Short Sales: Banks Blocking Way Out of Foreclosure Crisis

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.

It's a scenario that plays out constantly, everywhere in the United States. In a time of collapsing real estate values, where one in five homes are now under water, a short sale is increasingly the only option before foreclosure. It is less damaging to credit scores and spares the homeowner the shame of foreclosure.

It is also a better option for banks: According to one analysis, short sales resulted in loan losses of only 19 percent, compared with an average loss of 40 percent on homes sold after foreclosure.

So why aren't these sales more widely used?

The broad answer is that the American financial system simply can't handle a collapse of this magnitude. The fates of the banking and real estate industries are intertwined. But they don't work together -- and the result is that they end up working against each other.
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.

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."

Congress has had as much success untangling this mess as real estate agents.

"We've been trying to figure out probably for close to two years now why so few mortgages are being modified when it seems to make absolute business sense for the person holding the mortgage to modify rather than foreclose or to take a smaller loss selling it rather than a bigger loss foreclosing on it," said Rep. Brad Miller (D-N.C.).

Miller points his finger at securitization. Once the mortgages are bundled and sliced up into different pieces, known as tranches, the owners of the pieces get paid back according to a certain pecking order. Senior investors get paid back first and if there's a loss, the most junior investors won't get anything. It's those investors who are blocking short sales.

"The people with the least senior tranches have no reason to agree to the modification because they take a complete loss and the people in the most senior tranches don't lose anything. So they've managed to structure their mortgages in a way that makes it almost impossible to modify or sell short," said Miller.

Miller sponsored legislation to reform the bankruptcy code to allow judges to rewrite those contracts, taking away the ability of junior investors to sue and encouraging them to negotiate. But the House-approved measure died in the Senate, 51-45, killed last week by Republicans and 12 Democrats, leaving it 15 votes short of the 60 needed to overcome a filibuster.
http://www.huffingtonpost.com/2009/05/08/short-sales-banks-blockin_n_199...