Banks that received government bailout money are taking heat for spending billions of dollars on bonuses, executive pay, and lavish outings. But there’s another outrage that Washington seems to be missing: The growing number of bank-owned properties in foreclosure scarring neighborhoods across the country.
The volume of bank-owned foreclosed homes — known as REOs, or real-estate owned properties — is growing at an alarming rate, compounding the foreclosure crisis by sticking hard-hit neighborhoods with vacant and often trashed homes that drive down property values even more. REOs are foreclosed homes that lenders take back after they don’t sell at foreclosure auctions or sheriff’s sales. They keep the homes in inventory until they can be sold again.
Illustration by: Matt Mahurin
The foreclosure crisis, however, is changing the REO process, with some banks holding off on following though with foreclosures or letting empty houses sit in limbo – where they deteriorate further – instead of selling them. Some banks can’t keep up with the sheer volume of foreclosures. But others are waiting for a better deal from the government for their toxic mortgage assets, avoiding booking losses so they can qualify for more bailout funds, or neglecting homes with little value, some charge – leaving the properties vacant and vandalized. And neighborhoods pay the price for it.
Some 1.5 million foreclosed homes are expected to wind up as REOs this year, according to RealtyTrac, an online foreclosure database. Prior to the foreclosure crisis, bank REO volume totaled only about 160,000 in a normal year. In January, RealtyTrac already had 68,000 new REOs listed in its database, and the firm expects overall volume to double from last year, said RealtyTrac senior vice president Rick Sharga. REO inventory peaked last year at 900,000 properties in November. “The system is just overwhelmed,” Sharga said.
There’s more pain to come. RealtyTrac’s sampling of fourth-quarter data showed that as many as 70 percent of REOs it tracks haven’t yet been listed for sale — meaning a large number of bank-owned properties have yet to even hit the real estate market. Instead, they remain in limbo, with some banks hiring property managers to keep them up and others letting them fall into disrepair. All this comes at a time when new home sales are at record lows and the supply of unsold homes is at a record high.
“This is a big issue, and the number of REOs definitely is growing,” said Alan Mallach, a senior fellow for the National Housing Institute and at the Brookings Institution. “Its kind of like an iceberg. You only see part of it.”
What some neighborhoods see is blight, vandalism and neglect caused by vacant and foreclosed homes – owned not by speculators or slumlords, but by banks.
The problem is most deeply felt in neighborhoods in the older, urban areas in the Northeast, in the Rust Belt, and among newly constructed subdivisions in the far outer suburbs of California, Nevada, Arizona, and other bubble markets. Washington hasn’t seemed to notice – or care, Mallach said.
No one in Washington is moving to attach strings to future bailout money forcing banks to keep their foreclosed properties in decent condition, tear them down, or fix them up before dumping them on the market. For whatever reason, neglected REO inventories aren’t drawing the same attention given other bank misdeeds.
“Clearly, this was not a concern to the Bush Administration,” said Mallach. “The question is whether Treasury will do anything about it now. But some of the people Obama has put in the Treasury Department aren’t all that different. They have the same Wall Street backgrounds, the same high finance backgrounds. All this stuff looks like paper to them. It’s not about people’s lives and neighborhoods. It’s just paper.”
For people living in communities that don’t have a glut of bank-owned properties, it’s also a hidden problem, Mallach added. Fewer properties end up as REOs in stronger housing markets with more expensive homes, because people want to buy them. They don’t wind up back with banks. “I don’t think people appreciate the extent to which these other areas are being devastated by this stuff,” Mallach said.
In Cleveland, housing lawyers resorted to suing Wells Fargo and Deutsche Bank, accusing them and other banks of creating a public nuisance by neglecting foreclosed homes they owned, then unloading thousands of them at fire-sale prices of $1,000 or less to speculators and flippers. The suit, which is still pending, charges that the banks, which together own some 2,100 foreclosed properties in Cleveland, are responsible for causing property values to sharply decline. Wells Fargo received $25 billion in TARP money.
Cleveland blogger Bill Callahan, who has closely followed the city’s foreclosure crisis, noted that Obama’s new housing plan doesn’t include restrictions on what banks can do with their huge inventories of foreclosed homes. Yet for some cities, REOs have become a bigger part of the problem than foreclosures themselves. New foreclosures are “the easier part” of the crisis – with the “scary, destructive part” what banks from Citigroup to HSBC do with houses after foreclosure. From Callahan:
A federal government that’s shoveling tens of billions of TARP dollars into these corporations’ balance sheets should be in a position to assert some influence over their REO and property management practices.
Citigroup didn’t respond to a request for comment. Wells Fargo has not commented on the Cleveland lawsuit, but a bank spokesperson said Wells Fargo hires a property management firm to handle its REOs, makes sure that vacant homes are secured, and tries to put foreclosed homes back on the market as soon as possible.
“Wells Fargo is very concerned with preserving the condition of homes and neighborhoods,” said spokesperson Debora Blume.
Tom Kelly, a spokesperson for JPMorgan Chase, said the bank continues “to work hard on loan modifications,” which reduce foreclosures and the number of REOs. The bank’s interest, he said, is in getting the (foreclosed) home sold as quickly as possible.” Chase uses local real estate agents to sell REOs, and lists the properties on its website.
Regardless of lender efforts, REO problems are widespread. In New Jersey, “banks are just sitting on some of these really distressed properties,” said Robert Zdenek , president of New Jersey Community Capital, a nonprofit community development corporation. In California, newly-built subdivisions in the Inland Empire and the cities of Stockton, Modesto and elsewhere often linger half empty, with unoccupied an trashed REOs. California lawmakers last year passed a measure allowing cities to charge owners of neglected foreclosed properties up to $1,000 a day, hoping to stem the damage.
One lesson of the foreclosure crisis has been that empty houses quickly become targets for thieves, who strip them of anything valuable, including copper piping, appliances, lighting fixtures and even kitchen cabinets. Squatters and drug dealers move in. Angry former owners sometimes leave water running to damage the home, and no one repairs it. Lawns don’t get mowed or cared for; trash builds up. The cost is borne by neighbors, who have to live with the blight and who see their own home values fall as a result.
Cities are often too strapped to take care of all their foreclosed homes. Local housing courts have a hard time holding banks responsible, because they are located out of state, and servicers and lenders often point fingers at each other. Neighbors are helpless because even if they can figure out which bank owns the property, they can’t get through to contact them. The result is homes that look like this.
Bank-owned properties are the very end of the foreclosure process, the outcome that results from a homeowner defaulting on a loan, and the bank reclaims the property. The next move for the bank usually is to sell the home at a sheriff’s sale or foreclosure auction. Homes that can’t be resold there because bids are too low or because no one wants the properties are taken back by banks, which resell them or enlist real estate agents to to do so as quickly as possible, at a discount. The process generally moves at a quick pace, because banks don’t want to be managing properties and want to recover their losses as soon as they can.
But record high foreclosures in the last two years have changed the rules of the REO game.
With so many forecloses on their hands, lenders can’t quickly dispose of foreclosed houses, leaving some to sit vacant, and vandalized, before they are put back on the market. Even before that point, the foreclosure process itself can be lengthy, particularly in states with slow judicial foreclosure systems, where there is a lag of some 6 to 18 months from when the foreclosure is filed until the property becomes an REO. When a property eventually gets sold – if it does sell – it commands a much lower price, which affects the rest of the housing market as well. “The volume of problem loans has fully choked the system,” Sharga said.
Then there’s money from the Troubled Assets Relief Program. In a surprising twist, that TARP money is adding to bloated REO inventories, some say.
Some banks deliberately are holding off on foreclosing on homes and selling them as REOs, in part, because they want to avoid booking losses on their toxic mortgage-backed securities, said David Wyss, chief economist at Standard & Poor’s. Taking the losses would limit their access to additional government money, he said.
“They want to keep the paper active,” Wyss said. “They don’t want to take a loss on those securities because it affects how much they can borrow against them for TARP money.”
But something has to happen to foreclosed homes eventually. By the time some properties get to the REO stage, they are far worse off than when they first went into foreclosure. It’s “a big problem in places like Detroit, in the Inland Empire, anywhere where the housing market is just gone,” Wyss said.
Usually, banks recover 75 to 80 percent of the value of a mortgage by foreclosing and reselling the home. Because of the foreclosure crisis, that percentage is down to 40 percent, Wyss said. And in places like Detroit, it’s negative-10 percent, meaning it actually costs a bank to foreclose – giving it little incentive to do so. In Detroit, Buffalo and Cleveland, banks have been accused of walking away from homes, filing foreclosure notices but never following though. Cleveland housing professor Kermit Lind calls the result “toxic titles,” because a house is left empty, no one claims responsibility, and the city has to pay to clean it up. Housing courts in Cleveland and Buffalo have been trying to crack down on the practice.
Regardless, some banks have decided that it’s better to let a property sit, even after the owners leave, and take their chances, Wyss said. Banks and real estate agents also are reluctant to quickly list foreclosed properties as REOs because of the low bids they sometimes get, he said. “They keep hoping the market will somehow stabilize or recover,” Wyss said.
Sean O’Toole, CEO of ForeclosureRadar.com, which collects data on the California market, agreed. He said banks are hedging their bets, holding on to the possibility that the government eventually will create “bad bank” to take toxic assets off their hands.
“Lenders are consciously deciding not to foreclose,” O’Toole said. “We absolutely see that. There’s all this angst in Washington that lenders are foreclosing way too quickly, but it’s just not true.”
Sharga, of RealtyTrac, said some lenders are holding off on foreclosures until the Obama administration launches its new housing plan on March 6. The plan offers financial incentives to lenders and servicers to modify mortgage loans. A foreclosure moratorium by Fannie Mae and Freddie Mac also is scheduled to end at the same time.
As a result, foreclosures are backed up. The delinquency rate for mortgage loans reached nearly seven percent by the end of the third quarter last year, while the percentage of loans in foreclosure totaled less than three percent, figures from the Mortgage Bankers Association show.
Some loans just can’t be modified, meaning the property will go into foreclosure anyway and could end up as an REO. And lenders will have to do something, eventually, about all the foreclosed homes they haven’t yet listed as REOs. RealtyTrac predicts the housing market won’t be able to absorb all the REOs ahead until late 2011, at the earliest.
Keith Leggett, senior economist for the American Bankers Association, said it’s true that banks are backed up with foreclosures. But he dismisses that idea that TARP funds have anything to do with it. Even without TARP money, banks want to avoid losses, he said. And when it comes to foreclosures, banks are simply overwhelmed. They never were set up to sell or dispose of so many foreclosed properties, he said.
“Clearly banks are not in the business of managing real estate,” Leggett said. “When they get an REO they’re going to try to put it on the market as soon as possible.”
REOs, in fact, are adding to the troubles of already ailing banks, with new FDIC figures showing REO losses totaling nearly $27 billion in the fourth quarter, compared to $12 billion during the same period last year. One thing Leggett did agree on: The problem is only going to get worse.
Still to hit the REO process are vast numbers of homes in unfinished subdivisions, where ground was broken near the end of the housing boom. Development stopped when the mortgage market crashed. The green PVC sewer pipes that remain, sticking out of the ground and often visible from the highway, have caused them to be called PVC farms. Banks aren’t likely to be able to resell easily the vacant land from all the PVC farms, Leggett said. Surrounding communities will have to live with the result.
RealtyTrac doesn’t identify which banks own the most REOs. But foreclosures continue in areas already devasted by REOs. In Cleveland, just after announcing last month they would agree to a voluntary foreclosure mortatorium, the following banks or their subsidiaries filed 55 new foreclosure cases, according to Callahan: Bank of America, Wells Fargo, Citigroup, and JPMorgan Chase.
Foreclosed homes left behind by banks might seem like an obvious opportunity for community development groups, which could take control of the properties and redevelop them. But even that isn’t happening on a large scale, even in troubled areas, said Kathe Newman, an urban studies professor at Rutgers University in New Jersey, who has been working to create an REO database. Neighbors of an empty house may not be able to determine whether it’s an REO, who owns it, or how to track them down. “It’s really difficult to figure any of this out,” Newman said.
Zdenek, of New Jersey Community Capital, said even experienced neighborhood groups can’t quickly acquire REO properties and finance their development, given the demand. “I don’t think we can keep up with it,” he said. “There’s so much out there.”
New Jersey recently became the first state to require that banks or other entities that foreclose on a property take responsibility for it, both before and after it becomes an REO. The law goes into effect April 1.
Local ordinances also are popping up all around the country to hold lenders responsible for foreclosed homes, such as a recent effort in New Haven, Conn., Mallach said. Still, it isn’t enough, he said.
“I think the Fed has got to take a much stronger line with the banks in how they are dealing with properties and foreclosed houses,” he said. “They are a lot of things they could be doing to push banks into more responsible behavior.”
The Federal Reserve itself holds more than $100 billion in toxic-mortgage backed securities, acquired through the rescues of Bear, Stearns and insurance giant AIG, Chairman Ben Bernanke noted last month. The Fed announced in January that it was working to modify the loans it controls. But that raises the question of whether the Fed is piling up its own REOs, and what it will do with them, Sharga and others said.
The Federal Reserve in Washington referred a request for comment to the New York Federal Reserve, which did not immediately respond.
The issue goes beyond just TARP money. Bank REO behavior also spotlights what kind of regulations are needed for the financial system, and “what is appropriate behavior for banks and lenders when they deal with properties and foreclosed houses,” Mallach said.
For communities overwhelmed by bank-owned, broken-down foreclosed homes, it’s not a question up for debate. It’s their reality.