How Did We Get Here? Past, Present and Future of Short Sales (Part 2)

In Part 1 of this series we looked at the initial wave (or more appropriately, tsunami) of the recent global economic downturn and its impact on the housing market. In Part 2 of this 3 part series we will review the impact this downturn has had on homeowners who were “responsible borrowers” but whose property values plummeted in conjunction with unanticipated income loss (or reduction) due to rapidly deteriorating economic conditions.

The second phase of the tsunami

Although the first wave of foreclosure tsunami wiped out most of the “problem” loans – the ones that should not have been originated in the first place – the storm was not over and the global economy continued to take a beating.

Impacted by the deteriorating economy, employers quickly moved to implement changes in their workforces. Unemployment increased to historically high levels and homeowners who had actually qualified for their loans began to face serious financial challenges. Two-income households were faced with pay cuts, furloughs, reductions in pay or, worst of all, the loss of one or both incomes.

The resulting loss of income impacted peoples’ ability to afford their mortgages, household expenses and other debt obligations. When, from the end of 2008 to the first quarter of 2009, retirement assets dropped nearly 50% in value, the middle class officially became part of the crisis.

Dow Jones Industrial Average 2004 – 2010

The emotional turmoil wrought upon these borrowers was significant. This was the American middle class – working families with good credit and good intentions who had not abused the system or plundered the equity in their homes to make “indiscriminate” purchases. These were people who felt they had been “responsible” in borrowing money to pursue the American Dream. They simply had not seen what was coming and wanted desperately to keep their houses, remain at home and weather the storm until “things got better and the economy turned around”.

The impact of this change in fortune took a serious toll on these peoples’ self esteem, their relationships and their families.

For the responsible borrowers experiencing financial difficulties as a result of the economic downturn, it was not a challenge to demonstrate acceptable “hardship” which lenders and loan servicers could evidence to support and ultimately approve short sale requests.

2010 – The year of the short sale?

The election of President Obama in 2008 launched an onslaught of federal legislation, the purpose of which was intended to solve the housing crisis. The Making Home Affordable (MHA) program was initiated and a plethora of programs beneath it were created to provide incentives for lenders and servicers to modify existing loans, accept deeds in lieu of foreclosure and settle short sales. Unfortunately the programs were mostly voluntary and the incentives were mostly insufficient to motivate lenders and servicers to join forces with the legislation.

Still, lenders and servicers had spent two plus years ramping up resources, policies and procedures to address handling short sales. 2010 was a year of change for the major servicers like Bank of America, Chase and Wells Fargo.

Bank of America introduced a web based portal called Equator which supported the assignment and management of bank owned property sales via asset managers and began to process all short sales through this system. It took some time but this has made Bank of America one of the better servicers to work with when negotiating a short sale.

During the summer of 2010 Chase launched a department responsible for file setup of a proposed short sale prior to the marketing of the property and an offer being available to determine the lenders net payoff. This vastly improved the processing of an approval once an offer is received.

While almost all servicers will pursue Non-Judicial Trustee’s Sale foreclosure in parallel with their review for a short sale approval, due to the fact that the lender tends to recover more in a short sale versus foreclosure, almost all lenders and servicers will cooperate to halt or postpone a foreclosure sale when they are working to approve a short sale settlement.

Wells Fargo policy changes now make most of their short sales more difficult to complete and they will no longer postpone foreclosure sales to support the closing of an approved short sale. This puts pressure on the parties in the real estate transaction. Now an approval of a short sale could be delivered in conjunction with a foreclosure sale date pending sooner than a buyer can arrange financing and complete their due diligence for investigating the property. This has resulted in some properties being foreclosed while willing sellers and buyers do everything they can to close a short sale transaction.

Legislation efforts continue

The latest program introduced under MHA, called HAFA or Home Affordable Foreclosure Alternatives, took effect April 5th 2010. The intent of HAFA, once again, was to incentivize lenders and servicers to accept short sales and settle second position lien holders while doing so. The results of this program have not been inspiring.

What was shaping up to be “the year of short sales” (see here, here and here) has turned into a very difficult year to complete short sales as lenders and servicers largely ignored cooperating with the federal programs and instead continued modifying their own programs.

The perfect storm has been raging for years now. Unemployment plays a large role in the recovery of the housing market and it will take time to reduce the current 9.0% unemployment rate to an economically acceptable level, however the economy is starting to grow and we have seen 3 quarters of improvement.

Still, political and international risks remain. The political climate in the US is polarized, the financial troubles of Europe are unsettled and unrest in the Middle East is rising. Prognosticators and pundits are comparing the unrest in Jordan and especially Egypt with the replacement of the Shah with the Ayatollah Khomeini in Iran in the 1970’s.

As US homeowners adjusted to the poor economy they became hardened to the emotional aspects of their situation. They began to view the economy through an investment perspective filter. The conversation changed from “I am in financial trouble due to the economy and can no longer afford my mortgage” to “I can afford to make my mortgage payment but my house is so far underwater in value, why would I?”

Perceiving a 10 plus year horizon for their home to become worth what they paid for it, buyers began understanding the opportunity cost of remaining in their homes compared to the impact of walking away or short selling on their credit and so, the Strategic Default was born.

In the next and final installment of this series we will discuss the advent of the strategic default scenario and how home owners that could afford their mortgages began to move to resolve holding onto an underwater investment.