Monday, October 25, 2010

Two Thoughts on the Mortgage Meltdown:
A Plague o' Both Your Houses

I won't for a moment pretend to have read everything written on the topic but here are a couple of thoughts on mortgage meltdown that i haven't seen elsewhere.

One: the banks are going ballistic hanging tough over the question whether they should rewrite some of these deals so that buyers can stay in their homes. They've pretty well sandbagged HAMP and they talk about a possible Chapter 13 writedown amendment as if it were the End of Western Civilization as we Know it.

What this loses sight of is the question of what will happen if the banks don't get writedowns. For borrowers, this is a huge issue, of course. Either they get to stay in their homes or they do not. For banks, I suspect it is not a big deal. The point is: they are never going to see this money anyway.

Consider the debtor with a $400,000 loan on property worth $280,000. He's out of work and can't pay. He walks away, leaving a deficiency claim of $120,000. What then? In a nonrecourse state, the bank eats it as a matter of law: the bank is debarred from pursuing the debtor for the shortfall.

In a recourse state, the bank can sue the debtor for the shortfall, but I suspect in most cases it won't be worth the bother. The debtor either (a) goes bankrupt and discharges the shortfall claim; or (b) does not go bankrupt and just limps along judgdment-proof, i.e., with no assets to play the game.

The point is that in all three cases, the bank is no worse off than if it took a modification. Indeed I can think of only one way that modification changes things and that is it may allow the bank to get more. How can this be? The answer is that if it plays its cards right, the bank may be able to position the debtor where he is obliged (and willing) to pay a bit more than the bare minimum--in our case, say $290,000. If these are the right numbers, than the bank is better off taking a carefully-done rewrite than otherwise.

That's point one. Now onto point two. We hear a steady drumbeat of argument that the debtors ought to get relief because the subprime fandango was full of "massive fraud." Correct, the subprime fandango was full of massive fraud, but look as little closer. From what I hear, the main fraud claim is that the banks (or brokers for banks) structured deals based on grotesquely inflated estimates of the borrowers' ability to pay--faked data about income and employment,l for example. Sounds like fraud to me, but who is defrauded here? Maybe the buyers of this caca, who took it on the bank's recommendations. Maybe the shareholders, entering into the delusion that their agents the managers were spinning straw into gold and thus deserved massive bonuses.

But the borrower? Maybe he was lied to--e.g., when he was told that it was perfectly all right to declare his income at eight times its actual number. Yet for the life of me I can't understand why a grownup loose on the streets could be misled into believing that he could pay, say, a $3,600 monthly mortgage payment from his takehome down at the car wash. 

Sure, there are cases and cases. That's why we have courts and lawyers (and that is why, inter alia, it is so bogus for the banks to say that they ought to be able to foreclose without paperwork). I might add that I'd feel differently if we were dealing with people 26 years into a 30-year mortgage who got whipsawed by some unseen society-wide calamity. But people take chances; it is okay with me that they take chances, but if you take chances, there is a chance that you will loses.

So, a plague o' both your houses.   I don't think the banks are ever going to get their money back on this one and I don't think they deserve to.  On the other hand, I'm not losing much sleep over debtors who so eagerly bought into such a lunatic fandango.

Update:  The Wichita Bureau, who is skeptical that workouts will succeed,  offers a constructive program for relief:
The banks might be better off with a deed in lieu and a short term – three year lease with option to purchase deal. So would the borrower. The house would stay off the market for a while; the borrower would pay the taxes and upkeep and the bank wouldn’t have to sell into a falling market (if the foreclosure mess didn’t kill the market; a lot of people are suggestion that too many short cuts were taken).
 Wichita adds:
This whole mess seems to be a fight over who is going to get stuck with the loss – the borrower (unlikely), the bank or the investor who bought the asset backed security (which means the government). I’m betting the government eats it.
 Sounds right to me.

1 comment:

Anonymous said...

A bigger problem is going to be the fraud on the courts by the banks/servicers during foreclosure. This is just starting to bubble up in the MSM, somewhat coyly as something like "paperwork problems" - however, more likely "fraud on the court" (both state and federal): forged and "recreated" documents, forged signatures on affidavits, back-dated note assignments, and notary malfeasance are possibly going to lead to some pushback of loans to the originators and/or CDO packagers - i.e., mostly the banks at this point. Tim and Ben are trying to play this down, but there are securities litigators out there delighted with the turn of events.

Also, and possibly a help to the deficit, this and other paperwork fraud from originators and warehousers may allow the IRS to tax (highly) the previously tax-free REMICs, as without proper transfer the Trust doesn't hold up as a pass-thru.

But the biggest problem is beyond that: as long as 3 years ago, some were pointing out that the (then) soon-to-be 2008 sub-prime delinquencies were just the warm-up to the larger 2011 problems with prime and Alt-A loans. We're soon to see it play out.