Bloomberg’s Michael Moore has lots of detail today on the treatment of mortgage servicing rights in banks’ earnings reports. No, wait, it’s actually interesting! Especially when you look at the numbers involved.

Wells Fargo is the poster child here: it wrote down its mortgage servicing rights by a whopping $2.1 billion last quarter, but it actually made a profit of $1.5 billion on them, since the value of its hedges on those rights soared by $3.6 billion. At the end of the quarter, it valued its rights at $14.5 billion.

Moore tries to explain what’s going on here, but something smells fishy:

The value of the rights depends largely on the expected life of the mortgage, which ends when a borrower pays off the loan, refinances or defaults. When rates drop and more borrowers refinance, MSR values decline. Banks typically hedge the movements using interest-rate swaps and other derivatives…

Because there’s no active trading in the contracts, there are no reliable prices to gauge whether banks are valuing the rights accurately, analysts said.

Here’s the first thing which puzzles me: in the third quarter, mortgage rates fell by 0.26 percentage points. How could such a relatively modest decline in rates result in a plunge of $2.1 billion — more than 12.5% — in the value of a $16.6 billion portfolio? And what kind of hedges result in a $3.6 billion profit when rates decline by 26bp?

Over at JP Morgan, the numbers are a little more modest, although Jamie Dimon’s shop, too, contrived to make a profit on its hedges: the portfolio declined in value by $1.1 billion, or 7.5%, while the bank’s hedges went up in value by $1.5 billion.

I’m especially puzzled by the big writedowns because anecdotally there doesn’t seem to be a huge amount of mortgage refinancing going on, and I don’t think that expected default rates rose in the third quarter either. (If anything, judging by the prices of mortgage bonds, they fell.)

There also seems to be a strong correlation between the size of the writedown that a bank took, on the one hand, and the degree to which its hedges made money, on the other. Is there any good reason why this should be the case? Or are banks just taking writedowns as and when they manage to pay for them out of hedging profits?

Shahien Nasiripour does some more digging into the HAMP mortgage-modification figures today, following on from last week’s analysis. This time he’s looking at the percentage of trial loan mods which have been converted to permanent status, and the numbers are startling, to say the least:

Total number of trial modifications at the end of May: 50,130

Number of those being serviced by Ocwen: 1,058

Total number of permanent modifications as of September 1: 1,711

Number of those being serviced by Ocwen: 763

To put it another way, of the Ocwen has managed to convert more than 72% of its end-May trial loan mods to permanent status. The equivalent number for everybody else? 1.9%.

Ocwen’s looking good on other fronts, too, such as its redefault rate, which is much lower than the rest of the industry.

Is there any way to import Ocwen’s best practices to other servicers? Shahien quotes Valparaiso University’s Alan White as saying that Treasury “should start firing the under-performing servicers and bidding their work out to the successful companies”; what’s more, White is a law professor, which means that might even be legal.

More helpfully, Shahien explains one big difference between Ocwen and everybody else: Ocwen insists on having proof of income before it starts any trial modification. (And this doesn’t seem to have slowed it down at all; quite the contrary.) Other servicers might do well to follow suit.

Time looks at the problem of jingle mail, and explains how “because it underwrites low-cost housing for high-risk groups, the FHA’s problems are particularly acute”:

Homeowners of a new and unattractive breed are plaguing the Federal Housing Administration these days. Known as “the walkaways,” they are people who find themselves unable to meet their mortgage payments—and to solve the problem simply move out their belongings at night, drop their house key in the mailbox and disappear… In seven South Florida counties, walkaways have abandoned 3,000 FHA-guaranteed homes in the past twelve months.

The hat-tip goes to Mark Gimein, who dug this story up: it’s 47 years old, and it proves two things: (a) there’s nothing new about jingle mail; and (b) it’s entirely a function of jurisprudence and economics, rather than the Moral Character of the Nation.

Mark’s trod this ground before, but it bears revisiting: there are often very good reasons to walk away from your house. It’s never a first-best option: with interest rates low and banks under a lot of pressure to modify loans, it’s often possible to negotiate a deal whereby you get to stay in your house at a reasonable cost. But if your bank won’t be nice to you, then there’s no particular reason that you should be nice to them.

Shahien Nasiripour has an interesting datapoint, when it comes to the government’s HAMP loan-modification program:

Though the number of offers extended to eligible homeowners continues to rise, the number of offers accepted actually dropped, according to an analysis of Treasury Department data. In August, about 81 percent of homeowners accepted their modification offers; last month, just 54 percent of homeowners did so.

It’s not quite as simple as that, since it does take some time to go from the offer to acceptance. Specifically, once a homeowner receives an offer, they have a minimum of 30 days — and as much as 60 days, if the servicer permits, “to complete, sign, and return both Trial Period Plans, hardship affidavit, income documentation, first payment due under the Trial Period terms and any applicable executed disclosures”. Then, when they get the modification package, they have another 14 days to complete, sign, and return it.

All the same, if you look at the rate of change of loan modifications compared to the rate of change of offers extended, something weird shows up:

While the number of offers continues to grow, the number of new modifications is now falling, quite sharply. That can’t be a good sign.

Whitney Tilson passes on this chart, showing delinquencies at the FHA. He notes that the FHA is a crucial source of support for the housing market right now, providing a whopping 23% of all mortgages. If you have a subprime credit rating of 600, you only need to put 3.5% down to get an FHA loan; even if you have a positively wrecked credit rating of 500, you can still get a mortgage with only a 10% downpayment. And the people brokering a lot of these loans are often the selfsame shady characters who represented the worst face of the subprime bubble.

How high will the 2008-vintage delinquency rates eventually go? That’s the crucial question, since those mortgages represent more than 20% of the entire FHA portfolio. They’re already high, at 19.4%, but they could go much higher, given that the 2007-vintage loans are over 30%.

We’ve seen this movie before; we know how it ends. There’s going to be an FHA bailout, and it’s going to be big. The only question at this point is just how big it’s going to be.

Mike Konczal says that all mortgages should be prepayable without penalty. He’s right — but in fact he doesn’t go far enough. As Tyler Cowen notes, it would be even better if mortgages could be prepaid at a discount when mortgage rates rise — or property prices fall.

The result would be a sharp rise in mortgage prepayments: you’d repay when mortgage rates rise, by repurchasing your mortgage at a discount, and you’d repay when mortgage rates fall, by refinancing. Mortgage rates in general might have to go up somewhat in order to make up for all this new prepayment risk, but to offset that there would be significantly less default risk. And right now, when mortgage rates are low, is a good time to implement something like this: the damage you cause to a bank when you prepay a low-rate mortgage is very limited.

It’s true that prepaying at a discount doesn’t work as easily in the heterogeneous US as it does in the more homogenous Denmark, but there are ways around that; at the very least, homeowners should be given the opportunity to offset their mortgage liabilities in the broader capital markets. There’s got to be some way of doing that, and I’m not talking about zero-sum games like Bob Shiller’s housing futures.

As Stacy-Marie Ishmael says, “there has been an outbreak of contrarian thinking on the links between ratings, securitisation and the mortgage market” of late. She points to a paper by Ronel Elul, while Zubin Jelveh, who has been following the contrarian line for a while now, picks up on a different paper by Ryan Bubb and Alex Kaufman.

But the fact is that none of these findings are all that powerful. Elul, for instance, essentially confirms that securitization causes a decline in performance: “a typical prime ARM loan originated in 2006 becomes delinquent at a 20 percent higher rate if it is privately securitized,” he writes, and the fact that a similar pattern can’t be seen in subprime loans is basically just a function of the fact that “very few subprime loans were actually held in portfolio” — substantially all of them were destined for the securitization machine.

As for the Bubb-Kaufman paper, the chart that Jelveh picks up on shows a good 90% of subprime mortgages getting securitized. Can that really suggest, as Jelveh says, that securitization might not be to blame for the decline in lending standards? If lending standards dropped at the same time as the securitization rate soared, I’d say there’s a strong correlation between the two, and a pretty good prima facie case for a causal relationship too.

At heart, it all comes down to information: loans are stronger and more desirable than bonds, because a bank intends to hold its loan to maturity and does a lot of underwriting, shoring it up with covenants. Bonds, by contrast, are often held only briefly, and are often bought by investors who do precious little fundamental analysis; what’s more, they simply don’t have the kind of granular information that bank lenders have. And securitizations are even worse than bonds — no one really knows what’s in them, and they’re ultimately based more on models than on shoe-leather underwriting. So it’s entirely predictable that the boom in mortgage securitization was bad for the overall quality of the debt. And attempts to show otherwise are ultimately doomed.

Rosealea Yao reports:

Roughly 80 per cent of China’s urban residents own their homes – an astonishing number for a country that only began to privatise its housing stock in 1998.

Astonishing is right — and frankly, given the absence of any sourcing, I’m not sure I believe it. The high point of the influx from rural to urban China might be behind us, but it isn’t over yet, and all those poor Chinese workers looking to make their lives in the big city are unlikely to jump straight onto the bottom rung of the housing ladder. There might be some shenanigans going on with the definition of “residents” here — are all city inhabitants really included in the denominator?

That said, no visitor to China can fail to be astonished at the sheer quantity of housing stock which is going up in high rises across the country. If Yao is right, then substantially all of that stock is sold rather than rented, which helps to explain the astonishing amount of money in the Chinese construction industry. But it also means hundreds of billions of dollars of mortgages in the Chinese banking system, which I doubt were underwritten with particular assiduousness, and which have been written at extremely high price-to-income ratios. China could yet suffer a mortgage crisis of US proportions.

What year is this? 2005?

Ashley-Gayle Boothe and her husband Scott have applied for a USDA-backed loan to buy their first home, a three-bedroom house 30 minutes north of Tampa, for $127,500. “We didn’t want to put anything down,” says Ashley-Gayle Boothe. “We figured we’d have to buy appliances.”

Of course, the clue that this is happening right now is the lender — yes, USDA as in the Department of Agriculture. Somehow it’s got its hands on $10.5 billion to lend out as no-money-down home loans. And of course taxpayers have nothing to worry about:

The agency argues it adheres to strict underwriting standards, assessing each borrower’s credit, income, and cash flow.

What could possibly go wrong?

(Via Moore)

Kenneth Harney has got his hands on a fascinating new study from Experian and Oliver Wyman, which looks at the prevalence of strategic mortgage defaults, a/k/a “jingle mail” or “walking away”. Unsurprisingly, it’s financially sophisticated borrowers in non-recourse states like California who are doing this in droves: apparently there were 588,000 nationwide strategic defaults in 2008, more than double the total in 2007.

This is a perfectly rational and ethically defensible thing to do, but subprime borrowers, almost by definition, tend not to have the sophistication to default in the most financially-advantageous way.

Interestingly, the Experian-Wyman study (if anybody has a copy of it, do send it on over) recommends “that lenders and loan servicers take steps to screen and identify strategic defaulters in advance”. I’d love to know how lenders are meant to do that. Credit score obviously isn’t a good indicator, so what is? Financial literacy?