The MacNeil/Lehrer Report; Mortgage Foreclosures

ROBERT MacNEIL: Good evening. No area of the economy has felt the effects of the recession more than the home market with construction and sales crippled by high interest rates. Now another statistic has created news. The number of foreclosures -- people losing houses because they can't afford them. Last month, the Mortgage Bankers Association reported the highest foreclosure rate since their national survey began in 1953. In the first quarter of this year more than 100,000 homes were in foreclosure proceedings, and a million and a half were economically delinquent, meaning they were technically behind more than 30 days in their mortgage payments. Some of the reasons are obvious: unemployment, high interest rates and bad times generally. But some experts in the housing field also blame the increasing use of so-called creative or alternative financing -- imaginative ways around the impossibly high interest rates. Tonight, the rise in home foreclosures and the controversy over creative financing. Jim?

JIM LEHRER: Robin, there used to be just two basic ways to buy a house -- write out a check for the full amount, or put up 10 to 20 percent down and sign a 25- or 30-year mortgage for the rest. The rich are presumably still writing out checks for the full amount, but for the rest it's become a whole new world, a world of alternative or creative financing, as real estate brokers, eager buyers and desperate sellers have created an array of alternatives to paying the sky-high interest rates the old way would require. New terms like "wraparounds," "buy-downs," "take-backs," and "balloon notes" have been invented. Where there used to be only first and second mortgages, now there are third, even fourth mortgages. Where the savings and loans and the banks were nearly the sole financers of homes, now the sellers themselves have become a prime source of financing. Supporters of creative financing say it's what has made it possible for so many Americans to buy a new home. Critics say it's also responsible for part of the recent surge in home foreclosures. Both sides, interestingly enough, cite the balloon note as their prime example of what's good or bad. Under a balloon arrangement, normal monthly payments are made for three to five years when the rest comes or "balloons" due. The theory is that by then interest rates will have gone down while the worth of the house and the buyer's income will have gone up, so it can then be fully refinanced under more favorable market and personal conditions. But there are those who worry that it may not work out that way for everyone, and one who so worries is David Shulman, an associate professor of economics at the University of California, Riverside, who monitors the housing and credit markets for the UCLA Business Forecasting Project. He's with us tonight from Los Angeles. Professor Shulman, how much is creative financing, balloon notes in particular, contributing to this rise in home foreclosures?

Prof. DAVID SHULMAN: It's difficult to put exact numbers on it, but it seems that there is about $500 million of balloon notes coming due this year, in 1982, in California alone, and something close to $2 billion in 1983 and 1984, a year, coming due. Given the softening real estate market here in California, we believe it's becoming a factor in foreclosures. I've estimated that foreclosures in Los Angeles County this year will probably triple from the previous year, and probably will again increase in 1983.

LEHRER: Just to make sure we understand, explain in simple terms what the dilemma is and where the crunch comes for the person who does have a balloon note that comes due, say, this year.

Prof. SHULMAN: Well, the crunch would be -- and this year is really the first round of balloon notes coming due, because they started it in a big way of October of 1979 after the Federal Reserve Board changed its policies -- is a person tried to, say, took out a balloon note, say, for $30,000 or $40,000, say, around 12 or 13 percent in 1979 thinking that interest rates would be 8 or 9 percent or 10% in 1982. Well, 1982 comes along and interest rates are now 16 to 18 percent. That note has to be repaid in full. It has to be fully refinanced, and what the dilemma the original buyer faces is is they have to go to a savings and loan to refinance the entire transaction, or they have to go on the second trust deed market and refinance this balloon note at 20 to 25 percent a year interest rates.

LEHRER: So until interest rates come down, those people are in a vise, and there's no way out?

Prof. SHULMAN: They may have to walk away from the house or they're going to see a substantial increase in their home payments. They also have a problem with the seller of the house may need that money coming due to pay a balloon note that the seller had because the seller presumably also bought a house. So we may have a house of cards here.

LEHRER: You're in the forecasting business, as I said in introducing you. What do you see down the immediate road in terms of interest rates going down to help these people who do have balloon notes, and of course all others who want to buy houses?

Prof. SHULMAN: Well, we've said interest rates are going to come down. Now, they're going to come down one way or another. They're going to come down as a result of a change in policy at the Federal Reserve and in the administration, or they're going to come down after a real crash in the economy, and then we'll have a lot more to worry about than balloon payments coming due.

LEHRER: Yeah. Well, how would you place balloon notes, creative financing on the overall scale in terms of the causes of home foreclosures with just the general recessionary economy -- unemployment and so on?

Prof. SHULMAN: Well, in California we don't really face mass unemployment yet, and we're seeing a big increase in foreclosures. There are a lot of people right now who don't have sufficient equity in their houses. They have a balloon payment coming due; home prices are weak, and people are walking away. We didn't see that a few years ago because people had sufficient equity in their homes. So I think it's beginning to become a major problem, although there isn't any specific data that say that this one foreclosure was due to a balloon payment, or this other one was due to somebody being out of work. It's a complex -- there are a complex number of factors that are involved, but when you're talking about something like $2 billion in 1983 coming due, this represents a major chunk of home finance for the state.

LEHRER: And you think the end result is going to be an increase in home foreclosures?

Prof. SHULMAN: I think we will see a substantial increase in home foreclosures. We've seen that already in California, and we're not Michigan or Indiana or Wisconsin, or those states where there really is mass unemployment. We don't have that. Our unemployment rate is roughly the same as the national average, around 9 1/2%. So a lot of this, I think, will be as a result of these ballon loans coming due.

LEHRER: Well, when the mortgage bankers, as Robin said, forecast nationally 100,000 foreclosures in this first quarter, the quarter that we're in now, you would expect that to grow even higher in the immediate future?

Prof. SHULMAN: Yes, foreclosures are normally a lagging indicator, and they will normally lag the unemployment rate. So even if unemployment begins to drop a little bit, foreclosures will continue to increase. They typically lag the economic cycle. It's the last thing somebody does when they really throw in the towel.So this is going to continue to increase even if the unemployment rate stabilizes.

LEHRER: Professor Shulman, thank you. Robin?

MacNEIL: Creative financing has become one of the main selling tools for realtors in these hard times. Here is a current TV commercial.

HOMEBUYER: If we could afford the current interest rates, I'd buy this house like that.

REALTOR: Well, there are ways to pay less than current rates.

BUYER: Less?

REALTOR: Much less.

JINGLE: We're taking off our jackets/rolling up our sleeves/putting the strength of number one behind you.

NARRATOR: Yes, through alternative financing, we can help you pay less than current interest rates. Much less.

JINGLE: We're America's number one top seller/Century 21.

MacNEIL: That commercial was made for Century 21, the California-based real estate sales organization which says it has 7,000 brokerage offices across the nation and 65,000 sales people. In 1981, Century 21 accounted for roughly 10% of all residential brokerage activity in the country. Their president is Richard Loughlin, who is with us tonight in Los Angeles. Mr. Loughlin, you heard what Professor Shulman says. How much do you think balloon financing, particularly, or creative financing generally is responsible for the increase in foreclosures?

RICHARD LOUGHLIN: Well, Robert, we feel that a very small portion are responsible for the foreclosures. I think there is really a very direct correlation between unemployment and your delinquency situation and/or your foreclosure situation. I might draw a particular point to the viewing audience, and that is that right now our foreclosure rate is running somewhere around .53%, and in 1974 it ran at .52%. That was the high. That means that one one-hundredth of 1% difference between right now and in 1974, and there was no such thing as creative alternative financing being used at that time. So we really feel that it's a real small portion.

MacNEIL: That's just the -- '74 was the tail end of that which was previously the worst recession?

Mr. LOUGHLIN: That was the last recession, correct.

MacNEIL: And you say because those figures are almost identical so far, and creative financing wasn't around then, the difference must be in unemployment. Is that what you're saying?

Mr. LOUGHLIN: Yes. We say that the unemployment, the general economic conditions are vastly responsible for the delinquency and foreclosure rate. That is not to say, certainly, that there are people who will find themselves in a difficult situation if the economy continues on -- the balloon payments that David talked about -- if they are using creative or alternative financing in a very poor manner, using very poor judgment -- a very small down payment, huge balloon payments. A certain amount of good common sense has to be used when purchasing a property and utilizing alternative financing, certainly.

MacNEIL: Is it right that the balloon-type financing in particular is a deliberate gamble by the home purchaser that interest rates are going to go down and the house is going to increase in value? Isn't that part of the psychology of doing it?

Mr. LOUGHLIN: Well, it certainly is a small portion of the psychology. However, you can draw scenarios on a particular piece of property that, even without a vast appreciation, that if any type of earning ability increases, and something has been paid on that balloon payment, even interest alone, and it's a three- to five-year balloon, there should not be a difficulty in refinancing that property. Now, again, as David had said, you may have to pay a higher interest rate than what you're paying currently. But you, usually, if the creative financing is developed properly, have an opportunity to refinance that somewhere between the time of execution and that five-year due date.

MacNEIL: Typically, what is the spread in interest rates on these balloon payments? I mean, they would go in at a lower-than-market interest rate -- what would be lower than market now -- and what would the jump be to a new market interest rate? What would they have to assume?

Mr. LOUGHLIN: Well, it really depends entirely on when the transaction took place --

MacNEIL: What would be a typical example you're confronted with today?

Mr. LOUGHLIN: Well, you'd be talking about a second mortgage that would be carried anywhere from probably 14 to 18 percent on a seller-carry, and if that became due and you were unable to extend that through some negotiation with that seller, then you'd have to go out and secure a first deed of trust, or to cover both the first and the second, or go out and get another second deed of trust that would run right now probably somewhere between 18 and 20 percent interest.

MacNEIL: Would there be a real estate market today, as far as you're concerned, if there was not creative financing?

Mr. LOUGHLIN: I would say -- I would say no, Robert; I'll tell you why. There have been about two million homes sold in the last 18 months through alternative financing. That means two million American families have realized the great American dream thanks to alternative or creative financing. Without that they probably would never have qualified to be able to purchase and enjoy the home ownership.

MacNEIL: How do you instruct your brokers to advise people going into creative financing of the risk of that to them compared with conventional financing?

Mr. LOUGHLIN: Well, our entire system is well-schooled and trained in extending alternative financing to buyers and sellers, and in doing so, taking the necessary precautions such as I just mentioned a few moments ago: getting a sizeable down payment, having the buyer certainly pay on that interest -- pay something on the interest, on that particular second deed of trust; stretching that due date out as far as the seller feels they can handle it, certainly nothing less than three years, and three to five years would be preferable.

MacNEIL: Would it be, for many people today, safer not to buy a house but to go on renting a home until the economy straightens itself out and these interest rates come down?

Mr. LOUGHLIN: Well, you're probably asking the wrong person that question.

MacNEIL: I know whom I am asking it of.

Mr. LOUGHLIN: Okay. No, I would say definitely not. I think the appreciation factor in property has continued at a very steady rate.We're looking now at probably somewhere around 5 to 6 percent appreciation factor even with the economy the way it is.And I certainly would advise anybody that I was talking to to very definitely own real estate. I think it's a definite waste of resources to be renting. If you can handle the affordability of that property, handle the payments, and get into a home somehow, I'd say it's very advisable.

MacNEIL: Well, thank you. Jim?

LEHRER: A third view of creative home financing now from David Greenberg, legislative director for the Consumer Federation of America here in Washington. Mr. Loughlin says there is little connection between alternative creative financing and the rise in home foreclosures. Do you agree?

DAVID GREENBERG: No, I don't. I think obviously the economy has played a crucial role in this level of foreclosures. If you will, the economy has set the housing market on fire. Creative financing is like pouring oil on that fire. Thousands of people are trying to afford what they can't afford, and hoping that they'll be able to afford it in a couple of years. And I think that's a recipe for disaster.

LEHRER: Well, what is your data? You heard what Mr. Loughlin says, I won't go through them again, but comparing the 1974 foreclosure rate with the current one, he says there's no appreciable difference.

Mr. GREENBERG: I think we don't know yet because the balloons really haven't come due in massive numbers. If we look at the Canadian experience, where balloons have been present for years, we see that about now approximately 100,000 balloons are going to come due where people are going to have to refinance at double their original rate. Five years ago was a lot --

LEHRER: Double their original rate? In other words, the original three-to-five year was, say, 10% and now they're going to have to borrow at 20%?

Mr. GREENBERG: The average five years ago was about 11%. The average now is about 17% on those ones that are coming due.

LEHRER: Well, how do you answer Mr. Loughlin's point on creative financing generally that there were two million homes sold in the last 18 months on creative financing that would not have otherwise been sold? That two million people now live in homes that they wouldn't otherwise be living in.

Mr. GREENBERG: Well, I don't think that that home ownership will mean much to them if three or five years from now they have to face giving up their home. The whole problem we're facing is that we still have the same psychological, emotional and financial attachment to the American dream, but given the risks involved in alternative financing and all the newfangled mortgages we see out there, it's real possible for the American dream to turn into a nightmare.

LEHRER: You say it's possible; is it probable?

Mr. GREENBERG: It's probable in a significant number of cases. That may be a small percentage, but nevertheless, the devastating impact of losing one's home, one's equity, and the psychological and emotional attachment one has to owning a home is just devastating.

LEHRER: Are you just basically opposed to these newfangled ways to finance homes, particularly balloon notes, or do you think it's not being handled right, or overall what's your thought about it?

Mr. GREENBERG: Overall, what we see happening in this whole area is that the risks of the high and variable nature of interest rates are being imposed almost solely on buyers. What we think has to happen is two things: those risks have got to be shared. In other words, if you're talking about an adjustable-rate mortgage that can go up with inflation, there's got to be a cap on that. And the second thing is there has got to be more disclosure of what can happen. Right now when you buy a home that's seller-financed or creatively financed, you get less disclosure on the terms and conditions of that loan than you do when you buy an automobile or when you buy a stove, and that's inappropriate.

LEHRER: Whose responsibility is it to make that disclosure, the real estate salesmen, for instance, who work for Mr. Loughlin, or who?

Mr. GREENBERG: Well, I think obviously it is their responsibility, but I think that the government has to set a fair set of ground rules, just like they've done with the banking industry. It's a simple concept called "truth in lending." It involves a one-page disclosure of terms, and when the Federal Reserve Board floated the idea that seller financing should lead to a truth-in-lending disclosure, the realtors reacted furiously and ferociously. And I think that's wrong.

LEHRER: Well, what truth is it that the average homeowner who uses a balloon note or creative financing is not being told?

Mr. GREENBERG: I think they need to know the alternative scenarios. I think they need to know what could happen in stark financial terms to their payments every month if interest rates increase, say, 2% or 3% or 5%. And, of course, it's fine to let them know what will happen to their payments if interest rates decrease, but I think that the pressure on real estate brokers is to suggest that if we can just hold over for three to five years, things will be fine. And, as I said, in Canada that's not been the experience.

LEHRER: In a word, then, you do see this as a gamble.

Mr. GREENBERG: I think we ought to rename alternative financing "Las Vegas financing."

LEHRER: Thank you. Robin?

MacNEIL: Would you like to see it called that, Mr. Loughlin?

Mr. LOUGHLIN: I think his point is far from accurate. I think to compare the United States with Canada -- I mean, we're talking apples and oranges. The Canadian economy isn't even close to the economy of the United States. And I really take strong disagreement, respectfully, but strong disagreement with his approach.

MacNEIL: What about his point, though, that we haven't really begun to feel it because the balloon mortgages are just beginning to come due in very large numbers?

Mr. LOUGHLIN: Well, there are a lot of balloons that are coming due all the time, and there are -- I can, you know, give you numbers very quickly of many, many mortgagers would love to refinance. There is no problem out there currently with the money. I just don't see it. I think we're sticking at windmills. And unless a person has, in the creative financing or alternative financing area, used very poor judgment on their capacity, their capability to make those payments, and has made poor judgment in purchasing that home, there should absolutely not be any problem whatsoever.

MacNEIL: Professor Shulman, is it in your view just a question of poor judgment, or are people who exercised good judgment going to be at risk as more of these balloons come in?

Prof. SHULMAN: You've got to remember the psychology when this started in 1979 and 1980. We were in a super-inflating economy; the national inflation rate was around 15 or 16 percent, and people had to buy something just to protect themselves. The great inflation of the '70s is now over, and house prices have fallen. So what might have been very, very prudent in an inflationary environment has become very imprudent in a disinflating economy, and I think that's where the problem has come in. I think we have a lot of people right now who, if they take a really serious look at their balance sheet, will find out that their homes have a negative equity. They owe more on their home than what the home is worth, especially as in parts of California where home prices are off 20 or 25 percent. Another point I'd like to make is that creative financing is a code word for a price cut. The seller is taking back less interest than what would be in the marketplace. And it really means houses are selling for less than what the stated escrow price is. I think this is an important factor to remember. We could have sold those two million houses that Mr. Loughlin discussed by cutting prices, because a price cut is a perfect substitute for an interest rate cut.

MacNEIL: What about that, Mr. Loughlin?

Mr. LOUGHLIN: Well, you talk about losing equity, and then you talk about taking a price cut. Certainly our records, and we survey our system extensively -- we've just gone through a recent survey with some 61,000 sales in the first quarter of this year to come up with some of thefigures that I have mentioned, and we do not see a --

MacNEIL: But house prices have been appreciating at 5 or 6 percent.

Mr. LOUGHLIN: That's correct. House prices are continuing to appreciate. If you want to pick out pockets in various areas, surely you'll find somewhat of a depreciation factor from area to area. You may also, in various price ranges, find that homes may become a little softer in a certain price range area, but to say across the board there is a depreciation is absolutely wrong.

Prof. SHULMAN: Well, our data is contrary to that. Our data shows that when your wring out the creative financing and put in real interest rates, and not look at escrow prices but look at real transaction prices, prices have been falling for about a year and a half now.

MacNEIL: Mr. Loughlin, what about Professor Shulman's other point that what was prudent three years ago in the inflation psychology of the time may be imprudent now in this creative financing?

Mr. LOUGHLIN: Well, again, I would disagree because I think that as we take a look at material and labor costs -- which, obviously, housing is affected; that would relate directly to brand-new housing, but it also relates directly to resale housing -- that there is going to continue to be a basic appreciation factor in real property. The supply and demand will virtually force us there. It has been that way consistently, and we expect it to continue. Maybe not at the rates it has in the late '70s; certainly not. But there will be a strong value to real estate and an appreciation factor.

MacNEIL: Mr. Greenberg, what does the Consumer Federation of America think about that point, that there is still a strong appreciation in real estate values, taken across the country, and that therefore the element of risk is lessened because of that?

Mr. GREENBERG: I don't think I'd want to bet on that any more than I'd want to bet on hog belly futures. That's the problem with this whole area. People don't know what they're getting into; they don't know what could happen; and they're not even told up front what the possibilities are.

MacNEIL: So what do you advise people to do?

Mr. GREENBERG: Well, I advise people to try and figure out very specifically what their risks are to make sure that any balloon note that they pick up has a long enough term so that they can respond -- five or seven years at least. And I think generally they have to evaluate whether their intent to purchase a home has to do with housing or whether it has to do with financial security, because more and more, buying a home leads to insecurity under these sorts of financing arrangements and mortgages more than it does to security.

MacNEIL: Mr. Loughlin?

Mr. LOUGHLIN: Oh, I think that's totally incorrect, and I think most of the wealth in this country has been made through real estate, and it's continued to be made that way. Most of the security of this company is in a family owning their own home, and I think the American people honestly, and the consumers, should be concerned enough to see that home ownership is continued, and that that type of an attitude does not prevail. I really don't believe there's much substance to it.

MacNEIL: Thank you. Jim?

LEHRER: Professor Shulman, you heard what Mr. Loughlin said a moment ago in response to Robin's specific question, is this a good time to buy a house. What is your view of that?

Prof. SHULMAN: Right now doesn't look like a good time to hold many capital assets, aside from the highest quality bonds right now, in our view. At these real interest rates, very few assets seem to make investment sense, aside from the highest quality bonds, and that's essentially what the interest rate policy of the government right now is doing, is it's making asset prices fall as the economy disinflates. And it's very difficult for a house -- a house was a very good investment when it was going up at 1 or 2 percent a month, when people were paying, say, 8 or 9 percent interest rates. If house prices are going down and you have to pay 16 or 17 percent interest to hold the asset, it obviously is not a good investment. We have to have lower interest rates before housing will become a better investment, or a lot lower housing prices.

LEHRER: Mr. Greenberg, what would be your advice to consumers now on whether or not this is a good time to buy a house?

Mr. GREENBERG: Well, again, I think that they've just simply got to know what their risks are and evaluate their own financial circumstances. But I think it is a very poor time to buy a house other than for housing. Don't buy a house for investment purposes right now.

LEHRER: Would you agree with that, Mr. Loughlin, not to buy a house for investment reasons, but if you want to buy a house to live in, obviously, if that's your main motivation, it's okay to do it now? You won't concede that, right?

Mr. LOUGHLIN: No, I'm sorry. I really can't. I would say if you live in a supply-and-demand world, and you're involved in private enterprise, I would say the finest time to buy would be right now because you've got a tremendous number of homes for sale, because of the financing situation, that people have been unable to sell -- to sell their homes. It certainly is a buyers' market, and at this point in time you have such an array of homes to choose from, you can pick the financing that will match your needs and your financial capabilities.I'd say absolutely now is the time to buy. Prices will not be cheaper, and those people that hesitate are going to be lost.

LEHRER: Mr. Loughlin, finally, let me ask you this.We haven't mentioned it up until now, the Supreme Court decision a few days ago which restricted the ability of people to assume another person's mortgage, specifically those that are financed through federally chartered savings and loans. Is that going to impinge on the buying and selling of houses in a very drastic way?

Mr. LOUGHLIN: No, I don't think in a drastic way. It represents about 10 to 12 percent of the transactions where mortgages involving federally-chartered savings and loans, so it's a small portion of the business. It's certainly not something we smiled at and welcomed with open arms, but it is a small segment. It is far from a devastating situation for our industry.

LEHRER: What's your view of that, Mr. Greenberg?

Mr. GREENBERG: Well, my view is that without the assumable mortgage there is going to be more pressure on all of these new alternative financing schemes. And, again, I can't say it strongly enough: that just increases the pressure on companies like Century 21 to take some leadership in making sure that there is adequate disclosure industry wide.

LEHRER: Thank you. Robin?

MacNEIL: Yes, Mr. Loughlin and Professor Shulman in Los Angeles, thank you for joining us; Mr. Greenberg, in Washington, thank you.Good night, Jim.

LEHRER: Good night, Robin.

MacNEIL: That's all for tonight. We will be back tomorrow night. I'm Robert MacNeil. Good night.