California Foreclosure Center Shows Obama Challenge (Update2)

Feb. 18 (Bloomberg) -- It has taken Susan Erb just three years to see the value of her Merced, California, home plunge by more than half to $350,000. Next month, her mortgage payment jumps 20 percent to $3,321 and she knows she can’t afford it. Her bank won’t rework the loan unless she stops paying altogether.

“Now I know how people feel when I go knocking on their door,” said Erb, 53, a real estate agent who works for a company that notifies residents in foreclosed properties that they must vacate. “I’m in their shoes.”

Merced, the epicenter of the U.S. foreclosure crisis, demonstrates the steep challenges President Barack Obama will face in trying to stem defaults. One in 59 housing units in the Merced metropolitan area received a foreclosure filing in January, the highest rate in the U.S., according to RealtyTrac Inc., an Irvine, California-based seller of default data. For- sale signs are everywhere and a building boom fueled by subprime mortgages has been brought to a standstill. Just 16 construction permits were issued last year. In 2005, there were 1,427.

“We’re ground zero,” said Merced Mayor Ellie Wooten, 75. The city, population 81,000, had an unemployment rate of 15.5 percent in December, “and it’s going to get worse,” she said.

$275 Billion Plan

Obama unveiled a series of measures in Arizona to reduce record home foreclosures and halt the erosion of property values. As many as 9 million people can restructure or refinance their mortgages under the proposal.

The program will use $75 billion to bring down interest rates and encourage loan modifications, the White House said in a statement. The Treasury Department will double the amount of stock purchases of Fannie Mae and Freddie Mac to as much as $200 billion of each company.

Obama said he supported revised U.S. bankruptcy rules that would let judges reduce mortgages on primary residences to fair- market value, as long as borrowers pay their debts under a court- ordered plan. His proposal will use government funds to match reductions lenders make in interest payments and lower borrowers’ payments to 31 percent of their monthly income.

Treasury will share the cost when lenders reduce monthly payments by forgiving a portion of the borrower’s mortgage balance, the government said. The program may help as many as 4 million borrowers, and the average borrower’s home value could be stabilized against a price decline of up to $6,000.

Banks accepting help from the government’s financial-system bailout must adopt loan modifications, the administration said.

The measures come amid a worsening economy and plunging home values that have put 17.6 percent of mortgage holders underwater, or owing more than their property is worth, Seattle-based Zillow.com said Feb. 3.

‘Unsustainable Loans’

Modifying loans and reducing principal may not be enough to keep people in their homes and fix the housing market, said Ethan Harris, co-head of U.S. economics research for Barclays Capital Inc. in New York, in an interview.

“There’s a chunk of these loans that are unsustainable, where people have gotten divorced or lost their jobs, or the loans were way beyond the borrowers’ capability to pay in the first place,” said Harris. “A lot of the loans were not designed to be repaid, they were designed to be refinanced. That works only when housing prices are going up.”

Bad Loans

The “sheer volume of bad loans” is also a challenge, said Harris. “Getting the process going is very tough to do with such volume, even when it’s in everybody’s best interests.”

U.S. homeowners lost an estimated $3.3 trillion in house value last year, real estate valuation service Zillow said. In California, the state with the most foreclosure filings, the share of underwater owners will rise to a third of all mortgage holders by the end of the year, according to data provider First American LoanPerformance of Santa Ana, California.

Merced, located about 110 miles southeast of San Francisco in California’s agricultural Central Valley, became a housing boom town in the early part of the decade as buyers with subprime loans sought affordable property within commuting distance of Bay Area job centers, said Jeff Michael of the University of the Pacific’s Eberhardt School of Business in Stockton.

Median home prices in Merced rose from $150,000 in January 2002 to a peak $382,750 in December 2005, according to MDA DataQuick, a San Diego-based property research firm. In December 2008, the median stood at $120,500, down 52 percent from a year earlier, as four out of five resales involved properties that had been foreclosed on in the prior 12 months.

Subprime Loans

“There were a lot of young families and first-time buyers with not a particularly high income, so it was perfect ground for subprime lending,” said Michael, who directs the school’s business forecasting center. “You had people streaming in from the Bay Area. This was their chance to get in.”

Many of the people coming to town were immigrants priced out of other parts of California. About 17 percent of Merced’s population is of Laotian descent and 52 percent is Hispanic, city spokesman Mike Conway said.

Homebuilders constructed subdivisions to the north, west and east of the downtown, and today “no area is untouched” by the foreclosure crisis, said Brad Grant, city finance director.

Merced’s general fund revenue, mostly from property and sales taxes, will drop 12 percent to $38.6 million for the fiscal year ending June 30, and will probably decline a further 7 percent next year, Grant said. The city won’t fill 35 jobs and department managers are to cut budgets by 12 percent.

Job Losses

Bankrupt retailers including Mervyn’s LLC, Circuit City Stores Inc. and Linens ‘n Things Inc. have cut almost 200 jobs in town, and Quebecor Inc. may close its Merced printing plant and fire about 100 workers, Wooten said.

Rina Serrano, 35, an after-school program supervisor for the Merced County Office of Education, may lose her job next year due to budget cuts. The value of her house, built by Calabasas, California-based Ryland Group Inc. in the Bellevue Ranch development, fell by at least a third since she purchased it in 2007. Her husband’s cabinetmaking business is down by half.

“Nobody has given us any options, but my feeling is there should be some assistance,” said Serrano, 35, a mother of four. The couple took out a 30-year fixed loan and aren’t behind on payments but they are underwater by about $70,000.

Speculators helped drive up Merced prices during the boom, said Greg Parle, co-owner of the Branding Iron steak house on Main Street, not far from a historic courthouse built in 1875, three years after the city was established.

‘Tremendous Wave’

“We had a tremendous wave of Bay Area people coming through, and they were rolling houses,” Parle said. “You couldn’t touch a two-bedroom condo for less than $600,000 there. But you could buy a three-bedroom house for $250,000 here.”

The Obama plan probably can’t help Merced residents Bountay and Khamtanh Rattanavongsa, who walked away from their adjustable-rate home loan last year and were foreclosed upon after monthly payments jumped to $3,500 from $1,800.

They’re now renting a Bellevue Ranch house constructed by Kimball Hill Homes, the Rolling Meadows, Illinois-based homebuilder that filed for Chapter 11 bankruptcy protection in December. Across the street, wooden frames of partially built two-story homes, with no windows or doors, are clustered in a former cattle pasture.

Khamtanh, 63, a retired school aide, came to the U.S. from Laos in 1978 with her husband, 60, who works as a custodian. Their son lives with them and helps pay the $1,500 rent.

“I loved my house, I never thought I’d lose it,” Rattanavongsa said. “Now I have no credit. I’ve got nothing.”

To contact the reporter on this story: Dan Levy in San Francisco at dlevy13@bloomberg.net.

To contact the editor responsible for this story: Alan Mirabella at amirabella@bloomberg.net.