Cleaning House

For struggling home owners, options are few and help is hard to find. But for the businesses profiting off them, the boom has begun


About 150 people are assembled in the sanctuary of Valley Vineyard Church in Reseda, where a foreclosure-prevention fair is getting under way. Most everybody looks nervous. Senior Pastor Bill Dwyer starts off with comforting words (“I’m sure everyone who is here is under a great deal of stress”), and then L.A. city councilman Dennis Zine offers a pep talk (“You’re not bad people—you’re good people who deserve a break”). Sponsored by a nonprofit group, the fair is supposed to help borrowers learn about their options. After filling out a lengthy orange form, they are sent into conference rooms to meet with representatives from several loan servicers, including Washington Mutual, Countrywide, and J.P. Morgan Chase. Some home owners have brought shopping bags filled with paperwork. There are smiles and encouragement.

What no one points out, though, is that loan servicers—the companies that collect and process monthly checks for the investors in control of the mortgages—aren’t motivated to make adjustments. It costs them money and cuts into the revenues they receive from late fees. (The ideal situation is for a borrower to be regularly late on making a payment but not late enough to warrant a default notice.) Sometimes the investor, be it a bank or a hedge fund, might prohibit loan modifications. Even with the government requiring lenders to make more of an effort to adjust loans for struggling home owners, the tendency is to keep stonewalling—and making money.

Dismantling the real estate boom is messy—loans to adjust, home owners to evict, foreclosed inventory to clear, vacant properties to keep an eye on. Yet the profits to be made from other people’s misfortunes, and that’s what we’re really talking about, are hard to ignore. In just the first eight months of 2008, more than 24,000 homes in Los Angeles County were foreclosed. Before it’s over, thousands of additional properties worth billions of dollars could be up for grabs.

So with little fanfare, brokers, investors, speculators, loan servicers, and loan consultants are making their move. Some are bottom feeders; all are opportunists. That includes mortgage brokers who helped arrange those too-good-to-be-true loans in the first place and who now are profiting in the business of distressed assets—the term used for something that’s not performing the way it should. “We know from lots of experience that foreclosed property markets bring these people out,” says Paul Leonard, the California director of the Center for Responsible Lending, a watchdog group.

This is a world in which negotiations are brief, indebted home owners are out of the loop, and cash is king. It’s also a world in which success and failure can be random: A bank, without explanation, might turn down a $150,000 offer on a house and then agree to a deal the next day for $100,000. The marketplace has become contorted because there’s hardly any rationale for how property gets priced. Is it 80¢ on the dollar? Is it 30¢? And who gets access to the lowest offers? Ryan Ratcliff says he was outbid on several homes in the San Diego area by mystery buyers who topped his offers by up to 15 percent. “Ghost stories and bogeymen abound,” says Ratcliff, an economist who left UCLA’s Anderson School of Management earlier this year for a position at the University of San Diego. He never figured out how these deals were cut, though he did hear whispers about foreign investors buying in bulk and listing agents who ignored bids from everyone except their cronies.

The thing is, a distressed asset may be going through default or foreclosure, but it is an asset all the same. It has an intrinsic value—in this case the home itself, the land that it sits on, its proximity to work and school, and its access to utilities (water, electric, cable) and city services (police, fire). While the marketplace might value an asset up or down at any given time, it will always be worth something. The trick is determining what that something is when it comes time to buy or sell.

“I have a lot of [investor] clients that are buying bulk sales—30, 40, sometimes hundreds of houses,” says Brent Sprenkle, senior vice president of the L.A. office of real estate brokerage Sperry Van Ness. “Keep in mind that if you have a house that’s appraised for $200,000 and you’re buying it for one-fifty, you can turn right around and put it back on the market at one-eighty and make a small profit on it. It might only be a $20,000 profit, but if you can do that with 300 houses—you do the math.” Or they might hold on to the houses for a while. “Then when the market recovers,” he says, “they go in and do some cosmetic rehab, make the place look a little bit better, and sell it.”

Not that this is necessarily in the best interest of a community. Officials in Riverside and San Bernardino counties remember the aftermath of the savings and loan crisis of the early 1990s. That’s when foreclosed homes were purchased at rock-bottom prices by outside speculators, who either rented them out or quickly turned them over for small profits. California congressman Gary Miller has introduced legislation that would encourage the Treasury Department to work with public-private partnerships in the buying and selling of distressed assets. Miller has not offered any specifics on the plan, but he figures that local markets are more knowledgeable about their real estate than an asset manager sitting in Washington or New York.

What’s little discussed about the housing meltdown is how long it’s likely to drag out. We could be looking at eight to ten years. Real estate cycles are notoriously slow to run their course even under normal circumstances, and this time it’s worse because there is so much reckless behavior to unravel. Mortgage brokers are often singled out for nudging customers into making bad decisions—and that certainly happened—but many borrowers were also unaware or unwilling to consider their financial situation. “There are borrowers who made $5,000 a month but put down $10,000 on the loan application because they wanted what they wanted,” says Bruce Solomon, a senior loan officer with Los Angeles Neighborhood Housing Services, a nonprofit that sponsors housing fairs like the one in Reseda.

He estimates that seven out of ten home owners he sees cannot be helped—that is, they won’t be able to afford a loan even if it’s adjusted downward. He can only offer them suggestions on an exit strategy, which boils down to finding an apartment and making moving arrangements. “This is different from anything I’ve seen in my whole career…?, worse than I ever imagined,” says Solomon, who started as a trainee for a savings and loan in 1973.

Despite lawmakers’ wanting to help borrowers, more than 50 percent of the loans that get modified are likely to go through redefault after two years, according to Joseph Mason, professor of finance at Louisiana State University’s E.J. Ourso College of Business. For lenders, whether it’s a bank or the federal government, the process is like doubling down on a shaky bet. What this does is delay the inevitable by extending the foreclosure process through at least 2011 or 2012. That leads to more absentee owners and more empty houses, which lowers the worth of nearby real estate and results in additional foreclosures.

Through the first eight months of 2008, there were 56,433 notices of default in Los Angeles County, nearly a 100 percent increase from last year, according to the research firm DataQuick. Going into default is not the same as going into foreclosure, but it means that the borrower has gotten seriously behind on his or her payments—typically 60 days—and that the clock is ticking toward auctioning off the home. Of the home owners going into default, only 20 percent will be able to avoid foreclosure. ?A year ago the number was more than 50 percent.

When the notice of default is placed in the public record, details about the home owner’s situation become available to anyone with an Internet hookup. That’s when the home owner starts getting bombarded with come-ons: “We work for the home owner, not the lender,” “No equity, no problem,” “Trust an attorney to modify your loan.” Dave Miller, who had been trying to hold on to his house in Quartz Hill, a community in the Antelope Valley, says that he contacted a few of those kinds of businesses. “It didn’t seem like they could do anything other than what I could do on my own,” he says. But his loan servicer wasn’t any help, either. “It got to be a complete circus,” says Miller, who kept trying to get Citi Residential Lending, a unit of Citigroup, to sign off on a forbearance agreement for his defaulted loan. “They sent me to this person in this department and another person in another department. Then I would call the original person, and he was no longer in that department.” Miller says he wired Citi Residential $4,100, but the money was never deposited. Later he was told that yet more documentation would be needed. After months of back-and-forth, Miller’s house was foreclosed. He and his family now rent.

Stan Kurland believes a bad loan can be made better well before the borrower defaults. He is chief executive of a new company in Calabasas called PennyMac—short for Private National Mortgage Acceptance Company—which acquires thousands of distressed assets (he likes to call them “troubled”) and then works with borrowers to keep a home from going into default. “Most traditional services are inundated with requests, so they have very little time and in many cases very little incentive to work with the borrower,” says Kurland. “We’re bringing fresh, patient capital to invest in mortgages with the belief that the most value will be extracted by helping borrowers stay in their properties.” Steady mortgage payments mean steady returns for Blackrock and Highlands Capital, two enormous investment firms bankrolling PennyMac’s purchase of up to $2 billion worth of properties.

Kurland is not some anonymous administrator. He spent 27 years at Countrywide Financial, the mortgage giant (also based in Calabasas) at the center of the subprime lending crisis that was taken over by Bank of America in July. He resigned as president of Countrywide in 2006, part of a management shake-up. That year his compensation totaled $42.5 million, which included a $25.4 million termination payout and $15.2 million in option awards. Kurland is not alone in making the switch: Of the 15 senior executives listed on the PennyMac Web site, 13 have had experience at Countrywide Financial or Countrywide Bank.

The association is awkward. Countrywide faces a maze of state and federal investigations into its lending practices, possible misrepresentations of its financial results, and the selling of $100 million in stock by CEO Angelo Mozilo in 2006 and 2007, right around the time the company’s share price started to fall. When I bring up the problems at Countrywide, Kurland bristles, telling me, “I try to remind people that I had a 27-year career at what was a very good mortgage company, and I left in 2006.”

Antelope Valley real estate agent Donna Oehler seems almost embarrassed when I meet her in the parking lot of a Palmdale Starbucks. “I’m busier now than I ever have been,” she says as we climb into her SUV. Oehler talks a mile a minute and carries a Treo that keeps pulsing with calls. “I sometimes think I’m not tough enough to do this,” she says, flipping through a file folder of properties, many of them foreclosed.

Oehler concentrates on REOs, or real estate-owned properties, which are homes that did not sell during a foreclosure auction and must be put back on the market. She brokers deals and manages about 20 properties throughout the Antelope Valley. REOs can be more of a hassle than traditional listings because she needs to drop by every few days to make sure the vacant houses aren’t vandalized and the lawns have been mowed. Plus, commissions are lower because she’s not working for an individual seller. Even so, there’s no shortage of business: In Palmdale’s 93550 zip code, 450 homes were foreclosed in the second quarter, according to Dataquick, compared with 102 a year earlier. That’s 28.4 foreclosures per 1,000 homes, more than anywhere else in L.A. County. Foreclosures are creeping into the San Fernando Valley and the Los Angeles basin, but not nearly at the levels seen in the Antelope Valley. The top five zip codes for foreclosures were either in Palmdale or Lancaster, while the foreclosure rate in the Sherman Oaks 91403 area was 4.3 per 1,000.

My tour with Oehler is depressing. We stop at a foreclosed property that had been used as a drug house (pencil marks on a second-floor wall indicate who paid for what). Another home, its hot tub filled with fetid water, has been in and out of escrow three times. A third house seems like a steal at $289,000; a similar property across the street, also for sale, had gone for $700,000 at the height of the market. “Some of these people walked,” says Oehler. That’s been happening quite a bit; when loans were not requiring a down payment, home owners acted like they were renters. “You see the kids’ stuff they leave behind. There are a lot of photos and toys,” she says.

As Oehler drives from one housing tract to another, for sale signs at every turn, I get an idea of how immense this sorting-out process is going to be. Massive amounts of paperwork will be required, and unlike the mortgage companies’ anything-goes approach that contributed to this disaster, loans will be tough to come by. Income, employment, taxes, credit—lenders will find almost any excuse to turn someone down. That’s assuming the borrower can afford the higher interest rates. Oehler shakes her head. She and her husband were so sure the bubble would burst two years ago that they decided to sell their own one-acre property for $260,000 after buying it a year earlier for $112,000.

Looking back, it seems so obvious. The party couldn’t have lasted forever, right? Maybe that’s what everybody wants to believe now, but at the time—well, to quote Warren Buffett, “people don’t get smarter about things that get as basic as greed.” In any financial boom, he has said, there is always a progression of participants: the innovators, the imitators, and the idiots. Too bad there’s no chance for them to just stop in their tracks and undo the havoc that’s been created by wanting so much so fast. The economy, it seems, has its own rules.

Illustration by Brett Ryder