Markets Stagnate Until They Clear (Douglas French)
Monday January 7th, 2013
What the home and mortgage market needs — and it will not recover until then — is a rebooting to current values. To do that, principal amounts must be reset. They need to be reset not by government force, but by letting the market work. Let bankrupt mortgage holders fail.
The housing market has gone nowhere since the meltdown. Some 14 million homeowners are underwater on their mortgages. A good percentage of those people have stopped making their monthly payments.
In the initial wave after the housing crash, there were millions of strategic defaulters: homeowners who could afford to make the payments, but walked away because they believed it was the most prudent financial decision to make.
Now there are vast numbers of strategic squatters. People who could pay but aren’t. Instead of walking away, they remain in the home knowing that it may be not months, but years, before the lender will evict them. The average foreclosure now takes 728 days. In a few states, it’s over a 1,000 days. And this is after the lender has filed a notice of default. Some loans have gone 500 days delinquent before Bank of America has filed a notice to start the process.
This can happen only in a market dominated by the government. Fannie Mae, Freddie Mac, and the FHA comprise 90% of the mortgage business. Private lenders could never survive holding mortgage loans en masse that are nonperforming. Lenders must collect payments or they can’t pay their bills, or pay their lenders, for that matter.
There is no political will to let Barney Frank’s favorite entities go away. However, there is a bit of market-clearing good news. FHA auctioned 9,500 mortgage loans recently, and investors, including Lewis Ranieri Selene Investment Partners, paid an average of 36 cents on the dollar for these loans. The sales prevented $1 billion in fiscal 2013 losses for the agency’s insurance fund.
FHA is in a bit of a pickle these days. It’s facing a $16.3 billion shortfall and it may be forced to thrust its tin cup in the Treasury’s direction for the first time in its history, starting in the Great Depression.
In the new edition of my book Walk Away, available to Laissez Faire Club members for free download, my solution to the housing crisis is to let Fannie, Freddie, FHA, and the too-big-to-fail banks fail. The mortgage paper these entities hold would trade in a bankruptcy auction at pennies on the dollar. The buyers of these mortgages would quickly reach out to the borrowers and attempt to restructure the notes in ways that made sense to lender and borrower.
In my book, I provided the example of the mortgage legend Mr. Ranieri, whose firm would buy mortgages at a discount. The company felt that once the mortgage was obtained, it would be imperative to contact the borrower immediately and begin negotiating. Mortgage buyers spending real money don’t wait 500 days before they do something.
The properties are valued quickly and the borrower’s financial wherewithall assessed. A rewrite of the mortgage is done right away with terms reflecting the market value of the home, or foreclosure is started.
You might be wondering why the FHA doesn’t just go to homeowners themselves and make their own deals, rather than sell to investors at a steep discount. That’s because the FHA doesn’t have the legal authority to forgive principal. The FHA also can’t foreclose on a property and turn around and lease it to the defaulted owner. There’s as much flexibility at the FHA as there is in the TSA line or at the DMV. They have their rules and they’re sticking to them.
Of course, winning bidders are building in some cushion into their bids. They aren’t bidding 36 cent dollars if they think that’s what the underlying collateral is worth. They might think on average the houses securing the mortgages are worth 60 or 70 cents on the dollar of the loan amount.
But let’s not cry over spilled loan principal: It’s great news that these mortgages will end up in private hands. But (you knew a “but” was coming) these not quite 50,000 mortgages that may be peddled by the end of next year are a sliver of the 734,290 seriously delinquent loans in the FHA portfolio. Seriously delinquent loans are 9.6% of the 7.62 million loans on its books.
That’s more than 2.5 percent points higher than the 7% overall rate of serious delinquency tracked by the Mortgage Bankers Association, which tracks 50 million home loans.
Also in the good news department is Fannie and Freddie might start getting rid of some of their bad paper. If they do, the delinquent loan sale market might be $30 billion next year. According to American Banker,
“The two taxpayer-owned companies are under a mandate from their federal regulator to dispose of nonperforming assets. Fannie Mae, which has nonperforming loans with a total unpaid principal balance of about $233 billion, is planning to begin qualifying potential bidders for some of those mortgages as early as the first quarter of next year.” To sit on foreclosures is expensive. After FHA acquires a delinquent mortgage from the servicer, it pays for upkeep and marketing to the tune of $28.78 per day per house. Depending upon whom you believe, FHA is losing 63-71 cents on every foreclosure. Selling the delinquent loans seems to make sense. Especially in Florida, where the loans they auctioned were an average of 1,114 days delinquent.
“We’re seeing between a 15-20% better recovery than we would if those same loans went all the way through to foreclosure, and that’s a pretty big change,” Carol Galante, the FHA’s acting commissioner, told American Banker.
But Ed Pinto, Fannie Mae’s chief credit officer in the 1980s, wonders. “I’m having a hard time figuring out where they’re making up much financial benefit,” he said. He sees the auction as just a “backdoor” way of doing principal reductions and “doling out other pots of money.” It turns out that some of these mortgages may be eligible under a Treasury program for reimbursement up to 63 cents on the dollar of principal forgiveness.
So there is a ray of hope for market clearing. But alas, it will be on government time. An unfettered market would have taken care of this years ago. At this rate, it will be decades.
Douglas E. French is senior editor of the Laissez Faire Club. He received his master's degree under the direction of Murray N. Rothbard at the University of Nevada, Las Vegas, after many years in the business of banking. He is the author of two books, Early Speculative Bubbles and Increases in the Supply of Money, the first major empirical study of the relationship between early bubbles and the money supply, and Walk Away, a monograph assessing the philosophy and morality of strategic default. He is founder and editor of LibertyWatch magazine. Write him.