The Foreclosure Mess - What Happens Next

Just to review, we experienced a near-Great Depression in 2008 when the real estate market collapsed after fraudulent and near fraudulent mortgage lending, home buying and selling drove prices to unsustainable heights. Consequently, we have record numbers of delinquent mortgages, record numbers of foreclosures, record numbers of underwater mortgages, record numbers of strategic defaults and short sales. Foreclosed properties are leading the market and setting home prices nationwide.

At some point early in the year, the large mortgage lenders decided that the only way to create some stability in residential real estate pricing would be to tightly manage foreclosure inventory and the timing of putting homes on the market.

The first step would be to foreclose on every home in default as quickly as possible. The banks set up foreclosure mills to process foreclosures at lightning speed. In states without judicial foreclosure requirements, foreclosures quickly ramped up to unprecedented levels.

In states with judicial foreclosure, efforts to circumvent the judicial process were implemented, including legal lobbying efforts and outright fraud to circumvent the process of documenting an involuntary change in property title. As states caught on to what was happening and the level of fraud necessary to process thousands of mortgage claims in a single day, some of the banks took preemptive action to investigate their own foreclosure activity. And then the media finally caught on. Now as many as 40 states may begin investigating foreclosure practices if they haven't already and even president Obama has recognized how big this story is and has called for a national moratorium on foreclosures.

It's the residential real estate version of the gulf oil spill, with the difference that criminal activity is going to be easy to prove.

At the very least there are going to be tens of thousands of notarized affidavits fraudulent, criminally signed by bank representatives attesting to their due diligence in reviewing the mortgage, the property in question and the borrower's delinquency. There is no conceivable way that this does not constitute a criminal conspiracy on a massive scale.


And yet...


As Low has often posted, these foreclosures are necessary. By the millions, people are camping out in homes they no longer own. The financial health of the banking sector is going to remain murky until all these foreclosures are processed.

So, what to do?

What I would propose is a two year moratorium on mortages and a legislatively mandated write down of all underwater mortgages down to the real market price of the home in question, accompanied by a financial means test of the homeowner to be completed within this two-year period.

If the homeowner in question cannot afford the payments after the mortgage writedown as determined by the objective means testing, or determines subjectively that s/he will not be able to afford the payments, then the bank forecloses immediately and the owners are evicted.

Banks are not going to recover more than the actual value of the home, minus all the costs associated with pursuing foreclosures. This process would allow the banks to write off the bad loans at a predictable rate and let the housing market find a price bottom within a predictable time frame.

Unfortunately, it will have to come with some kind of taxpayer funded guarantee to limit bank losses, and there should also be some kind of homeowner fees so that they take some kind of financial hit and don't get an outright "free" mortgage writedown.

The voluntary system for mortgage writedowns as implemented by the Obama administration has been a failure. But some version of my plan is a legitimate way out of this mess that doesn't trample all over the system of property law that we have in place. Without it, more banks will fail, and the mortgage foreclosure mess will take a decade to work through.

 

Interesting proposals.

What's the justification for the 24 month moratorium? I could see the banks agreeing to something like a 90 day stay, but I think 2 years would start to have a negative effect in other areas. For example, let's say Boeing wants to expand and a executive has to move to Chicago. Would they not be able to sell or buy a home for 2 years? Or would you consider swapping his old mortgage for a new one, not a "new" transaction?

 

What I really meant was a 24 month period to work through the mortgage writedowns and foreclosures. It would be like a deadline for pulling out of Iraq, after which the president could declare that the combat operations in the war against fraudulent foreclosures were over.

The interesting issue is that the fraudulent foreclosure investigation is going to expose all the fraud that happened on the other end:

In the mortgage backed security frenzy, many of the mortgage originators were themselves fraudulent enterprises. If they never provided the the note and the mortgage lien documentation to the trust, then that documentation is now going to be unavailable for the foreclosure process, and that may be one of the reasons banks have been trying to streamline the process. Because in many cases, if the homeowner objects and says "where's the note that shows my promise to pay" and the lender can't produce it, then the fraud has extended much farther back into the giddy days of real estate boom where trustees were supposed to, but didn't, verify that they had all the proper documentation for the mortgage (the note and lien).

What this amounts to is frightening systemic risk and the threat that the entire real estate mortgage business and the $3 trillion or so still tied up in it even in these tough times could endure a second round of collapse if we fail to work through this legal nightmare in a timely manner. It could at the very least take down a few large banks and/or require TARP v 2.0.

I would bet money that we'll eventually see a huge regulatory solution that will include blanket immunity from criminal prosecution for entire classes of financial service employees. And we'll get to see how a Republican-led House of Representatives handles it. The typical "Blame the Homeowner" platform of fiscal conservatives isn't going to quite cut it.

 

I admit that I don't know a lot about the technicalities of this issue, but I do know that housing and real estate in general are still a huge mess.

My uninformed opinion on the housing situation in general:
-the government should investigate and crack down on fraud in foreclosure cases
-the government should reform, maybe even break up and privatize, Fannie and Freddie
-the government should evaluate and reform the Department of Housing and Urban Development, either redefining it or dramatically downscaling, even eliminate it from the Cabinet

We have to look at what works when government is involved, and what doesn't. Right now, people want housing prices to go back up. I don't think they should have gone that high to begin with. With the exception of fraud and other obvious cases where government should be involved, like simple regualtion to keep interest rates down, overall we should take a more laissez-faire attitude to this sector and let the market work it out.

Now it's time for those more educated and informed in this matter than me to attack my positions, and persuade me otherwise.

 

We have a significant number of people walking away from homes that are underwater even though they can afford to make thier mortage payments. I think we should start by criminalizing this behavior.

There are alot of people who've refinanced their homes to buy cars and boats and are now walking away with the cash and prizes. Why is that legal?

EDIT: Darth_Ghost, you may want to rethink your ideas. Because I agree with them!

 

You're talking about an exception, and I'd like to see some actual statistics on that "significant number." If someone has visible assets other than their home, in a lot of cases the bank can go after those in the event of a shortfall. Depending on the state, the bank can get a deficiency judgment and garnish wages or go after assets to enforce payment of the debt. Criminalizing the behavior is an unneeded step when the bank already has a remedy.

For most people their home is their primary asset if not their only asset. Strategic default is typically not going to happen short of desperation when trying to get a deficiency judgment against the homeowner is an exercise in futility. With the real unemployment rate at around 17% nationally, you can bet that it's the unemployed and underemployed and discouraged workers who are doing the most strategic defaulting, and it's probably not so much strategic as a panicky retreat from solvency. Especially people who made down payments on their home are going to find it hard to walk away from that perceived equity even when in reality it's no longer there.

One of the "blame the homeowner" tactics is to create and promote this fantasy scenario where people are frivolously going delinquent on their mortgage payments then using all that extra cash to party. Maybe it has happened, but is it widespread? In this economy? Doubtful.

 

It's just an anecdote, but when I bought my house a year ago, the previous occupants had a lot of luxuries in the home during our inspection (such as HDTVs in every room including some 50+ inch ones). And yet, they were severely delinquent on their mortgage (to the point that we had to move up closing because the bank was going to foreclose first).

I can't prove it, but I'd bet that they were probably able to afford their mortgage if they weren't buying those huge TVs.

Kimball Kinnison

 

If they didn't pay for their house, chances are they didn't pay for their tvs either. While many consumers were piling on the "secured" debt in the form of unaffordable mortgages they were also taking on unsecured revolving credit debt too.

Meanwhile, distressed sales are the only game in town. In Orlando, Florida, 70% of home sales are either short sales or foreclosure sales.

If the foreclosure sales grind to a halt because of investigations and moratorium, home sales will basically stop altogether.

 

Most banks in California, with the exception of Wells Fargo, have stopped doing foreclosures due to the mess the paperwork documenting the loan is in (which makes proving who the owner is difficult if not impossible).

My roommate sold her condo in a 'short sale,' because she owed $250,000 more than what the property is worth in this economy. She is not liable for the money the bank lost thru the short sale. She is liable for the home equity loan she took out to cover her down payment on the condo back in 2003. She is paying that back after working out a deal for a small monthly payment with the bank that held the note.

The foreclosure mess also makes it difficult to find a house to rent, since most renters don't know if the house will be foreclosed on and they will be evicted thru no fault of their own.

Don't know what the federal government can do, other than tightening up the regs so fewer fraudulent companies can do business.

 

At the end of the day, the problem is what's alluded to with the HD television anecdote. The problem isn't the mortgages themselves. The problem is how easy America has been able to get more credit than it can actually afford. Further, the American economy has been increasingly structured around spending; whenever there's economic downturn, what I hear is that America needs to increase spending in order to right the economy. I don't think that that's the case, since so much of the spending is effectively done with borrowed money. It might provide a temporary boost, but in the end the country is worse off than before.

The way out isn't spending, it's selling to other people. Unfortunately, the American trade deficit continues to get worse. Even some important military functions are outsourced to factories in China.

The American economic situation right now reminds me of nothing so much as the prisoner's dilemma writ large. A company can suffer against the competition and keep its manufacturing inside America, or it can export its manufacturing for more immediate gain potential but also greater overall loss - since if everyone does it, there's no one left making the paychecks to be able to buy the items it creates.

 

This is the choice between left and right we get in this country. The left are corporate cheerleaders and apologists, the right are corporate stooges and lapdogs.

 

Well maybe if you weren't a socialist you'd see the benefit of being governed by the fine folks at GE, C, BAC, and co.

I have some extended family that got involved in investing with a guy who would flip low end houses, and nobody, not the investors, the guy, or the title company were all that concerned with understanding risk management and thought it was entirely reasonable to expect 12% on an annualized basis with no risk of default. Of course when the housing market turned south the borrower just turned it all into a ponzi scheme to keep things going for several more years while the hapless investors stuck their heads in the sand until it was too late.

For me it as interesting microcosm of the problems of our nation as a whole. Anybody with a brain should have realized the risk of mortgaging your home at 6% to get 12%, and that beating the stock market might be a good hint of the risk involved. So you have hapless investors who have no interest in controlling their money, worrying about paperwork, or exercising risk management because look at that nice big check I just got, and the only difference is that once you get big enough, you've got the country at gunpoint to extract taxpayer bailouts.

And while Corporate America has taken over the country, homeowners as a whole have been just as good extracting benefits that renters could never see. Don't hold your breath waiting for your rent to be tax deductible. Of course home ownership is great for Corporate America because workers with a mortgage don't go on strike.

 

It's a complete insanity that these mortgages have been traded around to the point that home owners don't know whom they own money to. Has that situation been rectified? If not, I'd start with that.

 

Don't hold your breath. I bought my home a little over a year ago, and within a month of signing my final papers, my mortgage was sold twice (three different owners within four weeks). The first transfer was already in process as I signed my papers, and I asked my real estate agent and the bank loan officer "Isn't that how we got into this mess in the first place??" They assured me there was no danger; this happens all the time(!).

So then by the time my first payment was due, it rolled over again to my current holder: a huge bank that's one of the biggest in the USA and perhaps one of the biggest worldwide. I haven't missed any payments and I'm already seeing my monthly amount drop since I got through my first year.

I was telling a coworker about this story, and he told me not to worry about it. He said that my particular mortgage being sold to a bigger bank meant that they considered my particular mortgage to be a good investment. Okay. Uh, thanks? Seems like this IS precisely how this situation started: banks selling God knows how many mortgages, many of which were sold to folks with questionable credit, sold to other banks who basically took it on faith that this wouldn't be a problem as real estate was only going up, up, up.

Bottom line: I'm basically keeping my fingers crossed that my bank really is watching what mortgages they're acquiring from other sources. With the credit crunch still going on, I'm taking that to mean that folks signing mortgages these days are being subject to proper credit checks. So maybe my lender at least has learned its lesson about risk.