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Wednesday, July 9, 2008

Adding Context to More Mortgage Regulations Through the Most Annoying Mortgage Story of All Time

Barack Obama is fond of saying that the answer to the mortgage crisis includes a plethora of new mortgage regulations. Here is how he described it.

Obama proposed to rebuild the government's regulatory structure and promised not to clamp a too-tight hand on economic innovation. But he was unsparing in his view that industry lobbyists and weak legislators produced a misshapen deregulation of the economy.

"Instead of establishing a 21st century regulatory framework, we simply dismantled the old one," he said. "Aided by a legal but corrupt bargain in which campaign money all too often shaped policy and watered down oversight."

Obama criticized President George W. Bush, describing his proposals for dealing with this crisis as "completely divorced from reality." And Obama took on Senator John McCain, the presumptive Republican presidential nominee, who argued this week against vigorous government intervention in the housing market, saying Washington should not be bailing out banks and homeowners who in his view had knowingly plunged into risky mortgages.

To politicians like Barack Obama regulations are merely an abstract usually as a tool of politicking and vote buying. Of course, that's because politicians don't actually have to deal with the regulations they create. Once those regulations are implemented in reality they are almost always a nightmare to deal with and usually their effect is the slow down of business.

That's the flip side of regulations that politicians like Barack Obama don't think about. In theory, regulations curb irresponsible and unscrupulous behavior but in reality what it does is put further power into the hands of incompetent bureaucrats and makes business more difficult to accomplish. This story is a prime example.

I recently did a loan for the perfect borrowers. They had a near perfect credit score. They were putting down plenty of money and still had plenty left after their down payment. The issue with this transaction was the property. It was a three unit building with a detached two unit coach house. There was immediately a question mark as to how many units the property has. Most times the coach house has no legal units, and thus it first appeared to be a three unit. This thesis was confirmed by the website of the county's assessor's office. On their website the property was listed as a residential property with three legal units. Then, the realtor on the deal produced a zoning certificate from 2007 from the city that listed the property as a legal five unit.

All of this is very important because a residential property is capped at four units and anymore units make the property commercial. Different banks deal with residential and others deal with commercial. Furthermore, commercial loans are always significantly inferior in terms to residential.

Immediately, I was given conflicting information from different branches of the government. The county's classification was more long standing. This property had been around for many decades and had always been classified as a residential property. Then, for whatever reason, the city decided to zone it themselves as a commercial property. I sent all of the information to the residential bank I intended to submit the loan to. Their decision was that in fact this property is a commercial property.

Then, just as I began my search for a commercial bank, the attorney called me. They had just received the 2008 zoning and now the city zoned it as a four unit. Yes, you read that right. The same city the suddenly approved a residential property a newly minted 5 unit commercial property, then changed their minds again the next year and reduced it back to four units. If you are confused, think about how anyone that has to close on this property feels. Now, I have had three different classifications from three different sources all of which held authority in making a decision.

I, along with everyone else involved in the deal, assumed that given that the 2008 zoning was the final word and thus we sent the deal to a residential bank. Of course, the twists were only beginning. For whatever reason, the city zoned all three units in the main building as legal and one of the two units in the coach house. This raised new issues because each of the two units in the coach house were at ground level or above. One of the three units in the main building was slightly below ground. It makes more sense to have a unit below ground not count as a legal one than one below ground.

As such, the manner in which the property was zoned presented a problem for the appraisal. The appraiser had to disregard one of the two units in the coach house even though it would have made more sense to disregard the bottom unit of the main building. As such, upon looking at all our documentation the bank determined that it was in fact a five unit and denied the loan. Furthermore, had I taken this loan to a commercial bank they likely would have denied it as well since after all it is a legal four unit according to the most recent zoning. In other words, based on the execution of the regulations the local government has created, they have turned this property into one that simply cannot be financed.

This confluence of events are caused because different jurisdictions each make their own rules and those rules are combined with rules made by the industry and of course, ultimately the bank is loaning the money and so they can make up whatever rules they want. Keep in mind that none of the rules and regulations here even had anything to do with the borrower, and yet, the regulations created a nightmare for all involved: attorneys, realtors, sellers, buyers, brokers, and the bank. This is the sort of practical effect that the current crop of regulations have in reality on real estate.

Now, imagine a plethora of new regulations, along with incompetent regulators (like those that decide one year a property is four units and the next year five units) that get mixed in with all the regulations and regulators we already have. What this will do is make real estate that much more difficult to get done. Right now, real estate is terribly soft and difficult enough to get done. Yet, there are actually politicians that think the right answer is to create even more regulations to make things even more difficult. If they are more difficult, that means even less property is sold. This particular property could easily have been closed had an incompetent bureaucrat not suddenly decided to change its classification with no warrant.

Imagine regulations regarding to income, credit, property values, down payments, and other things related to the borrower in the hands of similarly incompetent bureaucrats. That is the reality of the theories of politicians like Barack Obama.


Anonymous said...

Hi! you have my complete sympathy. I am a title abstractor in South Carolina currently working on a property involving residental rental units on multiple lots.

The County's aerial maps show three streets and a series of Tax Map numbers. The recorded surveyor's plats show the same property encompassing two streets. The Tax Map Numbers stamped by the Assessor's office on the recorded deeds do not match the Tax Map Numbers on the aerial map. Go to MapQuest aerial map and you see 4 streets in the same area.

We haven't even gotten the appraiser involved yet because I am still dealing with the infighting between the Tax Assessor's office and the Planning Department about what numbers go to what properties. (All of which is on the poor borrower's dime.)

Yea, sure--"I'm from the County and I'm here to help you" are the 8most firghtening words in my vocabulary.

mike volpe said...

Likely once the bank is involved they will make their own determination on top of everything else. The point in both stories being that mortgages are regulated through a competing set of jurisdictions all with their own rules and interpretations. That is what we are dealing with now. Imagine adding a bunch of new jurisdictions to the rules we already have and the industry will simply not be able to function.

These nightmare scenarios only encompass the current crop of rules and regulations. Now, imagine adding some more and you will simply stunt the industry so that it can no longer function.