Beware of national averages like “One
in Four Borrowers Is Underwater.” The
problem is heavily concentrated in places like Phoenix, where 54% of
homeowners with mortgages have negative equity. That’s about half a million
underwater mortgages, more than the combined totals in Texas and New York state,
where 10 times as many people live.
University of Arizona law professor Brent T. White
says anyone with negative home equity should simply walk away. Arizona, like
California, is a non-recourse state, where a home lender cannot legally pursue
repayment beyond the value of the underlying collateral.
The situation looks much worse in America’s
Dubai, Las Vegas. Almost three-quarters Las Vegas homeowners with mortgages
have negative equity or near negative equity. A lot of them are really
underwater. Almost half of Nevada homeowners with mortgages have negative
equity in excess of 25%. The total residential mortgage debt in Nevada is 1.14
times the value of the underlying real estate.
The majority of America’s underwater mortgages,
about 5.5 million, are located in the four sand states: California, Florida,
Arizona and Nevada, according to a new study by First American CoreLogic. That’s
where homeowners face each month with a renewed sense of anxiety. Many
wonder if the next mortgage payment means throwing away good money after
bad. And almost all wonder how the next foreclosure will affect neighborhood
property values, and the fabric of their community.
Don’t feel smug if you live elsewhere, say Deutsche
Bank analysts Karen Weaver and Ying Shen. By 2011, they predict, one half of all American homeowners will
have negative equity, plus another 20% who will have borderline negative
equity. They expect the New York market, which so far has held up fairly well,
to collapse. By 2011, they estimate, three-quarters of homeowners in the New
York-White Plains-Wayne, NY-NJ market will be underwater.
Whichever numbers you accept, it’s clear that the
size of this mortgage crisis dwarfs everything else, including healthcare
reform, the war in Iraq and social security. America's $11 trillion in home mortgage debt is 45%
larger than public
debt owed by the federal government. And half of that $11 trillion was lent
or guaranteed by Government Sponsored Enterprises like Fannie Mae or Freddie
Mac. It's not just the solvency of the GSEs that’s at stake; it's the health of
the overall economy. Federal revenues were down by $400
billion this year because people have less taxable income.
President Obama will issue admonishments to
the banks. Robert Reich says we should change the
bankruptcy laws to allow for cramdowns. All well and good, but it's unrealistic
to hope that banks will fill the vacuum of leadership at the top. We’re talking
about sorting out the problems of 10 to 15 million individual mortgage
loans. The financial incentives
are too fragmented and too misaligned and too nontransparent for any private
party to sort out the mess. Given the numbers involved, these mortgage problems
are too big, and too interconnected, to be resolved on a scattershot basis in a
dysfunctional marketplace.
If the government wants the job done right, it
must do the heavy lifting itself. Here
are the three proposals to untangle the mortgage mess:
1. Perform due diligence on all borrowers at
risk.
Step one is to find out what’s going on with each
distressed borrower. It’s a very time consuming and labor intensive job, which
is why no one wants to do it. It requires a face-to-face meeting with the
borrower, plus independent verification of a borrower’s employment and income,
his financial assets and obligations. It requires figuring out if the
borrower would be motivated to continue servicing the loan if it were reduced
to an amount below the property’s current market value.
Each delinquent mortgage loan is a multi-layered
story. Some borrowers took out mortgages as part of a flipping scheme.
Some, who took out a loan they could not afford, were deceived by dishonest
mortgage brokers. Others took out a fully-documented 80% loan on a house that
lost 50% in market value. All the evidence shows that mortgage fraud went
viral during the real estate boom.
The root cause of the mortgage meltdown, and most
other financial scandals, was that everyone piggybacked off of somebody else’s
due diligence, which was never performed properly in the first place. As a
substitute, investors relied on credit ratings and financial models that were
fatally flawed. Now that millions of borrowers are in trouble, everyone
acts as if the situation can sort itself out on its own. If we really want to
take charge of the problem, the federal government should temporarily hire
50,000 people to perform actual due diligence on these borrowers and
loans. The private parties who contributed to the situation don’t have
the same incentive to do things right. They’re conflicted.
2. Nationalize loan servicing for private label
mortgage securitizations.
When mortgage loans are sold to securitizations,
the loan servicing process is outsourced to a company that has no financial
stake in the loans and has all sorts of incentives to play all sorts of tricks
on the borrowers. The loan servicer is ostensibly acting on behalf of the
security holders, who, because if different levels of subordination, have
varied and conflicting claims. The problem is compounded by the fact that
none of the private label mortgage securities have standardized loan
documentation or workout policies. The incentives are very different when a
bank keeps a loan on its own books, or when Fannie Mae guarantees mortgage-backed
securities. In those instances, one creditor has a singular financial interest
in working out the best possible solution for a problem loan.
By nationalizing this function, the federal
government would be able to assure that the workout function would be done with
honesty and integrity.
3. Create a transparent national
registry for every ownership claim, including every derivative claim, on a
mortgage securitization.
Here’s a very common scenario in loan workout
negotiations. Several creditors agree to some kind of temporary forbearance to
keep the borrower out of bankruptcy. But one holdout creditor shows no
flexibility. He prefers to push the borrower into bankruptcy, even if it means
that the eventual recovery will be far less. The holdout owns a credit default
swap, kept secret from everyone else, that will reimburse him immediately. With
complex securitizations and credit default swaps, the opportunities for bad
faith dealings in debt restructuring grow exponentially.
The only way to achieve an orderly and fair
workout process is to clarify who comes to the table with clean hands.
Once the government assembles the data of what’s
actually happening, it can assert pressure to enforce an orderly and reasonable
restructuring of America’s financial albatross.
Of course, this approach holds political peril. It’s easier to harangue against the
banks than it is to take responsibility for the mess created by someone else. Any
kind of government
intervention is red meat for the tea bagging crowd. Remember how it all
started in February 2009?
Do we really
want to subsidize the losers’ mortgages? This is America! How many of you
people want to pay for your neighbor’s mortgage? President
Obama, are you listening?… We're thinking of having a Chicago Tea Party in July. All
you capitalists that want to show up to Lake Michigan, I'm gonna start
organizing.
CNBC’s Rick Santelli, who disclaimed any political affiliation
after his famous rant, provided inspiration for Larry
Kudlow and countless others. You would think that people would have wised
up by now. But consider this, the sand states’ economies are all
blighted by record multi-year droughts.
Yet large blocks of voters are still brainwashed by a cable network that
says global warming is not real.
Finally, here are the numbers, simplified:
Source:First American CoreLogic
Sources: Federal Reserve, Congressional Budget Office