IPO's, REO's & Market Manipulation

Bank Foreclosure Sales Recall '90's IPO's

We've seen this movie before.

Specifically, many of the practices embraced today by banks selling foreclosures, or Real Estate Owned ("REO"), echo tactics used by Wall Street more than a decade ago to sell "hot" tech IPO's ("initial public offerings").

Consider these 3 parallels:

One. Artificially low prices.

At the height of the tech boom, it wasn't uncommon to see IPO's priced at $15 or $20 a share skyrocket to $100 or more the first day of trading.

Similarly, I can point to dozens of foreclosure sales in the Twin Cities this Spring that have attracted at least 10-15 offers, and sold for huge premiums over the artificially low list price.

In each case, the effect is to whet "investor's" appetite -- also known as "pump demand" -- for the next offering. Pretty soon, you have a full-blown feeding frenzy on your hands -- at least in the short run.

Two. Favored insiders.

In a practice called "spinning," Wall Street firms doled out cheap shares to favored customers -- existing and prospective -- who could quickly sell to dumb outsiders -- the public -- clamoring to get in on the "boom."

With foreclosure sales, the favored customers are the Buyers represented by the listing agents -- who also represent the banks!

Tech IPO's -- The Sequel?

Imagine you're conducting an auction with multiple bidders. If Buyers #1, #2, or #3 -- all of whom have their own agent -- submit the winning bid, you split the commission.

However, if Buyer #4, who happens to be your client, submits the highest offer, you get all of the commission.

As listing agent, you see all the other offers.

Now, guess how often Buyer #4 prevails?

Interestingly, such "dual agencies" are enough of a red flag that I've now seen an off-shoot practice: the listing agent steers Buyers to a supposedly independent agent in return for an undisclosed kickback.

Three. Legions of Losers.

We all know how the late '90's IPO boom turned out: eventually, the IPO market got sated, tech share prices collapsed, and the ensuing bloodbath brought down the rest of the stock market (and economy) with it.

We all know what that ushered in: free money, courtesy of the Fed, to revive a prostrate economy (be careful what you wish for!).

Do we really want to see what happens when the foreclosure feeding frenzy subsides, and the "winners" of all these bidding wars wake up with hangovers? What then: REO's -- the Sequel?? Pump-and-Dump . . and Dump again?

Even if foreclosure Buyers didn't overpay, it hardly excuses all the market manipulation on display, and what should instead be a focus on "discovering" -- honestly -- market-clearing prices for a huge class of assets.

If government is serious about (re-)regulating financial markets, a good place to start is policing how banks sell their REO's.

Banks Still Calling the Shots

Worst-Kept Secret: Foreclosure Banks
Flaunting MN Disclosure Laws

A problem has arisen in Minnesota regarding lenders who have acquired property through foreclosure and then listed those properties for sale to Minnesota consumers. The problem is that lenders are refusing to comply with Minnesota disclosure laws.

--Donald D. Smith and Brad J. Boyd, "Seller Disclosure Obligations Under Minnesota Law for REO Properties"

The above paragraph, from a memo drafted by the legal counsel to the MN Association of Realtors, is hardly news to anyone representing would-be Buyers trying to buy foreclosures lately (or to readers of this blog).

However, what's interesting is the Board of Realtors' response, undoubtedly borne of futility: instead of getting the appropriate legal authorities (MN Attorney General? U.S. Attorney General? Hennepin County Attorney? The Congress?) to get the banks to stop defying the law, it is shifting responsibility back to the Realtors.

Namely, it advises Realtors, when working with banks that refuse to comply with MN disclosure laws, to obtain from the bank the "legal support for that position." (Good luck with that one!)

Assuming, quite safely, that no "legal support" is forthcoming, then what?

Smith and Boyd again:

Without such evidence, supported by accurate and substantiated legal authority, Realtors in the state of Minnesota are being encouraged to avoid unwarranted personal legal liability and risk to themselves and their brokerage, by resigning from any and all listings with sellers who refuse to comply with these legal obligations.

That's right: put the burden on Realtors to ostracize law-breaking banks.

After everything that's happened to housing (not to mention the broader economy) the last couple years, is it really possible that banks are still running the show?? (and yes, that's rhetorical)