foreclosures

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Foreclosure Mess

Today’s news that the administration will side with the big banks and not call for a moratorium on foreclosures is just another example of the extent to which those in power will go to protect their banking benefactors. It is an extraordinary slap in the face for decency and common sense.

The issue is simple: there is growing evidence that our entire foreclosure process, which is driven at the state level, is hopelessly broken. People are at risk of losing their homes on false premisses. This is not to excuse those who rightfully should be thrown out due to non-payment of their obligations. But we live in a nation governed by due process. There are well known rules to be followed. Real estate law is highly settled and a well trodden path. There is little novelty about it.

That the big banks apparently are flouting the law with horrible regularity should be sufficient for a moratorium to be put in place while the extent of their law breaking is discovered.

The details are well known: during the final years of the binge, at the height of the bubble, such was the impress of activity that basic rules for proper documentation were thrown to one side. Workers deep in the bowels of the big mortgage lenders, such as the ill-starred Countrywide organization, we so overwhelmed by the flood of business that they simply ignored routine requirements. One of the biggest victims of this collapse of management was the storage and transmission of the papers relating to the liens established during a mortgage process. Remember that all mortgages consist of two separate pieces of paper: the loan and the associated lien. Obviously the lien is the piece that provides the power to foreclose.

When mortgages are packaged into securitized loans all their liens have to be transferred into the ownership of the trustee who manages the securitized package. That is a literal physical transfer as well as a written confirmation of transfer. Most states require the signature authorizing transfer from the issuing bank – e.g. Countrywide – to be in the form of “wet ink”. In other words it cannot be a simple computer or digital transfer. Someone has to sign each and every piece of paper. Plus, for the securitization to have effect, the transfer must take place at the inception of the trust. It cannot occur after the fact.

It seems that both these essential aspects of securitization were often not followed.

The consequence is this:

In the case of the absence of “wet ink” the transfer is not legal. The lien still belongs to the issuing organization. This is awkward since a large number of the original issuers are now bankrupt and no longer exist. The paper trail goes cold quickly, and it is often not easy to tell who has the right to start foreclosure proceedings. Far too many bankruptcy lawyers and accountants are now finding themselves rummaging through boxes of old documents looking for liens that courts are increasingly demanding as proof in support of a foreclosure action. And far too many are not finding them. In many cases documents are miraculously turning up in mint condition years after they were presumed lost. Funny that.

In the case of the non transfer of documents the issue has even more widespread ramifications: if the trustee did not have the liens at the inception of the trust, then the security based upon the mortgages does not exist, the loan becomes unsecured. That has devastating results. A large number of investors who bought AAA securitized loans thinking they were safely secured by mortgages, are now discovering that they actually own unsecured consumer debt worth a whole lot less. They were sold a bill of goods by the big banks.

No wonder the panic is setting in.

True to American form, the problem is now being taken seriously only because the big insurance companies and pension funds, who still own tons of these securitized loans, are threatening law suits to establish the level of security in their investments, and either the right to disgorge them, or the right to compensation if they discover they are unsecured. The fact that plenty of people are being thrown out of their homes on the basis of false or improper documentation has not caused that same level of concern.

The entire sorry mess is now so widespread that many of the big banks have stopped foreclosure proceedings for fear of being sued. So they should. They caused this problem, they should bear the consequences.

That Obama does not see fit to rally behind the people who have a legal right to defend themselves is sickening. This is a populist issue with huge political payback in some of the states most damaged by the bank’s rampage. Instead of siding with the common voters in those states, the administration has sided with the big banks.

Again.

And they wonder why they are unpopular.

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The Mortgage Crisis

In my post earlier today I argued that the recovery would be constrained by the state of the job market and that we may well have two parallel economies for a while until the employment situation improved and sparked an increase in consumer confidence.

The latest data on home mortgages seems to support that view.

One in eight home mortgages is now one or more payments in arrears. And the trend is worsening. Foreclosures are also picking up steam despite the administration’s efforts to encourage renegotiation.

The states most affected are the usual suspects with Florida being the leader in both foreclosure and arrears: 12% of the state’s mortgages are in foreclosure proceedings and 23% of mortgages are in arrears. Those are awful numbers. Next on the list come Nevada, Arizona, and Michigan. There is nothing really new about the fact these states have real estate markets that have collapsed.

What is new is that the cause of arrears and foreclosure has shifted. At the beginning of the crisis the collapse was sparked by sub-prime borrowers failing to pay as their interest rates shot up from the original teaser rates. Now the bulk of the new problems stem from unemployment: people who have lost their jobs and are now unable to maintain their home payments. A consequence of this is that the kind of mortgages now in trouble has shifted: at the onset of trouble it was those sub-prime borrowers accounting for the bulk of the failures. Now prime loans account for over a third.

The conclusion is obvious: unemployment is beginning to bite hard. Even well constructed and sensible loans are falling into arrears as the job market takes its toll on worker incomes. This will, with certainty, limit the upside of the recovery until jobs once again become abundant.

Meanwhile consumers will remain very conservative and save more than usual. And the more they save rather than spend the more likely we will run into difficulty next year.

Excessive thrift may well be our biggest problem in 2010.

How odd is that?

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What Kind of Recovery

Perhaps it’s simply Spring, but there has been some mildly encouraging data over the past two or three weeks. So the discussion has turned towards the nature of the upcoming recovery. In particular will it be a sharp upturn? Or will it be a long slow slog?

Before we get to that let me first say that the economy remains deeply mired in this recession and that in my opinion all the so-called early signs of our having reached the bottom are just as likely to be false omens.

Having said that, the housing market has shown a little life lately, but much of that activity is in the form of sales of foreclosed homes. These still count as home sales in the aggregate data, but they are hardly an early sign of strength. Quite the contrary. Foreclosures tend to press down on other homes in the same areas, so as sales of foreclosed homes gather pace the effect is to lower home values. Besides, home prices have still not fallen back to a level where affordability gets back to its historic norms. For that to happen we need another 10% – 15% drop.

With unemployment hanging ominously across the nation, and home prices still falling it is hard to paint an aggressive recovery picture.

Nonetheless some analysts are now predicting a very sharp upturn later this year and early next. I don’t agree with this outlook. Or at least I fail to see anything to support such a prediction yet.

The main premise upon which the optimists rest their case is the historic data since World War II. Every steep recession since then has been followed by an equally steep recovery. Conversely, slow or shallow downturns have been followed by slow or shallow upturns. It is tempting to suggest that this trend will repeat itself now.

I don’t agree.

My reasoning is as follows: most post 1945 recessions have been characterized by very sharp increases in manufacturing unemployment, particularly in the auto industry. Plant closings and layoffs typically accompany the first signs of a drop in demand and contribute to the gathering recession by eliminating wage earning jobs and hence potential consumption. This rapid snowballing of job losses and consequent cuts in consumption produce a sharp “V” shaped recession because consumption postponed by fearful consumers gathers pace anew as soon as the fear of job losses abates. Which it does once industry has closed sufficient plants and people realize ‘the worst is over’. The reappearance of consumers creates demand that manufacturers cannot meet from their diminished operations so they start re-hiring. Quickly this creation of new jobs, which is really the reinstatement of the old jobs, further quells fears and increases consumer purchasing power from the new wages being earned.

So a typical post war recession ends as sharply as it began, leaving the economy back where it was and following its historic growth pattern of about 3% to 4% GDP increase a year – right in line with population growth plus productivity improvements.

This time the downturn is far more widespread across the economy – job losses are not concentrated in manufacturing – and the banking crisis goes on unabated. This last factor alone suggests to me that getting a recovery well established will be difficult. Past post 1945 recoveries have not been as hindered by bank failures as this one will be. Without sufficient credit to fund expansion of factories and other operations businesses will be much more cautious about re-hiring than normal.

As long as we have weak banks, who are either unable or unwilling to lend, we will suffer through a long period of slow GDP increase. There will be growth, but it may well be insufficient to offset population growth, so per capita GDP may fall.

If, as I expect, inflation picks up during the recovery then we could be set for a few years of sluggish growth accompanied by rising prices. This is far from the pleasant picture being painted by the optimists, most of whom are connected with Wall Street so it is their job to paint scenarios in which investing in stocks can be encouraged. By and large these are the same people who said there was no bubble, so I feel comfortable disagreeing with them!

Overall I think the bottom of this decline will be reached in early summer – after further home price declines and all the large lay-offs have taken place. After that we will start the slow climb back. I just cannot see a healthy economy re-emerging until late 2010 or even early 2011. There are too many impediments and too much debris to clear away.

And I am not too sure that we are going to be successful cleaning up the banks any time soon. That’s still the issue to follow most closely.

Addendum:

I mentioned above that I expected inflation to pick up. Here’s why: All that money being pumped into the economy by way of bailouts and stimulus will eventually fuel an increase in prices – inflation. Any time the government increases the money supply at a rate above the general growth rate of the economy it runs the risk of stoking inflation because the increased amount of money is not matched by an increased amount of stuff to spend it on. To bring the amount of money into line with the amount of goods the price per item of goods goes up. Hence inflation.

The only time this doesn’t happen is when the money supply is pumped up while the economy is operating well below its ‘potential’. Under those circumstances the increased money supply goes towards getting the economy back to capacity: it is absorbed by the creation of more goods and services, rather than by increasing the prices of existing goods and services.

To the extent the economy arrives back at its potential, or at least is growing again, any excess money created during the stimulus or through bailouts runs the risk of fueling inflation later on.

Under our current conditions all the extra money being forced into the economy is not likely to create inflation immediately – we are simply too far under potential growth – but is likely to show up as inflation in the medium term after growth has re-emerged.

Hence my prediction of an uptick in inflation sometime next year or early 2011.

By the way: as a government policy I would argue that stoking inflation would be ‘good thing’. It eliminates deflationary fears; it alleviates debt burdens – future debt repayments are in inflated currency; and it pumps up bank profits because it raises interest rates. While it may sound odd to advocate a good dose of inflation, I think it would be sensible public policy right now … as long as we can rein it back in in the future.

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