Second coming of the housing crisis

Published: October 24, 2010

Servicers include the four largest US banks and a total of $2.6 trillion held in residential mortgage-backed securities could come under scrutiny. photo: file

The 2006 peak of property prices in the United States and subsequent free-fall was sparked by low interest rates, rampant speculation and irresponsible lending practices. Inevitably, borrowers started to default, speculators began to pull out and prices plummeted. The foreclosure crisis may well be the second coming of this debacle.

Mortgage-backed securities

Traditionally, banks were responsible for giving out mortgage loans and assessing the credit-worthiness of borrowers. Under this system, if a borrower defaulted, banks foreclosed the property in order to recoup their debt.

Investment bankers decided to join the party and securitised thousands of these mortgages into a Mortgage-Backed Security (MBS) which gave other investors and speculators exposure to the mortgage markets.

Banks increasingly began to focus on approving and selling mortgages without heeding the creditworthiness of the borrowers in exchange for handsome commissions, while investors assumed the risk of mortgage defaults in exchange for quick returns.

Foreclosures

Each time a mortgage is transferred, signatures of both the buyer and seller are required to complete the transaction. During the housing boom, mortgage-backed securities were heavily traded and the rightful owners of the thousands of underlying mortgages were tracked and recorded through an electronic database.

This task is the domain of a ‘servicer’ who is responsible for not only tracking these records but also collecting mortgage payments and disbursing them to investors.

During the speculative frenzy, irresponsible recordkeeping caused as many as 27 per cent of these mortgage records to be rendered obsolete. When the need arose to foreclose a property, servicers were unable to trace rightful owners and forged documents started emerging to avoid foreclosure delays and loss of income.

Most recently, Bank of America (BoA) was asked to halt all foreclosures until it cleared up the situation. GMAC, another servicer, also came under heavy fire since the deposition of one of its entry level loan managers gave insight into the roughly 10,000 foreclosure documents being notarised each month by him alone.

Delayed foreclosures have also had other interesting side effects. A MBS is divided into junior and senior debt tranches where investors in junior tranches take on the highest risk for a higher return but in case of foreclosure are the last to receive the proceeds.

Each time a foreclosure is delayed, both senior and junior investors continue to receive payments even though the home owner has defaulted. This means that junior tranches receive payments they would not have if the foreclosure happened swiftly, while the senior tranches end up compensating for this when in fact the opposite should be the case.

Between the struggle of junior and senior debt holders, falsified foreclosure documents and negligent notarisations, the Federal Reserve has stepped in to rein in the situation.

The servicers include the four largest US banks and a total of $2.6 trillion held in residential MBS could come under scrutiny. Most recently, the Fed has asked BoA to buy back part of its $47 billion in mortgages it has originated. BoA estimates that these buybacks may amount to $13 billion or 27 per cent of the total.

Other servicers face similar liabilities and yet another bailout may be required to rescue the banks from their own negligence. Tax payers will once again foot the bill and the global economy will take another blow on the road to recovery.

The writer is heading Online Strategy and Development at Express Media

Published in The Express Tribune, October 25th, 2010.

on Twitter, become a fan on Facebook

Reader Comments (3)

  • Oct 25, 2010 - 7:00AM

    Much ado about nothing! The markets have already factored in the impact of the foreclosures and the banks will solve their paperwork (and title to note) issues shortly. Then foreclosures will resume apace as they need to if the housing markets are ever going to return to reality.

    And on the positive side, the U.S, is now under-producing new housing units based on household formations, even at the current low estimates of immigration. Demand must increase, new home production will increase, prices will rise, employment within the housing industry will rise creating further demand and we will be back to a healthy housing market by 2012 if not sooner.

    Recommend

  • Shibil
    Oct 25, 2010 - 11:06PM

    Thanks for the eye-opener. Unfortunately I’m not as sanguine as the above commentator. Solving paperwork on 27% of (often securitized) mortgage transactions, and particularly getting title notes that require notarized signatures, is an incredibly complex feat. Just the cost of law suits against fraudulent foreclosures alone has the potential to become astronomical. But will tax payers agree to foot the bill for banks acting fraudulently? What will the political backlash be? Some banks may have proven that they are too big to fail. The same can not be said of most political careers, including Obama’s. Recommend

  • Oct 26, 2010 - 12:26AM

    Shibil:

    I am not of ruddy color so I assume you were referring to the more modern “cheerfully optimistic, hopeful, or confident” definition of sanguine to which I must plead guilty as it relates to the future of U.S. housing. I believe that history will show that the “fraudulent” aspects of the foreclosure fiasco are minimal compared to the more common ineptitude, carelessness and incompetence.

    I do not understand your final reference to Obama’s political carreer being a casualty of this specific problem as the housing collapse was the result of uncontrolled greed among many parties including homebuilders, lenders, Wall Street and investors/speculators as facilitated and abetted by the previous (Bush) administration which chose not to regulate their favorite sacred cow, capitalism.

    And yes, I remain cheerfully optimistic and confident about the future of residential real estate in the U.S.

    Dan . Recommend

More in Business