Today's jury verdict finding Fabrice (the "Fabulous Fab") Tourre liable on six of the seven civil counts against him represents a major victory for the SEC. That's not simply because of the prominence of the case, which involved the sale of a controversial motgage-backed derivatives investment and is the highest profile SEC enforcement action to come out of the 2008 financial crisis. It's because the agency's very efficacy has been under attack for the better part of a decade. Widely viewed as ineffectual, the SEC has re-established its presence as a cop on the beat. While one victory doesn't win the war, a victory this big will make a lot of corporate and white collar defendants think harder about settling, even if the price involves admitting to making bad choices.
Fabrice Tourre rolled the dice and lost. Litigation is a gamble, and some bets turn out to be losers. Perhaps he chose to fight instead of settling up front because he was angry about being a lower level guy who was singled out as a named defendant. But anger doesn't equate to victory in court. Above all, what matters is the evidence. Tourre may have been his own worst enemy, seemingly adding insouciance as too much of a fillip to his e-mails. Most likely, his attorneys will soon make motions for this and that, and perhaps later file appeals. But now that the jury has spoken, Tourre faces an uphill battle.
Goldman Sachs wasn't a party to the case. But it reportedly financed Tourre's defense. And perhaps it has reasons beyond loyalty to a former employee. Goldman faces potential liability in private civil lawsuits involving charges similar to those in the SEC case. If Tourre had won, Goldman might have negotiated more favorable settlements in those cases. Now that he's lost, GS has shifted closer to the 8-ball. But that's all just a matter of money, of which GS has a fair pile. GS isn't going to be kicked out of the securities business, as Tourre might be, because GS already settled with the SEC, thereby capping its regulatory liability. Now that he's been held liable by a jury, Tourre not only faces SEC sanctions, but perhaps demands for payment from the plaintiffs' attorneys in those private civil lawsuits as well. Poor Fab. Not so fabulous any more.
The financial press ends up looking silly. Not one publication of any prominence, to this writer's knowledge, predicted the SEC's victory. Many expressed serious doubt about the SEC's case. The coverage during the trial was frequently skeptical of the SEC's evidence and efforts. It might be interesting to know why the press coverage was so imbalanced. Whatever the reason, the press was scooped by the SEC staff, which convinced the jury to announce the real story.
Showing posts with label mortgage backed security. Show all posts
Showing posts with label mortgage backed security. Show all posts
Thursday, August 1, 2013
Friday, September 14, 2012
The Fed's QE3: An Old Dog Pulling An Old Trick
Since the financial crisis of 2008, the Federal Reserve has striven to show that an old dog can learn new tricks. Its grab bag of novel programs have at various times propped a variety of financial markets, ranging from commercial paper to asset backed securities to U.S. Treasury securities, as well as banks and other financial institutions. Its aggressive use of quantitative easing has in particular stood out from Fed monetary policy of yore, in which discount and fed funds rate adjustments, along with changes in bank reserve requirements, were the only flavors of monetary policy served up.
The recently announced QE3 looks innovative: it's permanent until the labor market is doing 70 in a 35mph zone, will involve $40 billion of purchases per month, and is focused on mortgage backed securities. The Treasury securities market isn't targeted (although it's still being stage managed through Operation Twist to push down yields on long maturities). But QE3 is really just an old trick performed in a different way.
Going back to the new paradigm days of Chairman Alan Greenspan, the Fed has believed that the real estate market leads recoveries. One of the Fed's major frustrations with the Great Recession has been the moribund housing market. It remains badly hung over from over-indulgence in leverage, and battered consumer balance sheets make it difficult for many wannabe buyers to qualify for loans. QE3 is a direct shot of liquidity into the housing market, made with the hope of lowering mortgage rates, stimulating buyers and boosting the economy.
But we've heard this song before. After the 2000 tech stock crash and the 9/11/01 stock market swoon, Chairman Greenspan squashed interest rates with the intention of goosing real estate in order to keep the economy growing. It worked. Already in recovery mode from a downturn in the 1990s, real estate skyrocketed in the early and mid-2000s. The economy grew. Employment levels were good. Everything was peachy.
Until the bubble burst. Since 2007, we have paid the price for the Fed's campaign ten years ago to use the housing market as a way to foster economic growth. Too much of America's wealth was invested in real estate, and the resulting losses continue to choke the economy. One would think the Fed learned a lesson--that concentrating America's capital into a single market sector is risky and when that market sector turns down (as all markets do from time to time), the losses are exacerbated by the over-concentration.
But perhaps old dogs fall back on old tricks. There is serious concern that the Fed has run low on ammo. It can't push interest rates much lower. It can't keep distorting the U.S. Treasury market and give the federal government a very low cost way to run up the deficit. And banks don't want to lend no matter what the Fed signals, because loans are risky and the banks could take losses. So the Fed has decided to directly finance the mortgage markets by purchasing $40 billion per month in the MBS market. In other words, it's going to goose the housing market in the hope of stimulating the economy.
Some people like roller coasters. Others find them nauseating. The last time we got on this roller coaster, the ride ended badly. Nevertheless, the Fed is getting on again. Short term, it may enjoy success, just as the Greenspan Fed enjoyed success--for a while. But long term, the Fed faces a dilemma. In order to prevent another real estate bubble, the Fed has to maintain prudent lending standards. But prudence won't lead to the euphoric exuberance that could launch the economy into the dramatic rise that the Fed seems to be seeking. Will the Fed use its supervisory powers over the financial system to loosen up lending standards, with the concomitant risk of a housing bubble and bust, followed by a Greater Recession? Aroma of rat drifts into the ambient environment. QE3 may not really work unless it fosters really large risks. And we know what can happen when there's a lot of risk around.
The recently announced QE3 looks innovative: it's permanent until the labor market is doing 70 in a 35mph zone, will involve $40 billion of purchases per month, and is focused on mortgage backed securities. The Treasury securities market isn't targeted (although it's still being stage managed through Operation Twist to push down yields on long maturities). But QE3 is really just an old trick performed in a different way.
Going back to the new paradigm days of Chairman Alan Greenspan, the Fed has believed that the real estate market leads recoveries. One of the Fed's major frustrations with the Great Recession has been the moribund housing market. It remains badly hung over from over-indulgence in leverage, and battered consumer balance sheets make it difficult for many wannabe buyers to qualify for loans. QE3 is a direct shot of liquidity into the housing market, made with the hope of lowering mortgage rates, stimulating buyers and boosting the economy.
But we've heard this song before. After the 2000 tech stock crash and the 9/11/01 stock market swoon, Chairman Greenspan squashed interest rates with the intention of goosing real estate in order to keep the economy growing. It worked. Already in recovery mode from a downturn in the 1990s, real estate skyrocketed in the early and mid-2000s. The economy grew. Employment levels were good. Everything was peachy.
Until the bubble burst. Since 2007, we have paid the price for the Fed's campaign ten years ago to use the housing market as a way to foster economic growth. Too much of America's wealth was invested in real estate, and the resulting losses continue to choke the economy. One would think the Fed learned a lesson--that concentrating America's capital into a single market sector is risky and when that market sector turns down (as all markets do from time to time), the losses are exacerbated by the over-concentration.
But perhaps old dogs fall back on old tricks. There is serious concern that the Fed has run low on ammo. It can't push interest rates much lower. It can't keep distorting the U.S. Treasury market and give the federal government a very low cost way to run up the deficit. And banks don't want to lend no matter what the Fed signals, because loans are risky and the banks could take losses. So the Fed has decided to directly finance the mortgage markets by purchasing $40 billion per month in the MBS market. In other words, it's going to goose the housing market in the hope of stimulating the economy.
Some people like roller coasters. Others find them nauseating. The last time we got on this roller coaster, the ride ended badly. Nevertheless, the Fed is getting on again. Short term, it may enjoy success, just as the Greenspan Fed enjoyed success--for a while. But long term, the Fed faces a dilemma. In order to prevent another real estate bubble, the Fed has to maintain prudent lending standards. But prudence won't lead to the euphoric exuberance that could launch the economy into the dramatic rise that the Fed seems to be seeking. Will the Fed use its supervisory powers over the financial system to loosen up lending standards, with the concomitant risk of a housing bubble and bust, followed by a Greater Recession? Aroma of rat drifts into the ambient environment. QE3 may not really work unless it fosters really large risks. And we know what can happen when there's a lot of risk around.
Monday, January 30, 2012
Freddie Mac's Silly Boo Boo
We are told today that Freddie Mac has some $3.4 billions in derivatives called "inverse floaters" that profit if homeowners do not refinance out of high interest rate mortgages. At the same time that Freddie Mac was accumulating its holdings of inverse floaters, it was tightening requirements for refinancings, thus either wittingly or unwittingly increasing its chances of profiting from its inverse floaters.
The contradiction between Freddie's investment in inverse floaters and its mission of fostering affordable housing for Americans is obvious. Freddie's regulator, the Federal Housing Finance Agency, has been pushing Freddie and Fannie Mae to limit the extent to which they receive taxpayer subsidies. Seeking investment gains has been one way of pursuing that goal. That may be why Freddie took a flyer with the inverse floaters.
While details remain scarce, it appears from news reports that these inverse floaters are interest only strips--investments that paying the holder (Freddie, in this case) the interest payments from a large pool of mortgages. Refinancings of these mortgages mean that interest payments from the pooled mortgages would stop (while interest payments on the new, refinanced mortgages would go to whoever holds the right to those payments, not to the strip). So the more the old mortgages in the pool are refinanced, the greater the likelihood of Freddie losing money on the strip. Inverse floaters are likely to be volatile in value if interest rates change, and probably aren't very liquid because they're risky.
Refinancings increase as interest rates drop. By investing in the inverse floaters, Freddie was in effect speculating on the direction of interest rates. If rates dropped, the inverse floaters would lose money. If rates rose, the inverse floaters could rise in value (although higher mortgage rates would detract from the value of the stream of interest payments, which would be detrimental to the value of the inverse floaters). These inverse floaters may have been a bet on largely stable interest rates.
The silly thing about all this is that Freddie was speculating on the direction of interest rates in volatile investments that would be an embarrassment if the financial press found out about them. After being nationalized in 2008, Freddie should have become greatly sensitized to the need to look good while doing good. These inverse floaters could produce outsized losses if refinancings pick up. Taxpayers might then be called on to provide more subsidies to Freddie, not fewer. And not because Freddie took losses trying to make homes more affordable for America but because it was betting homes wouldn't become more affordable.
It's entirely possible that Freddie's traders have an explanation for the inverse portfolios that sounded pretty good when they talked among themselves. But from a public relations standpoint, the inverse floaters are silly, at best. The true problem is that Freddie and Fannie have too many conflicting goals, attempt to fulfill too many differing expectations, and are simply too big. There are some pretty good arguments that the biggest banks should be broken up into smaller, not too big to fail pieces. All of those arguments apply a fortiori to Freddie and Fannie.
The contradiction between Freddie's investment in inverse floaters and its mission of fostering affordable housing for Americans is obvious. Freddie's regulator, the Federal Housing Finance Agency, has been pushing Freddie and Fannie Mae to limit the extent to which they receive taxpayer subsidies. Seeking investment gains has been one way of pursuing that goal. That may be why Freddie took a flyer with the inverse floaters.
While details remain scarce, it appears from news reports that these inverse floaters are interest only strips--investments that paying the holder (Freddie, in this case) the interest payments from a large pool of mortgages. Refinancings of these mortgages mean that interest payments from the pooled mortgages would stop (while interest payments on the new, refinanced mortgages would go to whoever holds the right to those payments, not to the strip). So the more the old mortgages in the pool are refinanced, the greater the likelihood of Freddie losing money on the strip. Inverse floaters are likely to be volatile in value if interest rates change, and probably aren't very liquid because they're risky.
Refinancings increase as interest rates drop. By investing in the inverse floaters, Freddie was in effect speculating on the direction of interest rates. If rates dropped, the inverse floaters would lose money. If rates rose, the inverse floaters could rise in value (although higher mortgage rates would detract from the value of the stream of interest payments, which would be detrimental to the value of the inverse floaters). These inverse floaters may have been a bet on largely stable interest rates.
The silly thing about all this is that Freddie was speculating on the direction of interest rates in volatile investments that would be an embarrassment if the financial press found out about them. After being nationalized in 2008, Freddie should have become greatly sensitized to the need to look good while doing good. These inverse floaters could produce outsized losses if refinancings pick up. Taxpayers might then be called on to provide more subsidies to Freddie, not fewer. And not because Freddie took losses trying to make homes more affordable for America but because it was betting homes wouldn't become more affordable.
It's entirely possible that Freddie's traders have an explanation for the inverse portfolios that sounded pretty good when they talked among themselves. But from a public relations standpoint, the inverse floaters are silly, at best. The true problem is that Freddie and Fannie have too many conflicting goals, attempt to fulfill too many differing expectations, and are simply too big. There are some pretty good arguments that the biggest banks should be broken up into smaller, not too big to fail pieces. All of those arguments apply a fortiori to Freddie and Fannie.
Sunday, January 9, 2011
It's Not Just a Foreclosure Problem, It's an Accounting Problem
A recent decision by the Supreme Judicial Court of Massachusetts (U.S. Bank, NA v. Ibanez, Jan. 7, 2011) to block certain foreclosures has deeper implications than has generally been reported. The court ruled that two banks, trustees holding pools of securitized mortgages that tried to foreclose on two of the mortgages, hadn't submitted the documentation required to establish valid ownership of the mortgages. Thus, the banks couldn't prove they legally held the mortgages in question, and consequently couldn't foreclose. Nor could they obtain title to the mortgaged homes when they purported to buy them at the auction, so they couldn't resell them. Although the court didn't expressly say so, the homes would appear to be still owned by the original mortgage borrowers.
The court's decision implies that, for perhaps numerous securitized mortgages in Massachusetts, foreclosure may be difficult or near impossible. Such a legal conclusion, if applied nationwide, would gum up the recovery of the real estate markets. Even though halting foreclosures will hold homes off the market (because foreclosing banks can't resell what they don't legally own), prospective buyers will be cautious with the prices they pay for the remaining houses on the market. The foreclosure problems will eventually be resolved and foreclosed homes would then be dumped onto the market. This would push prices downward. Anyone who paid an optimistic price today could end up underwater in a year or two. The real estate markets will not stabilize until the foreclosure problems are dealt with. Delaying them, which will be the result of the Massachusetts decision and similar decisions by the lower courts of other states, will only postpone the day of reckoning. And the delay will add to the costs to the banks for having been so careless about documentation requirements.
What makes things worse is that there's more than a foreclosure problem here. If mortgages haven't been legally transferred to trustee banks, the principal process for financing home purchases--securitization--would have broken down. Mortgages being securitized are supposed to be pooled together and held by trustees for the benefit of investors. The big banks that underwrote the mortgage-backed securities would have breached their contracts to the investors by failing to deliver mortgages to the securitization pool. Investors could demand their money back. And refuse to accept losses the banks claim were sustained on defaulting mortgages, on the ground that those mortgages were never validly transferred to the securitization pool and the investors have no liability for losses from mortgages not held by the pool.
Moreover, depending on how the courts interpret the law, the banks might be liable for fraud, especially if bank officers were aware of the documentation deficiencies but sold mortgage-backed investments anyway. That could result in more liabilities, to investors and in SEC enforcement actions. In the worst case scenario, criminal charges could be filed. Since trillions of dollars of mortgages have supposedly been securitized, but now perhaps weren't, the potential liabilities could be very large.
Another problem would come up with mortgages that banks bought, either directly or as part of a securitization offering. If those mortgages have the same documentation problems the Supreme Judicial Court found deficient, the banks wouldn't really own the mortgages (or securitized interests in them), but would have reported phantom assets on their balance sheets. Again, depending on how widespread the documentation problems are, the quantity of improperly reported assets could be tens of billions, or even hundreds of billions.
Banks are now closing their books for 2010, and will be filing their financial statements at the end of March. The impact of the mortgage documentation problems will grow as a result of the Massachusetts ruling. The banks will have to account for these problems, and make a variety of disclosures. The banks' auditors will likely advocate caution; the New York Attorney General's recent case against Ernst & Young over Lehman Brothers' accounting for quarter end repo transactions will surely loom large in their minds. If the banks understate their problems, they (and their auditors) could buy more fraud suits from other classes of investors or government agencies. Stay tuned. This crisis could make our times even more interesting.
The court's decision implies that, for perhaps numerous securitized mortgages in Massachusetts, foreclosure may be difficult or near impossible. Such a legal conclusion, if applied nationwide, would gum up the recovery of the real estate markets. Even though halting foreclosures will hold homes off the market (because foreclosing banks can't resell what they don't legally own), prospective buyers will be cautious with the prices they pay for the remaining houses on the market. The foreclosure problems will eventually be resolved and foreclosed homes would then be dumped onto the market. This would push prices downward. Anyone who paid an optimistic price today could end up underwater in a year or two. The real estate markets will not stabilize until the foreclosure problems are dealt with. Delaying them, which will be the result of the Massachusetts decision and similar decisions by the lower courts of other states, will only postpone the day of reckoning. And the delay will add to the costs to the banks for having been so careless about documentation requirements.
What makes things worse is that there's more than a foreclosure problem here. If mortgages haven't been legally transferred to trustee banks, the principal process for financing home purchases--securitization--would have broken down. Mortgages being securitized are supposed to be pooled together and held by trustees for the benefit of investors. The big banks that underwrote the mortgage-backed securities would have breached their contracts to the investors by failing to deliver mortgages to the securitization pool. Investors could demand their money back. And refuse to accept losses the banks claim were sustained on defaulting mortgages, on the ground that those mortgages were never validly transferred to the securitization pool and the investors have no liability for losses from mortgages not held by the pool.
Moreover, depending on how the courts interpret the law, the banks might be liable for fraud, especially if bank officers were aware of the documentation deficiencies but sold mortgage-backed investments anyway. That could result in more liabilities, to investors and in SEC enforcement actions. In the worst case scenario, criminal charges could be filed. Since trillions of dollars of mortgages have supposedly been securitized, but now perhaps weren't, the potential liabilities could be very large.
Another problem would come up with mortgages that banks bought, either directly or as part of a securitization offering. If those mortgages have the same documentation problems the Supreme Judicial Court found deficient, the banks wouldn't really own the mortgages (or securitized interests in them), but would have reported phantom assets on their balance sheets. Again, depending on how widespread the documentation problems are, the quantity of improperly reported assets could be tens of billions, or even hundreds of billions.
Banks are now closing their books for 2010, and will be filing their financial statements at the end of March. The impact of the mortgage documentation problems will grow as a result of the Massachusetts ruling. The banks will have to account for these problems, and make a variety of disclosures. The banks' auditors will likely advocate caution; the New York Attorney General's recent case against Ernst & Young over Lehman Brothers' accounting for quarter end repo transactions will surely loom large in their minds. If the banks understate their problems, they (and their auditors) could buy more fraud suits from other classes of investors or government agencies. Stay tuned. This crisis could make our times even more interesting.
Wednesday, October 6, 2010
The Monster Within the Foreclosure Crisis
The foreclosure crisis is going from bad to worse. More foreclosures are stopping. Buyers are stepping back from bank owned properties. The U.S. Department of Justice has started looking into the mess.
The crisis is a tabloid's dream: Robo-signers gone wild, lawyers and courts operating foreclosure mills, homeowners booted through fraud, politicians pontificating, and subpoenas flying. But there's a Frankenstein that lurks within this house of horrors: the question of who owns mortgages. This is the worst aspect of the crisis, and if the problem is widespread, it could have extremely damaging consequences.
News coverage has reported that, sometimes, banks attempting to foreclose couldn't prove they owned the mortgage in question (or that they represented the true owner, if the bank was servicing the mortgage). When proof of ownership was lacking, the bank evidently provided courts with documentation that may not entirely be on the up and up. This practice, which could amount to a fraud on the court and be subject to criminal punishment, is now under review as banks, judges, plaintiffs lawyers, prosecutors, and all kinds of other folks try to sort things out.
If the ownership problem is widespread--and it might be, since it seems to have arisen from the hyper-pace of creation and securitization of trillions of dollars of mortgages in past years--the implications could be enormously bad. Banks would have to write off mortgages they can't prove they own, and reverse any past recognition of revenue and earnings from those mortgages. After all, banks can't claim as an asset a mortgage they don't own, nor can they recognize revenue from a non-owned mortgage. The sheer scale of mortgage lending and securitization is such that even if only 1% of mortgages are affected by ownership problems, the amounts involved could reach $100 billion or more of mystery mortgages. (There are about $14 trillion of mortgages outstanding, $7.5 trillion of which are securitized.) The U.S. banking industry would have a tough time swallowing another $100 billion of losses, especially now that banks already need to bulk up their capital to meet heightened capital requirements. Taxpayers, put your hands on your wallets.
Another implication of the mortgage ownership problem is that the downturn in the real estate market could be dragged out for years longer than otherwise. Foreclosures aren't legit unless the true creditor is seeking to collect the loan. It will now take months and even years to plow through legal records to establish true ownership of the many, many thousands of mortgages that might be in question. Buyers will step back from bidding for foreclosed properties. No matter, since some title companies aren't insuring title to such properties, so the banks probably couldn't sell them anyway. The foreclosures now in suspension won't be held off forever. Eventually, some resolution of the current mess will be achieved, those foreclosures will proceed, and the recovered properties resold. So these properties overhang the market, and buyers will be cautious about bidding even for non-foreclosure listings.
Then, there are the foreclosures in states where court approval isn't required. About 23 or so states that require court approvals for foreclosures. The rest allow foreclosures to proceed without court orders. But that doesn't mean that inability to prove ownership of the mortgage is okay in those states. To the contrary, booting a homeowner without being the true creditor on the mortgage probably violates the law in more than one way. Doing so may well be a fraud on the owner. If a sheriff's deputies were used to evict the owner, the lender might be deemed to have lied to sheriff. Lying to a peace officer is never a good idea. A subsequent buyer would not obtain clear title, so the lender might well be deemed to have perpetrated a second fraud. If such clouds over title are widespread, real estate markets in nonjudicial foreclosure states could be crippled for years, as title insurance companies try to sort out their risks and buyers stay away.
Another aspect of the mortgage ownership problem emerges in the securitization market. Large quantities of foreclosure mortgages are or were securitized. The mortgage ownership question implies that investors in the securitizations of those mortgages might or might not have invested in actual mortgages. To the extent, they did not, the banks that underwrote the securitizations can look forward to receiving investors' fraud claims. To make things worse, in the case of past foreclosures, investors who received the proceeds of foreclosures on mortgages they didn't actually have an interest in might be liable to repay the money. Needless to say, they would look to the banks servicing the mortgages for recompense. Given the apparently lousy state of the recordkeeping, the morass on the securitization end of the things could take years to clear up. The revival of the securitization market might be pushed back for a similarly long period. If things turn out to be really bad, securitization as a large-scale method of financing may be gone forever.
The foreclosure mess bears watching. It seems to be about where the financial crisis was in 2007: a year before we see the worst of things. If the foreclosure mess turns out to be a real monster, expect Wall Street and the real estate industry to try to dump it where the financial crisis ended up--in the laps of taxpayers. Whether that will be politically feasible is open to question. We are now witnessing the largest taxpayers' revolt since the Whiskey Rebellion in the 1790s. Maybe this time the banks will have to bear the losses they created.
The crisis is a tabloid's dream: Robo-signers gone wild, lawyers and courts operating foreclosure mills, homeowners booted through fraud, politicians pontificating, and subpoenas flying. But there's a Frankenstein that lurks within this house of horrors: the question of who owns mortgages. This is the worst aspect of the crisis, and if the problem is widespread, it could have extremely damaging consequences.
News coverage has reported that, sometimes, banks attempting to foreclose couldn't prove they owned the mortgage in question (or that they represented the true owner, if the bank was servicing the mortgage). When proof of ownership was lacking, the bank evidently provided courts with documentation that may not entirely be on the up and up. This practice, which could amount to a fraud on the court and be subject to criminal punishment, is now under review as banks, judges, plaintiffs lawyers, prosecutors, and all kinds of other folks try to sort things out.
If the ownership problem is widespread--and it might be, since it seems to have arisen from the hyper-pace of creation and securitization of trillions of dollars of mortgages in past years--the implications could be enormously bad. Banks would have to write off mortgages they can't prove they own, and reverse any past recognition of revenue and earnings from those mortgages. After all, banks can't claim as an asset a mortgage they don't own, nor can they recognize revenue from a non-owned mortgage. The sheer scale of mortgage lending and securitization is such that even if only 1% of mortgages are affected by ownership problems, the amounts involved could reach $100 billion or more of mystery mortgages. (There are about $14 trillion of mortgages outstanding, $7.5 trillion of which are securitized.) The U.S. banking industry would have a tough time swallowing another $100 billion of losses, especially now that banks already need to bulk up their capital to meet heightened capital requirements. Taxpayers, put your hands on your wallets.
Another implication of the mortgage ownership problem is that the downturn in the real estate market could be dragged out for years longer than otherwise. Foreclosures aren't legit unless the true creditor is seeking to collect the loan. It will now take months and even years to plow through legal records to establish true ownership of the many, many thousands of mortgages that might be in question. Buyers will step back from bidding for foreclosed properties. No matter, since some title companies aren't insuring title to such properties, so the banks probably couldn't sell them anyway. The foreclosures now in suspension won't be held off forever. Eventually, some resolution of the current mess will be achieved, those foreclosures will proceed, and the recovered properties resold. So these properties overhang the market, and buyers will be cautious about bidding even for non-foreclosure listings.
Then, there are the foreclosures in states where court approval isn't required. About 23 or so states that require court approvals for foreclosures. The rest allow foreclosures to proceed without court orders. But that doesn't mean that inability to prove ownership of the mortgage is okay in those states. To the contrary, booting a homeowner without being the true creditor on the mortgage probably violates the law in more than one way. Doing so may well be a fraud on the owner. If a sheriff's deputies were used to evict the owner, the lender might be deemed to have lied to sheriff. Lying to a peace officer is never a good idea. A subsequent buyer would not obtain clear title, so the lender might well be deemed to have perpetrated a second fraud. If such clouds over title are widespread, real estate markets in nonjudicial foreclosure states could be crippled for years, as title insurance companies try to sort out their risks and buyers stay away.
Another aspect of the mortgage ownership problem emerges in the securitization market. Large quantities of foreclosure mortgages are or were securitized. The mortgage ownership question implies that investors in the securitizations of those mortgages might or might not have invested in actual mortgages. To the extent, they did not, the banks that underwrote the securitizations can look forward to receiving investors' fraud claims. To make things worse, in the case of past foreclosures, investors who received the proceeds of foreclosures on mortgages they didn't actually have an interest in might be liable to repay the money. Needless to say, they would look to the banks servicing the mortgages for recompense. Given the apparently lousy state of the recordkeeping, the morass on the securitization end of the things could take years to clear up. The revival of the securitization market might be pushed back for a similarly long period. If things turn out to be really bad, securitization as a large-scale method of financing may be gone forever.
The foreclosure mess bears watching. It seems to be about where the financial crisis was in 2007: a year before we see the worst of things. If the foreclosure mess turns out to be a real monster, expect Wall Street and the real estate industry to try to dump it where the financial crisis ended up--in the laps of taxpayers. Whether that will be politically feasible is open to question. We are now witnessing the largest taxpayers' revolt since the Whiskey Rebellion in the 1790s. Maybe this time the banks will have to bear the losses they created.
Thursday, September 30, 2010
Foreclosure Mess: the Mortgage Monster Rears Its Head Again
Like a ghoul in a low budget horror flick, the mortgage morass never dies. Just when you think it's dead, its eyes snap open. Then it smiles a fang-filled grimace and gets up to lurch again in search of victims. The latest resurrection of the beast is the foreclosure mess.
Recent news reports indicate that financial firms servicing mortgages have many times foreclosed on defaulting homeowners without really knowing if they had the legal right to foreclose. Mortgage records in some cases seem to have been evanescent. But, no matter, as key employees whose job it was to review mortgage files and determine that foreclosure was warranted apparently paid scant attention to the contents of the files anyway. One such employee reportedly signed off on thousands of foreclosures a month, perhaps spending only a minute or two per file. Let's guess that his nickname is Robopen.
Other news stories in recent months have reported courts balking at foreclosures when banks couldn't prove they owned the mortgages that were supposedly in default or that they truly had authority to proceed with the foreclosure. There have been allegations of document forgeries and other irregularities. Foreclosures by two major financial institutions--Ally Financial (formerly GMAC) and J.P. Morgan Chase--are grinding to a halt. Today's Washington Post reported that other banks may follow in applying the brakes to their foreclosures. Some state attorneys general are starting to investigate and members of Congress are making noise about compensation for homeowners improperly ejected from their homes.
This is seriously bad shhhhh . . . stuff. The news reports probably reveal only the tip of the iceberg. It's impossible right now to identify all the potential ramifications of this sewage spill. But what we can see already is really stinky.
Systemic risk. With the recently enacted Dodd-Frank legislation, systemic risk is all the rage. So why don't we start with it. There are trillions of dollars of mortgages still held by America's major financial institutions. If the recordkeeping of mortgage servicers is really bad, and numerous mortgages cannot be connected to a legal owner (i.e., a lender or investor who truly has title to the mortgage), a lot of bank writedowns may be necessary. If a bank can't prove it holds the mortgage it thought it held, it will likely have to write off the entire debt. And it will have to stop taking payments from the homeowner, since it can't legally take money it's not entitled to get. We aren't just talking about defaulting and defaulted mortgages. We're talking about all mortgages. A bank that can't document its legal right to a mortgage will have to write it down because you can't count as an asset something you don't own. And the bank can't take payments from a homeowner who doesn't legally owe it any money. The recordkeeping problem here could mean many billions of losses. Federal regulators concerned about bank capital levels just got another massive migraine.
A heroic effort to straighten out the recordkeeping problems might eventually link up a lot of orphaned mortgages with their true owners. But that will probably take months and years. By all indications, each mortgage's file will have to be manually reviewed and straightened out--and not by Robopen or his clones. Such labor intensive work, which likely will require lots of lawyer time, will blow up bank legal budgets nationwide. And, given the inadequacy of the records, lawsuits will sprout like mold in damp drywall. All the while, massive amounts of bank capital will be tied down in mortgages, because the banks won't be able to sell what they can't prove they own. And they may have to reimburse mortgage investors to whom they sold mortgages they didn't own in the first place. Future lending--for new home purchases or to support economic recovery--may recede from today's sputter to a trickle.
Investors, lawyer up and stop buying mortgages. Investors who hold mortgage-backed securities just found themselves living in a world of septic content. They may, or may not, own any mortgage interests. If banks can't be sure who owns which mortgages, they can't be sure what they sold to mortgage investors. The 2007-08 mortgage crisis was bad enough. But today's clouds over title to mortgages means the pricing of numerous mortgage-backed investments may have become hazy indeed.
Fannie Mae and Freddie Mac have been backing new mortgages, so investors in newly issued debt may be at less risk. But if the recordkeeping problems include recent mortgages, the U.S taxpayer (that would be you, dear reader) just got screwed. Oh well, chalk it up to life in a world of too-big-to-fail financial institutions.
Homeowners, to the ramparts. If you're struggling to pay the mortgage, and the mortgage servicing bank or firm is getting ugly, fight back. Fight back hard, because you don't want to be shoved out of your home by someone to whom you don't legally owe any money. Demand to see documentation proving their ownership of your mortgage. Hire a lawyer if you don't understand legal documents. If you're getting the runaround, call your Representative and Senators in Congress, and your state's attorney general. If you truly have defaulted, there may well have to be a settling of accounts eventually. But don't get bullied out of your home by someone who has no legal right to foreclose.
Buyers beware. If you're looking to buy a house, don't buy at a foreclosure auction, and don't touch any property that is a bank sale after a foreclosure. Also, if the property is now owned by ordinary individuals, think about avoiding it if it was foreclosed on in the past. There's no way to tell when the recordkeeping mess might have begun; if you want to be truly careful, don't buy anything that has ever been foreclosed on. You can usually tell if there's been a foreclosure by looking at the history of ownership of the home (often available online in county or city records). If a bank, other corporation, or corporate trustee, is listed as an owner, there's a good chance the property was foreclosed on. If you buy a property with a foreclosure in its history, the mortgage mess may mean that the previous owner who was forced out may actually still own the house and might be able to reclaim it from you. You would probably be able to recover money under your title insurance policy (be sure you have one of these, even if your lender also has one). But you'd be out of the house.
There are legal rules that would probably bar prior homeowners from trying to reclaim the house after a number of years, but you'd have to hire a lawyer in the state where the house is situated to find out how many years that would be. This isn't the short time period homeowners have after foreclosure to recover the home, but a longer period that homeowners would have to recover after being forced out due to the foreclosing lender's fraud. The law may not be entirely clear on this issue, which is why you might want to avoid homes that have ever been foreclosed on.
Sellers beware. Sellers may think that with foreclosures grinding to a halt, the flood of bank sales onto the market will abate and prices will rise. They shouldn't smile too quickly. The foreclosure mess will eventually be resolved and the defaulted properties put on the market. That overhang will keep buyers on the cautious side. Mortgage loans may become harder than ever to get, as mortgage investors from Fannie and Freddie to institutional investors everywhere step back from buying more problems until the current problems are fixed. Title insurance premiums could rise sharply. Higher costs mean fewer buyers. Closings could become more difficult, as title insurers verify two or three times over that the correct mortgagor and home equity lender, if there is one, are being paid off. The home(s) down the street whose foreclosures were just suspended may not be well-maintained, as neither a defaulting homeowner nor a bank that may or may not hold the mortgage have much incentive to keep the place up. Your neighborhood could go to weeds if no one is responsible for ownership. A vibrant real estate market can't exist without good recordkeeping.
Taxpayers. Need we say it? After the bailouts of 2008 and 2009, we all know who gets nailed in the end. Senior government officials will solemnly intone well-rehearsed proclamations about protecting the viability of the financial system, etc., etc., so on, and so forth. Then they'll foist the dog doo on you. Bank bonuses might again temporarily fluctuate, but rest assured that the wealthy and powerful won't truly bear the burdens.
Recent news reports indicate that financial firms servicing mortgages have many times foreclosed on defaulting homeowners without really knowing if they had the legal right to foreclose. Mortgage records in some cases seem to have been evanescent. But, no matter, as key employees whose job it was to review mortgage files and determine that foreclosure was warranted apparently paid scant attention to the contents of the files anyway. One such employee reportedly signed off on thousands of foreclosures a month, perhaps spending only a minute or two per file. Let's guess that his nickname is Robopen.
Other news stories in recent months have reported courts balking at foreclosures when banks couldn't prove they owned the mortgages that were supposedly in default or that they truly had authority to proceed with the foreclosure. There have been allegations of document forgeries and other irregularities. Foreclosures by two major financial institutions--Ally Financial (formerly GMAC) and J.P. Morgan Chase--are grinding to a halt. Today's Washington Post reported that other banks may follow in applying the brakes to their foreclosures. Some state attorneys general are starting to investigate and members of Congress are making noise about compensation for homeowners improperly ejected from their homes.
This is seriously bad shhhhh . . . stuff. The news reports probably reveal only the tip of the iceberg. It's impossible right now to identify all the potential ramifications of this sewage spill. But what we can see already is really stinky.
Systemic risk. With the recently enacted Dodd-Frank legislation, systemic risk is all the rage. So why don't we start with it. There are trillions of dollars of mortgages still held by America's major financial institutions. If the recordkeeping of mortgage servicers is really bad, and numerous mortgages cannot be connected to a legal owner (i.e., a lender or investor who truly has title to the mortgage), a lot of bank writedowns may be necessary. If a bank can't prove it holds the mortgage it thought it held, it will likely have to write off the entire debt. And it will have to stop taking payments from the homeowner, since it can't legally take money it's not entitled to get. We aren't just talking about defaulting and defaulted mortgages. We're talking about all mortgages. A bank that can't document its legal right to a mortgage will have to write it down because you can't count as an asset something you don't own. And the bank can't take payments from a homeowner who doesn't legally owe it any money. The recordkeeping problem here could mean many billions of losses. Federal regulators concerned about bank capital levels just got another massive migraine.
A heroic effort to straighten out the recordkeeping problems might eventually link up a lot of orphaned mortgages with their true owners. But that will probably take months and years. By all indications, each mortgage's file will have to be manually reviewed and straightened out--and not by Robopen or his clones. Such labor intensive work, which likely will require lots of lawyer time, will blow up bank legal budgets nationwide. And, given the inadequacy of the records, lawsuits will sprout like mold in damp drywall. All the while, massive amounts of bank capital will be tied down in mortgages, because the banks won't be able to sell what they can't prove they own. And they may have to reimburse mortgage investors to whom they sold mortgages they didn't own in the first place. Future lending--for new home purchases or to support economic recovery--may recede from today's sputter to a trickle.
Investors, lawyer up and stop buying mortgages. Investors who hold mortgage-backed securities just found themselves living in a world of septic content. They may, or may not, own any mortgage interests. If banks can't be sure who owns which mortgages, they can't be sure what they sold to mortgage investors. The 2007-08 mortgage crisis was bad enough. But today's clouds over title to mortgages means the pricing of numerous mortgage-backed investments may have become hazy indeed.
Fannie Mae and Freddie Mac have been backing new mortgages, so investors in newly issued debt may be at less risk. But if the recordkeeping problems include recent mortgages, the U.S taxpayer (that would be you, dear reader) just got screwed. Oh well, chalk it up to life in a world of too-big-to-fail financial institutions.
Homeowners, to the ramparts. If you're struggling to pay the mortgage, and the mortgage servicing bank or firm is getting ugly, fight back. Fight back hard, because you don't want to be shoved out of your home by someone to whom you don't legally owe any money. Demand to see documentation proving their ownership of your mortgage. Hire a lawyer if you don't understand legal documents. If you're getting the runaround, call your Representative and Senators in Congress, and your state's attorney general. If you truly have defaulted, there may well have to be a settling of accounts eventually. But don't get bullied out of your home by someone who has no legal right to foreclose.
Buyers beware. If you're looking to buy a house, don't buy at a foreclosure auction, and don't touch any property that is a bank sale after a foreclosure. Also, if the property is now owned by ordinary individuals, think about avoiding it if it was foreclosed on in the past. There's no way to tell when the recordkeeping mess might have begun; if you want to be truly careful, don't buy anything that has ever been foreclosed on. You can usually tell if there's been a foreclosure by looking at the history of ownership of the home (often available online in county or city records). If a bank, other corporation, or corporate trustee, is listed as an owner, there's a good chance the property was foreclosed on. If you buy a property with a foreclosure in its history, the mortgage mess may mean that the previous owner who was forced out may actually still own the house and might be able to reclaim it from you. You would probably be able to recover money under your title insurance policy (be sure you have one of these, even if your lender also has one). But you'd be out of the house.
There are legal rules that would probably bar prior homeowners from trying to reclaim the house after a number of years, but you'd have to hire a lawyer in the state where the house is situated to find out how many years that would be. This isn't the short time period homeowners have after foreclosure to recover the home, but a longer period that homeowners would have to recover after being forced out due to the foreclosing lender's fraud. The law may not be entirely clear on this issue, which is why you might want to avoid homes that have ever been foreclosed on.
Sellers beware. Sellers may think that with foreclosures grinding to a halt, the flood of bank sales onto the market will abate and prices will rise. They shouldn't smile too quickly. The foreclosure mess will eventually be resolved and the defaulted properties put on the market. That overhang will keep buyers on the cautious side. Mortgage loans may become harder than ever to get, as mortgage investors from Fannie and Freddie to institutional investors everywhere step back from buying more problems until the current problems are fixed. Title insurance premiums could rise sharply. Higher costs mean fewer buyers. Closings could become more difficult, as title insurers verify two or three times over that the correct mortgagor and home equity lender, if there is one, are being paid off. The home(s) down the street whose foreclosures were just suspended may not be well-maintained, as neither a defaulting homeowner nor a bank that may or may not hold the mortgage have much incentive to keep the place up. Your neighborhood could go to weeds if no one is responsible for ownership. A vibrant real estate market can't exist without good recordkeeping.
Taxpayers. Need we say it? After the bailouts of 2008 and 2009, we all know who gets nailed in the end. Senior government officials will solemnly intone well-rehearsed proclamations about protecting the viability of the financial system, etc., etc., so on, and so forth. Then they'll foist the dog doo on you. Bank bonuses might again temporarily fluctuate, but rest assured that the wealthy and powerful won't truly bear the burdens.
Sunday, September 12, 2010
Bank Capital Standards: Basel's Leaky Levee
An international gathering of bank regulators in Basel, Switzerland solemnly announced today an increase in bank capital requirements, to which they agreed in order to prevent another worldwide credit crisis like the one in 2008. Minimum capital requirements will triple. The definition of capital will be tightened up, so somewhat elusive assets won't be treated as a safety net. It's even possible that some national regulators may impose countercyclical capital buffer requirements (i.e., rules that would obligate banks to add to their capital in good times as a further buffer against bad times). Regulators worldwide are congratulating themselves on a job well done.
There is, however, a rosy tint to all the hoopla. The new rules, called Basel III, are just a nonbinding agreement among bank supervisors. Nothing is legally binding yet. The mighty dam against financial panic that the Basel Committee announced is not necessarily as sturdy as it might seem.
Implementation Schedule in the Slow Lane. The new rules have to be adopted through whatever regulatory or legislative means would be required in each member nation, and the members have until the beginning of 2013 to begin implementing the new rules. Capital requirements are supposed to double current requirements by the end of 2017, and more than triple by the end of 2019. That's nine years from now. A lot can happen in nine years. Nine years ago, in 2001, the stock market was on an inflation-adjusted basis higher than it is today and unemployment was a lot lower. In the intervening nine years, we would have a housing boom and bust, and a crippling credit crisis. Fortunes would be made in finance, while retirements for the rest of us would be deferred. Americans in 2020 may have a safer, sounder and more stable financial system. But we have to slog through years of same old, same old to get there. In the meantime, with the economy slowing and possibly headed for another recession, we could have yet another banking crisis before we have new bank capital standards in place. (In the past nine years, we've had two recessions, so one more in the next nine years is hardly unimaginable.)
Bank Lobbying and Political Contribution Budgets Boom. Because each member nation has to go through the process of legally adopting the new rules, bank lobbyists and bank-friendly politicians can reasonably anticipate improved cash inflows for the next few years. Banks have it real good at the moment--low capital standards, implicit and explicit government guarantees, gratifyingly generous government subsidies, and only a moderate amount of flak about exceptionally handsome executive compensation. The Basel III rules will lower profits, reduce incentives to use leverage, potentially reduce or eliminate dividends (at least for some years) and, worst of all, dampen banker bonuses. Banks will use all the political influence they have to delay and soften the rules. The preceding Basel II capital requirements, which didn't exactly cover themseves with glory given that the 2007-08 financial crisis happened on their watch and resulted in the largest bank bailouts ever, were announced in 2004, delayed in 2005, and are still in the process of being implemented. Now that the regulators have reached agreement on Basel III, look for the political scrambling to begin in earnest.
Outflanking Basel III. Because of the extraordinary costs of the bank bailouts and the continuing need for federal regulators to subsidize banks, it might not be altogether surprising if the Federal Reserve and other regulators implement Basel III largely as announced. Bankers will look to skin the cat in other ways. Accounting standards can be manipulated. In 2009, bankers called in political chits to get Congress to heap organic material on regulators until they agreed to loosen up accounting rules for mortgage-backed investments (held by banks in enormous amounts). The result was that so called "mark-to-market" accounting was made more of a discretionary judgment than a requirement. What self-interested banker (and is there any other kind?), comparing the losses that would result from marking mortgage-related assets to market, to the earnings that could result from overlooking the cruel dictates of the market, would not conclude that a liberal valuation of his bonus is preferable to a conservative valuation of the bank's assets? Rigorous capital standards don't accomplish much if accounting standards allow hinky assets to be swept under the carpet.
It's possible Basel III will ultimately produce a better financial world. But don't count on it. Keep your debt levels low, your saving rate high and your hand on your wallet.
There is, however, a rosy tint to all the hoopla. The new rules, called Basel III, are just a nonbinding agreement among bank supervisors. Nothing is legally binding yet. The mighty dam against financial panic that the Basel Committee announced is not necessarily as sturdy as it might seem.
Implementation Schedule in the Slow Lane. The new rules have to be adopted through whatever regulatory or legislative means would be required in each member nation, and the members have until the beginning of 2013 to begin implementing the new rules. Capital requirements are supposed to double current requirements by the end of 2017, and more than triple by the end of 2019. That's nine years from now. A lot can happen in nine years. Nine years ago, in 2001, the stock market was on an inflation-adjusted basis higher than it is today and unemployment was a lot lower. In the intervening nine years, we would have a housing boom and bust, and a crippling credit crisis. Fortunes would be made in finance, while retirements for the rest of us would be deferred. Americans in 2020 may have a safer, sounder and more stable financial system. But we have to slog through years of same old, same old to get there. In the meantime, with the economy slowing and possibly headed for another recession, we could have yet another banking crisis before we have new bank capital standards in place. (In the past nine years, we've had two recessions, so one more in the next nine years is hardly unimaginable.)
Bank Lobbying and Political Contribution Budgets Boom. Because each member nation has to go through the process of legally adopting the new rules, bank lobbyists and bank-friendly politicians can reasonably anticipate improved cash inflows for the next few years. Banks have it real good at the moment--low capital standards, implicit and explicit government guarantees, gratifyingly generous government subsidies, and only a moderate amount of flak about exceptionally handsome executive compensation. The Basel III rules will lower profits, reduce incentives to use leverage, potentially reduce or eliminate dividends (at least for some years) and, worst of all, dampen banker bonuses. Banks will use all the political influence they have to delay and soften the rules. The preceding Basel II capital requirements, which didn't exactly cover themseves with glory given that the 2007-08 financial crisis happened on their watch and resulted in the largest bank bailouts ever, were announced in 2004, delayed in 2005, and are still in the process of being implemented. Now that the regulators have reached agreement on Basel III, look for the political scrambling to begin in earnest.
Outflanking Basel III. Because of the extraordinary costs of the bank bailouts and the continuing need for federal regulators to subsidize banks, it might not be altogether surprising if the Federal Reserve and other regulators implement Basel III largely as announced. Bankers will look to skin the cat in other ways. Accounting standards can be manipulated. In 2009, bankers called in political chits to get Congress to heap organic material on regulators until they agreed to loosen up accounting rules for mortgage-backed investments (held by banks in enormous amounts). The result was that so called "mark-to-market" accounting was made more of a discretionary judgment than a requirement. What self-interested banker (and is there any other kind?), comparing the losses that would result from marking mortgage-related assets to market, to the earnings that could result from overlooking the cruel dictates of the market, would not conclude that a liberal valuation of his bonus is preferable to a conservative valuation of the bank's assets? Rigorous capital standards don't accomplish much if accounting standards allow hinky assets to be swept under the carpet.
It's possible Basel III will ultimately produce a better financial world. But don't count on it. Keep your debt levels low, your saving rate high and your hand on your wallet.
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