U.S. foreclosure activity in July 2008 increased 8 percent from the previous month and 55 percent from a year earlier, July 2007, according to the RealtyTrac Foreclosure Market Report released today.

• Bank Repossessions (REOs) accounted for 28 percent of all activity during the month,

• While defaults accounted for 41 percent and

• Auction notices accounted for 31 percent.

That is in contrast to REOs accounting for just 16 percent of all activity in July 2007, while defaults in July 2007 were still at 41 percent and auction notices were at 43 percent.

This shift in percentages shows that a higher proportion of properties that enter the foreclosure process are ending up repossessed by lenders.

View state-by-state details. Balto.Co. has 210 homes up for foreclosure, translating into 1 foreclosure for every 1552 homes in the county; Balto. City has a 340 homes up for foreclosure, translating into a whopping 1 foreclosure for every 870 homes in the city.

Could things get worse? Well, according to a piece by Les Christie of CNNMoney.com, the answer may be yes.

Turns out, prime mortgages are starting to default at disturbingly high rates - a development that threatens to slow any potential housing recovery.

Here is yet another strong and very expert view who says — you bet: Merrill Lynch’s Chief Investment Strategist Richard Bernstein said that investors are significantly underestimating the risks still associated with the credit crisis and suggested that we are not even close to the end of the problems.

• Traditional Prime Mortgages: The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May 2008, compared with 1.38% a year earlier (May 2007), according to LoanPerformance, a unit of First American, CoreLogic that compiles and analyzes residential mortgage statistics.
•  Jumbo Loans: And it gets worse. Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May 2008, compared with 1.11% a year earlier (May 2007). And prime loans issued in 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.

And now, the latest shoe to drop: Prime loans are just the latest class of mortgages to suffer a spike in failure rates. First were sub-prime mortgages. Next was the Alt-A loans. Now, as prime loans are added to the mix, the resulting foreclosures could haunt the housing market for a long time.

• Home prices are already off nearly 20% from their 2006 highs, according to the S&P/Case-Shiller Home Price index.

• And there’s a strong inverse correlation between home prices and defaults, according to Lawrence Yun, chief economist for the National Association of Realtors.

• More foreclosures will add to an already massive oversupply of homes on the market. Inventories are up to about 11 month’s worth of sales at the current rate.

•  Indeed, about 2.8% of all homes for sale were vacant as of June 30, according to Census Bureau statistics. That’s up about 50% from three years ago, and near historic highs.

More foreclosures, fewer loans: The failure of prime mortgages will also make it more difficult for new borrowers to find affordable loans - and that will slow sales even more. Lending standards have been tightening for months, but if prime loans start to look risky, lenders will be even more conservative about who gets a mortgage.

About 60% of the loan officers surveyed reported that they tightened lending standards for prime mortgages during the first three months of 2008, according to the April 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices from the Federal Reserve (see our indepth MarylandCommecialTitle Blog article on this subject), which is released quarterly.

While easy credit fueled the housing boom, restricted credit is certainly contributing to the bust. The question we all want to know is …. when will all this settle?

When it comes to 1031 Exchanges, beware. Do you know who has been entrusted with your money? A recent report in the Wall Street Journal article highlighted a rash of 1031 exchanges companys that have stolen investors’ funds and used them to fund an expensive lifestyle.

1031s Loosely Defined: Thousands of real estate investors have used 1031 exchanges to defer capital gains and other taxes due when buying replacement investment property. When the rules are properly followed, a 1031 exchange — also referred to as a Starker trust or Starker exchange — allows a real estate investor to buy and sell real estate without having to pay any federal income taxes on the sale of the property. The payment of any taxes is deferred until the owner of the property dies or sells the property and does not use a 1031 exchange.

The problem is that 1031 exchange companies are unregulated, and security is not high on their list of priorities. Making sure that investors’ 1031 funds are secure is expensive and time-consuming. So a lot of 1031 exchange companies don’t do it.

In the past few months, the faltering economy and slowing real estate market have meant trouble for many 1031 exchange companies that aren’t quite on the up and up. But the sheer magnitude of some of the ponzi cases, is startling. 

•  In Denver, the owner of the Southwest Exchange Inc. acquired a number of small 1031 exchange companies, combined them together and then took $100 million of $150 million in funds to invest in some European breast implantation technology. 
• On the East Coast, the owner of another 1031 exchange company used the company as his private piggy bank, pulling another $100 million out of it for personal use.

Real estate investors looking to do a 1031 exchange should ask companies a few basic questions to help establish where their funds will be held and how safe they are.

1. Know WHO you are dealing with;

2.  Ask WHERE  the funds will be held and how they will be held;

3. Ask IF the 1031 exchange company has a fidelity bond, and if you can get a copy of it;

4. Ask IF the 1031 exchange company carries errors and omissions (E&O)Insurance on each exchange.

If you have 1031 exchange funds held with a company that doesn’t follow best security practices, the end result can be devastating.

You got it. The IRS is unforgiving on this issue. Why? Because you have the right to choose any 1031 exchange company you want. And you will still owe the taxes, even if you can’t buy a replacement property and you have lost your money.

How much could you owe? If you failed to complete the 1031 exchange for any reason, you’d owe capital gains tax on your profit, any state taxes that would have been due and the recapture on any depreciation you took.

In short, you could be completely wiped out, especially if you have been doing 1031 exchanges over and over again, deferring hundreds of thousands of dollars in profits.

Today, Bloomberg News reported that 100 of the world’s biggest banks losses from the U.S. sub-prime crisis, and the ensuing credit crunch, crossed the $500 billion mark as write-downs spread to more asset types.

Further exacerbating the situation we now see that auction-rate securities have begun adding to the losses as regulators and prosecutors force banks to buy back bonds they’d sold to clients as safe investments.

• So, Is This Prediction Right? The International Monetary Fund (IMF) in an April 2008 report estimated banks’ losses at $510 billion.

• Or, Will This Horrific Predition Come to Fruition? Predictions have crept up since the IMF’s $500M number, with New York University economist Nouriel Roubini forecasting losses to reach $2 Trillion.

The collapse of the U.S. sub-prime mortgage market has weighed down banks worldwide with losses from declining values of securities tied to all types of home loans and commercial mortgages as well as leveraged-loan commitments.

The Gap: Banks and brokers have raised $353 billion of capital to cope with the write-downs. The gap between the losses and capital infusions, which stands at $148 billion, has regularly narrowed to about $80 billion as capital raising follows write-down announcements.

Much of the news over the summer of 2008 has been negative, somewhat depressing, and duplicative. Unfortunately, our post today is much of the same, but there comes a time when there is just no way to avoid the news. The truth is that we need to know how to set our course in the days to come.

As reported by Craig Torres today in Bloomberg News, the Federal Reserve said more banks made it harder to borrow money as defaults and delinquencies on home loans soared and the economy faltered.

• The survey, conducted last month, covers 52 domestic banks with combined assets of $6.1 trillion, along with 21 foreign institutions.
• About 75 percent of U.S. banks indicated they tightened standards on prime mortgage loans, up from 60 percent in the previous survey, the central bank said.

Most domestic institutions reported having tightened their lending standards and terms on all major loan categories over the previous three months, the Fed said today in its quarterly Senior Loan Officer Survey.

Funds were scarcer for homebuyers and small businesses, credit card loans became tougher to get, and even banks’ best customers were subject to greater scrutiny.

Along these lines, read the New York Times article  — Mechanism for Credit Is Still Stuck –that analyzes the credit issue in quite some depth. Ultimately, the question is, where will the credit come from?

Defying Monetary Policy : The Fed has reduced its main rate 3.25 percentage points over the past 11 months to 2 percent. Still, rates on a 30-year mortgage stood at 6.52 percent Aug. 7, nearly unchanged from 6.59 percent a year ago, according to data from Freddie Mack.

Banks may be reluctant to lend against housing collateral that is falling in value. Home prices in 20 U.S. metropolitan areas dropped 15.8 percent in May, the biggest decline since record keeping began in 2001, according to the S&P Case-Shiller Home-Price Index.

Bandwagon Effect: When times are tough, the herd starts running in the other direction, with tougher standards pretty much across the board. And here are the facts. The economy is, in fact, faltering:

• The unemployment rate has moved up 1 percentage point during the past 12 months to 5.7 percent,  
• Delinquencies on home loans to borrowers with weak or limited credit histories rose to 18.8 percent in the first quarter from 13.8 percent a year earlier.

Large majorities of domestic bank respondents reported having tightened their lending standards on prime, nontraditional, and sub-prime residential mortgages over the previous three months, the Fed said. Of the 32 banks that originate non-traditional mortgage loans, about 85 percent reported tighter lending standards, up from 75 percent in the prior survey, the Fed said.

Prime Standards

• For prime mortgage loans, about 45 percent of domestic banks said they would tighten standards in the second half of this year (2008), 

•  About 30 percent of domestic banks said they anticipated tightening standards in the first half of 2009.

• About 65 percent of domestic banks indicated they had tightened their lending standards on credit card loans over the previous three months, up notably from about 30 percent in the April survey, the Fed said. 

•  Most banks increased loan rates over their cost of funds for commercial and industrial borrowing, according to the central bank. The proportion of banks raising such rates rose to a net of 80 percent, compared with 70 percent in the April survey.

Business Credit

• Some 55 percent of domestic banks surveyed told the Fed that they would continue tightening credit standards for business loans in the second half of this year,

• With 65 percent of the institutions making terms stricter for loans to small firms.

• Federal funds futures traders see a 69 percent chance that the benchmark lending rate will remain unchanged at the October 29 meeting.

Is there finally some positive real estate news to report on? Looks like it. As we drill down on the raw data, and move away from a macro view, there just maybe activity that is starting to turn positive.

As reported in The Mortgage Reports, for the third straight month, at least 15 of the nation’s 20 largest real estate markets showed relative monthly improvement in May 2008, according to the S&P/Case-Shiller Home Price Index.

Instead of pulling the positives out from the data, newspapers are highlighting the year-over-year, cliff-diving-like decline in prices.  Lets take a look at the facts …..

The omnibus housing bill, otherwise officially know as Foreclosure Prevention Act of 2008, passed  in a 72-13 vote Saturday (July 26, 2008), the Senate concurred with previous House amendments to HR 3221.

In effect, the passing of this bill, grants the Bush administration’s request to give the Treasury Department the temporary authority to buy an unlimited amount of the debt of government-chartered mortgage financiers Fannie and Freddie. Some say this is the most important housing bill in a generation.

Only time will tell whether that statement will prove true, or not, but one thing is for sure:there will be much debate regarding the effectiveness and the propriety of passing this bill and how each of its provisions will evolve. In terms of legislation this is more of a tsunami than a mere ripple, and clearly worth much analysis in the days to come.

And here comes the criticism: As reported today by Inman News (July 30, 2008) on the day the President signed the the sweeping housing bill, HR 3221, inevitably has its critics. Some feel the legislation is a mixed-bag:

• Including Housing Secretary Steve Preston, who’s unhappy that Congress has placed a one-year moratorium on the use of “risk based” premium pricing for FHA loan guarantees.

• Home builders are also bracing for the elimination of seller-funded down payment assistance with FHA-guaranteed loans beginning Oct. 1.

• Others in the housing industry are lamenting that a $7,500 tax credit for first-time homebuyers that will expire July 1, 2009, must be repaid over 15 years — making it, in effect, an interest free loan.

You decide. The devils in the detail. Here is a full list of key provisions in the bill (for a more detailed review, click here to go to CCHs 7 page tax analysis and detailed summary of the bill, providing keys tips and practical insights):

FHA Modernization: 

• Authorizes a $25 million appropriation to improve technology, processes, program performance, eliminate fraud and provide appropriate staffing.

• Effective January 1, 2009, it also increases the FHA loan limit to the lesser of 115 percent of the local median home price or $625,500 with a floor for lower priced markets of $271,000,

• Establishes a 12-month stay on FHA’s proposal for risk-based premiums,

• Sets the down payment requirement at 3.5 percent and

• Prohibits seller-funded down payment assistance (both direct or through a third party).

GSE Oversight Reform: 

• Creates a new regulator (five-year term, appointed by the President, confirmed by the Senate) with oversight authority similar to bank regulators,

• Establishes a new affordable housing fund and capital magnet fund to be funded by a 4.2 basis point fee on all new loans,

• Significantly changes the affordable housing goals and raises the conforming loan limit to the higher of $417,000 or 115 percent of the local median home price, not to exceed $625,500 (the stimulus limits remain in effect until January 1, 2009).

FHA Rescue:

• Creates a voluntary program – which is really the wild-card in that no one knows which financial institutions will opt to take advantage of this program – for lenders to write down the loan balance in exchange for an FHA guaranteed loan not to exceed 90 percent of the newly appraised value of home.

• The lender would pay a 3 percent FHA loan origination fee. 

• To qualify, the borrower must have a debt-to-income ratio above 31 percent on the original loan. Check out one commentators view on this controversial new provision.

• The program is capped at $300 billion.

Tax Incentives: 

• Creates a $7,500 refundable tax credit for first-time home buyers,

• Expands the volume cap for the low income housing tax credit,

• Allows for tax-exempt treatment of bonds guaranteed by the Federal Home Loan Banks and

• Exempts the low income housing tax credit from the alternative minimum tax.

Low Income and Affordable Housing: 

• Encourages the development of low-income and affordable housing by harmonizing multi-family FHA mortgage insurance programs with the low income housing tax credit. 

• Allowing these two programs to work together will result in more effective uses of both programs.

GSE Backstop: 

• Authorizes the Treasury Secretary to temporarily increase the GSEs’ line of credit and to, if necessary, buy equity in the GSEs in order to provide confidence to credit markets.

• Also provides a role for Treasury and the Federal Reserve in GSE oversight to ensure safety and soundness.

TILA Reform: 

• Requires TILA disclosures to be delivered seven days prior to loan origination,

• Requires that disclosures include examples of how payments would change based on rate adjustments in addition to disclosing the maximum possible payment under the loan terms and

• Mandates that the consumer receive early disclosures before paying anything more than a nominal fee that covers the cost of a credit report.

Empowering States: 

• Raises the cap by $11 billion on tax-free bonds that state housing finance agencies may use to help at-risk homeowners by refinancing troubled loans and

• Appropriates $4 billion for states to purchase and renovate abandoned and foreclosed properties.

Licensing: 

• Encourages state officials to create a national licensing system for residential loan originators,

• Allows HUD to create a licensing system for those states that fail to enact their own,

• Establishes minimum qualifications for all loan originators and

• Requires federal regulators to create a registry for banks and thrift employees who originate loans.

When searching for answers regarding the workings of financial markets – past, present and into the future – it is often wise to turn to The Wharton School, one of the most well respected academic institutions, for insights.

In a thoughtful piece entitled, Collateralized Damage: Commercial Mortgage Securities Are at a Standstill, the on-line journal, Knowledge @ Wharton points out that with so much media and federal regulatory attention focused on the global credit crunch, especially the securitization of massive pools of home loans, there has been little notice of what’s been happening with the market for commercial-mortgage backed securities (CMBS).

The article correctly concludes – as this Blog has been writing about in its eight published articles since November 2007 — that the once zestful CMBS market is all but gone, for now.

The Facts: The market for CMBS — packages of pooled loans backed by mortgages on office buildings, industrial properties, malls and other retail centers, and apartment buildings — has been ravaged by market conditions since last fall.

• In the first six months of 2007, 39 deals totaling $137 billion were brought to market and successfully sold, from the highest rated (triple-A) bonds down to the riskier, higher-yielding and lower-rated classes of bonds called B-pieces.

• Through mid-July 2008, only 9 deals totaling $12.1 billion have been completed, a drop in issuance of more than 90%.

• No CMBS deal has been completed since a $1.27 billion offering from Banc of America Securities on June 19.

• There are currently no CMBS deals on the market.

Read the article in full for the full history of the CMBS market. The good news is that many of the CMBS deals are solid. Now the question is where and when will the financing coming from, moving forward?

As we have said on many occassions, commercial real estate is a lagging economic indicator. We have seen the strain in other areas like residential property (sub-prime crisis), rising food and gas prices, and a tightening of consumer finance options (Home Equity Lines Of Credit (HELOC), Credit Card Defaults, etc.).

Now the tail is finally starting to wag the dog (as we indicated in our recent Blog post — What the Fed Did NOT Say : US commercial real estate prices have registered their largest monthly decline since the inception of the Moody’s/REAL Index.

Moody’s said the Index stood at 174.97 in May 2008, down 3.5% from the previous month, and 5.7% below the same period last year. This represents three consecutive months of negative returns, and the largest one-month drop since the inception of the index.

Nonetheless, the CPPI still logs an increase of 3.9% over a two-year time period.The index now stands 8.8% below the peak in October 2007. Moody’s also noted that the average transaction price is steadily falling as transaction activity continues to shift to lower priced assets.

According to Noah Rosenblatts post in UrbanDigs,

we are currently in a CRECESSION. 

Noah coins an interesting term that describes the odd economic state that we currently find ourselves in. He calls this state a – Crecession. Here is the formal definition: 

A period of economic activity where available credit is contracting and the cost of credit is rising, leading to a disruption in the credit markets and difficulties for businesses that borrow short and lend long. The result will likely be a period of asset deflation leading to a lack of growth, rising unemployment, and rising commodity inflation due to pressure on the dollar. 

Seems right on the money to me …… 

So, will you survive the CRECESSION?