The $700 billion bailout – what are the ramifications for:

• A potential home buyer or investor – either waiting for the market “bottom”, or simply wanting to buy a home.
• A homeowner who’s “underwater” and struggling to make the mortgage payments.
• A homeowner who’s stopped making payments and is on the cusp of going into foreclosure.
• A homeowner already in foreclosure.

Leslie and I have been talking all weekend, trying to anticipate what might happen in each of these scenarios, and to see if Congress, Wall Street and the Administration might create unintended consequences.

First, all we know today is that the requested amount of the bailout is $700 billion, that it will be administered by the Treasury, that the Treasury might use reverse auctions to buy back toxic mortgages (and only from American institutions, not foreign – in essence, stiffing the investors who’ve financed a huge portion of our debt), and that it is for a term of 2 years. The intent is that lenders/Wall Street will spin off their most toxic portfolios of loans – but what does that mean exactly?

I need to bring that down to my little world here in Ventura, Camarillo and Oxnard, so here goes…

First, what defines a “toxic” loan?

• Case 1 – A homeowner who has stopped making payments?
• Case 2 – A homeowner whose loan is going to re-set to payments that can’t be made?
• Case 3 – A homeowner currently “underwater” but is making the loan payments ok?
• Case 4 – A homeowner in foreclosure?

Second, assume the Treasury buys the loan of your neighbor who is a Case 1. Under “normal” circumstances, if your neighbor stops making payments, the lender will start foreclosure proceedings. The property, at auction, will revert back to the lender and it becomes an REO (real estate owned).

But, the assumption is this: the Administration wants to stop the bleeding. There are too many REOs (and short pays) out there, killing real estate values. For this plan to work, and not cost “us” (taxpayers) huge bucks, property values have to rise, putting more collateral behind those toxic mortgages.

So in the case of your neighbor, will the Treasury not do a foreclosure on its (toxic) loan? Some Congressional members believe foreclosures must be unilaterally stopped across the board (this has huge repercussions for contract law, among other stuff). Does this owner now get a “free ride” (not make mortgage payments) in his home? Many people violently object to this potential unintended consequence.

For Case 2 – lots of talk out there about loan modifications, ie, lowering interest rates, going to fixed rate mortgages, etc. A Bush administration plan out there (FHA Secure) would re-set the homeowner’s house value to today’s market value, then give that homeowner a fixed rate loan of 90% on that value, giving the homeowner an instant 10% equity in his home. The intent is that with equity in the home, the homeowner will be motivated to make the new payments, and the “loss” to investors would be less than if the home went back to the lender as an REO and then resold.

Is this fair? So many of those “underwater” homeowners bought their homes with no money down and now they get a “gift” of 10% equity in their home?

For Case 3 – probably a variation on Case 2?

For Case 4 – will Congress unilaterally stop foreclosures (give a “time out”)? Who knows? I personally believe that homes, where an auction date has been set, will probably go to auction, simply because it’s tough to stop a speeding ship. But the first part of the foreclosure phase is the Notice of Default stage, which gives the homeowner 3 months to solve the default, and maybe at this stage Congress will stop the foreclosure.

Finally, for the person thinking of buying real estate (homeowner or investor) in this market, see September’s newsletter: “Crisis! Danger + Opportunity?”

Are we at or close to the “bottom”? Will property values start going up because of these proposed fixes?

The next week or so will tell us what’s (maybe) coming down the road. Stay posted!