IPFS
The Subprime Debacle: Act 2
Written by Ernest Hancock Subject: Economy - Economics USAThoughts from the Frontline Weekly Newsletter
by
John Mauldin
In this
issue:
The
Subprime Debacle: Act 2
Where is the Housing Recovery?
The
Foreclosure Mess
Some Foreclosure Takeaways
Yankees, Rangers,
and The Endgame
Trouble,
oh we got trouble, Right here in River City!
With a capital "T"
That rhymes with "P"
And that stands for Pool, That
stands for pool.
We've
surely got trouble!
Right here in River City,
Right here!
Gotta figger out a way
To keep the young ones moral after school!
Trouble, trouble, trouble, trouble, trouble...
-
From The
Music Man
(Quick
last-minute note: I think this (and next week's) is/will be one of
the more important letters I have written in the last ten years. Take
the time to read, and if you agree send it on to friends and
responsible parties. And note to new readers: this letter goes to 1.5
million of my closest friends. It is free. You can go to
www.frontlinethoughts.com
to subscribe. Now, let's jump in!)
There's
trouble, my friends, and it is does indeed involve pool(s), but not
in the pool hall. The real monster is hidden in those pools of
subprime debt that have not gone away. When I first began writing and
speaking about the coming subprime disaster, it was in late 2007 and
early 2008. The subject was being dismissed in most polite circles.
"The subprime problem," testified Ben Bernanke, "will
be contained."
My
early take? It would be a disaster for investors. I admit I did not
see in January that it would bring down Lehman and trigger the worst
banking crisis in 80 years, less than 18 months later. But it was
clear that it would not be "contained." We had no idea.
I
also said that it was going to create a monster legal battle down the
road that would take years to develop. Well, in the fullness of time,
those years have come nigh upon us. Today we briefly look at the
housing market, then the mortgage foreclosure debacle, and then we go
into the real
problem
lurking in the background. It is The
Subprime Debacle, Act 2.
It is NOT the mortgage foreclosure issue, as serious as that is. I
seriously doubt it will be contained, as well. Could the confluence
of a bank credit crisis in the US and a sovereign debt banking crisis
in Europe lead to another full-blown world banking crisis? The
potential is there. This situation wants some serious attention.
This
letter is going to print a little longer. But I think it is important
that you get a handle on this issue.
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.
First,
existing and new single-family home sales continue to slide, in the
wake of the tax rebate that ended earlier this year. We have declined
back to the down-sloping trend line. If you are a seller, this is not
a pretty picture.
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.
Lending
is tighter, as is reasonable. Banks actually expect you to have the
ability to pay back the mortgage you take out (solid FICO scores) and
want reasonable down payments. Only 47% of applicants have the FICO
score to get the best mortgage rates.
(Sidebar:
Gary writes, "Furthermore, false appraisals rose 50% in 2009
from 2008. The tax credit for first-time homebuyers cost taxpayers
about $15 billion, twice the official forecast, in part due to fraud.
Over 19,000 tax filers claimed the credit but didn't buy houses,
while 74,000 who claimed $500 million in refunds already owned
homes." Where are the regulators?)
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,
two charts 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.
Anyone
who tells you the housing problem is "bottoming" either has
an agenda or simply does not pay attention to the data. I really want
to see housing bottom and then turn around and the home builders come
back; the nation desperately needs the jobs. But my job is to be
realistic. When we see 3-4 months of non-stimulus-induced housing
sales growth, then we can start talking about bottoms.
But
housing sales are not really the issue. Let's look at the next leg of
the problem.
OK,
in a serendipitous moment, Maine fishing buddy David Kotok sent me
this email on the mortgage foreclosure crisis just as I was getting
ready to write much the same thing. It is about the best thing I have
read on the topic. Saves me some time and you get a better
explanation. From Kotok:
"Dear
Readers, this text came to me in an email from sources that are in
the financial services business and with whom I have a personal
relationship. The original text was laced with expletives and I would
not use it in the form I received it. Therefore the text below has
had some substantial editing in order to remove that language. The
intentions of the writer are undisturbed. The writer shall remain
anonymous. This text echoes some of the news items we have seen and
heard today; however, it can serve as a plain language description of
the present foreclosure-suspension mess. There is a lot here. It
takes about ten minutes to read it. - David Kotok
(www.cumber.com)
"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
"Before
mortgage-backed securities, most mortgage loans were issued by the
local savings & loan. So the note usually didn't go anywhere: it
stayed in the offices of the S&L down the street.
"But
once mortgage loan securitization happened, things got sloppy...they
got sloppy by the very nature of mortgage-backed securities.
"The
whole purpose of MBSs was for different investors to have their
different risk appetites satiated with different bonds. Some bond
customers wanted super-safe bonds with low returns, some others
wanted riskier bonds with correspondingly higher rates of return.
"Therefore,
as everyone knows, the loans were 'bundled' into REMICs (Real-Estate
Mortgage Investment Conduits, a special vehicle designed to hold the
loans for tax purposes), and then "sliced & diced"...split
up and put into tranches, according to their likelihood of default,
their interest rates, and other characteristics.
"This
slicing and dicing created 'senior tranches,' where the loans would
likely be paid in full, if the past history of mortgage loan
statistics was to be believed. And it also created 'junior tranches,'
where the loans might well default, again according to past history
and statistics. (A whole range of tranches was created, of course,
but for the purposes of this discussion we can ignore all those
countless other variations.)
"These
various tranches were sold to different investors, according to their
risk appetite. That's why some of the MBS bonds were rated as safe as
Treasury bonds, and others were rated by the ratings agencies as
risky as junk bonds.
"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.
"So
in fact, it wasn't that the riskier loans were in junior tranches and
the safer ones were in senior tranches: rather, all the loans were in
the REMIC, and if and when a mortgage in a given bundle of mortgages
defaulted, the junior tranche holders would take the losses first,
and the senior tranche holder last.
"But
who were the owners of the junior-tranche bond and the senior-tranche
bonds? Two different people. Therefore, the mortgage note was not
actually signed over to the bond holder. In fact, it couldn't be
signed over. Because, again, since no one knew which mortgage would
default first, it was impossible to assign a specific mortgage to a
specific bond.
"Therefore,
how to make sure the safe mortgage loan stayed with the safe MBS
tranche, and the risky and/or defaulting mortgage went to the riskier
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 world...you 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. MERS was essentially where the digitized mortgage
notes were sliced and diced and rearranged so as to create the
mortgage-backed securities. Think of MERS as Dr. Frankenstein's
operating table, where the beast got put together.
"However,
legally...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.
"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.
"The
broken chain of title might not have been an issue if there hadn't
been an unusual number of foreclosures. Before the housing bubble
collapse, the people who defaulted on their mortgages wouldn't have
bothered to check to see that the paperwork was in order.
"But
as everyone knows, following the housing collapse of
2007-'10-and-counting, there has been a boatload of
foreclosures...and foreclosures on a lot of people who weren't sloppy
bums who skipped out on their mortgage payments, but smart and
cautious people who got squeezed by circumstances.
"These
people started contesting their foreclosures and evictions, and so
started looking into the chain-of-title issue, and that's when the
paperwork became important. So the chain of title became crucial and
the botched paperwork became a nontrivial issue.
"Now,
the banks had hired 'foreclosure mills'...law firms that specialized
in foreclosures...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!
"So
in other words, a massive fraud was carried out, with the inevitable
innocent bystanders getting caught up in the fraud: the guy who got
foreclosed and evicted from his home in Florida, even though he
didn't actually have a mortgage, and in fact owned his house free
-and clear. The family that was foreclosed and evicted, even though
they had a perfect mortgage payment record. Et cetera, depressing et
cetera.
"Now,
the reason this all came to light is not because too many people were
getting screwed by the banks or the government or someone with some
power saw what was going on and decided to put a stop to it...that
would have been nice, to see a shining knight in armor, riding on a
white horse.
"But
that's not how America works nowadays.
"No,
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.
"That's
when things started getting interesting: that's when the attorneys
general of various states started snooping around and making noises
(elections are coming up, after all).
"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.
"The
move by the United States Congress last week, to sneak by the
Interstate Recognition of Notarizations Act? That was all the banking
lobby. They wanted to shove down that law, so that their foreclosure
mills' forged and fraudulent documents would not be scrutinized by
out-of-state judges. (The spineless cowards in the Senate carried out
their master's will by a voice vote...so that there would be no
registry of who had voted for it, and therefore no accountability.)
"And
President Obama's pocket veto of the measure? He had to veto it...if
he'd signed it, there would have been political hell to pay, plus it
would have been challenged almost immediately, and likely overturned
as unconstitutional in short order. (But he didn't have the gumption
to come right out and veto it...he pocket vetoed it.)
"As
soon as the White House announced the pocket veto...the very next
day!...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?"
(I
am not sure who wrote this, but if you want your 15 minutes of fame,
I will be glad to credit you next week. - John)
Let
me add a few thoughts. First, I agree, this is very serious. It has
the possibility of seriously hurting the housing market, which as we
saw in the first section is already on the ropes. But at the end of
the day, there is a cure.
Someone
borrowed money for a mortgage. Some entity is cashing a check if that
person is paying. That entity should have the title until it is paid
off. If someone is not making their mortgage payments, they should be
removed from the house and it should be sold to the benefit of the
ultimately correct and what everyone thought was the proper title
holder.
If
you took out a mortgage and now the title is in some doubt because
the investment banks and mortgage banks and all the middle guys
screwed up (big-time!) because they wanted to save some bucks and
make some commissions, you did not win the lottery. That is not
America as I know it. You can't pay the mortgage, I am sorry. But you
do not get to keep the house. The people who (thought) they bought
the mortgage in a fair deal need to end up with that mortgage.
If
you pay your mortgage, you get to have the American Dream.
We
CANNOT allow this debacle to continue. It will bring the system down.
Who will want to buy a mortgage that is in a securitized package with
no clear title? Who will get title insurance? Some judge somewhere is
going to make a ruling that is going to petrify every title company,
and the whole thing grinds to a halt.
Let's
be very clear. If we cannot securitize mortgages, there is no
mortgage market. We cannot go back to where lenders warehoused the
notes. It would take a decade to build that infrastructure. In the
meantime, housing prices are devastated. Whatever wealth effect
remains from housing gets worse, and the economy rolls over.
This
is beyond my pay grade, but there have to be some adults who can make
everyone play nice in the sandbox. Ideally, someone in authority at
the Treasury, with bipartisan support steps in and says everyone
follow these rules, whatever these rules need to be.
I
had a very spirited conversation with good friend Barry Ritholtz
today (of The Big Picture). Barry runs money but is also a lawyer and
has a somewhat different perspective. He thinks we do not need any
legislation and there is a legal cure. He says that real trained
people (lawyers and paralegals) need to look at each mortgage and
figure it out, and that it can get resolved. It is expensive to the
banks; but I agree, if it is just dollars I don't care. Fix it.
But
that is a maybe. Other people I talk to disagree. Some think we need
some regulatory fixes. Some think we will need a legislative cure.
But if we need to, there need be no finger pointing, no partisan BS.
This needs to get solved.
Someone
took out a mortgage. Some entity thinks they are owed money. Fix the
damn paper trail so that happens, whether in a legal if
time-consuming manner, in a regulatory fix, or with legislation.
Now,
that is not to say the people who did this stuff did not commit
felonies and such. We can sort that out over time. The longer we wait
the worse it will get. Fix the problem and then go round up the bad
guys. There are bigger issues in play here. (I know this will be
somewhat controversial. Oh well.)
I
get the fraud being done here. I am regulated by FINRA, the NFA,
various states, the British FSA, and ultimately the SEC. If I did
something in my business like the stuff described above, someone
would come in and justifiably shut me down, fine me, and ban me from
the securities business. Oh, wait. These guys ARE regulated by the
above groups.
Finally
on this topic, I shake my head when I think that the FDIC is now
running several of the banks (think IndyMac) that are part of this
foreclosure crisis. These are the guys who are supposed to be
preventing something like this. Again, where are the adults?
OK,
this letter is already getting too long. I am going to finish it next
week, as the next topic needs a lengthy treatment. But I will not
leave you hanging. A quick preview.
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.
And
all this coming as European banks are going to have to sort out their
own sovereign debt problems. Shades of 2008. I hope I am wrong, but
it's all connected.
I
travel on Monday to New York, where good friend Barry Habib is going
to take me to the Yankees-Rangers game. I will be the guy on the
second row behind home plate, behind the mayor, wearing the Rangers
jacket. Barry assures me I will be safe. Cliff Lee pitching. Can the
Rangers hold up to the pressure against the best there is? Stay
tuned.
My
book, The
End Game,
is coming along. It is out for comments from friends, and then I will
sit down with my co-author in London for four days and we will finish
this the first week of November, and then Wiley will push as fast as
they can to get it out.
This
has been a very tumultuous week for a host of reasons. It's all good,
but exhausting. I am more than ready to hit the send button. I just
turned on the TV to watch the last few innings. The Rangers have gone
from up 5 to zip to losing 6-5. Can we say disheartening?
Your
really wanting to see a World Series analyst,
John
Mauldin
John@FrontLineThoughts.com
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2010 John Mauldin. All Rights Reserved
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2 Comments in Response to The Subprime Debacle: Act 2
Letter to Wells Fargo Spokeswpman Vickee Adams,
Dear Ms. Vickee Adams,
In your recent Wells Fargo's press release, you declared that ""Our records show that Wells Fargo's foreclosure affidavits are accurate, When the company finds employees that don't follow procedure, it takes "corrective action."
That's a lie. I can say for a fact that Wells Fargo made us fraudulent mortgage loan and foreclosed my home based on hugely inflated and fraudulent appraisal and refused to correct its mortgage fraud.
Wells Fargo teamed up with its attorneys and spent last 4 years in Nevada courts defending its appraisal and mortgage fraud.
Wells Fargo and its attorneys knew it’s Category C Felony to make mortgage loan based on fraudulent appraisal.
Wells Fargo and its attorneys knew it’s Category C Felony to foreclose home based on fraudulent appraisal.
Wells Fargo chose to violate the law and chose to defraud us.
Hold Wells Fargo Accountable! Save American Dream! Restore banking integrity.
Please sign the Petition at http://www.wellsfargomortgagefraud.com. Let our voice be heard!
"Let's be very clear. If we cannot securitize mortgages, there is no mortgage market. We cannot go back to where lenders warehoused the notes."
Oh really John and why is that praytell?
"It would take a decade to build that infrastructure."
It'll take longer to rebuild our industrial infrastructure and dig ourselves out of debt Johnnyboy. We have the time.
"In the meantime, housing prices are devastated."
Do tell? That might be good news to a people who's income potential has suffered a permanent hit. They might like houses they can afford on what they ACTUALLY make this time eh?
"Whatever wealth effect remains from housing gets worse, and the economy rolls over."
Oh Johnny you silly, silly boy.Whatever "wealth effect remains" is TOXIC SLUDGE, EXTEND AND PRETEND, GHOST INVENTORY. It's the open secret Bernanke and Geitner keep shoving money onto to cover up.
"This is beyond my pay grade"
Yeah, I'm kind of getting that.
"...but there have to be some adults who can make everyone play nice in the sandbox."
Johnny you silly, silly boy, the adults in the sandbox are the Federal Reserve and it's various corporate stockholders. And it's their sandbox. See, that's why you were blindsided by all this and why your attempt at "explaining" it to us now is farcical.
Fact is Johnny, that you don't know what you are talking about. Now go ahead and prove it.
"Ideally, someone in authority at the Treasury, with bipartisan support steps in and says everyone follow these rules, whatever these rules need to be."
Spoken like a true American hero Johnny. With all your breathlessly fresh understanding, you know in your gut there are 3 things to do when confronted with a problem and they are call for government help, ask the government for help and finally, humbly demand the government help.