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Are Financial Conglomerates Prolonging the Foreclosure Crisis?

One way people try to avoid the damaging effects of foreclosure is through ‘short sale’ - a person who can successfully do a ‘short sale’ can avoid the embarrassment of foreclosure and potentially avoid damage to credit history.  A short sale is where the proceeds (net profit) from the sale of real estate would not be enough to pay-off an existing mortgage in which case the lender/mortgage holder has to agree to accept less than full pay-off by approving the sale.  Seller/borrower would negotiate with lender to either forgive the remaining balance on the mortgage loan or make some other payment arrangements. 

An interesting article on Huffingtonpost.com is claiming that financial conglomerates may be blocking/rejecting a good portion of these short sales and thereby making the mortgage/foreclosure crisis worse.  Here is the background story:

Brett Ellis, a real estate agent in Fort Myers, Fla., was thrilled when he got an offer for a property in Bell Tower Park in May 2008.

“It was a gorgeous property on the corner lot,” Ellis told the Huffington Post. The owner, who had lost his job, wanted to sell the apartment for a loss rather than go into foreclosure, a strategy known as a short sale.

The offer was for $350,000, and Ellis, who is a certified distressed property expert trained in executing such sales, knew it was as good an offer as he was going to get in this market. He immediately sent the paperwork into the bank.

He waited for four months. The bank finally told him it wouldn’t take anything less than $400,000—a price Ellis was sure he could never get. In September, the buyer’s agent called to say, “You know what, we gotta move on, we gotta buy something else.”

Now the property is sitting vacant as it slides into foreclosure. Its former owner’s credit is destroyed, and the house is losing value every day. “God knows what the condition is today,” Ellis said, adding he’d be surprised if the property is worth more than $290,000 when it resurfaces on the market. Add in the legal expenses involved in a foreclosure, and the bank cost itself a hundred thousand dollars more that it otherwise would have.

Keep in mind that a short sale is much less costly to both borrower and lender than foreclosure and lender may actually recoup more money in a short sale than a foreclosure.  But business dynamics or incentives are different if there is a second-lien or mortgage on the property.  There is where it gets interesting.

Financial conglomerates often serve two roles in this screwed-up mortgage system.  They are often mortgage servicer - a company that collects mortgage payments and performs other administrative functions related to mortgage loan.  The top mortgage servicers that account for over 50% of all mortgage loans: Bank of America, JP Morgan Chase, Wells Fargo and Citigroup.  These same financial conglomerates also own $441 billion of second-lien home-equity lines.  This means that if there is a second mortgage on the property it is highly probable that mortgage servicer and the second-lien holder are the same - one of the four mentioned financial conglomerates.  And guess who a borrower has to work with to get a short sale approved - that is right - the mortgage servicer.

According to research firm Campbell Communications, only 23 percent of short sale transactions are actually completed. “Three out of four potential short sale transactions fail, principally because the mortgage servicer takes too long to respond to the offer,” said Tom Popik, author of the survey. “When these same properties are later sold it further depresses real estate prices.”

Sounds like a huge conflict of interest for the financial conglomerates - being a mortgage servicer and second-lien holder on the same property.  The article offers one reason for lenders’ rejection of short sales: securitization.

The more precise answer is related to securitization, the method by which banks bundle together different mortgages and slice them up and sell the pieces to various investors. Securitization makes negotiating a real estate sale that results in a loss nearly impossible.

“The most significant aspect is that so many of the banks’ mortgages have been securitized, put together and bundled, sold off to Iceland or China or some godforsaken place,” said Dave Liniger, founder and chairman of global real estate company Re/Max, in an interview with the Huffington Post. “The bank has to go through all of the various people who are stakeholders and it becomes a very lengthy process, and the bank is turning off the realtors by not even getting answers back to them, sometimes for months.”

This is may be true but something else may be happening.  If the mortgage servicer is also the second lien-holder there is clearly an incentive to keep the first lien/mortgage performing or active because in a short sale or foreclosure the second lien/mortgage is often wiped out - no pay-off.  This means that if such a conflict or dual role is present then it is in the best financial interest of the mortgage servicer/second lien holder to keep someone in the home as long as possible even if the borrower is struggling. 

Bottom line: Financial conglomerates, who created this mess, are blackmailing us and are a huge drag on our economy.  It is long past due to break-up these financial conglomerates.