Banks foreclosing even on builders who never missed a payment

Imagine buying a new car for 10% down and a 5-year loan. As soon as you drive it off the lot, it immediately loses up to 25% of its value, which could technically mean that the value of the asset -- the car -- is worth less than the loan. Now let's say the bank is low on capital and, even though you've made all the payments on time, sends the repo man out (perhaps captured on a reality TV show) to grab your car in the middle of the night to re-sell because they'd rather get 75% of what they lent you now rather than risk the thought that you'd stop making your payments. Only they don't sell the car -- they just let it sit there and rust until its value plummets to almost nothing.

Sound far-fetched and unfair? Couldn't happen to you? Well, it is happening to private builders across the country, whose projects are being foreclosed upon even when they've never made a late payment. In fact, some builders contend that lenders encourage them to keep paying so they'll have nothing left for legal fees to fight the now-inevitable foreclosures. Expect some very nasty legal battles in the very near future about this.

So how is this good for the real estate industry, the country, or U.S. taxpayers? It isn't. It's due to bankers now under intense pressure from regulators to do something about real estate-related loans, even if building out a project could net more to them, the federal government, and ultimately, you. This is no longer about punishing greedy builders who over-built during the boom years. This is about something else entirely -- something Charles Darwin would likely appreciate. In the future, fewer builders could mean less competition -- meaning higher prices, fewer choices and crappier construction. From a New York Times story:

After riding high on one of the greatest housing booms in American history, the nation’s home builders today face a devastating reversal of fortune.

Although the housing crisis is nearly two years old, many banks had refrained from cracking down on small home builders.

They are starting to do so, and a wide swath of the industry could be forced out of business in the next few years. The trouble is concentrated especially in the Sun Belt, the scene of so much overbuilding.

Not only have new-home sales stagnated, but builders confront a rising wave of foreclosed properties coming to market at prices below the cost of building a new home. To move houses, they have to mark them down to less than the cost of construction.

The convergence of these problems is bringing many small and medium-size builders — who account for about 70 percent of new-home construction in the United States — to their knees...

No hard count exists of precisely how many builders have gone out of business since the downturn began. According to an estimate by the National Association of Home Builders, at least 20,000 builders — about a fifth of the total nationwide — have closed up shop in the last two years...

With the pullback accelerating, complaints among builders of hardball tactics and shoddy treatment by banks are mounting, as is a general sense of betrayal.

“The behavior of the banks is unprecedented,” said Mick Pattinson, a home builder from Carlsbad, Calif. who has organized a national coalition of builders to draw attention to what they regard as unreasonable treatment. “Yes, there was overleveraging in the industry. But the aftermath doesn’t need to have been as brutal as it has been.”

Some experts defend the banks, saying they are starting to do what is necessary to come to grips with the turmoil in real estate. For months, they have been under pressure from federal bank regulators and their own shareholders to curtail lending to a faltering industry...

In this climate, keeping loan payments up to date — something many builders are struggling mightily to do — is not necessarily any protection.Many loans in the building industry are of short duration, coming up for renewal at least once a year.

This allows banks to take a fresh look at the financial health of a borrower, as well as the assets securing their debt. A steep fall in cash flow or a decline in the value of the collateral — usually building lots or half-built houses — can mean an automatic default, whether a borrower has missed payments or not...

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