Fed report questions ownership assumptions

The mortgage troubles plaguing multi-family housing in parts of Boston are putting new strain on belief in the benefits of greater access to home ownership.

In a policy discussion paper on subprime lending and multi-family housing released on the last day of 2008, researchers for the Federal Reserve Bank of Boston argue that two widely-held beliefs in policy may have been overstated. One belief is that increasing owner-occupancy improves the quality of life for buyers and their neighborhoods. The other is in the growth of ownership among people of color - a trend that was also supposed to narrow the racial gap in wealth.

With the disproportionate toll of foreclosures on urban neighborhoods, advocates and public officials have put most of the blame on high-risk lending - especially subprime mortgages. But researchers at the Federal Reserve say the subprime loans and resulting foreclosures might also be viewed as a reflection of the buyers themselves.

"In other words," say the researchers, "these borrowers are more likely to default because they have a history of delinquency (perhaps providing a signal of their preferences) or lack the financial means to survive an adverse financial shock or life event."

Those same buyers would also be more vulnerable to a sharp downturn in the market. Adding to the risk would be the dependence on rental income and the need for repairs, especially in older buildings.

"If something goes wrong and you need to fix something, and nobody can live in the unit, you get into trouble very quickly," said Paul S. Willen, a senior economist and policy advisor for the Federal Reserve Bank of Boston.

"The good thing about the absentee landlord," he said, "is they have a lot of reserves and they have a lot more resources than a small owner."

The report from the Federal Reserve was confined to homes bought as multi-families. It confirms the number of black and Hispanic households who bought homes in Massachusetts doubled between 1998 and 2006. But the report also found the increase was solely due to subprime loans.

When researchers compared the number of home purchases to the number of home sales or foreclosures, they found the increase in subprime financed purchases between 2003 and 2006 in Massachusetts "was unlikely to have led to a significant increase in homeownership."

And, according to researchers, as subprime lending increased from 2003 to 2006, there were more transactions in which buyers and sellers were both people of color. "In other words," say researchers, "one could argue that it enabled a sort of churning of properties."

A more recent discussion paper from the Federal Reserve also shows that subprime lending practices changed over time. The earlier subprime loans were mainly for refinancing, while the later loans were almost entirely for home purchases. Also increasing over time were loans that combined less documentation of the borrower's income and assets with higher leverage - or a lower percentage of down payment. It was the increased leverage that researchers say contributed the most to the increase in defaults.

The resulting foreclosures are reminiscent of what happened in the late 1960s and early 1970s, when there was an attempt to expand home ownership opportunities for people of color by the Boston Banks Urban Renewal Group (BBURG). Under BBURG, loans were guaranteed by the federal government, so lenders had less reason to worry about risk - or finding a new buyer after a default.

Almost 40 years later, lenders were passing on risk by selling their loans to financial markets. And riskier subprime and "Alt-A" loans - with higher interest rates - were also attractive to financial markets because of their higher yields for investors.

But the most recent downturn in Boston's multi-family housing market brought yet another change in the pattern of ownership - the conversion of three-deckers into condominiums on a massive scale. Before the end of the boom, when more desirable three-deckers were selling for $500,000 to $600,000, recorded sales prices on converted units in Dorchester were as high as $439,900 apiece.

Public records indicate many of the unit buyers were not occupant owners. Even some loans given for the use of a unit as a primary residence went to buyers who received mortgages containing the same provision within a year on other properties.

In other cases, owners of multiple units at different locations had mortgages for "second homes" that also restricted use of the property for income. And most of the lenders were mortgage companies or thrifts, which were less tightly regulated than commercial banks.

On many three-decker conversions, there were also piggyback mortgages. And researchers at the Federal Reserve say the default rates for these loans were abnormally high.

Observers say the risks were also increased in some cases by transactions at inflated prices - which had an effect on the rest of the market: when prices were climbing, other properties became less affordable; when the market fell, some of those properties had less value than what was still owed on the mortgage.

According to figures for Boston from the Warren Group, the sharpest falls in the median sale price for condos last year were in Mattapan (55 percent) and Dorchester (18 percent).

The changes in subprime lending practices took place in years when housing prices in Boston were still rising, or at least before a sharp downturn. And, as researchers for the Federal Reserve note, the change in practices was gradual.

"Thus," they wrote, "rather than plunging into uncharted waters, investors may have felt increasing comfort with each successive round of weaker underwriting standards."

And Willen said prices during the boom years may have made those standards seem less important. "If house values are rising, it's not that risky," he reasoned. "If they're falling, even a documented loan is going to be pretty risky."

According to the city's Department of Neighborhood Development (DND), Boston had 1,750 foreclosures in 2006-2008, and more than half were on units owned by investors. As of last Nov.15, there were 955 properties taken by foreclosure that had yet to be resold.

Because so many of the foreclosed properties were owned by investors, the director of DND, Evelyn Friedman, argues against putting all the blame on homeowners.

"I don't think the issue is home ownership opportunities. The issue is the quality of lending," said Friedman. "Yes, we do want to have home ownership." We want to have sustainable home ownership."

And Friedman said that includes lending based on sound documentation of the borrower's ability to pay.

"The lenders have to be made to be responsible for whom they're lending to," she said. "That's the regulatory problem that has to be addressed."

Executive director of the Massassusetts Affordable Housing Alliance (MAHA), Thomas Callahan, says the best way to stabilize the city's multi-family houses is to have, in most cases, entire buildings in the hands of responsible investors and owner-occupants.

"It's not the right solution to give up on owner-occupants as the bulk of the three-family owners in the city," said Callahan.

"I think what you see in the market," he notes, "is investor owners walking away quicker than owner-occupants do."

Though Willen says some of the borrowers who ended up in foreclosure had taken home-ownership classes, Callahan says MAHA's delinquency rates for two- and three-family homes were even lower than the rates for condos and single-families.

"I think two- and three-family home ownership in Boston and Massachusetts can be very stable," he said, "if it's done right."

The city is using federal money to acquire seven foreclosed properties by early next month directly from Countrywide Financial, which has been acquired by Bank of America. The city's plan is to acquire more properties directly from companies holding the loans, and then to turn them over to private or non-profit developers and owner-occupants.

"I think the group of people we need to attract, and will be attracted to these properties are the young first-time home-buyer who can't afford Jamaica Plain or the Back Bay," said Friedman.

A new challenge in the current downturn is that foreclosures in multi-family buildings converted into condos have taken place one unit at a time, and occasionally months or years apart. Friedman says the city will only try to acquire units where it would control the entire building.

And, if past downturns are a predictor, there is no guarantee that other properties sold after foreclosure will be stabilized quickly.

Executive director of Citizens Housing and Planning Association Aaron Gornstein predicts that once the market reaches bottom - possibly after another wave of mortgage defaults caused largely by the economic downturn - recovery could take another five years. In the meantime, he says, the chance to buy cheap might not be enough to attract the kind of homeownership that benefits the neighborhood.

"Unfortunately," said Gornstein, "it tends to attract investors who don't have a long-term plan to invest in the neighborhood, who want to flip the property and get out."