holding on. With the Alt-A lenders now coming under pressure, borrowers are feeling the squeeze as the equity lines they used to buy new SUVs and take vacations are drying up.

I'm trying a new tack in finding blog fodder. Letters are being sent out to local attorneys, inviting them to submit questions they have about the appraisal process. I will then research the answers, and maybe all of us can end up a little smarter.

oops, I was too optimistic...

2007-07-24T23:27:00.000-04:00

So I go read the news, and see that Countrywide is experiencing economic nausea. This is a PRIME lender, folks, not a subprime operation. They are worried about defaults by the MOST creditworthy borrowers. Read :

http://news.yahoo.com/s/ap/20070724/ap_on_bi_ge/earns_countrywide_3

They don't seem to have any faith in the the campaign season, as I have.

Head Slapper

2007-07-24T22:20:00.000-04:00

I had one of those senior moments today.

Last week while running market stats for an appraisal in the Cuyahoga Falls (East) MLS market aea, I made the discovery that since the beginning of 2007 (actually, it began in the last quarter of 2006), mean sales prices in that market area have declined at the rate of about 1% per month. Because of that, I adjusted the sales prices of the comparables accordingly.

It was not until today that the impact of what I had discovered hit me. Consider this : a buyer signs a purchase ageement for a home in that market in January, using either FHA or conventional financing with 3% down. The deal closes at the end of March, and his first mortgage payment is due April 30. By the time he makes the first payment, he owes more on the home than it is worth; he has lost all his equity between the time the agreement was signed and the date of the first payment.

Worse yet, with listings running more than 3:1 over sales in the CRIS MLS area as a whole, and considering that today there is a 10 month unsold inventory in Cuyahoga Falls (East), a person buying a home in that market with a 10% downpayment risks losing all his equity before the end of a year.

If you have a secure job and are reasonably sure that you will not have to move in the next five years, buying a home now is probably -- again, run the numbers carefully -- a move at least equal to or better than renting, since the gloomiest prognosticators are anticipating the decline in sales prices to stabilize by mid-2008 (Elections ae coming! Elections are coming!). After that, the next 3-1/2 years should provide some recovery in pricing and coupled with the amount paid down on the mortgage, the buyer should be able to break even.

Otherwise, this does not appear to be a good time to go into debt, even to buy a home.

Non-governmental Statistics

2007-07-16T12:16:00.000-04:00

After having looked at some of the stats from both the CRIS MLS and the Office of Federal Housing Enterprise Oversight ( http://www.ofheo.gov/media/pdf/1q07hpi.pdf ) I had to laugh. "U.S. House Price Appreciation Rate Remains Slow, But Positive", says the headline. Then come the stats, and a nice bunch of graphs which show prices nose-diving since the beginning of 2006.

The OFHEO table shows a +0.84% change in house prices in Ohio for the one year period ending March 31, 2007. In contrast, the MLS data published in Ohio Realtor in January 2007 ("Ohio housing market posts second best-ever mark in 2006") showed a statewide decline of 2.1% in sale price in the period January - December 2006, and in April 2007 the published data for January - March 2007 showed a further 1.5% decline.

Therefore, it simply makes sense not to rely on headlines, especially government publications, unless you want to be fleeced. The best way to handle the situation is to crank out your own analysis, and a good spreadsheet is a valuable tool -- if you know how to feed it, use it, and understand the implications of its output.

The feeding of the spreadsheet is somewhat problematic. I am still looking for ways to feed the output of an MLS statistical report into a database, other than typing each field individually. I just set up a report template for Congress Township in Wayne County, and the public records data for the market trend analysis was drawn from PACE books. For what I needed to do immediately (the assignment was a Land Appraisal) I simply typed in the parcel number, the closing date, and the sales price, then let the spreadsheet handle finding the high, low, mean, median, and mode for each year.

I quickly realized that the data I had input was insufficient, considering that multiple transfers showed up and it became apparent that with long-term data it would be possible to track individual homes to measure possible appreciation in raw sales price. Coupled with the fact that many of the transfers that occur involve multiple parcels, it would be possible to refine site value extraction using that data. Using any MLS data, which could describe changes in homes between sales, it would also be possible to measure true appreciation as opposed to a rise in sales price caused simply by improvements to the home.

Why go to this trouble? I have recently been contacted and engaged by the U.S. District Court to perform appraisals on properties involved in Federal litigation. Three separate appraisals are required for each property, by different appraisers. I have no doubt that the results of the appraisals will vary, and depending on who is engaged for the work, the results may vary widely. I need to be ready to defend my work in the face of statistics published by the government.

There is also the specter of a tax increase due to the required sextennial reappraisal of all parcels in Ohio. Unquestionably, the value of many homes is higher today than in 2004, when the last mid-term adjustment took place. The rate of increase, however, may be open to dispute, since the Auditors statewide will be feeding government generated data into their AVMs. As with all such reappraisals, there are many people who contest the change in the appraised value of their homes, and hire an appraiser to challenge the Auditor's office. I need to be ready for that, and if a challenge occurs, be ready to defend my work.

People keep asking me if I enjoy my work. I think I'm having fun.

... more from Walter

2007-06-28T08:50:00.000-04:00

I figured this was relevant because WEW mentions the Great Savings & Loan Bailout, which is likely to be repeated sometime soon in a Congress near you ...

http://www.townhall.com/columnists/WalterEWilliams/2007/06/20/the_law_versus_orders

copy-n-paste, and then thinkaboutit

Walter Says ...

2007-06-27T09:27:00.000-04:00

(I wish I had been a student in his classes!)

http://www.townhall.com/columnists/WalterEWilliams/2007/06/27/straight_thinking_101

copy-n-paste into your browser address bar

We'll Try This For a While

2007-06-20T11:59:00.000-04:00

Maybe later I'll mess with the html but I like the post format better now.

Remodeling

2007-06-20T10:50:00.000-04:00

This site may be disrupted a bit for the next day or so. I need to change the template format -- too much wasted space as it is.

Idiots Rely on Government Data

2007-06-19T09:35:00.000-04:00

We have now extracted site values for three properties from the portion of the Southwest Akron (SUM34) MLS market area that was outlined in the map search. We also have one sale of a 45' x 108' lot (4860 sf) for $5,600 cash, which comes out to about $1.15/sf. The extracted site values for Sales 1, 2, and 3, respectively, worked out to about $0.82, $1.84, and $1.06. Thus, we have a nice range, into which the actual sale falls very neatly.

The site values were extracted from sales that took place in 2004 and 2005. Fortunately (or unfortunately, if you live in the area) there has been no increase in the average sales prices of homes in that market area for several years; in fact, the average sales prices have stabilized after years of decline. What, then, is happening to the property taxes of the people who live there? Have they gone down to reflect the change in the market? What should we say to an appraiser who states in his appraisal that he is basing his opinion of site value on the Auditor's assessed values? And how much confidence can we place in Automated Valuation Models (AVMs) that crank out their value estimates based on Public Records data?

Let's compare the extracted site values, from the actual sales, to the Auditor's appraised values for 2001, 2004, and 2006 from his data base and see:

Parcel	Extract	Auditor 2001	Auditor 2004	Auditor 2006
#1	$4,003	$2,810	$8,020	$8,020
#2	$4,797	$2,100	$5,920	$5,920
#3	$4,381	$2,660	$7,290	$7,290

What about the actual land sale on 3-17-2004 for $5,500? Well, it turns out that it resold to a builder on 11-30-2004 for $3,500. Hmmm. That was not an open-market sale, and we don't know if it was at arm's-length. It does, however, fit the pattern. The Auditor's 2001 value was $2,340, the 2004 value was $1,600, and the 2006 value ( a new house was built on the lot in 2005) was $8,020. Did the bare land suddenly become more valuable just because a new house was built on it? If the house were destroyed and the land put up for sale, would you buy it at the new value?

Every six years, Auditors in Ohio are required to do a reappraisal of all real estate. The last reappraisal occurred in 2001, and Auditors across the state are currently compiling their new numbers this year. The Auditor's appraised site values for these properties jumped 280% - 285% between Tax Years 2001 and 2002. This may have been a result of fraudulent property flipping by investors in this market (which this appraiser has been aware of since 1998), and may also have been partly a result of Federal government statistics which show increasing sales prices, also influenced by those fraudulent, non-arm's-length transfers.

The dirty little secret is this : the Auditor does not appraise homes at market value. He is not bound by the Uniform Standards of Professional Appraisal Practice, and does not typically employ licensed or certified appraisers. He relies on data from other government agencies to build his computer models for valuation, and cranks out a number. Property values across Ohio have stabilized (best case) or declined since the end of 2005. The data collected by the government is always outdated by the time it filters down to the agencies that use it. Will the 2007 Auditor appraised values reflect the boom years of 2002 - 2005, or will they reflect current conditions in 2007? Only your checkbook will know for sure.

Site Value Extraction : Case Studies, continued.

2007-06-18T09:18:00.000-04:00

Case #1

The first site we analyze belongs to a wood sided, 2 bedroom home which sold 9-3-2004 for $11,000 after a 205 day market time. Its original list price was $27,000, and it had been reduced to $23,000 at the time it sold. The MLS remarks stated that it was well maintained, with updated plumbing, furnace, roof (under 6 years), and water heater. Nevertheless, it seems to have been in less than average condition. It had an enclosed front porch and was on a 45' x 108' lot.

Marshall & Swift will be the source for the cost data, which states that for this type of home, the Low Quality, Two Story Cost Tables should be used. The numbers will be rounded. The Effective Age of the homes will be estimated based on the condition comments; this home appears to have had some updating in the past 10 years so we will judge it to have had its effective age decreased by 10 years from its actual age. We have :

YB - 1915	Eff Age 79	Act Age 89
GLA 1300 sf	$40/sf	$52,000
Bsmt 820 sf	$11/sf	$9,020
Porch 66 sf	$22/sf	$1,452
Cost New		$62,472
Phys Depr	88.8%	-$55,475
Depr Cost		$6,997

Subtracting the Depreciated Cost of the home from the open market sales price leaves $4,003 as the site value, or $0.824 per square foot of site area.

Case #2

The second case is a wood-sided, 2 bedroom home which sold 9-2-2005 for $12,000 after an 86 day market time. Its original list price was $19,900. Built in 1908, it was said to have been upgraded with a remodeled bath, newer kitchen, and freshly painted exterior. It also had an enclosed front porch. Its lot was a non-conforming parcel measuring 45' x 58'.

YB - 1908	Eff Age 77	Act Age 97
GLA 708 sf	$40/sf	$28,320
Bsmt 448 sf	$11/sf	$4,928
Porch 78 sf	$22/sf	$1,716
Cost New		$34,964
Phys Depr	79.4%	-$27,761
Depr Cost		$7,203

Subtracting the Depreciated Cost from the sales price gives us an extracted site value of $4,797, or $1.838 per square foot. Because this site was a non-conforming parcel but was grandfathered as a buildable parcel, the value per square foot may not have significant meaning.

Case #3

The third home is one which I appraised for its sale, which closed 2-11-2004. An aluminum sided 2-bedroom home that had a newer (1 year old) roof, it needed some repairs to plaster and flooring. The sales agreement also included a $1,000 concession to the buyer, which resulted in a net sales price of $18,500, a fact not reflected in the recorded sales price. The lot measured 38' x 109', and the home had enclosed front and rear porches. The repair estimate will be included in the physical depreciation figure. Due to the re-roofing, residing, and the glass-block basement windows, the effective age was judged to be about 25 years less than the actual age.

YB - 1913	Eff Age 66	Act Age 91
GLA 955 sf	$43/sf	$41,065
Bsmt 572 sf	$11/sf	$6,292
Porches 181 sf	$22/sf	$3,982
Cost New		$51,339
Phys Depr	72.5%	-$37,220
Depr Cost		$14,119

The extracted site value for this sale was then $4,381, or about $1.058 per square foot.

More next time.

Site Value Extraction : Case Studies

2007-06-14T14:18:00.000-04:00

So what do we do if we are appraising in a completely built-up area where there are few land sales? We may need to extract the value of the land from the depreciated value of the improved property. This requires a number of assumptions. We must assume that the sales price actually reflects the market value of the property being analyzed, and we must assume that we can account for all forms of depreciation. We must also realize that we will arrive at a range of value.

For our case study, we will choose an Akron market area, within the CRIS MLS Southwest Akron market (SUM34). Using a map search, the area studied was bounded north by Vernon Odom Blvd, west by Manchester Road, south by I-76, and east by the MLK Innerbelt. The area chosen is roughly described by Census Tract 5018 and Census Tract 5052, Block 1, with Year 2000 owner occupancy rates of 52% and 54%, respectively. The high ratio of investor-owned properties and the related "flipping", with equity cash-out refinancing, has created a market with very high foreclosure rates.

In the period from 1-1-2004 through 12-31-2006, that area returned 69 MLS sales. The sales prices ranged from $3,200 to $50,000, with a mean of $15,233 and a median of $13,500. The predominant price range was under $19,999. Of the 69 sales, 55 were bank repos. Out of the remaining 14, four sales of homes of similar design and quality were studied.

One land sale was found for that time period. It was a 45 x 108 lot (4860 sf) that sold 3-17-2004 for $5,600, cash, after 25 days on the market at $9,900. The parcel had previously had an older home which was condemned and razed, and the site was vacant and ready for new construction. The low sales price for a house (429 Berry Avenue) for $3,200 was a Freddie Mac repo for which the MLS remarks stated, "This house has been condemned." That site was a 25 x 125 parcel (3125 sf) which sold 12-17-2004; instead of being razed, it appears to have been cosmetically enhanced and "flipped" 9-2-2005 for $60,000 with a $54,000 loan from IndyMac Bank (according to Realist.com).

We will examine four relatively similar homes in this market pocket. We will compare the extracted site values with the lot sale that was found, and also with the 2006 Auditor's appraised value. I predict (because I already know the outcome) that we will demonstrate that appraisers who use the Auditor's site value in their reports are stupid and lazy.

	Appraisal: Auditor	Appraisal: Sheriff	Realist.com SP	REO SP	MLS Non-REO SP
Kenmore (N) Mean	$65,031.78	$67,931.51	$64,581.00	$29,929.19	$71,789.00
Kenmore (N) Median	$61,860.00	$69,000.00	$66,454.00	$30,000.00	$71,000.00

Summit Lake Mean	$39,802.00	$44,700.00	$46,074.00	$11,218.03	$21,125.00
Summit Lake Median	$38,720.00	$48,000.00	$43,553.00	$7,587.50	$22,750.00

	Appraisal: Auditor	Appraisal: Judgment	Appraisal: REO SP
Minimum Ratio	56.26	31.36	114.62
Maximum Ratio	165.12	247.81	1500.00
Mean Ratio	107.56	101.96	366.34
Median Ratio	104.12	98.63	276.00
Standard Deviation	15.92	28.29	238.74