The solution to the mortgage mess

By Felix Salmon
October 8, 2010
Mike Konczal and Annie Lowery try and explain the foreclosure mess, it's worth stopping to think about a possible long-term solution to the crisis.

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As people like Mike Konczal and Annie Lowery try and explain the foreclosure mess, it’s worth stopping to think about a possible long-term solution to the crisis. And given the sheer quantity of insufficiently-documented loans, the only sensible and scalable solution I can think of is to swap out those bad loans for good new ones.

There are three main ways this can be done. The first is to refinance the current loan, possibly through HAMP. The second is for the banks and the homeowners to negotiate a principal reduction. And the third is to allow a short sale of the house.

So long as the banks make sure they get their paperwork right this time, any one of those three actions would solve the problem at a stroke. Even better, any one of those three actions should actually be preferable, from the bank’s point of view, to a foreclosure in any event. As RealtyTrac’s Rick Sharga told Chris Isidore, short sales typically take place at a 15% discount to the value of the mortgage, while foreclosure sales normally take place at a 35% discount. That’s a big difference.

For homes which are in the foreclosure process right now, it’s probably too late to attempt a HAMP modification, so the banks will have to switch to either a principal reduction or a short sale. But for performing loans, or those which are delinquent but not yet in foreclosure, all three options should be aggressively pursued. The good news is that mortgage rates are very low right now, so a refinance is generally in the homeowner’s interest anyway.

Logistically, replacing all those old mortgages with new mortgages will be expensive and time-consuming; certainly the loans in or near foreclosure should get priority. But it seems to me a market-based and transparent solution to a very large problem for which there is no legislative fix. (Or rather, the one legislative fix that’s needed has already happened, and will remain in force through 2012.) And if it ends up hurting banks’ balance sheets, well, that’s condign punishment for their failure to keep their paperwork in order during the boom.

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Comments
17 comments so far

If the banks don’t actually own the loans – because somebody further up the loan chain does – then negotiations between the bank and the homeowner may not clear out the interest of whoever actually has title to the loan.

And so long as that’s a fear, the houses are unsaleable.

Posted by cynicalmoose | Report as abusive

Is it clear that someone holds a valid mortgage and note in most cases? If not, what incentive does the homeowner have to pay? If so, why can’t the holder assign it properly?

Posted by 3oosion | Report as abusive

the paperwork trail is gone…click the real estate keyword at naked capitalism for details…

http://www.nakedcapitalism.com/

Posted by rjs0 | Report as abusive

“short sales typically take place at a 15% discount to the value of the mortgage, while foreclosure sales normally take place at a 35% discount”

So, what should we conclude from this? That it would be better for the banks to allow a short sale than push for foreclosure? Or maybe short sales are only 15% off because banks don’t agree to them otherwise. This is apples and oranges.

Posted by TSTS | Report as abusive

I’m not quite sure why you think banks would be any better about negotiating sustainable principal reductions now. And no offense, but: “so long as the banks make sure they get their paperwork right” is utterly risible at this point.

“But it seems to me a market-based and transparent solution to a very large problem for which there is no legislative fix. (Or rather, the one legislative fix that’s needed has already happened, and will remain in force through 2012.)”

The only legislative fix that’s needed is there already? Really? I bet one could brainstorm a few others that might be helpful.

For instance, if judicial cramdown fixes hadn’t met with so many mishaps — politically speaking, they seem to have fallen down a lot of open elevator shafts– banks would have more incentive to work with borrowers. As things stand, bank incentives point in a different direction.

“it’s probably too late to attempt a HAMP modification, so the banks will have to switch to either a principal reduction or a short sale.”

The administration *has* rolled out programs (including HAMP) that were ostensibly created to do both of these things. Just to be clear. They were certainly sold to the public as such.

The notion that banks will start reducing principal to practical levels, on the scale needed, is not supported by the administration’s “voluntary incentives” track record — or by the kinds of proprietary modifications the banks have chosen to offer.

Regarding that “one fix,” btw:

http://www.washingtonpost.com/wp-dyn/con tent/article/2010/06/15/AR2010061505428. html
“Over the past year, lenders have become much more aggressive in trying to recoup money lost in foreclosures and other distressed sales, creating more grief for people who thought their real estate headaches were far behind.”

http://www.bloomberg.com/apps/news?pid=n ewsarchive&sid=aIf_vUQZFt.s
“King is among a rising number of borrowers who are learning that they can be on the hook for years after losing their homes. Amid a crisis that stripped $6.4 trillion, or 28 percent, from the value of U.S. residential real estate since the 2006 peak, lenders are exercising their rights to pursue unpaid mortgage balances. To get their money, they can seize wages, tap bank accounts and put liens on other assets held by debtors…

In states such as Florida, courts give mortgage holders as long as five years to seek a deficiency judgment and, if granted, up to 20 years to collect. Usually, they have the option of renewing the judgment if it’s not paid off within 20 years.

About a third of U.S. states… prohibit collection efforts on primary residences after foreclosure. In some cases, homeowners waive that protection if they refinance. Most states allow collection on unpaid home equity loans.”

Posted by j657 | Report as abusive

Felix,

I’m not sure how, in a detailed article someone as astute as you forgot to highlight a key point… one that nearly every other mainstream media org also forgot to highlight.

Through all the robosigners and under all the incomplete paperwork there is one simple truth. The mortgages are not being paid. It is almost as if the NYT and Reuters think that people are dutifully paying their bills and banks are throwing them to the street out of sheer evilness.

It’s absurd.

What should be done… exactly… should the people who stopped paying their mortgages be able to live rent free for years? Forever? How precisely should we deal with “the dog ate your homework so I’m keeping the house.”

The idea of further slowing down this train-wreck is (to borrow one of your all time best lines), “bat-$hit-crazy!”

The only beneficiaries of this foolishness are the 2-bit lawyers and the people who have cable, cell phones, newish cars, eat out weekly… all because their largest monthly expense hasn’t been paid in 6 months.

Does anyone see any social utility in this transfer of wealth from savers to borrowers?

me neither…

-y2kurtus

Posted by y2kurtus | Report as abusive

@-y2kurtus

I’m not an apologist for mortgage defaulters BUT responsibility in this context is a two-way street: both parties, borrowers and lenders, are at fault here. The borrowers may (as you claim) be in default HOWEVER the lenders have not maintained the paper trail that establishes and protects their rights in foreclosure.

If you lose your claim check for the dry cleaner, you could very well be SOL when you try to reclaim your nice suede jacket. Is it the dry cleaner’s fault that you didn’t exercise reasonable care with the document?!

In any case, I’m not sure how this foreclosure mess is a “transfer of wealth from savers to borrowers” (unless, of course, our genius President decides that the Federal government will just bail everyone out at taxpayer expense!).

Posted by dbsmith1 | Report as abusive

dbsmith… I could not agree more that banks should, do, and are bearing responsibility for their poor lending. If you look at banks stocks today vs 5 years ago most are trading at less than half their 2005 values. Many are out of business completely.

Banks have taken responsibility… those are called losses. By foreclosing on someone who has become unwilling or unable to pay the bank is recognizing that they made a mistake and are owning up to that mistake.

A foreclosure is the 2nd worst possible outcome for a bank on a residential loan. It use to be the worst possible outcome… but we’ve now invented a worse one. Drag out a process that should take a few months and result in a 50%-70% loss and let it fester for years and then take the 50-70% loss.

The transfer of wealth from savers to spenders has been going on for the better part of 2 years and will continue to quote the Fed, “for an extended period” perhaps 2 more years.

Zero short term interest rates.

Direct subsidy of mortgage loans via Fannie/Freddie/FHA.

Those policies are necessary if we are to avoid a depression but they come with real costs paid by real people… often debt free seniors who planed on living their “golden years” with some income off of their life savings to supplement their social security.

A million dollars today in an insured CD will net you perhaps 15,000 in interest. That’s a poverty line level income for a couple even including their social security.

The folks with a million bucks in the bank will be fine… they can spend some of their million bucks… no reason to lose sleep for them… but what of the people who have 100,000 in the bank and use to make $500 bucks a month. Those people are actually in trouble… just less trouble than people who are 3 months behind on their houses.

Posted by y2kurtus | Report as abusive

The banks may have out-smarted (out-dumbed?) themselves with MERS. It appears that the legal structure of MERS is now getting in the way of having clear chain of ownership of the mortgage notes used in the mortage-backed securities.

My suspicion is that at some point over the next 5 years, all of the mortgages that were sold for use in MBS’s may need to be redone, presumably at no expense to the homeowner (or even providing a discount to the homeowner), to re-establish valid claim to the asset for the lenders.

I think this is going to get really wild, but for right now the issue is so big that nobody in power in government or in the big banks dares to mention it, so “extend-and-pretend” continues with a rising stock market and decreasing volatility. We are probably sitting where subprime and derivatives were in late ’06-early ’07. Wile E. Coyote has run off the cliff but is still suspended in mid-air.

Posted by ErnieD | Report as abusive

“…you lose your claim check for the dry cleaner, you could very well be SOL when you try to reclaim your nice suede jacket.”

I doubt this intensely; in particular, I have lost any number of claim checks, and have never had a problem. I give my phone number and show some ID, and the nice suede jacket (or, generally, the less flashy navy blue suit) is back in my hands. If the cleaner balked, I would sue, and I’m reasonably confident in the outcome.

This is, in fact, EXACTLY the kind of distinction between substance (the coat belongs to me by right) and process (my paperwork is screwed up) that I’ve tried to point out in other discussions. When the borrower defaults on a mortgage, the servicer is supposed to foreclose on the house. The idea that, contrariwise, the borrower should simply have a huge debt forgiven and get another mortgage on better terms is very problematic from a standpoint of fairness.

Posted by ckbryant | Report as abusive

As a few economists, among them Buiter and Taleb, observe, there can be no long term solution to the Credit Crunch based on debt, and a solution is therefore required based upon a new approach to equity -ie ‘Qualitative’ rather than Quantitative easing.

I covered this ground in the FEASTA annual lecture here, a while ago

http://www.vimeo.com/5639127

I am getting a lot of interest, particularly in Scotland, in this debt/equity swap approach (but not equity as we know it), and am making an updated and comprehensive presentation tomorrow on the subject to over 20 major UK housing bodies. They own between them several hundred thousand properties, and have much to gain from replacing debt with non-toxic equity.

Posted by ChrisJCook | Report as abusive

ChrisJCook, in no meaningful sense of the word is Taleb an economist.

y2kurtus, I 100% agree with you. One of the issues here is a number of problems have become conflated. There are I am sure a number of places where the paperwork for titles has gone walkies. That this was somehow “fraud” is up there with me claiming that Obama is trying to buy dead people’s votes when the federal government sent thousands of stimulus cheques to dead people. I haven’t seen any proof that serious title issues – as opposed to people simply trying it on – and that the real issue has been overworked clerks at servicers.

I would love to know how many cases have actually been thrown out because of title issues, my instinct is pretty few but have no idea. Might be an idea for Mr Salmon….

Posted by Danny_Black | Report as abusive

@y2kurtus: Certainly, none of us like to watch people escape the financial consequences of their own mistakes. I can sympathize with you there.

High moral dudgeon aside, this is about justice in the legal sense – not whatever borrowers may deserve.

Say I decide that execs who made obscene amounts of money by blanketing disadvantaged communities with option ARMs deserve to be kneecapped. Say I hire someone to do that. We could argue about whether or not they had it coming; but when I got caught, the issue would be, is that behavior permissible under the law? What are the consequences of crossing a legal boundary?

Keep in mind that affidavits are sworn statements to the court. If servicers have been swearing to the truth of documents with invalid notarizations, that is fraud. In some cases it might be perjury. Perjury is very different from losing a dry cleaning receipt.

If this is really just a minor paperwork snafu, I will be surprised to have seen such an unprecedented (far as I know) show of interest from state AGs. Most of the borrowers may owe money to someone. But if banks have somehow f…ed themselves into claims that can’t be made on the grounds of a legally enforceable contract, the answer cannot be to rewrite the law on their behalf.

There are a lot of claims and predictions flying around right now, and few clear answers. So this kind of discussion is obviously constructive. But frankly, I think it may be difficult to design effective solutions until the full dimensions of the problem become clearer.

Posted by j657 | Report as abusive

We live in a country operated by the principle of “rule of law”. It isn’t a question of what is “right”, it is a question of what is legally required.

If the banks threw away the promissory note, then their legal options are seriously circumscribed and I’m not going to shed too many tears. Caveat emptor. They bought the note and they have no excuse for not understanding the requirements for properly completing the transaction. If they didn’t like the law they should have asked that it be changed BEFORE they threw it out.

Posted by TFF | Report as abusive

TFF, well if there is no title then surely the home doesn’t belong to the homeowner either. In that instance you’d just back-track to the last recorded title owner.

Would also be nice to know what happens to the loan. Does it become a non-recourse loan with zero collateral – ie the bank can only seize the non-existent “collateral” – or does it become a non-secured loan that the bank can still chase after them for, just without the automatic charge on the property. One of the frustrating things is that there are many many interesting questions that no one seems to think are worth asking.

Posted by Danny_Black | Report as abusive

j657, there is a difference though. If the issue is robo-signing then they hire a few more people, dot every i cross every t and it goes back to normal in a few weeks. In this case it was procedural sloppiness and long term has little effect – apart from maybe the mortgage service business model and some mid-level clerks getting screwed for trying to do a foreclosure every 1.5 minutes.

The issue of lack of title is more serious and harder to fix. That is why it would be nice to know what the splits are on this.

Posted by Danny_Black | Report as abusive

I’m just throwing this out to the cloud. I am a responsible individual who has never missed a payment on anything until September 1. Because of my divorce, I can no longer afford my mortgage payment. I’ve owned four homes and have never been one day late on any payment. I’ve engaged Wells Fargo from the outset and have gotten exactly nowhere. You can follow my saga at http://jkb0808.wordpress.com/

Posted by Jeff.Baldwin | Report as abusive
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