Monday, January 23, 2012

Could This Be Made Into a Business?

Reports of Romney opening up a bit of wiggle room on mortgage modification got me to thinking about why somebody isn't making serious, organized money off of short sales--and helping homeowners at the same time.  The market for this would the set of people who should strategically default, that is, homeowners whose houses are more than 10% underwater but who can still pay their mortgages.  These people haven't defaulted yet for one of the following reasons:
  1. They're emotionally attached to their homes and will do almost anything to avoid moving.
  2. They're afraid of their credit rating taking a hit, thereby preventing them from buying another house.
  3. They think it's morally wrong to default on your debts when you can pay.
So here's my question:  why wouldn't a mortgage originator purchase short sales for these people with the (contractual) understanding that they would immediately sell back the house to the homeowner for a fixed percentage price greater than the short sale price, and give them a 100% mortgage at the prevailing price?

In a little more detail, here's how it would work:
  1. Shorts 'R' Us approaches Joe Blow, the homeowner:  "We understand from the tax rolls in your area that your house is 20% underwater.  We'll broker a short sale with your lender, buy the house ourselves, sell it back to you at a profit to us, and give you a new mortgage.
  2. Joe Blow signs a contract with Short 'R' Us.  Joe Blow can get out of the contract if Shorts 'R' Us can't broker the short sale with the lender.
  3. Shorts 'R' Us goes to the lender offering to buy the property in a short sale, of course disclosing the deal with Joe Blow, as required by RESPA.
  4. Will the lender agree to this?  If it's convinced that the alternative is strategic default, I don't see why not.  They have to mark the mortgage as a loss, but if they carry the foreclosed property, they're writing down the same loss when they auction it off.  Of course, if there are secondary lienholders, things get a lot more complicated.
  5. The short sale goes through.  Shorts 'R' Us buys the house and pays off the lender.
  6. Shorts 'R' Us then immediately sells the house back to the homeowner for 2-3% more than the short sale value, and originates a new loan for the homeowner.
  7. Shorts 'R' Us then sells the loan to the secondary market (or as much of it as is now allowed by Dodd-Frank). 
  8. Lather, rinse, repeat.
What's in it for the original lender?  Well, he doesn't have to deal with the foreclosure, and he's got the crappy loan off of his books.  He does have to recognize the loss, but, duh, is that really an issue at this point?

What's in it for the homeowner?  He's got an almost-sustainable loan, with substantially reduced principal, although at a somewhat higher interest rate.   (More on this in a moment.)  He's got a fairly bad ding to his credit rating, but he probably doesn't care that much because he's got a new mortgage.  As long as he pays as agreed for a couple of years, he'll be fine, even if he trades properties.  Besides, a quarter of the country has the same ding on their credit rating.  Who cares?

Let's now look at Shorts 'R' Us in a bit more detail.  First, they're instantly making their markup on the buy-resell transaction, virtually risk-free.  It's possible that the original mortgage lender will demand that they kick in some commission, which would either reduce their profitability or force them to demand a higher markup.  Note that as the markup increases, you lose some chunk of your addressable market, because the homeowner's going to make the decision to do this based on whether his payments go down or at least stay the same.  It's likely that the new mortgage has a higher interest rate, because it's instantly underwater, although not by much.  What kinds of secondary markets are available may be somewhat limited, and the amount by which they're going to discount the loan is going to be a key variable.  On the other hand, the credit quality of the loans is higher than it looks on paper, because the homeowners have been paying as agreed and they're motivated to stay in the homes, or they wouldn't be doing this.

To sum up:

Credits to Shorts 'R' Us:
  • The markup on the re-sell
  • Commission to the original mortgage lender.
  • Discount on the sale of the loan to the secondary market.
What am I missing?  This sounds like a slam-dunk business.  Is there something that makes it illegal?

1 comment:

ken_anthony said...

The problem is housing via the bubble is way overvalued.

You could buy the bad loan from the bank but perhaps not at or below the true value of the property.

Then you tie up your money long term for only 2% or 3%.

You can make a lot more than that with less risky short term investments.

The only solution is a crash followed by keeping the govt out so the free market can do what it does.