Now it’s official: according to Realtor, the Pending Home Sales Index fell 1.8 percent in September 2010 after it had slowly began to crawl back up from a major drop-off of sales in July. What kept the index artificially high during the last five months was the effect of the tax credit wearing off rather slowly. The index is based on signed contracts, not on actual closings, so it can be seen as a preview of what’s coming down the road.

Media’s Obsession With The “Robo Gate”

The media have been obsessing about the impact of the “robo gate” on home sales and it would be hard to deny that it has caused widespread uncertainty as well as disrupted lenders’ efforts to unload foreclosure inventory. The tragic human dimension of the “robo gate” makes for easy media fodder, but the underlying mechanics of the decline in sales is more complicated. It also doesn’t lend itself to random sound bites.

The Persistence Of The Housing Market Slump Has Some Good Reasons

Sales of existing homes are about even with 2000’s levels, even though the U.S. population has grown by 30 million since then.

Several forces have aligned in putting downward pressure on sales numbers. The expiration of Obama’s tax credit for first-time home buyers overlapped with the onset of the “robo gate” in a general climate of economic malaise and growing frustration with the direction of Washington. But there is more to the sales numbers than meets the eye. NAR chief economist Lawrence Yun writes:

“Tight credit and appraisals coming in below a negotiated price continue to constrain the market”.

The key word is “tight credit”. The FHA has become the largest originator of home loans since the economic downturn began. Nearly one in three buyers pay in cash.

On top of this, the “The Wall Street Reform and Consumer Protection Act of 2009” a.k.a. the Frank-Dodd bill instead of expanding consumer choices has further curtailed seller financing by putting new restrictions in place.

Hidden in the 848 pages long document (view full text here) is this:

H. R. 4173—764
§ 129B. Residential mortgage loan origination
STANDARD.—Subject to regulations prescribed under
this subsection, each mortgage originator shall, in addition
to the duties imposed by otherwise applicable provisions of
State or Federal law—
(A) be qualified and, when required, registered and
licensed as a mortgage originator in accordance with
applicable State or Federal law (…)

It does sound all pretty nice. Unfortunately, it amounts to regulatory overkill.

The law puts in place restrictions where they are clearly not needed. It would be hard to argue that seller financing contributed in any meaningful way to the growth of the subprime bubble. What those restrictions do is the opposite of what was intended: even though the bill has somewhat bolstered bank oversight, Frank-Dodd gives large banks even more leeway with consumers by eliminating buyer’s choices.

The law has been created by career politicians and voted on with an eye on its marketability in the midterm elections 2010 (another miscalculation). It was ostensibly meant to fix predatory lending and reign in Wall Street excesses. It does neither one very well.

The midterms turned out to be rather disastrous for the Democrats. The GOP managed to ride the tidal wave of discontent and re-captured the House with 239 seats (that’s 21 seats more than required for the majority). Only with some sheer luck did the Democrats manage to hold on to their now rather slim majority in the Senate. The The Wall Street Reform and Consumer Protection Act of 2009 is at the center of the ensuing Foreclosure-Gate. According to the law to be a “qualified and, when required, registered and licensed as a mortgage originator in accordance with applicable State or Federal law” means that three residential properties are the upper limit per year.

The provisions of the law are disconnected from reality.

Hidden in the Fine Print: Residential Mortgage Loan Origination

Real estate investors who are in the business of rehabbing foreclosures and REOs will no longer be able to engage in any meaningful number of deals if they also intend to provide seller financing, at least not without some additional effort. Unless they obtain a mortgage originator’s license, the law limits sellers who provide financing to three such deals on residential units at any given point in time, and puts some additional restrictions in place (on the upside, the Frank-Dodd bill has also lifted FHA’s own limit from one to three).

Sellers can still provide financing but need a man-in-the-middle who can act as a licensed mortgage originator if they want to engage in more such deals than three. This requirement will drive closing costs up by creating more red tape. And not only that. Adding insult to injury, the law will cut some consumers off from the access to financing and here is why.

In order for the seller to be able to qualify for the three properties exception, the deals must fulfill some fairly unrealistic criteria. One of  them: the seller must “verify” the buyer’s ability to pay. In the light of the recent financial crisis this provision does sound reasonable, but only on paper.

Seller financing has been an alternative for buyers who could not obtain bank financing because either they do not fit into banks’ criteria or because banks are in no mood to lend to anyone (usually at a time of crisis like now). Buyers who are too young to have any meaningful credit history or who do not have a steady source of income because they work as independent contractors or freelancer (an increasingly common type of occupation given the current job market conditions) have a hard time convincing a banker and there is a reason they should: bankers are stewards of other people’s money. But a seller who has his or her own capital at stake should have the freedom to put their gut instincts ahead of formal criteria. Restricting this freedom does not do anyone any good. The law limits sellers’ ability to take reasonable risks for no good reason.

You can go to a casino and blow all your money in a matter of minutes but you cannot take a gamble by financing a sale of your real estate to anyone you please? What kind of logic is that? (Unless sellers can execute judicious judgment as to the buyer’s ability to repay a loan they don’t stay in the business for long anyway.)

“Existing-home sales have shown some improvement but the foreclosure moratorium [a.k.a. the robo gate moratorium] is likely to cause some disruption and contribute to an uneven sales performance in the months ahead,” writes NAR chief economist Lawrence Yun in the release.

In the long run, the robo gate will be an irrelevant blip in a drawn-out and painful recovery.

So long as government agencies dominate the landscape and big institutional lenders play it safe, housing market conditions are not going to change in any significant way in the foreseeable future (all other things being equal). Banks don’t lend because they are in the business of clearing foreclosure inventory right now and in the meantime they can make good money with lower-risk high-yielding investments such as tax liens (read how Banks Gobble Up Tax Liens Hoping to Put More Homeowners Through Foreclosure).

What the Frank-Dodd Wall Street reform act really means is that larger institutions have actually gained leverage from the restrictions of the seller financing provisions of the law. No wonder lobbyists are paid so much money.

There is no point in restricting seller financing other than to help banks wield even more power with consumers. It is hard to see how tighter regulations on remote control from Washington are going to give consumers more choice.

Hopefully, the new Congress will gather enough political will to rein in the FHA and put a stop to Freddie’s and Fannie’s gamble with taxpayers’ money. Now is the time to write our representatives in the Congress what really needs to be done about the housing market.

Whether a meaningful reform has any chance of happening, we will know soon enough.