How banks fail at foreclosure auctions

By Felix Salmon
December 8, 2009
James Hagerty's WSJ article today does a good job of explaining many of the potential pitfalls -- up to and including finding concrete poured down the toilet. But what really puzzles me is the degree to which banks seem to be just giving money away here:

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Buying homes at foreclosure auctions is not for the faint of heart, and James Hagerty’s WSJ article today does a good job of explaining many of the potential pitfalls — up to and including finding concrete poured down the toilet. But what really puzzles me is the degree to which banks seem to be just giving money away here:

Lenders, or the loan-servicing firms that represent banks and investors, are increasingly likely to set the minimum much lower [than the mortgage balance]. Their goal is to tempt others to buy the house and spare banks the headaches and costs that come with taking possession.

Sean O’Toole, chief executive officer of, a research firm, estimates that in November about 21% of homes sold in trustee sales in California went to investors rather than to a foreclosing lender, up from 6% a year earlier. The trend is similar in some other areas with high foreclosure rates, including Phoenix and Miami…

“The banks are so screwed up,” says Mr. Mirmelli, the Phoenix investor, that they don’t always have a clear idea of the value of the property they are foreclosing on.

It seems to me that lenders are simply allowing their plum properties to be picked off by these vulture-like speculators. (And I mean that in the best possible way.) What the flippers are doing makes perfect sense; what the banks are doing makes no sense at all.

The key thing here is that the banks know full well that they’re working in a world of imperfect, asymmetrical information: the buyers at auction know significantly more about the local property market than they do. The banks have a good idea of how much it will cost them, on average, if they take ownership of the property and sell it. And they then use that number to determine the minimum price that they’ll accept at auction in order that they don’t need to go through that hassle and cost.

But here’s the thing: the average loss associated with selling a foreclosed home is just that — it’s an average of homes where you lose a little, and homes where you lose a lot. What happens when you start allowing speculators to pick off the best homes at auction? They’re going to buy the 21% of houses where the bank would have lost only a little money (relatively speaking), and leave the bank with the 79% of houses where it’s going to end up losing a lot of money.

The bank then sees its average loss go up, since it no longer takes possession of the good properties to offset the bad. It then determines that this particular property market is even worse than it had thought, and lowers its minimums even further. It’s an outright gift to the speculators, directly from the bank and the owners of the underlying debt.

But it gets worse. Here’s Hagerty focusing on one property in particular:

Citigroup initially set the minimum bid at auction at $1.3 million, far more than the market value, given comparable sales in the neighborhood. Then, on the morning of the sale, Citigroup lowered that minimum to $379,900. PostedProperties, which monitors Web sites for such price changes, sent out an email on the opportunity to Mr. Mirmelli.

Mr. Mirmelli has his iPhone set up so he can call up the address of a home due to be auctioned, see a map of the neighborhood with a tap of his finger and then see panoramic photos of the street with another tap. While he researched the home, one of his partners drove out to see the exterior and make sure there were no occupants. A PostedProperties employee bid on their behalf and won the house for $486,300, a sum that then went through the trustee to Citigroup.

After expenses of about $54,000, including real-estate commissions and minor repairs, Mr. Mirmelli and his partners expect a profit of about $150,000 on the flip. “It turned out to be a very good return,” he says.

What on earth did Citigroup think it was playing at here? It’s much worse than just setting a minimum bid of $379,000 on a property which turned out to be worth $690,000. In fact what Citi did was set the minimum bid at $1.3 million in advance, well above the conceivable value of the property, basically telling anybody who might be interested in bidding that this one wasn’t for sale. And then, at the very last minute, it slashes the minimum bid by $921,000, setting off a mad scramble of mobile-enabled speculators who get in their cars to try and determine the most basic information about the house before the auction is concluded.

If you’re going to set a lowball bid at auction, it’s a no-brainer to do so well in advance, so as to maximize the number of informed bidders on the property. There’s no conceivable reason to lower the minimum at the last minute like this — if anything it just sends the message that you’ve discovered something horrible about the house (like a previously unknown first lien) which a last-minute drive-by inspection wouldn’t necessarily pick up.

It’s almost as if Citigroup was trying to lose as much money as it possibly could on this property: maybe it was just the servicer, and had no connection to the ultimate owners of the debt. But anybody holding mortgage-backed loans should be very worried about this story. If you think you’re going to get remotely market value on foreclosed property, think again.


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I don’t know how it works in other states, but in Ohio the banks don’t really have control over how much a property (either residential or commercial) will sell for at foreclosure. The property is put up for auction at a sheriff’s sale, with the only requirement being that the final sale price must exceed 2/3 of the appraised value of the property (and the appraisers are not under the banks’ control). So, at least in Ohio, you can’t blame the banks for what happens at foreclosure sales per se.

Posted by nolo | Report as abusive

I went to a foreclosure auction in Brooklyn where the banks set high minimums. The result was that almost everything went back to the bank. I suppose banks still have enough faith in the NY property market that they expect to be able to flip these, but when I look around at some of the neighborhoods I can’t imagine how people who would be willing to live in such ugly neighborhoods could possibly have the income to service a mortgage that big. I suppose they could be subsidized by a cash-flow-negative landlord dreaming of a reinflated property bubble, but this doesn’t seem like a sustainable housing model.

If you want to understand why banks would set low minimums, take a look at the growth of REO, the expense of REO, and the lack of recoveries at any California bank that doesn’t aggressively divest real estate below market prices. Cathay Bank is one I’ve taken a look at. If I were a bank that had to sell stock at below book I would take any amount of money over foreclosed empty land, half-built construction, or vacant CRE. Some managements decided against selling foreclosures or selling stock at prices 2x or 3x today’s levels, and now we get to watch what happens.

Posted by najdorf | Report as abusive

I would think banks with overwhelmed foreclosure departments might find themselves of necessity letting a lot of properties go for well less than they might otherwise like to. Ramping up the size of a foreclosure group (and keeping it competent) is probably hard to do by more than a factor of 2 over a period of a couple years.

I wonder whether Citigroup was, until the day of the auction, mechanically bidding the amount of the outstanding loan. (If so, they’re going to want to get that fixed, if they’re not too overwhelmed to do so.)

Incidentally, I know someone who recently bought a short sale, and mentioned that the second lienholder got $11,500, from which I presumed that the first lienholder believed foreclosure would cost at least that much. That story gets a lot more interesting, actually, but if I share that I’ll do it some other time.

Posted by dWj | Report as abusive

Nolo, najdorf — the question is whether the banks buy the property for the amount of the outstanding mortgage and then try to sell it so as to maximize their return, or whether they allow someone else to buy it for less than that amount, and thereby never need to sell the property at all. It’s entirely up to them. Buying for the amount of the mortgage doesn’t mean they expect to receive that much when they sell.

Banks were not good at underwriting loans or managing risk, why would you expect them to be good at loss mitigation in foreclosure auctions? If they did the legwork pre-loan they wouldn’t be so busy with foreclosure auctions.

Banks, and the biggest specifically, are not looking to make money the way the people buying at the auctions are: small amounts at a time on the back of actual examination and calculation of risk/reward. They’d rather trade MBS’s & derivatives than do the real work of markets – price discovery and capital allocation.

Posted by winstongator | Report as abusive

There should be plenty of people in the real estate industry available to staff up foreclosure departments if banks like Citi were serious about trying to minimize their losses there.

Posted by winstongator | Report as abusive

The post is unconvincing. If the auctions are competitive the speculators won’t be making giant profits on average. So they aren’t getting a gift. Naturally the article highlights the most successful purchases (which make the banks look dumb) but the average purchase won’t be as profitable. The last minute price change sounds like a mistake but there are always glitches.

Posted by JamesBShearer | Report as abusive

James, what makes you think the auctions are competitive? How many people do you think know the local market that well, are willing pay 100% cash without even seeing the inside of the house, etc etc?

The article depicts the auctions as competitive. You don’t need a lot of bidders to keep prices reasonable. You are assuming the auctions are attracting exactly one knowledgeable bidder which (absent collusion) won’t be typical.

Posted by JamesBShearer | Report as abusive

How is it these bidders have a more accurate opinion of the ‘AS-IS’ value than the bank does? Either party is likely only to have had exterior access to the property.

Posted by Shnaps | Report as abusive

I attended a Sheriffs Auction today. This was in central Ohio. The banks (their representatives) had reserved tables at the front of the auction. It seemed like every property was purchased by… the banks. When it came to the property I was there to bid on, I started bidding. I bid well over what was owed on the property, but the bank kept outbidding me. Can anyone explain what this is all about? It seems to be common knowledge in Central Ohio, you cannot outbid the banks at the sheriffs sales. It was quite apparent at this sale, 90% of the bidders were the banks representatives. Yet the banks turn around and sell the properties for far less than the auction price after the auction.

Posted by jomon2 | Report as abusive

Yes, the journalist found one sensational story. They always do. It’s what gets us to read their articles. I can assure those reading this that markets are very efficient. After attending, and bidding on at least 10 houses every week for the past 18 months, (keep in mind I’m the tiny fish at the aution with only 8 flips on the books, many have more then 40 selling upwards of 200 houses a year) the free market is working perfectly. I can tell you that the other investors know dam well what the house is worth. If the bank under prices a house it is a very rare exception one of us gets a great deal. In fact, over the last 6 months the # of knowledgeable, and unacknowledged, buyers has grown so much that I haven’t bought one house in 2 months. They are getting bid up too high. In my county, no one is making a killing on any one house. Me and 20 others are willing to make a lot less than a killing just to keep $ moving. Point being, there is no secret pot of gold at the auction just waiting to be discover. It’s a business like any other with high risk to reward.

Posted by kenhrat | Report as abusive

I went to an auction of a $58,000 market value condo. The banks bid was 250,000. They took it back then put it on the market for 75,000. It sold for $58,000 two months later. Is it because they can take such unrealistic write offs I wonder?

Posted by googlenut52 | Report as abusive