In this issue of Home Base:

The exploding growth of prime mortgage foreclosures and home buyers tax credit expiration could equal disaster.

Federal Reserve Board Chairman Alan Greenspan told the Economic Club of New York, on May 20, 2005 that “There are a few things that suggest, at a minimum, there's a little froth in this market. We don't perceive that there is a national bubble, but it's hard not to see that there are a lot of local bubbles."  In many ways the circumstances today are similar to circumstances then. In both cases numerous positive economic indicators abounded, but there were then, and there are today, growing and ominous economic threats on the horizon.

Consumer confidence has been pumped up by numerous positive economic developments. Indeed many of those developments, such as the recovery in the stock market, are due at least in part to the improving consumer confidence polls. Consumer and business spending jumped in July. The Cash for Clunkers program has been enormously successful, both contributing to economic growth and helping to restore automakers' balance sheets.

Anecdotal evidence suggests the $8,000 first time home buyers tax credit is a major factor in improvements in the housing market. New home sales rose almost 10% from June, and durable goods orders rose increased about 5%, continuing the trend of the last quarter. July’s new homes were up 10% over June on a seasonally adjusted basis according to the Commerce Department. The median U.S. home sales price has increased from $205,100 in March to $210,100 in July. In areas where prices still continue to drop, home affordability also continues to rise. How much longer can it be until those markets turn around as well?

With all this good news, why should we worry about any slowdown in the economic recovery? The answer is that there is also bad news. Some of it is very bad, and collectively it reverse the recent economic improvements. Home foreclosures continue at a rapid rate. Even more ominous is that most of the mortgages in foreclosure or seriously in arrears today are no longer subprime loans. They are prime fixed rate or prime adjustable rate mortgages, made to home buyers with previously excellent credit ratings.

This new prime mortgage foreclosure crisis has exploded in the last year. As recently as January, 2008 the share of prime mortgages (adjustable and fixed rate) in foreclosure or in serious arrears was little more than 1%. By the end of the first quarter of this year about 15% of prime adjustable rate mortgages and about 3% of prime fixed rate mortgages were in trouble.

In addition Fitch Ratings Ltd., a credit-rating firm, recently noted a severe drop in the mortgage "cure rate." The cure rate - the percentage of delinquent loans that catch up on their payments in a given month - dropped to 6.6% for prime loans in July from a 2000 - 20006 average of 45%. Barclays Capital estimates that the number of foreclosed homes for sale will rise from the estimated 688,000 at the beginning of July to 1.15 million by mid-2010. It is unlikely that the financial services sector can absorb such large and growing amounts of bad debt.

The most likely primary culprit is unemployment, which is now edging close to 10%. Many formerly gainfully employed homeowners are today unemployed or underemployed. Economic growth is not likely to blunt unemployment trends anytime soon. Most economists are predicting that economic recovery, whenever it comes, will be relatively jobless. That means there is little hope that new jobs will slow the growth in prime rate foreclosures as more and more homeowners deplete their savings.

Another factor is that as the amount of negative equity increases more homeowners are also recognizing that it will be many years until they get back to even on their mortgage.  Lenders who tell them that they aren't willing to discuss mortgage restructuring while their payments are still current are contributing to another problem. Some of those homeowners do the math and simply stop making payments, figuring they will be able to rebuild their credit long before they got back to even on their mortgages anyway.

Although the effect of most of the future federal stimulus spending has yet to be felt in the marketplace, the amount involved was not based on anticipated unemployment figures in the range of 10%. The Cash for Clunkers program is now history, and consumer spending may not have enough gas to sustain recovery in the automotive and durable goods sectors in the future. The $8,000 first time home buyers tax credit has played a major role in stabilizing the housing market, but it expires December 1 of this year. Because it takes at least 60-90 days to find and settle on a home purchase, its role in stabilizing home prices has already run its course.

The American Homeowners Grassroots Alliance believes that there are just too many looming major economic threats to sustain the recent rate of economic growth. When the stock market and consumers recognize their cumulative threat, we think that our economy will take another serious downturn unless Congress quickly intercedes. The most logical place to intercede is in the housing sector, which is where recession started.

The only federal legislation on the horizon with both broad and deep enough economic impact to stave off both the new prime mortgage crisis and its severe negative implications for the entire economy are House and Senate proposals to expand and extend the expiring first time home buyers tax credit. That tax credit has played a major role in the recent improvement in home values. If expanded and extended it could provide a counterweight to the new prime mortgage crisis, continued rapid growth in foreclosures, and the expiration of the existing buyers tax credit.

For that reason the American Homeowners Grassroots Alliance has urged the Chairman and ranking minorities of the Congressional tax writing committees to quickly pass S. 1230 and H.R.1245. These bills will increase the 10% first time home buyer’s tax credit limit from $8,000 to $15,000 and expand the credit’s eligibility to apply to any buyer. The legislation would also eliminate the current $75,000/individual and $150,000/couple income caps, and extend the tax credit for one year from date of enactment.

In its August 24 letters to Senators Max Baucus and Charles Grassley, and Representatives Charles Rangel and Dave Camp, AHGA urged the leaders of the Senate Finance and House Ways & Means Committees to make the passage of this legislation their highest priority in this Congress. “Because of the impending serious threat of the new prime mortgage crisis, we can’t afford to wait until it deals another serious blow to the economy while we are still in the middle of a deep recession,” said AHGA President Bruce Hahn. AHGA is also asking members and other homeowners to contact their legislators through www.AmericanHomeowners.org.

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Another alternative has been proposed by Senator Dick Durbin (D – IL). His solution is to resurrect the pending bankruptcy reform bill if the financial services industry is not able to complete 500,000 mortgage modifications by November. This would empower bankruptcy judges to maximize lender’s returns on their nonperforming assets. Bankruptcy judges are supposed to look out for the interest of creditors, and they could only restructure a loan if the outcome was worth more than the liquidated value of the home.

In such a scenario many homeowners at risk of foreclosure would still be able to afford to stay in their home. That number is certain to be much greater than the 500,000 goal that lenders are having trouble meeting. All parties to the transaction would be winners, and mortgage lenders would not need to expand their staff since the courts were handling the restructuring for them. Although some lenders have mischaracterized this assistance as a "cramdown", it is actually a helping hand. The government would not have to provide a taxpayer subsidy to either the homeowner or lender.

Of those two alternatives we like Senator Durbin’s best. One of the great things about President Reagan was that he disliked both budget deficits and taxpayer subsidies. Senator Durbin’s approach would not contribute to budget deficits or require taxpayer subsidies. Our federal deficit is already huge. Its recent growth was caused in a large part by the need to address recent mortgage lender underwriting practices that didn’t involve such quaint concepts as verifying borrower’s assets or income. If we are going to run the deficit up even more, it would be nice to spend it on something constructive this time, like universal healthcare instead of seed money for next year’s financial services CEO bonuses.

Dr. Feldstein’s approach assumes most homeowners would ignore their negotiating leverage with lenders and be happy to accept a mortgage for substantially more than the home’s current market value as well as forgo existing protections for other current or future assets. It would severely aggravate our budget deficit and requires taxpayer subsidies for the industry that caused the recession. Giving mortgage lenders even more taxpayer subsidies also runs the risk that lenders will adopt an even more "Freedonian" approach to the mortgage servicess in the future. As Freedonia President Rufus T. Firefly (a.k.a. Groucho Marx) noted in Duck Soup, "If you think this country's bad off now/Just wait till I get through with it." Senator Durbin’s approach by contrast involves neither taxpayer subsidies, bigger deficits, or taxpayer subsidies to a group of financial services CEOs whose management competence bears an uncanny similarity to President Firefly’s cabinet.

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If you are making money from your hobby, you need to understand the tax implications.

Hobbies – such as photography, woodworking, stamp collecting and scrap booking – are often done for pleasure, but can result in a profit. Indeed, during tough economic times such as these many homeowners are trying to make money (or make more money) from their hobbies. If your favorite activity does make a profit every year or so, there may be tax consequences. You must report income to the IRS from almost all sources, including hobbies.

Here are eight questions that will help determine if your activity is a hobby or a business.

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity. If you are conducting a trade or business you may deduct your ordinary and necessary expenses.

More information about not-for-profit activities is available in IRS Publication 535, Business Expenses, also available on the IRS.gov Web site or by calling 800-TAX-FORM (800-829-3676).

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As emergency measures begin to ease the recession, it’s time to think about long term prevention.

Here’s something scary: despite all that has been done to address the financial crisis, there are currently no measures in place that would prevent mortgage lenders from returning to most of the same policies that brought about our economic debacle. Congress is beginning to address that challenge with the consideration of House and Senate legislation to create a new Consumer Financial Protection Agency (CFPA) to protect consumers of financial services products, including mortgages, credit and debit cards, payday and other consumer loans, credit reporting agencies, and investment advisory and financial advisory services. Ironically, despite strong Administration support for its own similar plan, regulatory agency turf wars may prove a bigger challenge than financial service company opposition.

The new legislation comes on top of recent credit card reform legislation, parts of which just went into effect. The latter requires that credit card issuers must mail credit card bills at least 21 days before their due date (versus 14 days previously). Card issuers must give you at least 45 days’ notice (versus 15 days previously) before increasing their interest rate or the fees, and they must give you the option to pay off your outstanding balance under your current rate.

Legislation creating the new consumer agency has been introduced in the House by Financial Services Committee Chairman Barney Frank (D-MA). Banking regulators have testified in the Senate that elements of the Obama administration proposed reform plan would actually undermine oversight of the financial services industry. Treasury Secretary Timothy F. Geithner subsequently ordered the heads of half a dozen agencies to stay out of the process in the future. The damage may already have been done, as financial services firms will be certain to use the testimony in their efforts to block the bill.

Nevertheless prospects for House passage of the bill are good. Senate Banking Committee Chairman Christopher J. Dodd (D-CT) remains confident that his committee will pass a comprehensive regulatory bill this year as well. We will know more about the shape of the Senate plan when Congress returns from the August recess. It will involve new government power to regulate large financial companies and markets, restricting risky Wall Street investment options and establishing procedures for the orderly liquidation of troubled firms. The creation of a new agency to protect financial consumers is popular, but there will be a cat fight over the transfer of existing agency powers to it.

The authority of the new CFPA would extend to all financial services offered to consumers, including mortgages, credit cards, and (in our opinion) real estate services. CFPA would regulate unfair, deceptive or abusive acts or practices, which would give it a broad mandate to delve into some of the anticompetitive practices in the real estate services sector. It could reduce kickbacks in the real estate services sector, and regulate "affiliated" businesses connected with real estate brokers and other firms in the real estate field. It may also restore fiduciary obligation of real estate agents and brokers to assist their clients in negotiating the most favorable pricing and terms in all cases. Such requirements would turn help do away with state dual agency laws relieving them of that obligation.

The American Homeowners Grassroots Alliance strongly supports the creation of CFPA. Currently consumer protection authority is fragmented and many agencies suffer from varying degrees of regulatory capture by the industries they are charged with regulating. A new agency would end many abuses and make mortgage, real estate services and other disclosures far more useful to borrowers.

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