The Charlotte (North Carolina) Observer just published a really nice piece of investigative journalism, some of which appears below. This is pretty much self-explanatory, but keep a couple of things in mind as you read: 1) Though the story is about housing in a single state, it's probably representative of the rest of the country, and 2) the work these reporters did is the kind of research you'd think Wall Street analysts (each of whom is paid more than these three reporters combined) would be doing regularly. But based on their knee-jerk "buy" recommendations on the mortgage lenders, homebuilders, and investment banks, it's clear that most Wall Street analysts are missing some crucial parts of the story.

Oh, and pay special attention to the discussion of how little the government knows about the all this.

Failed mortgages fly under the radar
Binyamin Appelbaum, Lisa Hammersly Munn & Ted Mellnik
Wed, Mar. 21, 2007

The city of Charlotte does not count foreclosures. Neither does Mecklenburg County. Nor the state of North Carolina. Nor the federal government. As a result, authorities did not notice an emerging pattern: Foreclosures increasingly were concentrating in starter home neighborhoods.

An Observer analysis of county records found 35 Mecklenburg developments of low-priced homes built in the past decade with foreclosure rates of 20 percent or higher. Dozens of residents say the concentrations have damaged their communities. Prices fell. Renters moved in. Crime sometimes rose.

But as the foreclosures piled up, authorities were unaware. "We wouldn't know it on a neighborhood level," says Mark Pearce, deputy N.C. commissioner of banks, which regulates loan sellers. "A 20 percent foreclosure rate in a neighborhood that's new is surprising and troubling."

Even the Federal Housing Administration, which insured many of the failed loans, didn't track the concentrations. The Observer on Sunday profiled Southern Chase, a neighborhood of 406 houses in Concord built by Beazer Homes USA. Seventy-seven buyers lost their homes to foreclosure. Forty-five of the failed loans were insured by the FHA. But federal officials expressed surprise when asked about the concentration. The Department of Housing and Urban Development, which administers the FHA program, was unable at first to say how many loans it insured on streets in Southern Chase. It was unable to say which ones had foreclosed. And it didn't know all the failed loans were in one neighborhood.

The lack of information about the location of foreclosures makes it harder to regulate the lending industry. Buyers share responsibility for the loans they accept, and foreclosures sometimes result from the loss of a job or an unexpected expense. But regulators say that concentrations of foreclosures often indicate misconduct by someone else, such as a broker who arranged a number of loans or an appraiser who valued the homes. None of the government agencies contacted by the Observer plans to start tracking foreclosures.

Federal authorities
About 8,700 homes have foreclosed in Mecklenburg County over the past four years. The county's foreclosure rate is the highest in the state. An Observer study found almost 30 percent of the foreclosures in 2003 and 2004 were associated with loans insured by the federal government.

The FHA encourages lending to lower-income families by promising to repay lenders if the borrower does not. The money comes from premiums paid by borrowers, not from taxpayers. In the mid-1990s, the FHA started insuring riskier loans. Borrowers were no longer required to make a down payment. Lenders could arrange larger loans simply by projecting that a borrower's income was likely to increase. The share of Americans who own homes rose to almost 69 percent last year from 65 percent in 1996. The FHA was responsible for a share of the increase. So were subprime lenders, which make loans with high interest rates to the same people traditionally served by the FHA. But now the number of foreclosures also is pushing into record territory, driven by defaults on FHA and subprime loans, according to estimates made by the lending industry.

"The mortgage industry has said they have increased home ownership," HUD's inspector general, Kenneth Donohue, told a U.S. House committee last week. "However, at what cost to the American people?"

The FHA has tightened some of its standards in response to the problems. In 2004, it stopped allowing lenders to increase the size of a loan by projecting a borrower's income would increase. Beazer arranged such loans for 147 buyers in Southern Chase. More than a quarter ended in foreclosure, often because the borrower's income did not increase. But the FHA continues to allow buyers to purchase homes with no money down. It requires a 3 percent down payment, but it allows sellers to provide the money to the buyer indirectly. Federal studies show the price of the home is often increased to cover the expense. That leaves buyers with no equity. Government reports have criticized the practice because borrowers foreclose more often if they don't own a stake in the home. In Southern Chase, Beazer provided down payments for 135 borrowers. More than a quarter have foreclosed.

State authorities
The newspaper found that Beazer, which arranged loans for most buyers in Southern Chase, in some cases arranged larger loans than buyers could afford. Facts were misstated on an appraisal obtained by the Observer. North Carolina's regulatory boards license mortgage brokers and lenders, appraisers and other real estate professionals. They can revoke licenses and refer cases to law enforcement. But regulators lack basic information about who is involved in the lending process. The name of the lender appears in public records, but not the name of the appraiser, or the broker that arranged a loan. The N.C. Appraisal Board usually investigates only after receiving a complaint. That means it often relies on homeowners to figure out the price of their home may have been inflated -- and which state agency to call.

The N.C. Commissioner of Banks is prioritizing examinations of mortgage brokers whose loans result in a large number of foreclosures, deputy commissioner Pearce said. But Pearce said the agency continues to rely mostly on complaints from the public to know which brokers deserve scrutiny. After the Observer first reported last year on Mecklenburg County's spiking foreclosure rate, state legislators filed a bill to include appraisers and mortgage brokers in the public record. It died in committee.

Some legislators haven't believed foreclosures are a problem, says Rep. Becky Carney, D-Mecklenburg, a vice chair of the House committee created to study foreclosures after the Observer's stories last year. There's more attention on the issue now, Carney says, because of the problems in the subprime lending industry. Some legislators, she says, "are as surprised now as some of us were last year."