Housing Hullabaloo

Another coming catastrophe!

from Business Insider:
Even the baseline scenario in places like Las Vegas and Miami is grim, where Case Shiller projects a 21% decline in home prices from 2010 to 2012.
But in one scenario it could be worse.
6.7 million delinquent mortgages are waiting to flood the market around the country -- and with near-zero cure rates most of them will. Another 2 million homes in foreclosure are being held off the market by banks.
Economist Keith Jurow says distressed asset investors are ignoring this threat: "If you are an investor thinking of buying one or more properties in Miami-Dade County, for example, you need to know that 24.9% of all active first liens there were seriously distressed. This means that more than 91,000 properties are almost certainly going to be dumped onto the market. Will that exert downward pressure on prices? Absolutely."
Distressed mortgages represented over ten percent of all mortgages in ten large markets, as of Q3 2010.

List of Bad Banks Grows, But So Do Profits

It's troubling to me that the only reason profits rose is that banks are setting aside fewer reserves for loan losses. Considering that the entire industry earned $14.5 billion, and expected losses for the foreclosure mess are now expected to hit nearly $750 billion, we're still is very deep trouble!

from Fox Business:

U.S. bank industry earnings fell by almost $7 billion in the third quarter but were far better than a year ago as the industry continues to recover from the financial crisis.

The Federal Deposit Insurance Corp announced on Tuesday that net income for the banking industry was $14.5 billion for the third quarter, which compares to $21.4 billion in the second quarter and $2 billion in the third quarter of 2009.

The agency said that third-quarter earnings would have reached a three-year high had it not been for a $10.4 billion goodwill charge taken by Bank of America during the quarter for its card business.

"The industry continues making progress in recovering from the financial crisis," FDIC Chairman Sheila Bair said in a statement. "Credit performance has been improving, and we remain cautiously optimistic about the outlook."

The banking industry has been setting aside less money to guard against losses, helping to boost earnings.

The amount of bad loans, those 90 days or more past due, declined for the second consecutive quarter, the agency said in its latest quarterly report. The balances for these loans declined by 2.1%, or $8.3 billion, in the third quarter.

The number of banks on the agency's "problem list," however, grew from 829 to 860, which is the highest number since March of 1993 when there were 928 institutions on the list.

RealtyTrac: Mortgage Losses May Get Much Larger

After two years in exile Fannie Mae and Freddie Mac are returning to center stage, ready to battle with the nation's lenders. The fight isn't over championship belts or gold medals, instead we'll find out who really owns foreclosure losses worth billions of dollars.
The unfolding war has significant implications for both foreclosure buyers and property owners in general. If mortgage investors start winning court battles, lenders will be forced to dump accounting fictions and show real losses. At that point there's little reason to hold foreclosed properties off the marketplace, hoping for higher prices. Instead, there will be a rush to dump distressed properties and accelerate short sales. While foreclosures now represent a quarter of all real estate sales, the percentage could quickly jump and force down home values, at least in the short run.

The “good” news — a term to be used cautiously — is that once foreclosure inventories fall, markets can then stabilize and in some areas home values might actually begin to rise.
The Secondary Market
Fannie Mae and Freddie Mac are “GSEs” or government-sponsored enterprises. They are special corporate concoctions at the heart of the “secondary” market, an electronic trading post where the GSEs buy loans from local lenders, package the mortgages into securities, and then sell the securities they created to investors. The continued functioning of the secondary market is a big deal because about 75 percent of all single-family mortgage originations are purchased by the GSEs.

A lender anywhere in the country can sell qualified mortgages to Fannie Mae and Freddie Mac. Investors from all over the world can buy and sell mortgage-related securities, an expression which can include pass-through securities and mortgage-backed bonds. The money investors pay for such securities enables the GSEs to buy more local loans and so the cycle continues. Along the way the GSEs “guarantee the timely payment of principal and interest on the mortgage-backed securities they issue” according to Freddie Mac.
The key to the system concerns those “qualified” mortgages. The GSEs are willing to buy conventional, FHA and VA loans because such mortgages have precise requirements and standards. A lender who tries to stick the GSEs with an unqualified mortgage can be tossed out of the program. No less important, a lender who sells a tainted loan can be forced to buy back the offending mortgage at face value.
Loan originators thus have every possible reason to carefully follow underwriting guidelines. A loan which fails because of nonpayment within 120 days — or a loan which fails at any time because of fraud — can generate an ugly and unpleasant buyback demand.
How Many Billions?
By the end of the third quarter the GSEs held massive numbers of foreclosures, properties that could not be unloaded with a short sale or through a foreclosure auction. Freddie Mac held 74,910 REO properties while Fannie Mae had 166,787 homes in its REO inventory.
“Not only do the GSEs have an REO problem, they also have a guarantee problem because they promised to make good on the securities they sold to mortgage investors,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com. “The potential liability of the GSEs is a matter of debate but there's little doubt that the final total will be enormous.”

Indeed, some of the loss estimates are astronomical.

• The Federal Housing Finance Agency (FHFA) says Fannie Mae and Freddie Mac have borrowed $148 billion to date from the Treasury but that additional draws could range “from $221 billion to $363 billion through 2013.” 
• Credit Suisse says Fannie Mae and Freddie Mac could face $321 billion in losses if home values decline by 10 percent in a year, are flat the next year and rise 3 percent annually thereafter. Of course, if things don't go so well then the losses could amount to $448 billion. 
• Standard & Poor's says “the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the $148 billion already invested — money largely spent to make good on loans gone bad.” Things could get worse, however. S&P says that $280 billion “could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize.”

To put these numbers in context consider that in the second quarter of 2010 all of the nation's banks jointly earned $21.6 billion in “profits” — earnings which were achieved in part because loss reserves were reduced by $27.1 billion when compared with a year earlier.
Who Pays?
If Fannie Mae and Freddie Mac are facing vast losses on the mortgages they bought then do they have any claims against the lenders who sold such loans? Can they force private-sector lenders to buy back failed mortgages?
Fannie Mae and Freddie Mac were taken over by the federal government in the summer of 2008. They are now operated by the Federal Housing Finance Agency (FHFA), a governmental entity that in July issued 64 subpoenas “to determine whether misrepresentations, breaches of warranties or other acts or omissions” were made by lenders who sold loans to Fannie Mae and Freddie Mac.

And just what documents does the government want? It's “seeking the contents of loan files, which include documents used in the underwriting process, such as loan applications and property appraisals.”

The potential for lender buybacks has not gone unnoticed and it involves not just Fannie Mae and Freddie Mac. The biggest case so far concerns the Maine State Retirement System and other mortgage investors who sued the Bank of America — the successor to Countrywide Financial — claiming that loans worth $352 billion should be bought back at face value. The suit has just been dismissed — but “without prejudice,” meaning it can be re-filed. As a result of the dismissal, says Bank of America, its liability has been reduced to not more than $31 billion — a sum greater than the profits of the entire banking system in the second quarter.
Meanwhile, other claims loom. As examples, the Federal Reserve Bank of New York and several large investors want Bank of America to buy back mortgage-related securities worth $47 billion. On the West coast, the Federal Home Loan Bank of Seattle has sued 11 lenders, seeking buybacks worth $4 billion.
In one suit, the bank alleges that a mortgage seller “made numerous statements to the plaintiff about the certificate and the credit quality of the mortgage loans that backed it. Many of those statements were untrue. Moreover, the defendants omitted to state many material facts that were necessary in order to make their statements not misleading.”

How much, if anything, mortgage investors can get back from loan originators and packagers is unknown. A report from Goldman Sachs says the nation's four largest banks will likely need $26 billion to cover “putback” claims during the next few years — that's $15.5 billion for the Bank of America, $5.3 billion for JPMorgan Chase, $2.2 billion for CitiGroup and $3 billion for Wells Fargo. The number for JPMorgan Chase could grow by an additional $3.5 billion if more loans from its Washington Mutual subsidiary do not work out. Whatever the case, the numbers suggested by Goldman Sachs can be easily absorbed by the larger banks.
But what if mortgage investor claims are more successful? What if settlements and remedies against dozens of lenders and Wall Street firms amount to hundreds of billions of dollars? Or more? Massive losses will need to be written off immediately so it will no longer make sense for lenders to have a foreclosure inventory or to wait for higher prices. Instead — under inevitably new management — the fresh strategy will be to clean up the books, dump REOs, speed short sales, blame old management, regain public confidence and move on.
____________________
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.

Mortgage Delinquencies Edged Higher

The number of new foreclosure notices fell 5.5% but a slightly larger proportion of mortgages became delinquent in the third quarter of 2010, according to a New York Federal Reserve Bank survey released on Monday.

About 2.7% of current mortgage balances fell into delinquency between June and September, compared to 2.6% in the second quarter, marking the first rise in this figure since last year.

Fitch Warns On Entire Mortgage Sector

"Fitch Ratings has assigned a Negative Outlook for the entire U.S. Residential Mortgage Servicer ratings sector on increased concerns surrounding alleged procedural defects in the judicial foreclosure process. This industry-wide issue will cause all servicers to be under increased scrutiny from a wide range of state and federal regulators, state attorneys general, and GSEs. All servicers will be affected, even those fully in compliance with all foreclosure rules and regulations."

Standard & Poors Increases Estimate of Taxpayer Mortgage Bailout to $685

from Standard and Poors today:

As Standard & Poor's Ratings Services sees it, the problems in the U.S. housing market are far from over. Moreover, with a growing portfolio of unsold homes, a sluggish economy, stubbornly high unemployment, the prospect of rising foreclosures, and billions in legacy losses, it appears unlikely in our view that housing and mortgage markets will be able to operate normally without continuing and substantial government involvement. That will likely mean further taxpayer support for Freddie Mac and Fannie Mae, the government-sponsored enterprises (GSEs) that, along with the Federal Housing Administration, now buy more than 90% of all home loans compared to less than half before the crisis.

That support has so far come at a price, which we believe is likely to rise substantially. Standard & Poor's estimates that the ultimate taxpayer cost to resolve Fannie Mae and Freddie Mac could reach $280 billion, including the $148 billion already invested--money largely spent to make good on loans gone bad. (Both GSEs are already in receivership.) That $280 billion, however, could swell to $685 billion, by our estimate, with the establishment of a new entity to replace Fannie and Freddie that the government would initially capitalize. Although federal authorities have taken no concrete public steps toward sponsoring a GSE alternative, , Standard & Poor's believes that it's a useful exercise to consider how much such a recapitalization might cost taxpayers.

Here Comes Mortgage Meltdown, Act 2 (part 2)

part 2 from John Mauldin:


At the end of last week's letter on the whole mortgage foreclosure mess, I wrote:
"All those subprime and Alt-A mortgages written in the middle of the last decade? They were packaged and sold in securities. They have had huge losses. But those securities had representations and warranties about what was in them. And guess what, the investment banks may have stretched credibility about those warranties. There is the real probability that the investment banks that sold them are going to have to buy them back. We are talking the potential for multiple hundreds of billions of dollars in losses that will have to be eaten by the large investment banks. We will get into details, but it could create the potential for some banks to have real problems."
Real problems indeed. Seems the Fed, PIMCO, and others are suing Countrywide over this very topic. We will go into detail later in this week's letter, covering the massive fraud involved in the sale of mortgage-backed securities. Frankly, this is scandalous. It is almost too much to contemplate, but I will make an effort.
But first, let me acknowledge the huge deluge of emails I got over last week's letter, the most I can ever remember. I thought about just making this week's letter a response to many of them, but decided I needed to go ahead and finish the topic at hand. Maybe another time. As a side note, I quoted a letter that came to me anonymously via David Kotok. I said if I found out who wrote it, I would give them credit. It was originally written by Gonzalo Liro, at www.gonzalolira.blogspot.com.
Many of you wrote to point out that his argument about the tracking of title was not correct, but others pointed out many other issues as well. This is one of the most complex problems we face, and I got a lot of good information from readers. It just makes me wish I had our new web site finished so you could avail yourselves of the wisdom among my readers. We are close, down to final changes. And now, on to today's letter.

They Knew What They Were Selling

It's hard to know where to start. There is just so much here. So let's begin with testimony from Mr. Richard Bowen, former senior vice-president and business chief underwriter with CitiMortgage Inc. This was given to the Financial Crisis Inquiry Commission Hearing on Subprime Lending andnd Securitization andnd Government Sponsored Enterprises. I am going to excerpt from his testimony, but you can read the whole thing (if you have a strong stomach) at http://fcic.gov/hearings/pdfs/2010-0407-Bowen.pdf. (Emphasis obviously mine.)
"The delegated flow channel purchased approximately $50 billion of prime mortgages annually. These mortgages were not underwriten by us before they were purchased. My Quality Assurance area was responsible for underwriting a small sample of the files post-purchase to ensure credit quality was maintained.
"These mortgages were sold to Fannie Mae, Freddie Mac [We will come back to this - JM] and other investors. Although we did not underwrite these mortgages, Citi did rep and warrant to the investors that the mortgages were underwritten to Citi credit guidelines.
"In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets. This situation represented a large potential risk to the shareholders of Citigroup.
"I started issuing warnings in June of 2006 and attempted to get management to address these critical risk issues. These warnings continued through 2007 and went to all levels of the Consumer Lending Group.
"We continued to purchase and sell to investors even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production."
Mr. Bowen was no young kid. He had 35 years of experience. He was the guy they hired to pay attention to the risks, and they ignored him. How could a senior manager not get such an email and not notify his boss, if only to protect his own ass? They had to have known what they were selling all the way up and down the ladder. But the music was playing and Chuck Prince said to dance and rake in the profits (and bonuses!). More from his testimony:
"Beginning in 2006 I issued many warnings to management concerning these practices, and specifically objected to the purchase of many identified pools. I believed that these practices exposed Citi to substantial risk of loss.

Warning to Mr. Robert Rubin and Management

"On November 3, 2007, I sent an email to Mr. Robert Rubin and three other members of Corporate Management... In this email I outlined the business practices that I had witnessed and attempted to address. I specifically warned about the extreme risks that existed within the Consumer Lending Group. And I warned that there were 'resulting significant but possibly unrecognized financial losses existing within Citigroup.'"
And now taxpayers own 75% of Citi, and our losses to them are huge. They are going to get worse, as we will see.
Now let's turn to the testimony of Keith Johnson, who worked for various mortgage companies and in 2006 became the president and chief operating officer of Clayton Holdings, the largest residential loan due diligence and securitization surveillance company in the United States and Europe. This is testimony he gave before the Financial Crisis Inquiry Commission. Part of the testimony is by his associate Vicki Beal, senior vice-president of Clayton. The transcript is some 277 pages long, so let me summarize.
Investment banks would come to Clayton and give then roughly 10% of the mortgages that they intended to buy and put into a security. Clayton rated them on whether the documentation was what it was supposed to be, not as to whether they thought it was a good loan. Still, 46% of the loans did not have proper documentation (out of a pool of 9 million loans) and 28% had what was determined to be level 3 disqualifications that simply had no mitigating circumstances. Understand, these were loans that were already written, and there was no effort to check the facts, just the documentation.
And ultimately 11% of these loans (39% of the level 3's) were put back in by the investment bank. And what happened to the loans that were rejected? (This might require an adult beverage and a few expletives deleted.)

Popping Through

They were put back into another pool, where again only 10% of the loans were examined. Quoting from the testimony:
"MR. JOHNSON: I think it goes to the 'three strikes, you're out' rule.
"CHAIRMAN ANGELIDES: So this was a case of - okay, three strikes.
"MR. JOHNSON: I've heard that even used. Try it once, try it twice, try it three times, and if you can't get it out, then put -
"CHAIRMAN ANGELIDES: Well, the odds are pretty good if you are sampling 5 to 10 percent that you'll pop through. When you said the good, the bad, the ugly, the ugly will pop through."
Yes, you read that right. If a loan was rejected a second time, it went back into yet another pool for a third try. The odds of coming up three times, when only 5 or 10 percent are sampled? About 1 in a thousand. Popping through, indeed.
Clayton presented their data to the ratings agencies, investment banks, and others in the industry. They were frustrated that no one was really paying attention or taking heed of their warnings.
Here is what Shahien Nasiripour, the business reporter for the Huffington Post, wrote (his emphasis). For those interested, the entire article is worth reading. (http://www.huffingtonpost.com/2010/09/25/wall-street-subprime-crisis_n_739294.html):
"Johnson told the crisis panel that he thought the firm's findings should have been disclosed to investors during this period. He added that he saw one European deal mention it, but nothing else.
"The firm's findings could have been 'material,' Johnson said, using a legal adjective that could determine cause or affect a judgment.
"It's unclear whether the firms ended up buying all of those loans, or whether Wall Street securitized them all and sold them off to investors.
"'Clayton generally does not know which or how many loans the client ultimately purchases,' Beal said. That likely will be the subject of litigation and investigations going forward.
"'This should have a phenomenal effect legally, both in terms of the ability of investors to force put-backs and to sue for fraud,' said Joshua Rosner, managing director at independent research consultancy Graham Fisher & Co.
"'Original buyers of these securities could sue for fraud; distressed investors, who buy assets on the cheap, could force issuers to take back the mortgages and swallow the losses.
"'I don't think people are really thinking about this,' Rosner said. 'This is not just errors and omissions - this appears to be fraud, especially if there is evidence to demonstrate that they went back and used the due diligence reports to justify paying lower prices for the loans, and did not inform the investors of that."
"Beal testified that Clayton's clients use the firm's reports to 'negotiate better prices on pools of loans they are considering for purchase,' among other uses.
"Nearly $1.7 trillion in securities backed by mortgages not guaranteed by the government were sold to investors during those 18 months, according to Inside Mortgage Finance. Wall Street banks sold much of that. At its peak, the amount of outstanding so-called non-agency mortgage securities reached $2.3 trillion in June 2007, according to data compiled by Bloomberg. Less than $1.4 trillion remain as investors refused to buy new issuance and the mortgages underpinning existing securities were either paid off or written off as losses, Bloomberg data show.
"The potential for liability on the part of the issuer 'probably does give an investor more grounds for a lawsuit than they would ordinarily have', Cecala said. 'Generally, to go after an issuer you really have to prove that they knowingly did something wrong. This certainly seems to lend credibility to that argument.'
"'This appears to be a massive fraud perpetrated on the investing public on a scale never before seen,' Rosner added."

It's Time for Some Putback Payback

Investment banks large and small originated a lot of subprime garbage in the 2005-2007 era. This week PIMCO, Black Rock, Freddie Mac, the New York Fed, and - what I think is key and no one has picked up on - Neuberger Berman Europe, Ltd., an investment manager to a managed-account client, came together and sued Countrywide for not putting back bad mortgages to its parent, Bank of America. This is the first of what will be a series of suits aimed at getting control of the portfolio and peeking into the mortgages. (Text of lawsuit at http://www.ritholtz.com/blog/2010/10/full-text-of-letter-to-bofa-from-ny-fed-maiden-lane-freddie-mac-pimco-western-asset-mgmt-neuberger-berman-kore-advisors/)
Basically, if buyers of 25% or more of a mortgage-backed security can come together, they have standing to sue the mortgage servicer to do its duty to the investors and make putbacks of bad mortgages, and if they fail to do so the plaintiffs can take control of the process and take the issuer to court directly (that's a very simplistic description but roughly accurate).
There are two key take-aways. First, note that a European entity is involved. Hundreds of billions of dollars of this junk was sold to European banks and funds. And these guys get together at conferences (sometimes they even invite me to speak). So Helmut will be talking to Lars who will talk to Jean Pierre and they will realize they all own some of this junk. They will be watching with very real interest to see how the big boys at PIMCO and Black Rock and the New York Fed fare in their efforts. And then you can count on them all piling on (more later on this).
Second, little noticed this week was the fact that The Litigation Daily wrote that Philippe Selendy of Quinn Emanuel Urquhart & Sullivan has been retained by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, to investigate billions of dollars in potential claims against banks and other issuers of mortgage-backed securities.
Who? Not on your celebrity list? Just wait. He will soon be getting the best tables everywhere. He and his firm are the guys representing MBIA in all their cases against Countrywide and Merrill Lynch. And they are kicking ass. Slowly to be sure, but very steady. That means Fannie and Freddie are getting ready to get serious.
They were sold well over $227 billion of the subprime garbage issued in 2006 and 2007. And the bad stuff started before then. But they have one advantage that the guys at PIMCO, et al. don't have: they (or actually the FHFA) are a federal agency. That means they have subpoena power. The agency has sent 64 subpoenas to issuers of mortgage-backed securities, and although they have not said who they went to, they obviously include almost everyone and clearly all the big players. (They couldn't have ignored Goldman, could they? Naah. Too obvious.)
From American Lawyer.com (I know, this website is probably already on your favorites list, but for those souls who actually have a life I provide the text):
"Through those subpoenas, the agency could gain access to the loan files for the mortgages that backed the securities it bought and thus establish whether the mortgages were what the issuers represented them to be in securities contracts. According to the Journal, the difficulty of obtaining loan files has been a big obstacle for investors trying to force issuers to repurchase bonds.
"If the FHFA were to decide down the road to initiate litigation, it would still have to have the support of a percentage (usually 25 percent) of its fellow bondholders for each issue. But given what the agency and its Quinn lawyers will be able to see before bringing suit, it probably won't be too hard to get other investors on the bandwagon." (http://www.quinnemanuel.com/media/183456/hurricane%20warnings%20fannie%20mae%20and%20freddie%20mac%20hire....pdf)
It is tough not to jump to the conclusion, but we need one more piece of the puzzle before we get there.

The Worst Deal of the Decade?

Arguably Bank of America had Merrill shoved down their throats, but no one can say that about the acquisition of Countrywide. And Countrywide could end up costing BAC $50 billion or more in losses. That may prove to be a serious candidate for worst deal of the decade. (Although WAMU is a leading candidate too!)
Let's look at a report by Branch Hill Capital, a hedge fund out of San Francisco. And before we start on it, let me point out they are short Bank of America. You can see the full PowerPoint at http://www.businessinsider.com/bank-of-america-mortgage-report-2010-10#-1.
(And let me say a big thanks to the author of the report, Manal Mehta, for all the background material he sent me and his help with this week's letter. It helped make it a lot better. Of course, any erroneous conclusions or outrageous statements are all mine.)
First, they point out that the potential size of Bank of America's (BAC) liabilities is $74 billion (with a B). And that is just for Countrywide. That does not include Merrill, which is also large. Against that they have set aside $3.9 billion. You can count on more suits than just the PIMCO, et al. mentioned above.
In the MBIA case, the judge has ruled that the suit can proceed even though BAC has denied responsibility. Although on appeal, this is high-stakes poker. Countrywide originated over $1.4 trillion of mortgages in 2005-2007. MBIA alleges that over 90% of the defaulted or delinquent loans in the Countrywide securitizations show material discrepancies. Care to take the under in the over/under bet on that?
Further to the case on BAC, Merrill was the largest originator of subprime CDOs during the housing boom, for another $120 billion, along with about $255 billion of residential mortgage-backed securities.
And then there are all those CDOs (collaterized debt obligations). Merrill did a lot of those that went sour. This deserves it own leter, but a gentleman named Wing Chau went from making $140k a year to $25 million in just a few years, putting together CDOs from Merrill, some of which were completely bankrupt in just six months.
Countrywide has already settled with the New York pension funds for $624 million, one of the largest securities fraud settlements in US history. And the line is growing longer.
Of course, BAC CEO Brian Moynihan denied this week that there is a problem. Let's look at Moynihan's statements at the last earnings call and compare them to what the judge in the case said earlier. Moynihan:
"... we execute repurchases on a loan by loan basis... And as we learn more, and again, our perspective on this - we're going to be quite diligent as I said in defending the interest of our shareholders. This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review."
Back in June the judge on the case (a Judge Bransten) said (from the transcript):
"I think that it makes all the sense in the world that you can use a sample to prove the case because otherwise I can't imagine a jury listening to 386 thousand cases. Even if you have that available, nevertheless you are not going to present that to a jury or even to a judge. I'm patient but not that patient. So therefore it is going to be a sample in the end..."
OK, let me get this straight, Brian. Your company committed fraud, with robosignings and all the rest, and you won't man up and take responsibility? You and your lawyers want to thrash this out, case by case, fighting a trench-warfare, rear-guard action? Well I'm afraid that's not going to work out for you. There are so many examples of Countrywide outright fraud that it is going to be hard to convince a jury that BAC is not on the hook. Will it take years? Of course.
You can read the PowerPoint for details. Bottom line: BAC is probably liable for putbacks that could total over a hundred billion. And that is just BAC.
Think Citi. And any of the scores of mortgage originators and investment banks. There were a couple of trillion dollars in these securitizations issued. Plus how many hundred of billions of second-lien loans? And can we forget CDOs? And CDOs squared?
And let's not forget all those completely synthetic CDOs that were written at the height of the mania. Most of it AAA, of course. Frankly, anyone stupid enough to buy a synthetic CDO should lose their money, but that is not what the courts will base their decision on. It is all about representations and warranties. And maybe a little fraud.
I picked on BAC because that is the analysis I saw. But it could be any of dozens of banks. Look at this list from the Branch Hill PowerPoint.

Could we see a hundred billion in losses to the major banks? In my opinion we will for sure, over time. $200 billion? Probably. $300 billion? Maybe. $400 billion? It depends on how organized the investors in the securities get and what gets settled out of court. Out of a few trillion dollars in securitizations? It's anybody's guess. I just made mine.
But let's not forget the $227 billion sold to Fannie and Freddie. Taxpayers are on the hook for $300-400 billion in losses. Those putbacks could save us a lot. Will this threaten the viability of some banks? Maybe. But most will survive. BAC made $3 billion last quarter. A steep yield curve (with the help of the Fed) can cure a lot of evils. But it will absorb the profits of a lot of banks for a long time.
And that of course, will come back to haunt the rest of us as banks have to raise more capital and get more conservative.
Anyone who owns stocks in banks with relatively large MBS exposure is not investing, they are gambling that the losses will not be more than management is telling them. There will be no bailouts (at least I hope not) this time around. Fool me once, shame on you; fool me twice, shame on me. There will be little sympathy for shareholders or bondholders this time, if it comes to that.
One more sad point. The FDIC (read taxpayers) is liable for some of this, as they took over some of these institutions. It just keeps on coming.
Final rant. If you were part of a group that knowingly created or sold flawed and fraudulent mortgage-backed securities to pensions and insurance companies and took home tens of millions in bonuses, up and down the management chain, maybe you should consider moving yourself and your money to a country that does not honor US extradition, because my guess is that, as all this comes out, you may have to hire some very expensive lawyers and get measured for pinstripes.
And the Mozilo agreement was a sham. Sigh. That would be the equivalent of fining me $10,000 and letting me keep my tanning bed. I don't have the space to go into the fraud at Countrywide, but their internal documents show they all knew what was going on.

Here Comes Mortgage Meltdown, Act 2 (part 1)

by John Mauldin:

Trouble, oh we got trouble, Right here in River City!
With a capital "T" That rhymes with "P"
And that stands for Pool, That stands for pool.
We've surely got trouble!
Right here in River City,
Right here! Gotta figger out a way
To keep the young ones moral after school!
Trouble, trouble, trouble, trouble, trouble...
- From The Music Man
(Quick last-minute note: I think this (and next week's) is/will be one of the more important letters I have written in the last ten years. Take the time to read, and if you agree send it on to friends and responsible parties. And note to new readers: this letter goes to 1.5 million of my closest friends. It is free. You can go to www.frontlinethoughts.com to subscribe. Now, let's jump in!)
There's trouble, my friends, and it is does indeed involve pool(s), but not in the pool hall. The real monster is hidden in those pools of subprime debt that have not gone away. When I first began writing and speaking about the coming subprime disaster, it was in late 2007 and early 2008. The subject was being dismissed in most polite circles. "The subprime problem," testified Ben Bernanke, "will be contained."
My early take? It would be a disaster for investors. I admit I did not see in January that it would bring down Lehman and trigger the worst banking crisis in 80 years, less than 18 months later. But it was clear that it would not be "contained." We had no idea.
I also said that it was going to create a monster legal battle down the road that would take years to develop. Well, in the fullness of time, those years have come nigh upon us. Today we briefly look at the housing market, then the mortgage foreclosure debacle, and then we go into the real problem lurking in the background. It is The Subprime Debacle, Act 2. It is NOT the mortgage foreclosure issue, as serious as that is. I seriously doubt it will be contained, as well. Could the confluence of a bank credit crisis in the US and a sovereign debt banking crisis in Europe lead to another full-blown world banking crisis? The potential is there. This situation wants some serious attention.
This letter is going to print a little longer. But I think it is important that you get a handle on this issue.

Where is the Housing Recovery?

We are going to quickly review a few charts from Gary Shilling's latest letter, where he review the housing market in depth. Bottom line, the housing market has not yet begun to recover, and it is not only going to take longer but the decline in prices may be greater than many have forecast. I wrote three years ago that it could be well into 2011 before we get to a "bottom." That may have been optimistic, given what we will cover in this letter.
First, existing and new single-family home sales continue to slide, in the wake of the tax rebate that ended earlier this year. We have declined back to the down-sloping trend line. If you are a seller, this is not a pretty picture.

The homebuilding industry, which was the source of so many jobs last decade (aka the good old days), is on its back. This country needs a healthy housing construction market to get back to lower unemployment, and until the overhang in the foreclosure market is cleared out, that is unlikely to happen.

Lending is tighter, as is reasonable. Banks actually expect you to have the ability to pay back the mortgage you take out (solid FICO scores) and want reasonable down payments. Only 47% of applicants have the FICO score to get the best mortgage rates.
(Sidebar: Gary writes, "Furthermore, false appraisals rose 50% in 2009 from 2008. The tax credit for first-time homebuyers cost taxpayers about $15 billion, twice the official forecast, in part due to fraud. Over 19,000 tax filers claimed the credit but didn't buy houses, while 74,000 who claimed $500 million in refunds already owned homes." Where are the regulators?)
Shilling thinks prices are likely to fall another 20%. Given what I am writing about in the next section, that is a possibility. There is certainly no demand pressure to push up housing prices.
Finally, two charts on foreclosures. Residential mortgages in foreclosure are near all-time highs, close to 1 in 21 of all mortgages, up from 1 in 100 just four years ago. That's got to be bad for your profit models.


Anyone who tells you the housing problem is "bottoming" either has an agenda or simply does not pay attention to the data. I really want to see housing bottom and then turn around and the home builders come back; the nation desperately needs the jobs. But my job is to be realistic. When we see 3-4 months of non-stimulus-induced housing sales growth, then we can start talking about bottoms.
But housing sales are not really the issue. Let's look at the next leg of the problem.

The Foreclosure Mess

OK, in a serendipitous moment, Maine fishing buddy David Kotok sent me this email on the mortgage foreclosure crisis just as I was getting ready to write much the same thing. It is about the best thing I have read on the topic. Saves me some time and you get a better explanation. From Kotok:
"Dear Readers, this text came to me in an email from sources that are in the financial services business and with whom I have a personal relationship. The original text was laced with expletives and I would not use it in the form I received it. Therefore the text below has had some substantial editing in order to remove that language. The intentions of the writer are undisturbed. The writer shall remain anonymous. This text echoes some of the news items we have seen and heard today; however, it can serve as a plain language description of the present foreclosure-suspension mess. There is a lot here. It takes about ten minutes to read it. - David Kotok (www.cumber.com)
"Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper...only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan
"Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn't go anywhere: it stayed in the offices of the S&L down the street.
"But once mortgage loan securitization happened, things got sloppy...they got sloppy by the very nature of mortgage-backed securities.
"The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
"Therefore, as everyone knows, the loans were 'bundled' into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then "sliced & diced"...split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
"This slicing and dicing created 'senior tranches,' where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created 'junior tranches,' where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)
"These various tranches were sold to different investors, according to their risk appetite. That's why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
"But here's the key issue: When an MBS was first created, all the mortgages were pristine...none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full...but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads...but what will the result be of, say, the 723rd toss? No one knows.
"Same with mortgages.
"So in fact, it wasn't that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.
"But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn't be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
"Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?
"Enter stage right the famed MERS...the Mortgage Electronic Registration System.
"MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again ...I know, I know: like the chlamydia and the gonorrhea of the financial world...you cure 'em, but they just keep coming back).
"The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein's operating table, where the beast got put together.
"However, legally...and this is the important part...MERS didn't hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.
"But the REMICs didn't own the notes either, because of a fluke of the ratings agencies: the REMICs had to be "bankruptcy remote," in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.
"So somewhere between the REMICs and MERS, the chain of title was broken.
"Now, what does 'broken chain of title' mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it's the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the 'chain of title.'
"You can endorse the note as many times as you please...but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.
"If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.
"To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.
"Read that last sentence again, please. Don't worry, I'll wait.
"You read it again? Good: Now you see the can of worms that's opening up.
"The broken chain of title might not have been an issue if there hadn't been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn't have bothered to check to see that the paperwork was in order.
"But as everyone knows, following the housing collapse of 2007-'10-and-counting, there has been a boatload of foreclosures...and foreclosures on a lot of people who weren't sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.
"These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that's when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.
"Now, the banks had hired 'foreclosure mills'...law firms that specialized in foreclosures...in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.
"Well, what do you know, it turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently repair the chain-of-title issue, thereby 'proving' that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills might have even forged the loan note itself...
"Wait, why am I hedging? The foreclosure mills did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this 'service' from a company called DocX...yes, a price list for forged documents. Talk about your one-stop shopping!
"So in other words, a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud: the guy who got foreclosed and evicted from his home in Florida, even though he didn't actually have a mortgage, and in fact owned his house free - and clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.
"Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it...that would have been nice, to see a shining knight in armor, riding on a white horse.
"But that's not how America works nowadays.
"No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.
"In every sale, a title insurance company insures that the title is free -and clear ...that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because...of course...they didn't want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.
"That's when things started getting interesting: that's when the attorneys general of various states started snooping around and making noises (elections are coming up, after all).
"The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem...obviously. Banks that size, with that much exposure to foreclosed properties, don't suspend foreclosures just because they're good corporate citizens who want to do the right thing, and who have all their paperwork in strict order...they're halting their foreclosures for a reason.
"The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act? That was all the banking lobby. They wanted to shove down that law, so that their foreclosure mills' forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their master's will by a voice vote...so that there would be no registry of who had voted for it, and therefore no accountability.)
"And President Obama's pocket veto of the measure? He had to veto it...if he'd signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order. (But he didn't have the gumption to come right out and veto it...he pocket vetoed it.)
"As soon as the White House announced the pocket veto...the very next day!...Bank of America halted all foreclosures, nationwide.
"Why do you think that happened? Because the banks are in trouble...again. Over the same thing as last time...the damned mortgage-backed securities!
"The reason the banks are in the tank again is, if they've been foreclosing on people they didn't have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.
"And it won't matter if a particular case...or even most cases...were on the up -and up: It won't matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.
"People still haven't figured out what all this means. But I'll tell you: if enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free? That's basically a license to halt payments right now, thank you. That's basically a license to tell the banks to take a hike.
"What are the banks going to do...try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.
"This is a major, major crisis. The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn't handled right...and handled right quick, in the next couple of weeks at the outside...this crisis could also spell the end of the mortgage business altogether. Of banking altogether. Hell, of civil society. What do you think happens in a country when the citizens realize they don't need to pay their debts?"
(I am not sure who wrote this, but if you want your 15 minutes of fame, I will be glad to credit you next week. - John)

Some Foreclosure Takeaways

Let me add a few thoughts. First, I agree, this is very serious. It has the possibility of seriously hurting the housing market, which as we saw in the first section is already on the ropes. But at the end of the day, there is a cure.
Someone borrowed money for a mortgage. Some entity is cashing a check if that person is paying. That entity should have the title until it is paid off. If someone is not making their mortgage payments, they should be removed from the house and it should be sold to the benefit of the ultimately correct and what everyone thought was the proper title holder.
If you took out a mortgage and now the title is in some doubt because the investment banks and mortgage banks and all the middle guys screwed up (big-time!) because they wanted to save some bucks and make some commissions, you did not win the lottery. That is not America as I know it. You can't pay the mortgage, I am sorry. But you do not get to keep the house. The people who (thought) they bought the mortgage in a fair deal need to end up with that mortgage.
If you pay your mortgage, you get to have the American Dream.
We CANNOT allow this debacle to continue. It will bring the system down. Who will want to buy a mortgage that is in a securitized package with no clear title? Who will get title insurance? Some judge somewhere is going to make a ruling that is going to petrify every title company, and the whole thing grinds to a halt.
Let's be very clear. If we cannot securitize mortgages, there is no mortgage market. We cannot go back to where lenders warehoused the notes. It would take a decade to build that infrastructure. In the meantime, housing prices are devastated. Whatever wealth effect remains from housing gets worse, and the economy rolls over.
This is beyond my pay grade, but there have to be some adults who can make everyone play nice in the sandbox. Ideally, someone in authority at the Treasury, with bipartisan support steps in and says everyone follow these rules, whatever these rules need to be.
I had a very spirited conversation with good friend Barry Ritholtz today (of The Big Picture). Barry runs money but is also a lawyer and has a somewhat different perspective. He thinks we do not need any legislation and there is a legal cure. He says that real trained people (lawyers and paralegals) need to look at each mortgage and figure it out, and that it can get resolved. It is expensive to the banks; but I agree, if it is just dollars I don't care. Fix it.
But that is a maybe. Other people I talk to disagree. Some think we need some regulatory fixes. Some think we will need a legislative cure. But if we need to, there need be no finger pointing, no partisan BS. This needs to get solved.
Someone took out a mortgage. Some entity thinks they are owed money. Fix the damn paper trail so that happens, whether in a legal if time-consuming manner, in a regulatory fix, or with legislation.
Now, that is not to say the people who did this stuff did not commit felonies and such. We can sort that out over time. The longer we wait the worse it will get. Fix the problem and then go round up the bad guys. There are bigger issues in play here. (I know this will be somewhat controversial. Oh well.)
I get the fraud being done here. I am regulated by FINRA, the NFA, various states, the British FSA, and ultimately the SEC. If I did something in my business like the stuff described above, someone would come in and justifiably shut me down, fine me, and ban me from the securities business. Oh, wait. These guys ARE regulated by the above groups.
Finally on this topic, I shake my head when I think that the FDIC is now running several of the banks (think IndyMac) that are part of this foreclosure crisis. These are the guys who are supposed to be preventing something like this. Again, where are the adults?

The Subprime Debacle: Act 2

OK, this letter is already getting too long. I am going to finish it next week, as the next topic needs a lengthy treatment. But I will not leave you hanging. A quick preview.
All those subprime and Alt-A mortgages written in the middle of the last decade? They were packaged and sold in securities. They have had huge losses. But those securities had representations and warranties about what was in them. And guess what, the investment banks may have stretched credibility about those warranties. There is the real probability that the investment banks that sold them are going to have to buy them back. We are talking the potential for multiple hundreds of billions of dollars in losses that will have to be eaten by the large investment banks. We will get into details, but it could create the potential for some banks to have real problems.
And all this coming as European banks are going to have to sort out their own sovereign debt problems. Shades of 2008. I hope I am wrong, but it's all connected.

The Next Leg In the Mortage Crisis

Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit, people familiar with the matter said.
A group of bondholders wrote a letter to Bank of America and Bank of New York Mellon Corp., the debt’s trustee, citing alleged failures by Countrywide to service loans properly, their lawyer said yesterday in a statement that didn’t name the firms. The New York Fed acquired mortgage debt through its 2008 rescues of Bear Stearns Cos. and American International Group Inc.

The Magnitude of Foreclosure-Gate Comes to Light

from Business Insider:

The system for financing mortgages and regulating that financing has failed, completely and utterly. The mortgage and real estate markets are now in collapse.
Yesterday I wrote about how positive feedback loops lead to collapse. Welcome to the U.S. housing and mortgage markets. As I have documented here numerous times, the entire U.S. mortgage market has already been socialized: 99% of all mortgages are backed by the three FFFs--Fannie, Freddie and FHA--and the Federal Reserve has purchased a staggering $1.2 trillion in mortgage-backed assets in the past year or so to maintain the illusion that there is a market for mortgage-backed securities.
There is, but only because the mortgages are backed by the Federal Government and propped up by the Federal Reserve.
The mortgage market is completely dependent on government guarantees and quasi-Government purchases of securitized mortgages. If the mortgage market were truly socialized, then the Central State would own the banks which originate, service and own the mortgages.
But then the private owners and managers of the "too big to fail" banks would not be reaping hundreds of billions in profits and bonuses. And since the banking industry has effectively captured the processes of governance (that is, Congress and the various regulatory agencies), then what we have is a system of private ownership of the revenue and profits generated by the mortgage industry and public absorption of the risks and losses.
Could anything be sweeter for the big banks? No.
The incestuous nature of the system is breathtaking. The Fed creates the credit which enables the mortgages, the Treasury guarantees the mortgages via Fannie, Freddie and FHA, the Fed buys the mortgages ($1.3 trillion in mortgages are on their balance sheet) and the private banks collect the fees and profits.
One of the core tenets of the Survival+ critique is the State/Financial Plutocracy partnership. There are many examples of this partnership (crony capitalism in which the State is the "enforcer" which collects the national income and distributes it to its private-sector cronies), but perhaps none so blatant and pure as the mortgage/banking sector.
But now the entire legal basis for that privatized-profits, socialized losses system has dissolved. The foreclosure scandal is not just a "scandal" in which various frauds were brought to light; it is the failure of the entire system of originating mortgages that props up the entire real estate market.
I recently reported on the depth of the crisis for AOL's Daily Finance: The Foreclosure Crisis: Eroding Trust -- and Ending the Recovery?
The Mainstream Financial Media has been forced to gingerly poke around the delicate topic, and surprise, it is difficult to put a positive spin on the crisis:
Document Questions Cloud Recovery: Agents Fear Housing Could Stall as Uncertainty on Foreclosures Unnerves Buyers, Especially Investors.

"Title companies would be crazy to ensure title on anything remotely associated with a foreclosed property because we don't know how this is going to resolve itself," said Mark Hanson, an independent housing analyst in Menlo Park, Calif.

The result: Not only could sales slow on foreclosures now listed for sale, but it could also become harder to sell or refinance properties that have been foreclosed upon at some point in the past few years.

Real-estate agents are particularly worried about the situation's impact on investors, the buyers who fix up foreclosed homes for resale. Investors accounted for 21% of all home sales in August, according to the National Association of Realtors.

Little-Known MERS Faces Big Challenges in Foreclosure Battle:

Success in challenging MERS’ role in a foreclosure could mean the owner of a mortgage holds a loan without claim to the house as collateral, Mr. Weissman said. That result could set off a chain reaction reducing the value of mortgage servicing rights, an asset many banks keep as an investment.

Here is another MSM story: Are We Headed for Housing Armageddon?
So to summarize:
1. The banks which depend on revenues collected from mortgage servicing are facing the possibility that millions of distressed mortgages will enter legal limbo and not be paid; additionally, millions of underwater homeowners realize they can stop paying their mortgages with no near-term consequence because the foreclosure system is frozen.
If you doubt this, please read Gonzalo Lira On The Coming Middle-Class Anarchy.
2. The mortgages which the banks are holding on their books as income-producing assets at full face value are in effect either worthless or depreciated to some significant but unknown degree. If this fact were reflected in their balance sheets, all the big banks would all be insolvent.
3. Evictions based on foreclosures can be halted, delayed or even cancelled. Consider this alternative response to wrongful eviction: Evicted Family Breaks Into Their Former House(WSJ.com)
4. Pending sales of properties that were foreclosed are now of dubious legality.
5. Anyone buying a house in foreclosure, or a house that was foreclosed, cannot get title insurance.
6. Investors who have been propping up the housing market by snapping up properties in foreclosure (REOs or "distressed properties") face high risks and uncertainties in buying any real estate that was in or is in the foreclosure pipeline. That means markets will lose 30% to 50% of their buyers.

7. Buyers who closed on foreclosed homes now face legal challenges to their ownership and potentially even "clawback" of the property as the previous owner can claim he/she was defrauded by a flawed/defective foreclosure process.
8. Real estate attorneys can rejoice: everyone will get sued, in every court in the land. Banks will get sued, title insurance companies will get sued, realtors will get sued, foreclosure mills will get sued, MERS will get sued, and so on. The attorneys general of the states will all sue the banks and mortgage mills, claiming billions in damages.
Anyone who thinks this is all trivial technicalities is wrong.
9. The real estate market will collapse as the imbalance of buyers and sellers swings to extremes. Buyers vanish as trust in the institutions of real estate finance and property rights has collapsed, and millions of distressed/defaulted mortgages don't get paid. Underwater sellers have a stark choice: either dump the house for cash (assuming the bank allows a short-sale and eats a massive loss) or stop paying the mortgage and see what happens.

That sets up a new positive feedback loop in a very tenuous market: millions of underwater homeowners will realize their homes are plummeting in value and "recovery" is hopeless. Millions more who were on the edge will be pushed underwater as prices fall. The incentives for the newly underwater are clear: stop paying the mortgage, since price "recovery" is hopeless and the foreclosure process is frozen.
The imbalance between few buyers and millions of properties on the market or in the shadow inventory has only one "capitalist" resolution: the destruction of price down to levels that clears the inventory.
Las Vegas offers a example of this clearing: condos are selling for 15% or 20% of their bubble-era valuations--and this is with massive Federal subsidies of the mortgage market.
10. There is a fundamental legal battle playing out between the property rights and rules of law embodied in state laws, and the Central State/Federal laws which enable MERS to transfer ownership of mortgages as securities. You can't have both systems at the same time; either transfers of mortgages and ownership and the procedure of taking real property (foreclosures) meet state laws or these laws have been rendered moot.
Either there is due process of law or you have a kleptocracy/"banana republic" oligarchy. At present, that is the decision we face as a nation. If the banking Elites and their partners in the Central State (Fed and Treasury) are allowed to "win" and gut the property laws of the states, then the U.S.A. will be revealed as a kleptocracy/"banana republic" oligarchy.
If state laws are upheld, then the "too big to fail" banks are insolvent and they will fail.Then the question of kleptocracy arises once again: will the banks be allowed to fail as per Classic Capitalism, that is, their owners and managers will have to absorb the losses of that bankruptcy/failure, or will the Central State use its powers to collect taxes and cover the private losses of the Bank/Financial Power Elites? Privatizing profits and socializing losses has been the entire game plan since the global house of cards collapsed in 2008.
It's decision time, citizens. Either the banks/Central State "win" and we are a kleptocracy/ "banana republic," or they lose and the U.S. mortgage/ banking sector implodes and is either formally socialized (i.e. owned lock, stock and barrel by the Central State) or rebuilt from scratch without big banks, Federal guarantees and the Fed's incestuous interventions. ("We create the credit that enables the mortgage, you issue the mortgage, and then we buy the mortgage.")
There is no "fix" or half-measure that can patch this over now.
The non-mainstream media can speak the truth directly. For example, here is the excellent Acting Man blog:
Total Chaos:

The biggest question of all, is there anyone working on a solution? I know the answer to that: No.
We now have socialized housing. If you disagree, just imagine the consequences if government intervention were withdrawn. Real estate markets would collapse immediately. The government is the market. There is no exit strategy.

The feedback loops are in full runaway mode, and the end-state will be a collapse of one system or the other: either the incestuous banking cartel/Fed/Treasury system of "private profits, socialized losses" implodes, or property rights and the real estate market implode.
Right now, both are imploding, and each system's implosion reinforces the other's collapse.

Mortgage Crisis #2 Begins to Escalate

There is a "heightened risk of a more dismal scenario. If negative momentum in the housing market kicks in, and feeds into the banking system and broader economy, it will be hard to fight." -- Bank of America

Citi Says Foreclosures Gone WIld

Yesterday, Citigroup's homebuilding team hosted a call with investors in which the guest speaker was Adam Levitin, an associate professor of law at Georgetown University. Far from providing the "all green" call participants had desired, Levitin said that what we have recently seen and heard in the news is “just the tip of the iceberg” and that the foreclosure halt may well cause a "systemic problem", as was suggested on Zero Hedge when the news of the Florida's court involvement was first made public (here and here) a month ago. And since by now everyone knows what the key tension points in this potentially massive development are, we will cut straight to Levitin's somewhat unpleasant conclusions: "Our speaker predicted that more and more lenders are likely to stop their foreclosure processes in both judicial and non-judicial states. He also expects more states’ attorney generals to get involved. At the federal level, it is possible than banking regulators might step in as there is legal and reputational risk for the banks involved. Ultimately, if these issues do in fact escalate, the Administration may try to broker some sort of settlement. If such deal brokering does take place, Levitin believes that “some payment” will be exacted from the lenders and servicers. The Administration could bargain for more mortgage principal write downs." In other words, the endgame will likely end up being the extraction of material concession from the banking syndicate, in the form of systemic mortgage writedowns, with Obama's blessing, which will likely put the 25% of homeowners who are underwater on equal footing with the other 75%. It may turn out that this was the plan all along. And people naively wonder why banks have hundreds of billions in cash stashed on the sidelines...
As for Citi's official take on Fraudclosure here are the key issues:

Issues Concerning Affidavits

When the aforementioned paperwork is lost, an agent of the mortgage servicer can sign an affidavit swearing that he or she has personal knowledge that, although now lost, the trustee was once in possession of the necessary documents. The affidavit is considered to have the same weight as sworn testimony in a court of law.

Two problems have emerged with regards to affidavits. First, several news stories have reported that the people signing these affidavits had no knowledge of the matters in question despite the fact that there were legally testifying that they did. Many of these people have since been labeled “robo-signers” given the tremendous volumes of affidavits which they signed in relatively short periods of time. Second, the affidavits may be irrelevant because the issue is not that the mortgage documents were lost but they were never properly transferred at each step of the aforementioned securitization process.

Issues Concerning Tax and Trust Laws

Beyond the affidavit issues, our speaker highlighted potential problems concerning the trusts which hold the securitized mortgages. Most mortgage trusts were set up as REMICs (Real Estate Mortgage Investment Conduits) which are special purpose vehicles used to pool mortgages. Under the IRS code, REMIC confers a special tax status in which the cash flows to the trust are not taxed. Investors in the trust pay taxes. The tax exempt nature is important. If the trusts were in fact to be taxed, the taxes would distort the yields required by investors.

To qualify as a REMIC under the IRS code and enjoy the beneficial tax treatment, the trust (1) must be passive and (2) cannot acquire any new assets 90 days following the trust’s creation.

If, as described above, mortgage documents were never correctly passed through to the trust when it was established, then the trust may not actually own the underlying mortgages it purports to own. Although it is possible that this issue could be remedied by some legal maneuvering, doing so could violate the REMIC status since the trust would be acquiring assets long after the aforementioned 90 day period has expired. Such a violation in turn could trigger a sizeable tax burden for investors. Our speaker indicated that there are a handful of open questions on this front and that this is a legal gray area.

Issues Concerning Title Insurers

Levitin noted that all of the above issues may impact how title insurance companies act. If a scenario emerges in which title companies are unwilling to issue title insurance, in those scenarios lenders may cease lending.

When a home with a mortgage on it is sold, the mortgage must be released at closing by the current mortgage owner before a new mortgage with title insurance is issued. If it is not known with certainty who owns the mortgage in question, it cannot be released. If the title company is not satisfied that there is a good release on the old mortgage, it will refuse to insure the new mortgage.

None of these issues affect mortgages for newly constructed homes. Our speaker expects the mortgage market for new homes to continue to function without any material hindrances.

Issues Concerning MERS

MERS (Mortgage Electronic Registration Systems) functions as a centralized electronic registry of mortgages and tracks ownership of mortgages. MERS allows mortgage ownership to change hands efficiently and relatively quickly since it is electronic and allows all parties to forgo making a filing in local land records. Indeed, MERS was designed to function as a substitute for local land records.

Although MERS was designed to enhance efficiency in the mortgage assignment process, Levitin argued it may not conform with the law. “Slowly but surely” courts are issuing decisions which “cast validity on the MERS process.” Although ~60% of mortgages list MERS as the “nominee” which owns the mortgage, a handful of recent court cases have ruled that MERS has no standing in foreclosure actions either because (1) physical paperwork must be transferred when a mortgage is assigned by one party to another or (2) MERS has no true economic interest in the mortgage in question since it collects no payments from the borrowers.

Of course, all this is irrelevant without an appreciation of the endgame. And that may very well be what the Fed is pursuing all along - the elimination of trillions of private debt, however instead of Uncle Sam eating it all this time (via the GSEs), the banks would end up sharing some if not all of the pain. Of course, if this is indeed the case, it will be a very dangerous tight rope act, as many may just refuse to pay their mortgages outright going forward, and cause major additional pain for the TBTFs, and/or result in other traditionally unpredictable outcomes.
Full citi report, with thanks to Village Whisperer :

Select ratingCancel ratingPoorOkayGoodGreatAwesome
CitiBank Report: Foreclosures Gone Wild

The Legal Quagmire of the New Mortgage Crisis

from Zero Hedge:

I have one central thought of where this fraudclosure fiasco could lead, and this is why everyone should watch very carefully how the various players move their pieces in this subprime middle game.

Up until now, the banks have been making sweeping statements that this all reflects a "technical" glitch in foreclosure processes.

Well, having a posse of State AGs band together to commence a joint investigation is no longer a minor "technical" glitch. Allegations of masses of forged signatures, falsified or fabricated notarized documents,  back dating etc., if true, collectively amount to an institutional pattern of criminal behavior. Having the Justice Department announce it is opening a preliminary investigation raises the stakes even higher.

Being forced to suspend all foreclosures has obvious "material" economic consequences to the CDO note holders.

Having title companies pull out of the residential real estate market because they no longer trust the veracity of bank provided documents presages claims by mortgagors who lost their properties as well as the subsequent purchasers of same. The only way to conclusively cure that kind of problem is to get waivers, and releases from the various claimants wherever they may be or pass retroactive curative laws or laws doing things like creating a bailout fund to indemnify those who are injured (yikes!). You cannot simply say this is immaterial, sprinkle in the word MERS and hope this will all go away.

The CDO note holders will have potential claims stemming from the interruption of non-performing loan processing. Think breaches of the trust servicing agreements and allegations of "gross negligence or willful misconduct", the latter being magical legal hurdle in these types of agreements. However, the much more troubling aspect, is the growing realization that the various pools of securitized mortgages may never have been properly assigned, transferred and recorded at inception. If this turns out to be the case, game over--the noteholders will have to be made whole (here we will be expanding into the universe of securities "underwriter" liability).

How these problems are all handled in public disclosure documents is another key area to watch. The standard for "materiality" is whether a reasonably prudent investor would consider an item of disclosure important in making an investment decision. What would you say is important?

Remember that RICO is what brought down Drexel. RICO claims can be brought by the state or by private parties. Private RICO actions have apparently already been filed by certain litigants. This is a securities and white collar crime litigators wet dream.

Over and above the criminal and civil liability issues, are the regulatory and reputational risks. The damage to the reputation of a bank caught defrauding its customers is serious indeed. However, think of all the regulatory detonators that can be potentially triggered by all of this. 

The list goes on and on.

What this means is that Jamie Dimon and his 2Big2Fail CEO brethren can no longer pretend that this is just a minor technical hiccup. These developments constitute material risk factors threatening the very 2Big2Fail existence of their banks. That's not hyperbole.

They cannot pretend not to know what happened. They no longer have the luxury of taking the high road. It is now clearly their fiduciary duty to find out what happened and to take whatever corrective measures are necessary to protect the shareholders.

Any fatal mistakes at this point are more than likely to constitute "good cause" for termination. Moreover, as we all know and Messrs Nixon and Clinton will attest, it is often how one behaves in the post facto spin and damage control operation that can lead to ultimate ruin.

They are all spending their Columbus Day weekend lawyering up.

Someone is going to suggest a forensic/legal examination of the documentation. This will take months and months, particularly if they have to look at fraudclosures already processed. 

The good news? Here is a new job class created under Obama, Mortgage Fraud Forensics Specialist. This is not something an accountant is trained to do. This is a legal exercise. Unemployed real estate lawyers take heart. Work is on the way.

The end game may not be here quite yet, but it is approaching very soon, because they will all have to start thinking seriously about how to re-mark these toxic loan portfolios given the stark new market and legal reality.

So where is this great game leading?  Talk of a TARP II rescue would lead to torches, pitchforks and political suicide in Tea Party America.

No, this could very well lead to a 2Big2Fail checkmate. We shall see...

WilliamBanzai7, Esq.

Surprise! Home Prices Resume Their Decline!

More U.S. homeowners slashed their asking prices for a third straight month in August to lure buyers into a market hindered by high unemployment, a study showed Wednesday.

Owners cut prices on 26% of homes for sale last month, up from 25% in July and the highest since a matching 26% in October 2009, real estate websiteTrulia.com said.

Lingering job market weakness, a hefty supply of foreclosed homes and soft demand after the homebuyer tax credit ended in April kept buyers in the driver's seat in many markets.

"Nationwide, sellers continue to slash prices and this is a worrisome trend," said Pete Flint, Trulia's chief executive. "However, we're seeing gradual improvement in many U.S. cities-- several for consecutive months."

Homeowners in some areas still grapple with pricing realistically for a housing market that faces many hurdles and a snail's-pace recovery, according to Trulia.

One In Ten Homeowners Faces Foreclosure

This is going to get worse, too. The whole thing doesn't peak until mid-2012!

from AP:

WASHINGTON — One in 10 American households with a mortgage was at risk of foreclosure this summer as the government's efforts to help have had little impact stemming the housing crisis.

About 9.9 percent of homeowners had missed at least one mortgage payment as of June 30, the Mortgage Bankers Association said Thursday.
That number, which is adjusted for seasonal factors, was down slightly from a record-high of more than 10 percent as of April 30.
In a worrisome sign, the number of homeowners starting to have problems with their mortgages rose after trending downward last year. The number of homes in the foreclosure process fell slightly, the first drop in four years.
More than 2.3 million homes have been repossessed by lenders since the recession began in December 2007, according to foreclosure listing service RealtyTrac Inc. Economists expect the number of foreclosures to grow well into next year.
The number of Americans missing payments and falling into foreclosure has followed the upward trend in unemployment, which has been near double digits all year and has shown no sign of dropping soon.
"Ultimately the housing story, whether it is delinquencies, homes sales or housing starts, is an employment story," Jay Brinkmann, the trade group's top economist, said in a statement. "Only when we see a consistent increase in employment will we see an increase in sales and starts, and a sustained improvement in the delinquency numbers."
There was some modestly encouraging news. The percentage of mortgage borrowers receiving foreclosure notices fell slightly to 4.57 percent in the April-to-June quarter. That's down from 4.63 percent in the January-to-March period and the first drop in four years.
And the percentage of loans receiving their first notice of foreclosure also dipped. That fell to 1.1 percent in the second quarter from 1.2 percent in the first quarter.
Besides forcing people from their homes, foreclosures and distressed home sales have pushed down on home values and crippled the broader housing industry. They have made it difficult for homebuilders to compete with the depressed prices and discouraged potential sellers from putting their homes on the market.
Government efforts haven't made much of a difference. Nearly half of the 1.3 million homeowners who have enrolled in the Obama administration's main mortgage-relief program have been cut loose through July, the Treasury Department said last week. The program is intended to help those at risk of foreclosure by lowering their monthly mortgage payments.
Roughly 32 percent of those who started the program have received permanent loan modifications and are making their payments on time.

David Stockman: PIMCO Holding Americans Hostage

Its much worse than that. What Bill Gross did was pure blackmail!

Some raids on the US Treasury by America’s crony capitalists are so egregious as to provoke a rant -- even if you aren’t Rick Santelli. One such rant-worthy provocation is Pimco latest scheme to loot Uncle Sam’s depleted exchequer.

According to Bill Gross, who heads what appears to be the firm’s squad of public policy front runners, the American economy can be saved only through “full nationalization” of the mortgage finance system and a massive “jubilee” of debt forgiveness for millions of underwater homeowners. If nothing else, these blatantly self-serving recommendations demonstrate that Matt Taibbi was slightly off the mark in his famed Rolling Stone diatribe. It turns out that the real vampire squid wrapped around the face of the American taxpayer isn't Goldman Sachs (GS) after all. Instead, it's surely the Pacific Investment Management Co.

As overlord of the fixed-income finance market, the latter generates billions annually in effort-free profits from its trove of essentially riskless US Treasury securities and federally guaranteed housing paper. Now Pimco wants to swell Uncle Sam’s supply of this no-brainer paper even further -- adding upward of $2 trillion per year of what would be “government-issue” mortgages on top of the existing $1.5 trillion in general fund deficits.

This final transformation of American taxpayers into indentured servants of HIDC (the Housing Investment & Debt Complex) has been underway for a long time, and is now unstoppable because all principled political opposition to Pimco-style crony capitalism has been extinguished. Indeed, the magnitude of the burden already created is staggering. Before Richard Nixon initiated the era of Republican “me-too” Big Government in the early 1970s -- including his massive expansion of subsidized housing programs -- there was about $475 billion of real estate mortgage debt outstanding, representing a little more than 47% of GDP.
Had sound risk management and financial rectitude, as it had come to be defined under the relatively relaxed standards of post-war America, remained in tact, mortgage debt today would be about $7 trillion at the pre-Nixon GDP ratio. In fact, at $14 trillion or 100% of GDP the current figure is double that, implying that American real estate owners have been induced to shoulder an incremental mortgage burden that amounts to nearly half the nation’s current economic output.

There's no mystery as to how America got hooked on this 40-year mortgage debt binge. At the heart of the matter is the statist Big Lie trumpeting the alleged public welfare benefits of the home-ownership society and subsidized real estate finance. Once the conservative party embraced this alluring but dangerously destructive idea, the cronies of capitalism have had a field day conducting a Washington bidding war between the two parties which is now in its fifth decade

During this time span all of the congregates of the HIDC lobby -- homebuilders, mortgage bankers, real estate brokers, Wall Street securitizers, property appraisers and lawyers, landscapers and land speculators, home improvement retailers and the rest -- have gotten their fill at the Federal trough. But the most senseless gift -- the extra-fat risk-free spread on Freddie and Fannie paper -- went to the great enablers of the mortgage debt boom, that is, the mega-funds like Pimco, which did little more than hang out an “open to buy” shingle as billions poured in year after year. Sadly, there isn't a shred of evidence that all of this largese serves any legitimate public purpose whatsoever, and plenty of evidence that the HIDC boom has been deeply destructive. But the intellectual cobwebs spun by the housing cronies so obfuscate these truths that the only way to grasp them is through an examination of the contra-factual -- a postulated world without Freddie/Fannie/FHA and the $100 billion annual tax subsidy on mortgage interest.

In that world, households would be tax-indifferent as to whether they acquired shelter services through renting or owning, and appropriately so. There's simply no evidence that home ownership produces any externality or “public good,” such as making people better citizens, causing them to work harder or aspire higher, turning them into better neighbors, or even growing hair on their chests. Housing is a commodity like furniture and automobiles, and inducing citizens to buy more of it is no business of the state.

Moreover, to the extent that households prefer the cultural intangibles associated with home ownership, they'd have to bear the full economic costs. This would mean mortgage rates priced to the specific risk profile of individual borrowers rather than homogenized through the Federal guarantee machine, and down payments of 40% or more to create loan-to-value spreads capable of encompassing -- without risking the moral hazard of strategic default -- what we now know to be the true range of housing price fluctuation. It would also mean that benchmark mortgage rates would be several hundred basis points higher because a Fed not in the thrall of the HIDC propaganda on the virtue of inflating housing investment, employment, and asset prices would never dream of jamming its thumb on the scale to the tune of its recent $1.4 trillion purchase of GSE mortgages and debt.
Apart from the readily refutable canard that the massive HIDC subsidies benefit the poor (see below), the truth is that subsidized mortgage interest rates and terms confer strictly private benefits, and shower them among American households in an utterly capricious manner. Thus, there are about 110 million households in America. Among them are 35 million renters and another 30 million who own their homes debt-free. These citizens get comparatively nothing from the HIDC gravy train

By contrast, the remaining 50 million households (45% of the total) have mortgages they shouldn’t have gotten in the first place, or enjoy the benefits of a more “affordable” mortgage than the private market would provide -- meaning that they have money left over for widescreen TVs and pedicures thanks to the taxpayers. If this is justice, it's the same league as the ancient ritual of sacrificing firstborn sons.

Dismantling the HIDC subsidy system would dramatically reduce the nation’s mortgage debt burden as existing paper matures and new mortgages were written far more sparingly, and at market rates. It would also have profound, and mainly salutary affects on the real economy. For one thing, in response to sharply higher mortgage rates and more restrictive housing credit terms, it's likely that home-ownership rates would drop from the current 66% rate to perhaps 50% or even below, thereby approximating rates in countries like Germany which don't seem to be suffering from inadequate shelter as a result.

In the process, the 4 million households with current negative equity of 50%, and probably the 9 million with 20% or higher negative equity, would likely default --  relieving them of a lifetime of debt slavery, even as they reverted to the status of credit-impaired renters. Indeed, under market-based housing finance, additional trillions of still-illusory housing asset values would be quickly purged from the economy as housing prices found an economic bottom. Letting housing prices clear the market would subtract millions more from the ranks of faux homeowners -- households whose incomes have been essentially garnished by the HIDC anyway.

Secondly, dismantling the HIDC would stem the current wasteful misallocation of societal resources, and perhaps just in the nick of time. America is a rapidly aging nation that's become hopelessly incapable of paying its bills in the world economy. As a result of importing roughly $8 trillion more in goods and services than we've exported over the last three decades, we've sent abroad a frightening share of the nation’s value-added output and employment.

In July, for example, the BLS reported 68.3 million jobs in goods production and the core private business service sectors such as retail/wholesale transportation, information technology, the professions, FIRE and business support services. That figure represented virtually no job gain at all from the December 2009 bottom; a reduction of 8 million jobs (11%) from the December 2007 cycle peak; and an even larger contraction from the nearly 77 million high-value jobs reported in these categories way back in January 2000.
The HIDC subsidy system, then, has been doubly perverse. Whereas the nation lived way beyond its means by saving too little at home and borrowing too much abroad, even the meager savings we did generate were artificially channeled into the least-productive investments. Thanks to the pervasive HIDC subsidy system we now have big, new houses and small, aging factories.

Nor should the magnitude of this resource misallocation be gainsaid. In the post-war years prior to 1980, single-family construction, home improvement expenditure, and real estate broker commissions typically amounted to about 3.5% of GDP on a combined basis. By contrast, at the peak of the housing bubble in 2006, these activities added up to nearly 6% of GDP. This means that $300 billion of GDP was going into enlarging the stock of housing, increasing average square footage, adding marble countertops and churning the turnover rate. When these kinds of outcomes are the fruit of Mr. Market at work, they are, of course, unobjectionable. But when they're gifts of the state, trouble eventually comes, and now it has with a vengeance.

At the end of the day there are upward of 15-20 million American households that can't afford their current mortgages or will be strongly disinclined to service them once housing prices take their next -- and unpreventable -- leg down. But Pimco’s gold-coast socialism is exactly the wrong answer. Rather than having their mortgages modified or forgiven, these households should be foreclosed upon, and the sooner the better. In that event, there's absolutely no danger that impacted families will go without shelter. The supply of rental units is swelling by the day and rental rates will come down further as speculators buy up REO and recycle back to the rental market.

Stated differently, pulling the plug on HIDC will rescue millions of households from mortgage-payment slavery and put them into a buyer's market for rented-housing services -- a social welfare gain under present circumstances. To be sure, they'll loose their credit and probably their credit cards in the process. But the days of living off the housing ATM and bank-issued plastic are over for the American people anyway. Creating an honest financial environment where households are required to rebuild their balance sheets and consume within their means isn't a disservice or injustice to anyone.

Likewise, millions of additional families that can, in fact, service their mortgages or that own their homes debt-free will face a further shrinkage of their paper wealth. The $16.5 trillion of household real estate value reported by the Fed in its Flow of Funds for the first quarter of this year was already down about 30% from the 2006 peak, and could readily decline by another 20%. But would the implied $3 trillion loss of paper wealth be avoidable in any event?
The fact is, there are about 78 million baby boomers inexorably heading for their next to final final berth in a nursing home. Given the shambles of the American economy, who is going to buy their over-valued castles anyway? Certainly it won’t be their downwardly mobile children. So why not purge this phony wealth now and let boomers began to plan for their golden years based on reality, not illusions.
Additionally, the great wave of foreclosures that would result from pulling the plug on HIDC will cause the enablers of the housing debt boom to suffer huge losses on the outstanding mortgage paper. Admittedly, much of that loss will accrue to the $5 trillion or so of mortgages guaranteed by Freddie/Fannie/FHA. But the taxpayers are on the hook for those losses already, and crystallizing huge write-downs now would actually have a very salutary effect. The voters would get in unmistakable terms a reckoning of the massive harm inflicted on them by the congressional housing princes such as Barney Frank and Chris Dodd and their crony capitalist paymasters. Hopefully, the result would be a thorough-going purge of the political system, too.

As to the enablers in the world of fixed-income managers, they'd get their just desserts as well. They'd be forced to absorb hundreds of billions in write-downs on impacted private-label residential and commercial mortgages -- perhaps sharpening their eye for credit risk in the future. But more importantly, pulling the plug on HIDC would eliminate in its entirely any new issues of federally guaranteed housing paper and the no-brainer spreads that the likes of Pimco have harvested from it for decades. Indeed, in a HIDC-free world, the great fixed-income fund managers would be transformed from parasitic enablers of financial bubbles to old-fashioned credit risk managers -- surely a gain to society, if not to their bonus accounts.

Finally, flushing out underwater mortgages and faux homeowners will create the greatest renter's market of all time, permitting lower-income households to rent shelter services at better prices than they've ever been afforded. Indeed, propping up HIDC actually works against the economically disadvantaged because the whole purpose is to keep housing asset values artificially high and foreclosed properties off the rental market.


To be sure, it could be accurately observed that there are millions of lower-income households that can't afford adequate housing services even at these prospective bargain-basement rents. But Milton Friedman pointed out long ago in one of the instances where he was dead-right that this is a problem of too little cash income, not of insufficient housing. And he proposed to address the social problem of inadequate cash income for housing, food, clothing, and all the other necessities of life, with a mechanism to efficiently supply disadvantaged families with additional cash -- the negative income tax ("NIT”).

Needless to say, the crony capitalists of America have never been interested in the negative income tax because it would produce only social justice, not artificial economic windfalls to privileged suppliers of subsidized goods and services. Having loudly professed his heartfelt concern for the plight of the less advantaged, perhaps now would be a good time for Bill Gross to swap out his Fannie for a NIT.