Tuesday, April 10, 2007

Who Would JP Morgan Invite?--Part II

Earlier, I wondered aloud how the subprime mortgage meltdown would play out; and in particular, whether (or how) anyone could impose a political settlement--who would JP Morgan invite to his yacht (link)?

I've been favored with a thoughtful repsonse from someone who obviously undestands the business. With permission, and with some minor cosmetic editing, I offer these thoughts here. It's a bit of inside baseball, meant for readers who really care about this stuff. But a remarkably large slice of the readership of this blog seems to fit into that cstegory. So here goes:

The loan servicer will be doing the foreclosing; in point of fact, I expect that in CA, for example, the servicer will engage a foreclosure company actually to handle the foreclosures. There should not be recourse to the originating lender; otherwise, from a regulatory standpoint, it would be treated as a loan from the originating lender to the loan purchaser, which defeats the whole purpose of the sale/securitization.

This can be unnecessarily complicated and jargon laden, but to oversimplify, the broker was most likely never the originating lender; the originating lender was likely a mortgage banker (which then pooled the loans and sold them) or, say, Citibank, which the mortgage loan broker or maybe even a mortgage banker brought to the table (which, in turn, pooled the loans and sold them); as noted above, however, the sale was undoubtedly without recourse, and the originating lender is out of the picture.

The more interesting questions for me are more practical: (1) how will the lenders structure their credit bids, (2) what they do with the REO (I know that they will sell it eventually but under what general or specific guidelines (i.e., how long will they hold it, to what will they cut the sales prices, etc.?)), and (3) if the lender is a sold out junior holding a note not protected by Cal. Civ. Code §580b, willl the lender seek to sue the debtor on the note?

There are a bunch corollary questions, such as: can we expect to see judicial foreclosures given what should be the whopping deficiencies (and I think the answer is "no" given the fair value limitations)? That sort of leads to the second set of questions. At least in CA, because of the interplay of the one action rule and the anti-deficiency protections, I think that the lenders pretty much have to suck up the losses, except in the specific case referred to in (3) above. Given the fact that the debt has been securitized and sold on "the street," I don't know that there is a list of people whose arms can be twisted, unless it's the servicers, but their discretion is generally speaking severely limited, and they have to act in accordance with the loan documents and the indenture or other operative document that governs their engagement.

Similarly, I'm not sure I know what segment of the economy really gets hurt because they are holding, to put it mildly, less valuable securities. In other words, I don't think this will be like the S&L meltdown, but I don't know exactly who holds the securities (is it only pension funds?) and, thus, who will feel the pain. What I would expect is pressure from some quarters to stop making loans that aren't exactly predatory but that subject the consumers and the economy at large to undue risks because they can't be collected, result in the driving down of property values, etc. Whether this pressure comes from the government, the industry, or "the street" or all three, is another question.

And a goodbye comment that invites showcasing by itself:

Furthermore, I have to assume that someone has figured out how to profit from this on a large scale and is in the process of doing it, but I also don't know who that is.

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