To Bailout or Not to Bailout: Mortgage Mess Endgames Emerging

To Bailout or Not to Bailout: Mortgage Mess Endgames Emerging
In the last week, several ideas for fixing the housing market have  
surfaced. One is the Third Way proposal, which appears to be an  
Administration trial balloon. Predictably, it is yet anther bailout,  
with plenty of smoke and mirrors to disguise that fact.

A second proposal, from Sheila Bair yesterday, is to establish a  
“foreclosure claims commission“. This is in keeping with the direction  
that Iowa’s Tom Miller has been pushing for with the 50 state  
attorneys general investigation. This scheme sounds more promising  
that the Third Way proposal, but is very likely to wind up in bailout  
territory.

Third is a not-widely-covered plan by Senator Jeff Merkley which has  
two provisions that would force banks to address the fact that  
mortgages are deeply under water. That makes it firmly anti-bailout  
(or more accurately, any resulting bailouts would be explicit as  
opposed to buried in various mortgage market gimmies to banks). It  
would thus speed recognition of housing market losses, force debt  
writedowns, and accelerate repricing and clearing of the housing market.

The Merkley proposal is pro consumer and pro investor; the other two  
are pro bank. Sadly, it isn’t hard to see which is likely to prevail  
in the absence of public pressure.

The Bair proposal was presented at the Mortgage Bankers Association  
meeting in DC, In addition to the not-very-fleshed out idea of a  
claims fund, she also proposed a list of fairly modest but still badly  
needed servicing reforms, the biggest being required write downs of  
second mortgages when the servicer is negotiating the first mortgage  
with a borrower, and a independent process for appealing loss  
mitigation turn-downs. The latter is useful but needs to be made  
broader. Borrowers still lack any recourse save costly and time- 
consuming litigation if they believe servicers have made errors, so  
independent review should include a disclosure and dispute process for  
routine servicing.

The restitution fund concept is worrisome. It is not yet clear whether  
it will be funded, which means it could be a joint private/public  
kitty. The provision of any explicit government funding in the absence  
of a serious investigation, including possible criminal action, is not  
warranted. The hallmark of this financial crisis is no perps, save  
some foot soldiers (the hapless robosigners, for instance) have been  
identified, much less held to account.

And even the private funding model is likely to prove unsatisfactory.  
HousingWire suggested that it might be based on the BP restitution  
fund. That’s a red flag. The BP fund was seen as a win for the  
embattled oil company, since BP was given several years to contribute  
money to the fund. In addition, even though the fund in theory did not  
limit BP’s liabilities, most investors reacted as if the damage had  
been capped. And given that any participant in the fund claims process  
had to waive his rights to litigate, the process did serve to limit  
exposure (particularly of the punitive damages sort). Moreover, many  
people who applied for damages were deemed not to be eligible because  
the harm they suffered was allegedly too indirect (think hotel owners  
in affected areas). Others were denied because they could not document  
revenue and expenses (many small fishermen run heavily cash-based  
operations that are not hugely profitable even in the best of times).

So it is also easy to imagine, as with the various government mortgage  
mod programs, that the banks will run the process and will use strict  
documentation requirements as a way to limit payouts, when their abuse  
of the documentation procedures they created is at the root of this  
crisis.

By contrast, there is much to like about the Merkley proposal, which  
was covered by Dave Dayen at FireDogLake. It has two mechanisms to  
force banks to recognize and realize losses on underwater mortgages,  
and thus put an end to “extend and pretend”.

First is a “national short refinance program”. Per Dayen:

When a bank sends a home into foreclosure, it becomes an REO property,  
to be sold at auction at a large loss for the investors. Instead of  
going through the long process of resale, with the attendant upkeep  
that has to be spent by the bank on the home, and the disruption to  
the property values from having a vacant home in their neighborhood,  
this short refi program would allow qualified families facing eviction  
to refinance to an FHA-guaranteed mortgage based on current property  
values and interest rates. In the interim the family could stay in the  
home during the appraisal, new underwriting and final resolution. Many  
families would be able to pay a reduced payment if the home was  
written down to real value. The investor would get a bigger payoff  
than selling a vacant home in foreclosure. Neighbors would see their  
communities stabilized without a vacant property in their midst. And  
the family would get to stay in their home.

The main effect of the FHA short refi program is likely not to be a  
wave of mass refis, but to force servicers to offer deep principal  
mods. If a mortgage leaves the pool via a refi, the servicer loses all  
of the fees associated with that loan. If the servicer concludes a  
mod, it still gets ongoing servicing income, but on a lower principal  
balance.

The second mechanism is judicial modifications, aka bankruptcy  
cramdowns. In pretty much every other type of secured lending, save  
for residential mortgages (which were exempted via legislation), when  
the borrower goes into bankruptcy, the secured debt is written down to  
the value of the debt, and any amount owing beyond that is added to  
unsecured debts. The idea is commonsensical: you can’t say a $200,000  
mortgage is “secured” by a house now worth $160,000. The court process  
is well established and not controversial (as in you don’t see  
fulminating about abuses).

The scaremongering by the banking industry used to forestall judicial  
foreclosures is that every Tom, Dick, and Harry will run to the  
courthouse to get out of his mortgage, As anyone who has contemplated  
or gone though bankruptcy knows, it’s a very painful, humiliating, and  
disruptive process. And the widespread use of background checks as  
part of employment screening, with a bad credit record seen as a sign  
of bad character, is yet another deterrent. Correspondents of mine who  
would be ideal candidates (for instance, one is underwater due to  
investments gone sour and Chinese drywall making a sale of their home  
impossible, yet still have decent cashflow from their main business)  
are still loath to file.

Proof of the legitimacy of judicial mods as an option comes from the  
fact that most mortgage backed securities investors favor it, because  
they see it as a device for servicers to offer principal mods. With  
servicer fees and expenses coming first out of mortgage cashflow, the  
costly foreclosure process comes out of investors’ hides. All but a  
small percentage prefer principal mods because it will produce lower  
losses to them than costly foreclosures and sales of distressed  
property.

The Merkley plan has some other promising elements, such as requiring  
servicers to have a single point of contact (the Bair servicing  
reforms include this idea), a broad third party review process for  
mortgage mods (similar to successful programs at the state level) and  
the end of the “dual track” process (which keep the foreclosure  
process in motion while mod discussions are underway; this idea was  
present in a watered down form in the Bair speech as part of the  
foreclosure “settlement”).

Frankly, although individual borrowers may continue to suffer, the  
best prospect for an equitable long term solution is to let the wheels  
of justice continue to grind on. The outburst of reform ideas seems to  
be the direct result of the Massachusetts Supreme Judicial Court  
Ibanez decision. The terms of debate are, perversely, still very much  
skewed in favor of banks despite the considerable harm they have done  
to homeowners, investors, and communities. But judges are increasingly  
abandoning the assumption that banks must be right in foreclosure  
cases, and a more objective posture is sure to put the banking  
industry even more on the back foot. Letting the courts continue to do  
their work offers the best hope of exposing, and therefore ultimately  
remedying, large-scale misconduct by the securitization industry.






naked capitalism 1/20/11 2:44 AM Yves Smith Banana republic Banking  
industry Credit markets Legal Politics Real estate Regulations and  
regulators Comments

-- 
dadl-ot mailing list
http://mail.thehood.us/mailman/listinfo/dadl-ot_thehood.us
http://news.gmane.org/gmane.music.dadl.ot