Friday, June 29, 2012

Let's talk about the scariest thing we've heard in the mortgage market for a minute

While we rarely post residential-related updates here, an article out today caught our attention and frankly scared the beejezus out of us. Apparently this plan has been making its way through the various political and business echelons for some time now, and we've just missed it. An article in Bloomberg today highlighted a plan where municipalities would use their eminent domain powers to condemn all the mortgages in their county that are underwater, pay a reduced wholesale price to the mortgage holders (i.e. the Federal government, taxpayers, and other investors), and then refinance the homeowners into new mortgages based on market values.

I provided a few snippets and links below for your reading pleasure, and I'm going to avoid the most obvious arguments... okay, I'm going to make just one. If you are a company and you borrow money that is backed by some form of hard asset as collateral, and that hard asset goes down in value, you have to post new collateral - right? Not with a home, but that is kind of the way the world works. You borrow $100k and use a $120k house as collateral, if the house burns down, you need to replace that collateral - you don't just get to write down the amount that was borrowed - that would be insane. If anything, mortgage holders should be asking for more collateral, not writing it off. And why is the government stepping into this process again - it isn't working guys, please stop trying to help us.

A private investment firm (Mortgage Resolution Partners LLC; MRP) is pushing this plan forward and apparently has made great headway in some locales such as San Bernandino County where local ordinances have been drawn up to allow this to happen.

They are not talking about bailing out homeowners who are delinquent, mind you. The plan is for *help* underwater homeowners who are current on their payments. So, a local government is using it's laws to pass substantial costs back to the Federal government - Our $100k example above might mean that the San Bernandino resident gets a free $50k (not completely free, he'll owe taxes - at least there is some justice in the world!) while the residents of all the other counties in the United States will essentially cover the other $50k for him through our tax dollars. The taxpayer will get stuck with this in two ways: Directly - i.e. the Federal government guarantees principal on Fannie, Freddie, and Ginnie deals. and Indirectly - someone is going to have to fund the bailout of all the Pensions and Investment Companies that are going to crash from the non-agency bonds impacted.

And who is going to ever lend money to any homeowner that lives in one of these counties EVER again if this goes forward? I've seen a few comments that reply that it is absurd to think that originators will get over it in time, or work around it - do they not remember what happened a few years ago in Georgia when a new state law allowed for legal liability all the way up to the individual bondholders if a mortgage was not underwritten correctly... Almost every national originator closed shop until the law was struck down. Fannie and Freddie won't ever be able to do business in San Bernandino county again.

Even if an originator decides to start writing new mortgages in this county in the future they are without a doubt going to add language holding the homebuyer responsible, demand larger down payments, increase various costs, and only lend to the highest quality borrowers.

The complexity of the deal is enormous as well - there would be fights for decades over the valuation of the properties. San Bernardino is not just ripping off a little old lady here - they're ripping off EVERY little old lady in the country by hitting their retirement accounts and increasing their tax liabilities at the same time. Even the head of MRP, Steven Gluckstern, stated "no bondholders will be hurt because the loans would be bought for amounts that could be objected to in court." (he left out, "for years, and years, and years of trials and debates and great expense to everyone involved because this is the worst possible approach to solving the problem", but I'll tack it on there for him.)

They do realize the mortgage market is on the order of $14 trillion  - it's kind of a big deal - right?

Oh, and one more thing - Shiller thinks this plan is a good idea?!?!

Shiller ?


crabsofsteel said...

Who should get punished for making bad loans? If you're going to point the finger at anyone, shouldn't it be at who provided the easy money?

Concrete Jungle said...

The originators and the borrowers should take the loss - clearly they both are at fault for making their own decisions that turned out to be faulty.

If the borrower lost their job, then that is a little different, but they still take the loss because that is what they signed up for.

If the borrower could never afford the loan in the first place then it's the same.

Obviously legislators and regulators bear some culpability as well, but ultimately the originator and the borrower made the decision jointly and this is the big kids pool.

That being said, we should never have a case where a municipality is basically usurping centuries of contract law and passing it's citizens losses onto citizens that are in other municipalities!!! People should be up in arms over this!

crabsofsteel said...

You can blame the originator, if you want, but they were using bond buyer's money and not their own to make bad loans. Borrower's equity was trivial by comparison. No one has suggested clawing back New Century's profits because that money is unreachable. Even if you could, it wouldn't be enough to pay off the unmodifiable option-arm mortgages. A haircut is inevitable.

Matt Dvolatility said...

interesting news: Chicago considers eminent domain to seize underwater mortgages