Housing: The see-no-evil muddle-through approach

By Felix Salmon
January 10, 2011
David Streitfeld reckons that if mortgage delinquencies continue to pile up without turning into foreclosure actions, that could be good for the economy as a whole:

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David Streitfeld reckons that if mortgage delinquencies continue to pile up without turning into foreclosure actions, that could be good for the economy as a whole:

Foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period…

If the slowdown continued through this month and into the spring, it could be a boost for the economy. Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy’s most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing.

“Anything that buys time, that reduces the supply of houses coming onto the market, is helpful,” said Karl Guntermann, a professor of real estate finance at Arizona State University.

I think he’s probably right. Consumer confidence is a key factor in the health of the housing market and there’s an obvious connection from lower supply to higher prices, to higher confidence in housing as an asset class. That confidence might well turn out to be misplaced, of course. But a warm occupied home is a much happier thing, economically speaking, than a cold and empty one, even if the occupiers haven’t made a mortgage payment in years. Foreclosures carry a large economic cost and all things being equal, the less of them there are the better.

There’s something conceptually attractive, especially to small-government libertarians, about ripping the bandage off the patient harshly. Foreclose on anybody who’s delinquent, stop providing massive government subsidies to the mortgage sector and let the market find the true market-clearing level for house prices. But we simply can’t do that — it would mean a financial crisis much larger than the last one, with substantially the entire banking system becoming insolvent; the resulting plunge in stock prices and global economic growth could make the last recession look positively tame.

The realistic alternative is to muddle through — to artificially support the housing sector and mortgage valuations for however long it takes, which might well be forever. As Bethany McLean notes, “federal involvement in housing has been a constant since the 1930s” and it’s hard to see any politically-acceptable way of changing that.

The big winners in all this will be the delinquent homeowners who continue to live in their houses without making their mortgage payments. The losses, meanwhile, will be spread around a large number of banks and investors, all of whom can cope with — and even fully expect — smaller streams of cash flowing from their mortgage portfolios.

Some potential buyers, worried about the shadow inventory of homes which could be foreclosed upon at any minute, will choose to rent rather than buy — that’s fine, and indeed is probably a good thing. We want the homeownership rate to fall. Other buyers, seeing rising prices and a shrinking supply of houses coming on the market, will jump in regardless. And so long as there’s enough government support and buying interest to keep prices from falling further, everybody will be more or less content. The tail risk will still be there, of course. But merely running the risk of a catastrophic outcome is surely a better idea than actually triggering that outcome.

29 comments

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and the homebuyers will presumably be the guys with the cash in the bank right? Because if you can’t foreclose on people who aren’t paying their mortgage then you aren’t going to lend to them or at least not a collateralised rates. Hope for your plan that lots of being have 200k+ limits on their overdraft and credit cards.

Posted by Danny_Black | Report as abusive

Danny_Black, I believe you are conflating a few separate issues here.

(1) Due to shoddy documentation, foreclosure on many past loans may be difficult. Likely not impossible, but it may take extra time/effort to put the paperwork in order and the courts at this time are likely to reject any foreclosure where it is NOT perfectly in order.

(2) If the market has already declined 50%, and the mortgage is underwater by 30% or more, then you won’t get much by pushing a foreclosure through anyways. Is it better for the bank to let the defaulted borrowers ride rent-free? Or to renegotiate terms that eliminate the default? Or to foreclose in a hurry and try to sell in a weak market? You could make a reasonable argument for any of the above, depending on the situation. Note that the first option does not in any way preclude foreclosing at a LATER date. It is simply a preference for keeping the property occupied to keeping it vacant.

(3) These bad loans were paradoxically written at terms that were *favorable* to the borrowers. Now, when the actual risk has been reduced, you are arguing that the terms on new loans should be priced higher? I do understand that is the typical cycle — but it is grounded in backwards-looking risk management rather than any logical argument. Housing prices might fall a bit further, but they don’t have nearly as far to fall as they did in 2004-2005. The risk on new loans is greatly reduced, and (in the event that they do default) careful documentation procedures will ensure that foreclosures on these new loans can proceed without a hitch.

Posted by TFF | Report as abusive

Also note that a cash-purchase housing market isn’t impossible — it just operates at lower valuations. You could even argue that is a GOOD thing. (Though it would greatly diminish the pace of residential construction.)

If a couple can save 25% of their gross income for eight to ten years, then they’ll have enough to pay cash on the purchase of a modest home. Unfortunately the tax incentives are presently set to discourage this, both because taxes take a large bite out of investment returns on taxable savings and because mortgage interest is deductible while rent payments are not. The tax incentives definitely push people to buy early, on leverage, and pushing prices higher.

Posted by TFF | Report as abusive

I think Streitfeld (and his analysts) badly underestimates the impact of the paperwork scandals, especially when he hangs his story on “Over the last several months, some banks have been reluctant to seize homes from distressed borrowers…”

Bank of America, and other servicers, stopped foreclosing on homes for two months at the end of the year. Before their official freeze, many of them slammed on the brakes for their investigations. As a result, bank seizures plummeted. I’m a real estate reporter, and I collect data for my coverage area in the suburbs and exurbs of San Diego, aka foreclosure crisis central. When B of A stopped foreclosing, foreclosures dropped precipitously (I have the data to show that, if anyone cares).

Writing a story on the rapid fall in seizures in the fall of 2010 and crediting the drop to anything besides a massive foreclosure freeze is simply erroneous. If we see the trend in the first few months of 2011, then we’ll have something.

None of which really undermines Felix’s point in his post, regarding the validity of a tear the bandaid off approach. But that NYT story is problematic.

Posted by ericwolff | Report as abusive

Felix,
I know that your position is meant to be both responsible, from a macroeconomic perspective, and humane. But let me point out some big problems here. First, from the point of view of the homeowners in question, keeping them in limbo indefinitely is not necessary a blessing. Yes, they may save money today, but unless they get a mod locked in that guarantees them a sustainable tomorrow, they may just be postponing their pain. All the power remains in the hands of the lenders, and you don’t know from one day to the next what will happen to your situation. Believe me, this is a path to madness. Suicide, divorce, alcohol abuse, mental illness–all these will rise.

Secondly, you seem to expect that those outside this market (renters, potential buyers, those already foreclosed on) will accept with equanimity this “bargain” and jump back in on the rigged terms. I think not, at least not with the sort of speed that will actually allow the market to recover. Read the comments on articles about foreclosure if you want to see the anger that millions of “patient renters” are feeling about the status quo. Yes, they can sound nasty, like people on the street shouting “jump, jump” to a would-be suicide on a window ledge. But they have a point. The system is rigged against them, and to let people sit in homes they can’t afford will only feed the anger. Again, the country as a whole loses.

TFF is right, we have to let the market correct and look to the tax code to correct imbalances that push people toward over-leveraging to buy overpriced housing.

I’d also recommend Gillian Tett’s piece in the FT this weekend: http://www.ft.com/cms/s/0/02834ec8-185f- 11e0-88c9-00144feab49a.html#axzz1AdsoyA0 0

It talks about the different narratives that have evolved over the last few years to “explain” the housing crisis, from blaming the homeowner to blaming the banks to seeing the loss of one’s house as “liberating.” Interesting stuff.

Posted by LadyGodiva | Report as abusive

TFF, the assumption with a collateralised loan is that if you default i can seize the collateral relatively easily. If that is not the case then I need to factor in the cost of getting that collateral – ie higher interest rates – or in a limiting case just not lend to you. Got nothing to do with house prices. Simple case of more risk so more expensive.

Also, I am guessing every single person attempting to exhaust the bank will demand that the original note be produced – not in duplicate – from the vault in which it is stored, well thats a couple of grand right there. Then because if you lose it then you are going to have to fight to prove you ever had it then it has to go in one of those super secure armoured cars with foolproof tracking – thats another grand or so. Well every single mortgage is going to have to price that in.

Finally the average time between first default and actually have the foreclosure completed is over a year. How much rent-free time you suggesting the people have? Are people who have no stake in the house but are waiting for some arbitrary and/or random deadline when they will be kicked out going to look after the house?

Shoddy documentation is a completely different matter. If you are not careful with your process you deserve to get screwed and if they get screwed often enough and for enough money you can be they will fix it.

Posted by Danny_Black | Report as abusive

ericwolff, my understanding is most of the banks have restarted foreclosing. You seen any change in the backing documentation they are bringing, ie amount, detail, originals vs copies, quality? Is there a pattern to whom they are restarting with or do you get the impression they went back, “fixed” it and are full steam ahead?

LadyGodiva, also remember the fees and interest etc are accruing for a home you probably will lose anyway. Also, at least in the UK, owning a house was always a cultural goal, even if it made no economic sense.

Posted by Danny_Black | Report as abusive

“the assumption with a collateralised loan is that if you default i can seize the collateral relatively easily. If that is not the case then I need to factor in the cost of getting that collateral”

I would argue that has NEVER been the case for mortgages. Foreclosure is simply not an “easy” process, and the bank attempts to cut corners did not pass muster in this court decision.

Agreed that the cost of seizing that collateral will be be baked into the required downpayments, the interest margins, and the fees, but in this case that spells a return to “normal” conditions from the easy-money terms that were offered for half a dozen years at the peak of the mortgage boom. The court did NOT create new laws or requirements, it simply reaffirmed that which already existed.

The cost of issuing a mortgage (if done properly) runs a few thousand dollars. This is either assessed as an up-front fee or amortized into the interest rate (generally over a five-year period). Offers of “no fee” mortgages fall into the TANSTAAFL catch-bin.

Posted by TFF | Report as abusive

@LadyGodiva, assume for the sake of argument that the homeowner is already so far underwater, and so far behind in payments, that there is no question of them ever catching up again. There is definitely pain — they will ultimately lose whatever money and emotion they put into that house (unless the bank decides to offer a loan mod). But aside from the possibility of a loan modification, the painful event has already happened.

At this point, continuing to live in the house RENT FREE has to be considered a positive. It allows them the opportunity to save money that would otherwise go towards housing. Pay down credit cards (whose interest rates were likely jacked through the roof at the time of the initial default). Plan ahead…

It is definitely an uncertain situation, not knowing what tomorrow will bring, but they hold the upper hand in this situation — they can choose to either remain where they are and take advantage of the financial benefit (at the cost of the uncertainty and stress) or they can move out, eliminating the uncertainty, and mail the keys to the bank. Call it a “self-directed foreclosure” if you like.

I’ve read stories of both happening.

Posted by TFF | Report as abusive

Danny Black,
You write: “also remember the fees and interest etc are accruing for a home you probably will lose anyway.” Precisely. Homeowners camping out under these terms are much more likely to end up declaring bankruptcy.

I am shocked at how few people seem to understand the distinction (I’m sure everyone here does, but out there??). If I can give back my house in an orderly manner (via short sale or deed-in-lieu) I can get my credit back in two years or less. If I go through BK it’s gone for 7 years.

For a middle class wage slave, that’s a huge difference.

Posted by LadyGodiva | Report as abusive

TFF,
Allow me to politely disagree. The pain of the underwater homeowner will increase significantly when the family has to ultimately declare bankruptcy and still can’t keep the house. Please see my reply to Danny B on this one.

I should know, too. I did a deed-in-lieu on a house that was later sold for half its 2004 sale price. Think I could ever have got a mod that would have dropped my mortgage by a third? Not on this planet.

Now I have the chance to buy a home that has also dropped 50% from the peak. Thus, my old loss will be erased. In fact, I will end up ahead because my new property tax rate will be set much, much lower by the greatly reduced sale price of my new home. AND I will own my house in about a decade, whereas before I was essentially renting from the bank in perpetuity (as I would have remained underwater for a decade).

This is why I want my fellow debt slaves to NOT be talked into clinging to their underwater homes. Jump, debt slaves, jump! You have nothing to lose and a lot to gain.

Posted by LadyGodiva | Report as abusive

TFF, hence the modifier relatively in front of easy. You’ll have the same argument over collateral in the wholesale market too.

Also technically the bank is not cutting corners the crappy lowest fixed bid lawyer is.

Posted by Danny_Black | Report as abusive

Danny_Black, modifier observed, but I still don’t see how there is any threat of “in a limiting case just not lend to you” from this. Was that hyperbole? My guess is that the cost of doing the paperwork properly (as opposed to the slip-shod manner they were already doing) comes to less than a quarter percent on the interest rate or fees equal to 1% of the loan value. Are you estimating a higher figure?

Remember, these aren’t new requirements. Once upon a time, banks actually followed them and mortgages were still available.

The major losses will be taken on loans already written. First, it is many times more expensive to go back and fix problems than to do things properly in the first place. That alone would double or triple the estimates above. Second, as you noted, this is an open invitation for foreclosure lawyers to issue challenges against any loans written during the period in question which must be addressed in court. That is VERY expensive, though if the banks can demonstrate that their current procedures are sound then new loans will likely not be challenged. Third, poor procedure is only one of many ways in which they were lowering standards and cutting costs. It all adds up to a huge mess.

Posted by TFF | Report as abusive

Agreed, LadyGodiva, giving the house back in an orderly manner is better for the borrower. I believe, however, that is a separate issue from whether an immediate bankruptcy/foreclosure is more or less painful than a delayed bankruptcy/foreclosure. There are some people who may benefit from the delay, especially in non-recourse states.

Posted by TFF | Report as abusive

@ Danny_Black: “Also technically the bank is not cutting corners the crappy lowest fixed bid lawyer is.”

Well, technically, the bank cut corners in selecting a crappy, lowest price lawyer.

And in the case of high-volume servicers, they actively and negligently cut corners by selecting and rewarding those lawyers for speed and low prices, which together with lack of reasonable oversight is a recipe for disaster.

And when facts that the disaster was actually happening came to light, the servicers actively, negligently and fraudulently continued to use law firms they knew were committing illegal acts on behalf of the servicers.

So yes, the servicing bank did not cut corners, they are active members of an organized conspiracy to defraud in a RICO capacity.

Much better.

Posted by SteveHamlin | Report as abusive

SteveHamlin, well there was a RICO case brought in Arizona to much fanfare back in October. Hows it doing? I suspect writing claims about fraud and actually proving it will turn out to be rather different. Don’t let that stop you parrotting the claim.

TFF, don’t think anyone doubts this will prove expensive for the banks. As I keep trying to point out, servicers are unlikely to be coining it in a down market with a truly unprecedented number of foreclosures. I doubt their systems were in place to handle like the volume, plus all the random new regs about modifying loans etc. But in the end, the borrower will pay. If the banks have to factor in weeks of defence lawyers demanding to see an actual original note and then demanding to each and every single original contract for assignment then that is going to add up quite a bit to your mortgage. If you look at places where the sitting tenant has very very strong rights, then getting rental and/or mortgages is next to impossible.

Posted by Danny_Black | Report as abusive

Danny_Black, I still think you exaggerate about the impact this will have going forward.

If the banks are able to meet those procedural challenges consistently, defense lawyers will stop raising them. That time in court is as costly for the defense as it is for the banks.

The problem is that the banks have NOT been following proper procedure in recent years, thus the defense wins a non-negligible fraction of the challenges. That simply encourages further challenges.

Follow proper procedures on new loans. Defend them successfully a few times in court. Problem solved.

None of this is new case law, none of the requirements are new. The specific requirements vary by state, and may not require producing the original note in court. The MA Supreme Court did not suggest that was necessary.

Again, I doubt this will add more than a couple thousand to the cost of new loans. Probably not even that.

Posted by TFF | Report as abusive

@Danny_Black: “I suspect writing claims about fraud and actually proving it will turn out to be rather different.”

I’m not an attorney bringing any causes of action, nor am I conducting discovery – I neither have the ability nor interest in “proving it” in court.

(You do know about an ongoing, multi-state AG investigation into the main foreclosure mills and servicer abuses, right? Totally baseless, I’m sure.)

For example, I believe Goldman Sachs and/or its employees committed crimes in the Abacus transactions, based on the facts that I’ve read, even if the SEC settled civilly with Goldman.

The government didn’t take a complex criminal case to court, therefore a crime didn’t happen – is that your point?

Like that, I believe that the servicers and/or/thru their counsel are committing fraud on the courts, certainly on individual cases and probably en mass, and at least have knowing violated applicable civil rules of procedure. Even if there have not been convictions yet, or even if never.

I have no problem making that statement. Do you really wait until a formal legal conclusion before you form a personal & reasonable belief about a well-known and discussed legal matter?

Posted by SteveHamlin | Report as abusive

Another factor to consider is the pricing point set by the smaller local banks (which at least in my town proudly advertise that they don’t sell their loans). Their interest rates are typically a quarter point higher than those of the mortgage mills, but that is the cost of doing business correctly.

I’m betting my local bank won’t face many legal challenges over their notes, either. (Most likely the mortgage is already properly recorded.) If they do, their repository can’t be more than a few miles away.

Posted by TFF | Report as abusive

SteveHamlin, of course you don’t have any interest in “proving it”. You already know it for a fact, right? The world must be a scary place when banks secretly control the world….

Posted by Danny_Black | Report as abusive

Any suggestion like this implies that “mark-to-fantasy” accounting stays on for ever!!

What a way to rebuild America … Morals be damned, Justice be damned, banksters go scot free, endless bailouts, Fed and Treasury con job!!

Posted by killben | Report as abusive

Also I have a suggestion to regular mortgage payers …. please do not pay your mortgage. After all there is going to be NO FORECLOSURE .. so the wise choice would be to NOT PAY THE MORTGAGE … SAVE THE MONEY (TILL YOU ARE NOT FORECLOSED UPON) TO BUY A HOUSE LATER … RENT YOUR NEW HOUSE AND STAY ON RENT FREE TILL FORECLOSURE HAPPENS IN YOUR EXISTING HOME …

BOTTOM LINE .. DO NOT PAY MORTGAGE, ENJOY RENT FREE ACCO, SAVE THE CASH ….

Posted by killben | Report as abusive

@Danny_Black: http://www.ritholtz.com/blog/2011/01/abo ut-that-perjury-judge/

But I’m sure you don’t think there’s anything wrong there, a few isolated instances, stuff happens, it’s not reflective of actions of the servicers regardless of their settings standards and practices…

I couldn’t possibly have legitimate reasons to think otherwise, right?

I posit that your mindset is a perfect example of why people complain about the dangers of cognitive capture of the regulators – you simply can’t think of this topic from any other perspective that as an insider.

“It is difficult to get a man to understand something when his job depends on him not understanding it.”

Posted by SteveHamlin | Report as abusive

SteveHamlin, we had a little contest going a while back for percentage of cases where this sort of egregious behaviour was happening. In particular, with people who were wholely up to date, either getting foreclosed on or the bank acting like it had foreclosed. Some one bet it would be less than 1875 cases, from recollection after much searching of the internet a grand total of 4 cases were found.

As you are a more avid fan of Mr Ritholtz than me maybe he answer where those masses of SEC CDO cases he predicted would occur in the wake of the ABACUS case. Weirdly, the lawyer he seems to think is a fearless prosecutor of these cases went soft on one of the few cases where it seems clear a bank DID mislead investors:

http://www.bloomberg.com/news/2011-01-11  /sec-watchdog-probes-enforcement-chief- over-citigroup-settlement.html

Posted by Danny_Black | Report as abusive

After reading Felix’s post I was immediatly driven to respond but after reading Danny Black’s 11:24 comment I doubt anyone could put it more clearly than that.

This “landmark case” will change very little except for the parties directly effected. My bet is that banks across the country will continue to bring foreclosure actions to court because they have no other choice. 90% of those trials will go unchallanged by the borrower who will fail to appear… once the eviction notices get put up the people will move to an appartment or back in with relitives and then the house will be auctioned to some vulture property investor.

I agree that this case puts the banks more on notice to get things right the first time or face high costs. To the extent that banks throw more resources at their servicing operations to minimize mistakes that’s a good thing. (as Danny Black pointed out the cost of those additional resources will be born by borrowers.)

I disagree that this case will allow non-payers to live on indefinatly as squatters.

While I will not defend or appoligize for poor document handling of mega-banks I will point out that “killben’s” 3:18am comment is the path a growing minority want us to take… it leads to nowhere.

That so many people fail to see that scares me.

Posted by y2kurtus | Report as abusive

@Danny_Black: The egregious conduct I was referring to is not foreclosing on a home with no mortgage, it is the systemic filing of false and forged documents in the most routine of foreclosure cases. That is not 4 cases, nor 1875, but quite literally tens of thousands.

And I don’t believe that you can say that statement is not a fact – it is documented in many court opinions, in depositions from insiders, and from investigations by various reporters and lawyers.

The Rule of Law has meaning, and the most routine of foreclosures in most lien-theory states are civil lawsuits before a court. Retained lawyers, law firms and the foreclosing lenders with actual knowledge of the malfeasance by retained counsel are violating the rules of civil procedure, are forging documents, and are committing a fraud on the courts. Notarizations that are impossible, knowingly false affidavits, forged documents created to mislead the court, process service abuse – those acts happened, those instances are real.

Do you disagree with those statements? Could you be specific on what you disagree with?

Posted by SteveHamlin | Report as abusive

SteveHamlin,

Since Danny Black is probably shoveling out from 2 feet of snow I’ll respond to keep the post alive until he’s back.

I’m a banker, I don’t work in our loan servicing department but I know all the people who do. The only loans my bank sells we sell to Freddie Mac. Our deliquency rate is exceptionally low… so low that a rookie bank auditor flaged it as suspicious until his boss told him… no they are just good.

I am quite sure that you are right and that all the large mortgage factory banks are bending and breaking procedures, rules and due process are being violated.

There is no other way forward. The bogus documents (most conjured up by people trying to do the right thing) are probably not the proper documents the court and the non-payers deserve.

What else would you have them do?

If the loan owner can print off some reports that says ok… Mr. and Ms. Jones took out a 360 month loan 44 months ago…. for the first 37 months they paid us 1082.45 for for the last 7 months they paid us nothing…. our computer says they still owe us 323 payments and they don’t seem too interested in that… but yikes when we bought this RMBS it seems like we didn’t get everyting we needed for the file.

Should they take a total loss on the difference there Steve? Do the Jonses get their house after 37 months?

Poorly orginized improperly handled documents should beat no documents in my mind. Anything else is to transfer wealth to those who least deserve it.

Posted by y2kurtus | Report as abusive

y2kurtus,

In reference to the banks widespread practice of forging documents and perpetuating fraud upon the courts (practices you acknowledge are occurring) you ask “What else would you have them do?”.

I would have have them obey the law just as the rest of us are expected to do. I am appalled but no longer shocked at banker’s constant assertions that they should be exmpted from the rules that the rest of us must follow. As to your assertion that not letting banks engage in illegal behaviour would result in “transferring wealth to those that least deserve it”; do banks that created the problem by their recklessness and now break the law to escape the consequences desreve it any more?

Posted by chris9059 | Report as abusive

@y2kurtus: “What else would you have them do? ”

What I would have them do: Not lie to the courts, not forge documents, and present the best fact-based legal case they can – and all while not simultaneously committing felonies and violating the entire spirit of civil procedure and legal ethics.

That’s not too much to ask, is it?

Chris said it well: “I would have have them obey the law just as the rest of us are expected to do. I am appalled but no longer shocked at banker’s constant assertions that they should be exempted from the rules that the rest of us must follow.”

Outside of that, I have no concerns.

Posted by SteveHamlin | Report as abusive