Wednesday, October 12, 2011
Background: "Strategic" mortgage delinquencies are soaring.
Strategic delinquencies, or mortgages that turn 60 days late after home-price drops wipe out the equity of homeowners who are remaining current on other debt, totaled between about 12,000 and 14,000 a month over the past year among the loans, JPMorgan analysts led by John Sim wrote in a Sept. 30 report.
“The more sophisticated prime and Alt-A borrowers are significantly more likely to choose to go delinquent, even when they appear to have the means to continue paying,” the New York-based analysts said.
The share of strategic delinquencies among the total has risen to about 26 percent to 27 percent from 20 percent a year ago, according to the report.
In my opinion, mortgagors who deliberately do not repay loans they freely entered in to are not "strategic," they are immoral. But that is a long argument for another time. My question for the Occupiers is this: Are rising "strategic" delinquencies just, consistent with your objectives, and perhaps a measure of your success, or are they evidence that at least some of the time borrowers are defrauding banks rather than the other way around?
Despite my Wharton education, I have to admit that I must have partied through the lecture that established that no asset can EVER drop in value below it's purchase price.
Who told these guys that when you buy a house, it's value can NEVER drop below what you paid for it?
What do Donald Trump and Mitt Romney have in common?
They're both serial strategic defaulters. The private equity business model relies on the possibility of strategic debt default to optimize the potential equity optionality of the upside.
We've got a huge and mostly still unrealized residential mortgage problem. Even if you could insist upon it, having folks pay mortgage debt on homes that are way underwater makes no long-run economic sense. Not if we want to get back to Growth.
It's a significant part of a still larger problem -- Big Debt Overhang.
We need a Debt Jubilee of some sort. The alternative is to debase money. Or suffer perpetual bread riots.
Iggy, I think we have debased the currency, and that will take care of the overhang. Only the massive collapse of credit (and therefore demand) has prevented consumer prices from rising much.
That said, debt is clearly a big problem, and loan securitization, which has many advantages, is clearly an obstacle to the restructuring of small credits (like home mortgages). I do not know if a Debt Jubilee is the answer -- inflation spreads the costs much more widely, which in a situation this widespread is probably more "fair," to the extent things can be.
Not sure I agree on your point about private equity. It is one thing to buy a company with leverage with a specifically structured and negotiated financing, and have it go bad (perhaps because the borrower does not generate sufficient cash flow) and another to just decide not to pay a loan back, even if it is perfectly within your resources.
A large proportion of every housing purchase is a consumption decision -- most Americans live in more house than they genuinely need -- and I do not understand why we should subsidize that consumption decision, either with tax breaks for borrowers or laws against recourse loans (as in California, which routinely has real estate booms and busts).
Anon Attorney here.
Meh. Enough of the morality play BS, TH. A mortgage is a contract, nothing more and nothing less.
Businesses, including mortgage banks, break contracts every day. Hell, I advise my clients to break contracts on a routine basis when the underlying business conditions render a contract disadvantageous to their business interests. It's just business.
Can you honestly tell us that in your capacity as a corporate tool you've never breached a contract when business conditions warrant??
Ignoramus, you Rock! I am too busy in my practice right now to read many blogs, much less to comment, but you've been on a roll lately. Keep preaching the truth!
Right or wrong, mortgages were historically priced around the idea that people felt an obligation to pay them back. The new idea that "efficient breach" is just another option will place a much greater premium on one's credit rating in the lending decision. That will hurt a lot of people, including those who paid their debts.
Remember when people threw parties when they paid off their mortgages? That was a value we should return to.
And, while I am a corporate lawyer and a CFO, I do not recall ever countenancing efficient breach of a contract for my company. Cross defaults and other compliance considerations make that challenging. Renegotiation, that we do all the time, but not unilateral breach.
"Strategic default" is an issue with mortgages, but it's more of a result than a cause. People weren't taking on mortgages with a view to default. If you're now in a house with substantial negative equity, and you know that you won't get pushed out for many months, maybe even years, why would you pay a dime?
No Wall Street trader would. If they did, and I was their boss, I'd fire them on principle.
I've got a good contact on the retail mortgage side. He tells me that most people in trouble are scared. They don't understand what they can get away with. "Scumbags" have been gaming the system, but it will spread to more and more of those that are just holding on.
This is a local phenomenon. Location, location, location. But in many locations, it will have significant second-order effects as municipal tax revenues dry up. I expect that many localities will see the benefit of keeping people in their homes, so long as they pay taxes. Why should they give a flying fuck about the mortgage rights of GIMP 2007-3? Wait until local judges connect those dots. There's relevant precedent from the 1930s.
The American mortgage market is broken. It's 90% conforming, and run through Fannie/Freddie which have been nationalized. They lose money -- far more than we've put into GM, Solyndra is nothing by comparison. They should be "on balance sheet" which would balloon US debt outstanding to an even higher level of debt to GDP (way past Greece). Ironically, smart investors used to buy GSE debt to gain 50bps over Treasuries in reliance on the implicit USA guaranty. Now I wouldn't want GSE paper because of the risk that the USA could renege on more express assurances. You see the risk, don't you?
Foreclosures are frozen for reasons I don't totally understand, but I have some clues. It's potentially another scandal of epic proportions, but so dull in detail that it too will pass on by.
Forget it Jake, it's Chinatown .....
One of my friends asked her bank for a lowered payment and was told, "We can't/won't unless you are behind on your payments." So she quit paying. We'll see if she now gets help. Otherwise she'll eventually lose the house, I suppose, though the inexorability of that is seriously to be questioned, these days.
Ms Kenton and I are going about 0.75 million in debt in the next few months, because
-- we can pay it, and
-- I'm making a bet we'll pay it with debased dollars. When you've been running up > 1-trillion debts for three years running and you're sovereign, what else are you going to do?
Simon wrote, "One of my friends asked her bank for a lowered payment and was told, "We can't/won't unless you are behind on your payments." So she quit paying."
I have members of my family who were told the same thing. How much of the current change was forced on the banks by Federal Regulation?
I know a bit about mortgages but I invite criticism of what follows, as there's a lot going on behind the scenes I may not know:
Most residential mortgages got securitized. The Big Bank doesn't own the mortgage -- it's held in a trust for the benefit of mortgage-backed security holders. The Big Bank acts as "servicer" for the trust. Under the securitization contract the Big Bank has nearly no contractual ability to modify current mortgages, including to cut principal, even if it makes sense. It has just a little if the mortgage is in default, but the way that the REMIC tax rules work there's a tight cap on how much they can do.
So all the Obama & Co plans like "Hope for Home Owners" were structurally dead on arrival.
Cynics say that the Big Bank makes more money if the mortgage is in foreclosure. They can charge higher serivcing fees, force howeowners to pay for forced-placed insurance, etc, I even hear that they mark up legal fees by a factor of 5x. If true, they have an incentive to drag out foreclosures, I'm not sure of this, but it would explain a lot.
Iggy, I know a certain amount about securitization -- as a young corporate lawyer, I did the first bond backed by credit card receivables -- and you are fundamentally correct. I think the last bit is a bit too cynical, though. The bigger issue is that mortgage servicing is concentrated, and the banks with a big servicing business were simply overwhelmed with issues once the default rate soared. They struggled to catch up (remember "robo-signing"), but basically cannot deal with even those loans they are permitted to renegotiate in anything like a reasonable period of time.
In almost every situation where a cynical profit-driven conspiracy or a bureaucratic or operational screw-up are alternative explanations for the same phenomenon, pick the screw-up. Odds are very high that you will be right.
On the last part, I admit I'm not sure.
I hear "robosigning" was a symptom of bigger problems. They needed the kid in the mailroom to sign "to best knowledge" else those in the know would be committing perjury. It wasn't just a "handwriting fatigue" problem.
There's a bigger problem. Mortgages weren't always delivered to the trustee, as they should have been per the express terms of the "pooling and servicing agreement" and applicable state trust law (usually New York). If so, the trust never got properly formed. Hence, no "MBS". You can't fix this years later -- there's a REMIC tax issue on top of the state law issue. I heard this as a rumor way back -- it's now in threatened Martin Act charges filed by the New York AG in the proposed $8.5 billion Countrywide settlement -- charges that would be against the trustee -- Bank of New York, not just Countrywide.
I've got even more scuttlebutt. If half of it's true it's a big problem.
It's also not clear how much applied only to the likes of Countrywide, who clearly were a Den of Thieves.
One thing is clear: Bank of America in the Lewis era could not do due diligence if its life depended on it. Which it did depend, by the way.
Yeah, the blown trusts and the unsigned documents seem like a big problem. How big, I don't know. And they raise two issues.
First, where was internal audit? I mean, at most companies internal audit *lives* to find documents that are not properly executed and processes that create exposure. Why wasn't internal audit blowing every whistle within reach? Very strange. If I were the audit committee of any of these banks with servicing issues, I'd clean house in internal audit.
Second, I've long thought that these issues (and many other aspects of the credit crisis) are ample evidence that Sarbanes - Oxley is pointless and ineffective, in addition to being expensive. How do you give an opinion on the controls environment if this sort of stuff is going on?
You raise a key question: Where were the audits? I've got an interest in this, because of my day job. I'm still trying to figure it out.
The SEC wrote new rules for ABS and MBS disclosures that came out in 2004. They provide for an "attestation report" by an outside auditor, but this appears in practice to have been limited in scope and mostly to focus on the payment streams, not on "foundational compliance". Regulation AB also had the effect of being "rating agency centric." Investors only got pool level aggregate data. Self-help diligence sampling of the loan pool wasn't allowed. Trust Us! It's AAA. What could go wrong?
The SEC has been rewriting Regulation AB -- and will sometimes admit that they fucked up -- but now the market's gone.
I wouldn't let BAC off so easy. They were into Countrywide for at least $20 billion in lending lines when they bought CFC for only $4 billion.
Most of Sarbanes-Oxley is an abomination. It's all about process. I don't know that they I could sit through a latter-day board meeting and deal with the mind-numbing trivia. SOX and what we did to Wall Street research and IPOs has made it difficult to create new $1 billion market cap companies. Some of these grow to be $100 billion companies. That's the real engine of growth for the USA. Not the proverbial small business guy filing under Subchapter S we keep hearing about. But we've been legislatively strangling these infants in the cradle.
The defaulting problem now is the result of the price of houses NOT being watched like a hawk and acted on by federal financial forces, unlike the price of milk or cement. All this attention to managing inflation, while ignoring it in the biggest ticket item that Americans spend their income on: housing. And sadly, so much attention is being paid to the symptoms that none seems to be left over for developing new monitoring and feedback mechanisms for dealing with the cause now or in the future.
Starting with eliminating interest-only loans and other such inane financial schemes whose only outcome can be to blow up real estate prices like a balloon. Continuing by limiting fixed-rate loans to 30 years max duration at 5% or higher, 15 years at any lower rate, and, say, forcing adjustable loans to vary within a fixed range (which the payer must qualify for at the top end of which).
Real estate should never have been made into a game of musical chairs.