What Are They Selling?

A number of people have sent me articles and blog posts about the suspension of foreclosures by several major mortgage servicers, and even suspension of foreclosure by all lenders in two northeastern states because those state Attorneys General called a “time out” for all servicers.  The latter was to be expected when three of the very largest servicers clearly have procedural problems that may infringe on some borrowers’ rights.

When any article states with certainty that all MBS are worth zero, my question is “What are they selling?”

Some are selling gold.  Others are selling foreclosure delay legal services (where the payoff is living rent free for months or years while you “fight” foreclosure).   Still others simply enjoy a good disaster tale with a whiff of conspiracy theory thrown in, so they are selling drama and asking you to join them in their performance art.

The truth is, as usual, not nearly as drastic or dramatic as the chorus of doomsayers would like you to believe.  What are the facts, and who will be the winners and losers?

I’ll start by providing a link to a cool chart on the RealtyTrac web site.  If you go to the chart, it’s worth rolling your mouse over the comments section for the states, especially if those states allow both judicial and non-judicial foreclosure.  Where both forms are allowed, RealtyTrac estimates which type is more common in that state.

The first point we should all acknowledge is that when you aren’t paying your mortgage, your ownership claim on the property is weak to non-existent.  Also,  you can’t enjoy the benefits of a sympathetic judge if your foreclosure never has to go in front of a judge.

From that same RealtyTrac page, I especially like the explanation of the difference between types of foreclosure, so I’m copying it below:

“The foreclosure process varies somewhat from state to state, and depends primarily on whether the state uses mortgages or deeds of trust for the purchase of real property. Generally, states that use mortgages conduct judicial foreclosures; states that use deeds of trust conduct non-judicial foreclosures. The principal difference between the two is that the judicial procedure requires court action on a foreclosed home.

To foreclose in accordance with the judicial procedure, a lender must prove that the mortgagor (borrower/homeowner) is in default. Once the lender has exhausted its attempts to resolve the default with the homeowner, the next step is to contact an attorney to pursue court action. The attorney contacts the mortgagor to try to resolve the default. If the mortgagor is unable to pay off the default, the attorney files a lis pendens (lawsuit pending) with the court. The lis pendens gives notice to the public that a pending action has been filed against the mortgagor. The purpose of the action is to provide evidence of a default and get the court’s approval to initiate foreclosure.

Non-judicial foreclosures are based on deeds of trust that contain the power of sale clause. The clause enables the trustee to initiate a mortgage foreclosure sale without having to go to court. The trustee is typically required to issue a notice of default and notify the trustor (borrower/homeowner) accordingly about the default status. If the trustor does not respond, the trustee then initiates the steps for conducting the mortgage foreclosure sale of the home.”

(source)

I’ll take the voluntary halts in foreclosure by Ally (GMAC), JP Morgan Chase (including former WAMU) and Bank of America (including former Countrywide) in 23 states as indication that for these three giants of the mortgage business, they only have 23 states where they could end up arguing for their foreclosure rights in front of a judge.

In cases where the original paperwork is lost, judges may award the houses to the borrowers, although I think that copies of the paperwork and questioning by the judge may establish that the borrower did borrow the money, the lender did lend it, and the house was indeed the collateral for the loan.  In that case, it will be an unusual judge that decides to make a multi-hundred-thousand dollar gift to the borrower as punishment to the lender for losing the originals.

This would flow out of the fundamental difference between criminal and civil courts.  Criminal courts let crooks go free when police or prosecutors misbehave or fail to follow procedure because the awesome power of the state to take our liberty has to be guarded against vigilantly.  That’s to protect all of us from the state.

In civil court, the over-riding common law principle is “equity” or fairness.  The judge is charged with coming up with what’s fair.

Is it fair to give a house to a deadbeat because overworked or sloppy clerks at a mortgage servicer can’t lay their hands on the original of some document?  In what way does that protect the rest of us?  In fact, it forces a loss on the rest of us (either through the taxpayer-insured bank or through our participation in the MBS bonds owned by pension funds, insurance companies, etc.)  Before a judge could rule in favor of the lender, that lender may have to provide additional proof that they actually made the loan, that the borrower really did stop paying, and even that no one else has a valid claim on the property.  No doubt that would take more time and expense than having all the right paperwork the first time.

Still, I think anyone that believes every delinquent borrower just won the Publisher’s Clearinghouse sweepstakes should calm down and stop being silly.  There’s just no way that thousands of judges across the country are going to decide to give away houses to borrowers who aren’t paying their mortgages and pile the cost onto everyone else.  It’s just not fair, and I (maybe naively) believe that most judges try to be fair.  Will there be a few judges that want to send a stern message to the evil bankers?  Sure.  Will there be some who want to send a message to slackers looking to enjoy a free ride by making it extra expensive to have chosen to play for years of free rent?  You bet.

So, who are the winners and losers?

One group of winners will the lawyers, because they will get paid by both sides in every case that goes to court, and paid more the longer they make the cases last.  Unfortunately, the taxpayers will suffer from paying for all those court hours, and probably also suffer as investors or bank customers (or both) as the eventual higher out-of-pocket costs deducted from the eventual sale price of the houses will lower the recovery.

Probably the biggest winners will be purveyors of “foreclosure assistance” services.  There will be enough people in trouble on their mortgages willing to fork over $1,000 or so to these characters that some serious money will be made, probably with no more benefit to society than that provided by bedbugs.  Some borrowers are already winners.  I’ve seen interviews with people still in their homes more than two years after they stopped paying their mortgages.  Those are serious winners, but morally bankrupt even if they have healthier household balance sheets as a result.

Another class of winner is very technical.  Those would be holders of subordinated bonds in MBS structures that were about to be wiped out by realized losses.  The way that works is that the deals were set up with as many as a dozen thin “slices” of credit exposure, ranging from AAA all the way down to unrated (residual or equity).  Most of the unrated claims on cash flows have long since been written off, and even most lower-rated bonds ranked A+, A, A-, BBB+, BBB, BBB-, BB+ and BB have been written off by now, as well.  But some AA+, AA, AA- bonds still have principal left (this varies by deal among the thousands of deals that were priced during the boom years).

If I happened to own a bond that was in the process of taking principal writedowns over the past month or two, yet still had principal, I might have been expecting to see my last dollar of cash flow this month or next (this is because these thin “credit tranches” are often just a half a percent or one percent of the whole deal, and the flood of foreclosure hit deals with that much or more (often several percent) of new loans going into foreclosure every single month.  If each foreclosure eventually results in 50% losses, then it only takes resolution of 2% of the original pool balance in foreclosures to wipe out a 1% “thick” credit slice.  Anyway, if I happen to own such a bond that was about to be wiped out, I might get another month or two of interest payments, courtesy of the servicer, because the Pooling and Servicing Agreements probably specify that the Servicer must advance all scheduled principal and interest for the mortgage loan until they realize the loss by resolving the foreclosure through sale or cure (where the borrower pays the back interest, principal and late fees).

That servicer advance will make the eventual severity of the loss higher, though, because they will stand at the head of the line for recoveries when the house eventually gets sold.  They even get a little interest paid on their advance, so it’s slightly worse than a zero-sum game, even before you count the time value of the money.

So, if there’s a AA bond that gets a windfall of a couple extra months of interest due to this temporary suspension of foreclosures, that windfall, plus interest, will end up coming out of the AAA bond’s payments.  If the AAA bond is already taking losses, then it’s only a time-shift exercise, and makes the AAA bonds worth a bit less because the extra expense and delay created by the suspension and legal actions will come out of the eventual total cash flows to bondholders.

The losers will be pension holders, and other investors if the mortgages are pledged to MBS deals, or the banks if they are held in portfolio without having been securitized, or the taxpayer if the loans are part of Fannie or Freddie pools.  The loss won’t be as huge as some are predicting, because they will end up being the value of a couple more months of the borrower living rent free, plus the extra legal and administrative costs.  It’s bad, but nowhere near as bad as those who don’t understand the business think it will be.

Another big scare is being promoted regarding the use of the nationwide MERS system to manage and track transfer of servicing while not requiring constant re-filing of individual liens with Town and County clerks all across America.

In essence, MERS stands in as a nominee for the beneficial owners and servicers of the mortgages so that secondary market transfers can be more efficient.  It was one of the best innovations of the mortgage business in the 1990’s and cut down on errors and cost substantially.

Today some lawyers with an agenda and plain fools among the chattering crowd are trying to claim that registration through MERS irretrievably “breaks” the chain of mortgage ownership, giving 60% of the mortgage borrowers in America the option of willfully defaulting on their mortgages and keeping the houses.

Maybe some judge somewhere will fall for this line of argument.  My guess is that they will be reversed before the ink is dry.

A number of years ago a judge in Federal bankruptcy court in Arizona ruled in the case of American Southwest (a non-bank finance company owned by a group of homebuilders that provided mortgage financing to new home buyers) that the creditors had the right to stop payments to MBS and CMO bonds issued by an American Southwest subsidiary until the court determined whether the creditors might assert a claim.  Before the next business day the Federal Appeals Court (second highest court in the land) had reversed that ruling.  I’m sure the bankruptcy judge was shocked at how fast it happened.

A smart lawyer may put together a convincing-sounding argument regarding MERS, but a ruling that handed free houses to 50 million lucky borrowers is as likely to stand as the claim that all stocks are free if Dow Jones and Company ran out of ink one day and printed their stock price pages with blanks where the numbers belong.

hh

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One Response to What Are They Selling?

  1. hhill51 says:

    HousingWire.com is a daily read for me. Today’s column by Jacob Gaffney does a nice job on this same topic.

    http://www.housingwire.com/2010/10/06/forestalling-foreclosures-bites-the-hand-that-feeds-the-mortgage-market

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