Posted on Friday, 9th October 2015 by Robert Domini

A Few Interesting Court Cases


In the City of Long Beach v. Sun NLF Limited Partnership, Supreme Court, Appellate Division, New York, January 14, 2015, wherein Sun owned three non-contiguous parcels. The City of Long Beach, New York began condemnation proceeding of Sun’s parcels in April 2006. Sun’s appraisal of parcel 1 was accepted by the City. Parcels 11 and 13 were non-contiguous and were separated by Parcel 12 which was owned by an unrelated third party. Sun’s appraiser put a value on parcels 11 and 13 with the assumption that they would be assembled along with parcel 12 to form a site for multifamily development. The problem arises that Sun did not own parcel 12. Also, parcel 12 had no value as an independent site. Sun’s appraiser put a value of $11.8 million on the assembled site with parcels 11, 12 and 13. The court ruled that there was a reasonable probability that the three parcels could and would be combined and awarded $11.8 million to Sun. I disagree. Sun had no purchase contract or letter of intent from the owner of parcel 12. As the Sun appraiser was working on this assignment, certainly his clients had ample time to make the owner of parcel 12 a reasonable offer for their mutual benefit. This was not done. As a result, Sun walked away with $11.8 million based on a speculative conclusion by the State Supreme Court of New York.

Montgomery County v. Lane, Court of Special Appeals of Maryland, April 2, 2015. Tax court may use subsequent sales of condominiums in same building, and of same age and condition, to assess value of condominium. The Assessor placed a value on a condominium of $2.13 million effective January 1, 2011, whereas the previous year it had been $1.92 million. Lane presented evidence of a lower value with sales from 2008 and 2009 while no sales occurred in 2010. The Assessor had the property re-appraised with sales from May 2011 which supported a value of $2.075 million. The May 2011 sales were in the same building and very similar units. The Court of Special Appeals ruled that the sales subsequent to the tax lien date were valid evidence of value even though they were subsequent to the date of value. This is in consideration of the code which clearly prohibited consideration of sales subsequent to the date of finality. The court ruled that the sales comparison approach was the most accurate method of appraising real property. The initial assessment of the Lane property was done by a computer-assisted mass appraisal technique. I agree. In fact, the “yellow book” which is the appraiser’s manual for federal appraisals allows sales subsequent to the date of value if there is evidence that the sales reflect value as of the date of value. Some appraisal reviewers draw a strict line and reject sales subsequent to the date of value in eminent domain cases. I disagree with them, but I do agree with this court decision.

In Re Bilmar Team Cleaners, Supreme Court of Vermont, January 16, 2015. Cost to cure pollution was sufficiently reliable to determine fair market value. The property was a gasoline station that was in operation from about 1940 to 1970. In 1987 Bilmar purchased the property for a place to operate their dry cleaning business. About 1993, it was discovered that the ground water was being contaminated by leaking from the property. It was undoubtedly coming from old underground storage tanks. Bilmar spent $20,000 for engineering studies and to set up ground-water monitoring. At that time it was learned that Bilmar could invest an additional $10,000 in order to tap into the Vermont Cleanup Fund which would provide an additional $990,000 for any future remediation. The property was assessed by the Board at $193,000 based on an appraisal of $225,000 less $10,000 for the cleanup and adjusting for equalization which brought the taxable value to $193,000. Both the taxpayer and the Board agreed that the value would be $225,000 were it clean. The taxpayer argued that the pollution created a stigma which damaged the property far beyond the cost to cure and the property had a value closer to zero. The Supreme Court ruled in favor of the Board with a value of $225,000 less $10,000 cost to cure and an equalized value of $193,000. I agree. Appraising contaminated properties can be a complex endeavor. Treating the problem like the Vermont Supreme Court did simplifies an otherwise complex problem. Logic tells us that a property is worth the value as though uncontaminated less the cost to cure (remediate). This is not to say that properties can’t be stigmatized. We know that houses such as those where a murder is committed can be stigmatized. Such is the case with some of the Jeffrey Dahmer murder scenes. In order to justify damages due to stigma, however, the appraiser must produce comparable sales data of properties which have been stigmatized.



An article by David Stockman, Ronald Reagan’s Budget Director says  that a Financial Crash is coming. “A major market correction is coming as the world’s debt bubble implodes. It will burst harder and faster than you think”. He predicts that it will obliterate $15 to $20 trillion of household net worth. He says that the printing presses of the Federal Reserve have injected $3.5 trillion of fiat liquidity into Wall Street since Lehman’s collapse in 2008. I really don’t understand this, but he says that the “Fed uses credits conjured out of thin air to acquire real government bonds that previously funded the purchase of such things as military equipment. The Fed is swapping nothing for something.” He explains that Wall Street investors buy, say, a ten-year Treasury yielding 2.2% and immediately put up the bond as collateral and borrow 95% of it in the repo market. The net result is that they collect 220 basis points from Uncle Sam and give back only 5 points to their repo lender. Stockman is predicting that we will soon be into a global period of deflation which will tip the U.S. economy into recession. Here’s what I can understand. If rates go up even a little bit, any and all new borrowing by the Fed to roll over existing and new bonds will be at a higher rate. With trillions of dollars in bonds out there, the Federal Government will be into a massive cash flow drain situation.



James R. DeLisle, PhD writes in The Appraisal Journal, Summer 2015, that Cautionary Signals are coming from Commercial Real Estate Markets and Consumers. He notes that there are many positives at the present time such as decent job growth, sedate inflation, low interest rates and fairly strong consumer sales. For Commercial real estate conditions have continued to improve during the last five years with vacancy rates declining, steady rental increases and declining cap rates. Overall he believes that the economy (GDP) is growing anemically, but steadily. Here’s what I don’t see coming. DeLisle sees problems in the capital markets, not in the real estate fundamentals. He cites a Wall Street Journal article August 12, with the headline, “Surge in Commercial Real Estate Prices Stirs Bubble Worries; Soaring demand for commercial properties has drawn comparisons to delirious boom of the mid-2000s.” Buyers are beginning to chase assets. We can all relate to that feeling of chasing assets. It’s called buying high and selling low. Not a good way to invest.

A recent Wall Street Journal article is predicting faster consumer spending which, if it comes to fruition, would certainly be incentive for a Fed rate increase. Ironically, more than half of the countries in the world feel we’re still in a recession. Despite the Greek crisis, most of Europe is experiencing improved consumer spending led by Russia, although Italy and France are still lagging. The Chinese economy as evidenced by recent stock market volatility is slowing down. The National Federation of Independent Business Small Business Optimism Index fell dramatically at the end of the second quarter. Small business is reporting lower sales and profits as a result of an economic slowdown. An upcoming drag on business and consumer optimism is sure to rear its head as politicians from both parties paint a negative and gloomy picture of the economy. Still, the PWC Third Quarter 2015 investor survey is reporting increasing rents, lowering vacancy and declining cap rates over the last five years at a fairly strong pace. What can or will happen to dampen this string of consecutive positive years? Perhaps it’s a financial collapse brought about by increasing interest rates. Certainly the U.S. Government will have difficulty dealing with higher rates to finance mountains of debt.





This is an amazing book because it delves into the seamy business of  the mortgage bond financing of subprime loans. When almost no one was paying attention, a very few analysts began to dissect and understand what was really behind these financial instruments. This is my summary of what the author had discovered and the story he told in this book and it is my hope that each and everyone who reads this review goes out to buy this fascinating book.

The characters in this book are real. The author digs into their lives and speaks as though he were there. Yet, this is a story about real people, Steve Eisman, Michael Burry, Greg Lippmann, Charlie Ledley, Jamie Mai, Vincent Daniel, Danny Moses, Porter Collins and Ben Hockett. Michael Lewis is author of The Blind Side among many other novels. This one is a true story, not fiction.

The story begins with Steve Eisman who had recently graduated from the University of Pennsylvania and Harvard Law School. He worked a brief stint as a lawyer and decided to take a job at Oppenheimer with his parents as a stock analyst at age 31. He first noticed the subprime mortgage market when Aames Financial went public, and soon thereafter Eisman became lead analyst for Aames. In short, the subprime market made mortgage loans to cash-strapped people. This goes back to the early 90s. The money for the subprime loans came from mortgage bonds. Each bond financed hundreds of subprime mortgage loans. Each bond consisted of tranches which were groupings of bonds ranging from those with greatest risk which had the highest interest rate to those with the lowest risk which had the lowest interest rate. The loans were not for people buying houses, they were for people who wanted to cash out their equity. Actually, the subprime mortgage bond market was built upon the second mortgage, not the first. The borrowers were trading their credit card debt for second-mortgage debt. Within short order the bonds were being sold by big houses such as Solomon Brothers.

As a result loans were being made to people with reckless abandon by mortgage originators who quickly cashed out on their loans as they collected their money from the sale of the mortgage bonds. We can all remember the saying, ‘oh well, they don’t have to worry about those loans, they are being sold on the secondary market’. At the time, however, they were required to keep a small portion of the loans on their books. This was the mortgage bond market which most of us knew very little about. Initially, Steve Eisman and a few others thought they were doing something good for people who were at a disadvantage in our economy. Enter Lewis’ second character Vinny Daniel who had a job as an auditor for Arthur Anderson auditing the books of Solomon Brothers. He bumped into a question almost immediately wondering why they owned those mortgage bonds, and no one could explain them to his satisfaction. About a year later he was hired by Eiseman and the two of them together shared a mutual skepticism about the mortgage bond industry. Vinny’s first assignment was to find out why Moody’s gave Mortgage-Backed Securities a AAA rating. Many of the loans were for manufactured housing and/or mobile homes which had an incredibly high default rate. He searched and investigated these pools of loans for a period of six months and what he found was that the subprime lending companies were “growing so rapidly and using such goofy accounting that they could mask the fact that they had no real earnings, just illusory, accounting-driven ones”. This was 1997, and Eisman published a scathing report on the subprime lenders. A year later the collapse of Long Term Capital caused a flight to safety and the subprime market evaporated.

By 2000 subprime lending was making a comeback with $55 billion in mortgage bonds only this time the subprime originators didn’t keep any of the loans on their books. They sold them all into the mortgage bond market. Actually what they did was to sell them to the big Wall Street investment banks which in turn packaged them into mortgage-backed securities and sold them to investors. So now the new model was originate and sell. Those Wall Street firms deep into the subprime business were Bear Stearns, Merrill Lynch, Goldman Sachs and Morgan Stanley.

In 2004 another investor, Michael Burry became interested in subprime loans and mortgage-backed securities. He learned that ARM interest-only mortgages were only 5.85% of the market in 2004, but by the summer 2005 they were up to 25.34% of the pool. The loans continued to deteriorate with the so-called liar loans where a borrower need not divulge his income or his assets. Burry knew that the subprime mortgage-backed securities were doomed, that was for sure. He just didn’t know how to profit from this knowledge. Burry was able to promote and establish a credit default swap mechanism for mortgage-backed securities. This is in essence, an insurance policy against the default of a bond. The price for the insurance was an annual 2% premium for a ten-year period. So, you could buy insurance on a million dollars of mortgage bonds for $2,000 per year. The most you could make was $1 million and the most you could lose was $20,000.

On May 19, 2005, Mike Bury bought his first credit default swaps for $60 million of mortgage bonds. The price was $10 million each for six bonds. He bought them directly from Deutsche Bank because he felt that Deutsche Bank was one of the investment banking houses which would be able to afford to pay off their debts in case the subprime market collapsed which he believed it would. At the time there was a flurry of ARMs sold into MBS (mortgage-backed securities) which started at 6% and in two years the borrowers’ rate was scheduled to increase to 11%. He was certain that they would default en masse some time in 2007. Also, remember that he was paying a premium of 2% per year for the insurance or a total of $1,200,000 per year for $60 million in MBS. In addition, the way the CDS (credit-default swaps) were designed, the insured would collect insurance benefits at regular intervals as the borrowers defaulted. The six bonds were handpicked because they were the worst loans he could find. The factors were loan-to-value ratios, liens on the homes, the location of the homes, the absence of loan documentation and proof of income of the borrower. He was surprised that the price of CDS were the same no matter how low the quality of the underlying loans. The price of the insurance was based on Moody’s and S&P’s ratings. The best tranches had a AAA rating while the BBB tranches were for the lowest-quality bonds. These tranches would be worth zero if the underlying mortgage pool had a loss of just 7%. The price for a AAA tranche was .20% while the price for a BBB tranche was 2% per year. By the end of July 2005 he owned $750 million in subprime mortgage bonds. With one billion invested in May-June, by November 2005 the loans were going bad at an alarming rate. A November 2005 story in the Wall Street Journal explained that the ARMs were going bad after only nine months, more than a full year prior to the rate adjustment.

So, Goldman Sachs, Deutsche Bank and the rest were selling the CDS (credit default swaps), but as it turned out, they were not taking the risk. They were just making money as the middleman and the company holding the entire bag of garbage was AIG. AIG was a AAA-rated company that could afford to back massive bets on mortgage-backed securities. It’s impossible to imagine how so many smart people within AIG including Hank Greenberg could have made a $100 billion wager on subprime mortgage loans.

In case you’re still flogging yourself for not seeing the subprime collapse coming, here is a recap of behind-the-scenes conversations occurring within AIG as their kingdom collapsed. A fellow named Gene Park was promoted to the job as ambassador to Wall Street’s bond trading desks. Upon being appointed to the job he decided to examine the loans which AIG was insuring and take a very close look at them. He discovered that these supposedly diversified pyramids of consumer loans were almost entirely comprised of subprime mortgages. He asked people who were involved in the decision to sell credit default swaps such as Gary Gorton, a Yale professor, who had built the model AIG used to price credit default swaps. When asked, Gorton guessed that the piles of mortgages in the tranches were no more than 10% subprime. Park asked a risk analyst in London who guessed 20%. None of them knew it was 95%. In fact, Allen Greenspan didn’t know. I suppose Moody’s and S&P who put BBB ratings on the lowest of tranches didn’t know either. The author of this book believes they were all making too much money. Here are a few direct quotes. “The AIG FP traders were shocked by how little thought or analysis seemed to underpin the subprime mortgage machine. It was simply a bet that home prices would never fall”. AIG had sold $100 billion in credit default swaps. Or, in other words, they insured $100 billion of mortgage-backed securities and agreed to pay that amount if the bonds defaulted.

Well, well, lo and behold on July 1, 2006, S&P announced plans to  change the model used to rate subprime mortgage bonds. The plot thickens and the collapse is on. In the summer of 2006, house prices peaked and for the entire year of 2006 they fell 2%. The investors in credit default swaps looked for the bonds with the most rotten loans. They looked for packages of loans with the highest concentration of no-doc loans which were loans to people who were not required to show evidence of income or employment. A second characteristic was loans originating in the sand states of California, Florida, Nevada and Arizona. House prices had risen fastest during the boom in those states and could be expected to crash the fastest. (By the way, I just read that houses in Florida have increased in value 40% since 2012.) Also, many of the dubious lenders were from those states such as Long Beach Savings and Washington Mutual. In fact, their favorite was Long Beach Savings which pushed loans to people with no proof of income on a floating basis with initial teaser rates. One example was a loan in California to a strawberry picker from Mexico was given a loan over $700,000.

At that same time in 2006, I did an appraisal south of Washington DC in Prince William County which was a fully-platted, proposed subdivision the U.S. Department of Interior was interested in acquiring. In appraising it, I researched neighboring subdivisions and was shocked to see what was occurring and what had occurred. The homes were very modest, probably in the 2,200-square-foot range. Prices started around $250,000 in 2004 and peaked in late 2005 at over $700,000 followed by re-sales coming back down the ladder to $250,000 within a two-year period. The names on the mortgages were clearly of people from other countries such as the Middle East, Central and South America. Many resales were to people of the same or similar nationality which I found curious. I’ve never verified this, but I have a feeling that a great many of the loans were being made to people from other countries, some here legally and some not.

The big Wall Street firms such as Bear Stearns, Lehman Brothers, Goldman Sachs and Citigroup had a goal to pay as little as possible for the home loans and charge as much as possible for their end product, the mortgage bonds. The price of the end product was driven by ratings assigned to the bonds by the ratings agencies such as Moody’s and S&P. It was the job of the bond traders making millions to coax the highest ratings for their MBS. The people at Moody’s and S&P didn’t actually evaluate individual home loans. In fact, they didn’t even look at them. The only thing they looked at were the FICO scores which could be rigged. In fact the Mexican strawberry picker making $14,000 a year could have had a high FICO score because he had no credit history. Moody’s and S&P didn’t care if they were loans with low teaser rates. They also had no idea if a package contained no-doc loans. To make a long story short, the millionaire bond traders were able to game the rating agencies for high ratings in order to beef up their sales prices of the bonds. One CDS investor sent his analysts to pay a visit to Moody’s and S&P to investigate how they came up with their ratings on MBS. What they learned from a Moody’s employee, whose job it was to evaluate subprime mortgage bonds, was that she wasn’t allowed to downgrade bonds that deserved to be downgraded. She was required to send a list of 100 bonds to her bosses that she thought should be downgraded, and, typically, they came back to her approving only 25 of the 100. It was as though they had a vested interest in keeping the bond ratings as high as possible. When the analysts asked the bond evaluator how she determined that a bond containing subprime mortgages could be rated AAA or even BBB, she couldn’t answer the question.

As the defaults became epidemic during the first half of 2007, and when the bonds were in full default, small players such as Burry and even Eiseman were having a hard time cashing in on their credit default swaps. The total losses to Morgan Stanley, Bear Stearns, Merrill Lynch and the rest were $1 trillion dollars. In the end the small players were able to cash in, but they had to negotiate settlements piecemeal. The collapse resulted in a near collapse of the world economy in late 2008. It was all because of subprime lending and the packaging of them into mortgage-backed securities. One big player actually made money, Deutsche Bank.

By the way, AIG was insuring the subprime bonds until the end of 2005, and gave up on it after that. Moody’s and S&P continued to rate the MBS the same, AAA and BBB. Here’s another question. What is a CDO? It means “collateralized debt obligation”. Yes, we know that. After AIG exited the insurance of subprime paper, Wall Street turned to using the CDOs to turn crappy BBB-rated subprime bonds into AAA bonds. From the end of 2005 through mid-2007, Wall Street firms created upwards to $400 billion in subprime-backed CDOs. This means that after it was widely known that the mortgage-backed securities were rotten through and through the Wall Street firms continued to sell them newly packaged as CDOs. As the crash began, Bear Stearns was sold to J.P. Morgan for $2.00 a share. On September 28, 2008, Lehman Brothers filed for bankruptcy. Merrill Lynch with $55.2 billion in subprime losses sold itself to Bank of America. The Federal Reserve loaned $85 billion to AIG.

Is it any wonder our real estate values collapsed. For those of us who had property in Florida, the collapse was painful.

In more recent news, as of December 2014, Fannie Mae is offering a 97% loan-to-value. FHA loans are being offered with 3.5% down. VA loans are being offered with 100% financing and no mortgage insurance. Both rates are offered at either .25% or .375% below conventional loan rates. The program can be used by either first-time buyers or repeat buyers. The loan terms must be 30-year amortization. No ARMs are available nor are 15-year loans. The size of the loan can’t exceed $417,000.



I hope you enjoyed reading this newsletter. This is the first issue in two years and it’s because I’ve heard from several people who’ve said they really enjoyed them. Please remember that Continental Valuations is a commercial real estate appraisal company. We can provide residential appraisals through our sister company, Coastal Appraisal, which is located within our building. Our commercial appraisal offerings include the full range of commercial properties ranging from offices to retail and industrial types of properties. In addition we’ve had experience with unusual types of properties through the years including dairy farms, churches, enclosed shopping centers, medical facilities and marinas, just to name a few. We also do appraisals for eminent domain purposes both for the acquiring agency and for the property owner. If you’re considering litigation, this is something I personally enjoy. Give us a call. If we do not have experience with a particular property type, we’ll either recommend someone else or find a qualified appraiser to form a team.

Best regards,

Continental Valuations, Inc.

Robert D. Domini, MBA, MAI

Certified in Ohio, Michigan and Florida

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