Have you forgotten about the mortgage-bond scandal yet? I’m sure a lot of bankers are hoping that you have. But Adam Levitin hasn’t, and his written testimony today to the House Financial Services Committee is well worth reading in full. He concludes:
The foreclosure process is beset with problems ranging from procedural defects that can be readily cured to outright fraud to the potential failure of the entire private label mortgage securitization system…
In the worst case scenario, there is systemic risk, as there could be a complete failure of loan transfers in private-label securitization deals in recent years, resulting in trillions of dollars of rescission claims against major financial institutions. This would trigger a wholesale financial crisis…
A critical point in any global settlement must be removing mortgage servicers from the loan modification process. Servicers were historically never in the loan modification business on any scale, and four years of hoping that something would change have demonstrated that servicers never will manage to successfully modify many loans on their own. They lack the capacity, they lack the incentives, and the lack the will…
For many, the preferred course of action is not to deal with a problem until it materializes and certainly to avoid any loss allocation that might threaten US financial institutions. But if we pursue that route, we may well be confronted with an unmanageable crisis. We cannot rebuild the US housing finance system until we deal with the legacy problems from our old system, and these are problems that are best addressed sooner, before an acute crisis, then when it is too late.
David Dayen reports on the consequent follow-up, in oral testimony, between Levitin and Brad Miller, who’s arguably the most sophisticated member of the House when it comes to mortgage finance.
Levitin said that we don’t have the full data sets from the servicers, or any comprehensive data to see whether there is a full-on crisis of unclear title and improper mortgage assignment. In other words, we don’t quite know the full extent of the problem. Levitin said, essentially, “The federal regulators don’t want to get info from servicers, because then they’d have to do something about it.” They don’t want to recognize the scope of the problem because it would require them to act.
And Levitin in particular singled out the Treasury Department. “The prime directive coming out of Treasury is ‘protect the banks’ and don’t force them to recognize their losses.”
Essentially, there’s a three monkeys act going on here: the servicers will hear no evil, the trustees will see no evil, and Treasury will speak no evil. And so long as they all remain deaf, dumb, and mute, they can ignore the problem as it slowly approaches systemic levels.
One very suggestive datapoint here comes from Tomasz Piskorski, Amit Seru, and Vikrant Vig, who have written a very dense but important paper on what happens to houses and mortgages when borrowers are delinquent on their loans. One finding is that banks are much less likely to foreclose on delinquent loans if they own the mortgage themselves than if they’re simply servicing the mortgage on behalf of RMBS investors. Foreclosure destroys value for the owner of the loan—but, crucially, it does not destroy value for the servicer, who therefore has very skewed incentives.
And then there’s this chart, at the end of the paper:
What you’re looking at here is the percentage of delinquent mortgages which are put back to the lender after they turn delinquent. All of these mortgages had early pay default clauses, which allowed investors to put back any loan which went delinquent within three months.
The investors, of course, can’t put back the bonds themselves: they have to rely on their trustee to do so for them. But the trustees are so otiose that they don’t do that.
Look at the y-axis: the highest number there, about 14%, is the fraction of loans which went delinquent in the very first month, and which were returned within three months. For loans which went delinquent in the third month, less than 5% were ever put back.
By rights, 100% of those loans should have been put back: that’s the whole point of having an early pay default clause in the contract. But the otiose trustees instead simply do nothing.
Levitin makes an extremely strong case that it’s much better to bite the bullet now, even if that involves socking the banks with losses, than to wait for the situation to continue to deteriorate to the point at which a devastating crisis is unavoidable. But Treasury, it’s clear, is not going to act, any more than the servicers or trustees are. Maybe because the technocrats at Treasury don’t really mind seeing pain being borne by homeowners and investors. Just so long as the banks are OK.