Monday, October 18, 2010

Looks Like Fannie Mae and Freddie Mac Crossed the Streams Again: Son of Subprime About to Administer the Coup de Grâce to the Economy

You may want to sit down before reading this one.

Bad Chalupa points us to a gut-wrenching economic analysis by John Mauldin of Investors Insight. Read the whole thing, but the following digest version should serve as an adequate introduction.

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...

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.

...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, [a word] 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.

[Editor's Note: arrow and caption added by your beloved editor.]

The Foreclosure Mess

"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...

"...once mortgage loan securitization happened, things got sloppy...they got sloppy by the very nature of mortgage-backed securities. ...These various [securitized bundles of loans or] tranches were sold to different investors, according to their risk appetite... the loans were 'bundled' into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes)...

"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.

[Since investors didn't know which mortgages would actually default and needed to tie the loan to the 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 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... legally [however]...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...

"...Now, the banks had hired 'foreclosure mills' firms that specialized 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!

"...[But the] 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.

..."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.

"[And] 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?"

...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.

The culprits, once again, are Fannie Mae and Freddie Mac -- the job-shop for connected Democrats that has utterly and completely destroyed the housing market.

And these are the same geniuses who tell us they can run the health care system using a Soviet-style, authoritarian, centralized bureaucracy.

What's that number for Goldline again?


Joan of Argghh! said...

Holy crap!

Of course, there has been a contingency of folk who have believed all along that bankers were looking to eventually own all property; i.e., a "bankers' manifesto" from somewhere back in the 70s. Folks who feared that sort of control would be just the kind of folks to figure out how to stick it to the banks instead.

Of course, the only solution will be to do away with private property and make all property a state-owned reality.

Is Germany accepting immigrants?

Georg Felis said...

"if the chain of title of the note is broken, then the borrower no longer owes any money on the loan..."

Incorrect. If Larry's loan gets sold to Moe, who screws up on the sale to Curly, Moe STILL owns the loan, and the payments on the loan are INCORRECTLY being sent to Curly, and Larry is still legally obligated to pay off the loan.

Heres where it gets fuzzy. Neither Moe or Curly have "clear title", and Larry may *suspend* his payments due to (insert legal term for "Don't know who holds my loan" here), but he still owes the money, and is probably best off paying his payments into single-purpose bank account until Moe and Curly finish beating each other up in court. (because whoever wins will want their back payments, although since it was their fault the title chain was fouled up, I dont think its likely a judge will enforce any payment penalty. I think. Maybe.)

There is no magic legal "You goofed up so I'm scot free on my loan". Try it in court and find out what living in your car is like.

May we get a real lawyer to weigh in here please? I just stayed in a Holiday Inn Express last night.

Joan of Argghh! said...

Well, lawyers in California may not have slept in a Holiday Inn, but they are winning their case:
The latest of these decisions came down in California on May 20, 2010, in a bankruptcy case called In re Walker, Case no. 10-21656-E–11. The court held that MERS could not foreclose because it was a mere nominee, and that as a result plaintiff Citibank could not collect on its claim. The judge opined:

“Since no evidence of MERS’ ownership of the underlying note has been offered, and other courts have concluded that MERS does not own the underlying notes, this court is convinced that MERS had no interest it could transfer to Citibank. Since MERS did not own the underlying note, it could not transfer the beneficial interest of the Deed of Trust to another. Any attempt to transfer the beneficial interest of a trust deed without ownership of the underlying note is void under California law.”

In support, the judge cited In Re Vargas (California Bankruptcy Court); Landmark v. Kesler (Kansas Supreme Court); LaSalle Bank v. Lamy (a New York case); and In Re Foreclosure Cases (the “Boyko” decision from Ohio Federal Court). (For more on these earlier cases) The court concluded:

“Since the claimant, Citibank, has not established that it is the owner of the promissory note secured by the trust deed, Citibank is unable to assert a claim for payment in this case.”

The_Bad said...

I am SO confused. I was told by the first person to ever hold the Office of President-Elect that this situation was caused by the failed policies of George W. Bush. Our Dearest and Most Historic Leader wouldn't have lied to us, would he?

Jim - PRS said...

Georgefelis is correct. The debtor still owes the money, the only issue being to whom does he pay it. That may have to be sorted out in court in an interpleader action, where the court appoints a stakeholder to hold onto the the debtor's payments until the rightful payee is determined.

Joan of Argghh! said...

And don't you just wonder who that stakeholder will be, eventually, if Asia is holding all our mortgages?

The State.

Joan of Argghh! said...

I'm not concerned about folks moving back into their homes when they haven't paid for them (although some have done this. . . I think it's deplorable), I'm just concerned that the Gordian Knot is so great there will be another fiat by our Great Reader and his henchmen.