Sunday, October 24, 2010

Megabank incompentence and the implications for the housing market

James Galbraith weighed in last week on the foreclosure crisis in We Don't Know National Journal 10/18/2010. Here's how he frames the situation:

It appears that many millions of mortgages lack a chain of ownership sufficient to establish who actually owns the note. It appears that in many cases, this deficiency has been made up illegally, with forged, falsely notarized, or otherwise irregular documents. It appears that more than 60 million mortgages are registered in an electronic system that has subverted the legal recording of property deeds and liens (and also evaded payment of fees required for this purpose). It has been argued that this entity, known as MERS, which is charged by the ultimate lien-holder with initiating foreclosures, lacks standing to do so.
Banks are vulnerable to the effects of the crisis in three ways: losses from foreclosures that cannot be carried out either because the individual ownership of the debt is legally in question or because of a freeze on foreclosures due to the magnitude of the problem; losses from additional homeowners who may decide that because the foreclosure process has broken down they can stop paying on their mortgages, too; and, "losses due to suits by investors (and to actions by Fannie Mae and Freddie Mac) forcing banks to take defective residential mortgage-backed securities back onto their own balance sheets, and to absorb losses they thought to have passed along to those investors." Galbraith thinks the first is the more immediate problem for the banks.

Galbraith emphasizes that the widespread failure in maintaining accurate ownership records of mortgage debt, created by the mortgage securitization fad which was essentially a gambling operation, represents a very basic breakdown in the system of mortgages. It's implications are large:

Next, let's consider the effects on the housing market. One is that some houses that would otherwise fall vacant will stay inhabited and off the market – a good thing, at least for now. A second is that some houses previously foreclosed may become unsaleable, owing to doubts about the integrity of title. This effect could impair the sale of all houses with mortgages registered electronically, since the release of a mortgage at time of sale can be definitive only if, in fact, the system reliably tracks the claims.

If title insurance claims then become a major problem, we may need to worry about the title insurance companies – and therefore about the viability of all sales of existing homes.

Following this logic, the most likely effect on most home prices is to push them down, increasing the number of underwater mortgages and the temptation to strategic default. However, there may be a contrary price effect for some homes – those with clear title and especially those not mortgaged – as potential buyers seek to protect themselves from title risk. [my emphasis]
Galbraith argues that the crisis requires that the federal government re-evaluate it's poorly-designed review of the viability of large banks it conducted in 2009. That superficial review that allowed the banks to use essentially fantasy evaluations of their mortgage-backed securities holdings, was seemingly designed to avoid putting more large banks like Citigroup and Bank of America into federal receivership and thus wiping out their shareholders' values in the stock of those companies. It left badly wounded large banks operating.

He also hopes that the current situation will lend:

... new urgency to mounting demands for a serious effort to investigate and prosecute mortgage and foreclosure fraud. Plainly, the ongoing failure to pursue the massive frauds in mortgage originations, ratings, and securitization has left in place people and institutions with little respect for law. But such respect can be restored - if the government decides to do so.
In those two instances, he sees a possible benefit if the responsible authorities in the federal government and the Obama Administration do the right thing. In a third possible development, he sees an immediate benefit to the economy:

Third, as homeowners default, the interest and principal otherwise spent on servicing a mortgage are spent on groceries and fuel. The losses to investors and bank shareholders are (dollar for dollar) gains to economic activity. Over time, this can be a significant source of economic recovery, rooted in families that would otherwise be displaced and homes that might otherwise be destroyed.
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