Yesterday Pro Publica released a piece about Freddie Mac retaining the interest portion of some of their securities, Freddie Mac Bets Against American Homeowners. Their theory is that Freddie Mac has set up a hopeless conflict of interest because by retaining the interest-portion of certain securities they GSE is incentivized to disallow refinances to lower interest mortgages.
As Yves Smith points out in nakedcapitalim, Pro Publica’s Off Base Charges About Freddie Mac’s Mortgage “Bets” this story is simply incorrect.
It’s difficult to defend the behavior of either GSE, Fannie or Freddie, because — borrowing from Abba Eban — the GSE’s never miss an opportunity to miss an opportunity to do the right thing. While I don’t believe they’re anywhere close to the root cause of the housing bubble, they’re definitely the root cause of the foreclosure fraud scandal that followed it. It’s long past time they were shuttered and that we drop this myth that they’re viable independent organizations.
Still, this is one area where Freddie Mac didn’t do anything wrong and the statistics support that their decision to retain the interest portion of the securities in their portfolio is not affecting their modification decisions.
Before digging in to specifically what Freddie is accused of, and why it’s one of the few areas where they did nothing wrong, let’s jump to the end and inspect whether it’s affecting modifications. I wrote a piece of analysis just last week that dug into mortgage modification statistics that partially addressed this issue, Mortgage Modifications: Slaying Zombie Debt.
I’ll summarize key portions of that article; every quarter the Office of the Comptroller of the Currency (OCC) releases a study detailing loss mitigation options, including modifications, for mortgages. Their latest study was release for Q3, 2011. They break modification options down into several buckets, including capitalization, interest rate reduction, interest rate freeze, term extension, principal reduction, principal deferral, and “not reported” (the servicer cannot contractually explain what modification term they offered).
Freddie Mac was accused by ProPublica of making financial decisions that create a conflict of interest for lowering interest rates. This is directly refuted by the fact that Freddie regularly freezes and lowers interest rates in modifications.
Keep in mind, while reviewing the figures, that most modifications involve more than one category of relief, so results add to over 100%.
Freddie reduced interest rates in 74% of the modifications they offered and froze rates in 7.6% of their mods. In contrast Fannie reduced rates in 70.4% of their mods and froze rates in 3.6%. In contrast government-guaranteed (FHA, VHA, etc..) loans lowered rates in 93.7% of their mods, private investors lowered rate in 71.5% of their mods, and portfolio loans lowered interest in 83.6% of their mods.
That is, the facts just don’t support that Freddie is especially stingy about lowering or freeze interest rates when modifying mortgages.
Back to Pro Publica. Summarizing their article, they reported that Freddie retained the interest rate obligations of certain pools of mortgages they’d bundle, but sold off the principal portion.
So what? Pooling and selling mortgage is what the GSE’s do. Love them or hate them their job is to purchase mortgages, bundle those mortgages into pools, then sell those bundles to investors so that they have money to make more mortgages.
Freddie then hedged the interest-rate portion that they kept, so that if rates fluctuated their financial position would not be adversely affected. Not only is there nothing wrong with this, but it would be entirely irresponsible of them to do so.
Finally, it’s important to remember that the new government proposed refinancing programs are refinancing, not modifications. There is nothing Freddie can do one way or another regarding refinancing: borrowers simply take out a new loan at a lower interest rate.
That is, if this issue had any effect on Freddie’s decision-making process — which it appears not to — Pro Publica didn’t even focus on the area where it would matter, modifications, not refinancing.
Finally, because loan modifications arguably run afoul of investors — who have paid for and are contractually entitled to the terms they purchased — retaining the interest bearing portion makes modification of that same interest bearing portion considerably easier than if they sold it.
This akin to running a story that a surgeon is knocking random people unconscious then cutting them open. Technically it’s true but it’s also misleading. It’s especially bad if the surgeon is a hack who routinely botches their operations, which is a fine analogy for the GSE’s behavior.
I’m not sure why Freddie kept the interest bearing portion, but one possible reason is that nobody wanted to purchase it, or that potential buyers wanted even higher rates which Freddie would need to pass on to new borrowers.
There’s lots of reasons to criticize the GSE’s, but retaining the interest bearing portion of mortgages is one of the few areas where they’ve done nothing wrong.
Every year Reporters Without Borders issues their Press Freedom Index, detailing the degree to which a country’s press is free. This year the US slipped to #47, and the US territories are #57 thanks to how the press was treated during the Occupy protests.
No matter whether one loves or can’t stand the Occupy movement, journalists should be allowed to cover the protests without fear of being arrested. Further, unless protesters are rioting the protesters themselves shouldn’t be arrested, which happened to Gavin Aronsen of Mother Jones this weekend.
Over the past few years it’s become fashionable for certain political groups to shout about some hidden meaning of the Constitution, demanding some form of Constitutional purity that conveniently suits their political agenda. They’re not as enthusiastic about those sections that do not further their agenda, or even those that do but are being used by groups that they disagree with.
Repeating a pattern I see when I hear pundits talk about housing, mortgages, and foreclosures sometimes I wonder if they’ve actually read the text. Even though I should have to I’ll briefly repeat that the Bill of Rights, the first ten amendments, was adopted along with the rest of the text. It’s relatively short and to the point:
“Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the Government for a redress of grievances.”
While the US Constitution had some serious flaws — especially the well-known definition of slaves as three-fifths of a person and the exclusion of women from the democratic process — it remains the the bedrock sample of Democracy; countless countries have virtually copied it.
Something is wrong when Standard & Poor’s cites “freedom of speech” as the right to actively mislead MBS investors when rating MBS pools — the ratings section of prospectuses aren’t exactly high prose — but those same rights are ignored by thuggish police.
I spent the weekend parsing — that is, taking apart — MBS prospectuses so I can put them together in a more manageable form. While writing computer programs to slice-and-dice the material it occurred to me that at least we have the material in the first place, and retain the right to write about them.
Somebody, somewhere, way back when, had the good sense to require investors to disclose this information, and the framers of the Constitution the foresight to guarantee an absolute write to ink our thoughts and findings.
Granted, there was the ill-fated attempt to allow corporate censorship of the Internet, though once the wheels of Democracy started to spin saw saw an abrupt about-face; that is, the Democratic mechanism to protect ourselves worked. Similarly, Gavin Aronsen was released from jail after a call from his editor.
In a perfect world legislation to censor the Internet should never have been introduced. Gavin (and, arguably, most if not all the protesters) should never arrested. But at least they’re free, not rotting endlessly like they would in some countries.
As I sit and electronically sort through a mountain of paperwork that go to the heart of what broke the world economy, with an expectation that I’ll write about my findings, I don’t worry much about the police breaking down my door and arresting me. Conversely, the thought shouldn’t even cross my mind.
Change, for better or worse, tends to happen slowly so that what once was unthinkable becomes the new normal, and we have to carefully monitor and protect our rights in the same manner that we monitor and protect our economic freedom and foundation. Free markets, including the right to fail, and Free Press, are more intertwined than most people realize, and both show disturbing trends lately.
But maybe I’m an eternal optimist: I believe that over the long run American’s are good people and the US tends to do the right thing. Our country is relatively young age and, like most young people, we excel at quickly getting ourselves into trouble. But we also tend to work our way out of it, to do the right thing given enough time.
As I return to my compilers, database, and spreadsheets I’m not especially worried about being able to eventually publish the results, even if those results are upsetting. Judging by what S&P has gotten away with I can even publish them if they’re entirely wrong and I know it, though I hold myself to a higher standard than that.
But just because those freedoms exist right now doesn’t mean that we don’t need to maintain vigilance to ensure that those rights are preserved and strengthened. Freedom of Speech, and Economic Freedom are two bedrocks of the US, the former written explicitly and the latter referred to endlessly. Let’s make sure that we pass both to our children and their children with the same care that they were passed to us.
Another month comes to an end and the 50-State Attorney General agreement is as far from finished as it has ever been. Granted, no agreement is better than a bad agreement, but no progress is the worst of all.
As days turn to weeks, weeks to months, and months into over a year now the level of distrust continues to grow.
It’s irrelevant what one thinks about the agreement because, outside of a small group of insiders, we’re guessing. Feelings about the settlement are a Rorschach test — the test administered to judge what people perceive a random ink-blot to be — because we don’t know what we’re looking at.
We listen to rumors, politically motivated anonymous sources, and outbursts that make no sense when one thinks about them for a minute.
For example, take FL Attorney General Pam Bondi’s browbeating at state’s that rejected the settlement. Many think she’s right, and others think that she’s wrong. But nobody seems to be saying “who knows what she’s talking about, because we have no idea what the terms they’re objecting to are, much less whether we agree about why they rejected those terms.”
Given that Jamie Dimon and bank-friendly Bondi are two of the few who are both aggressively agitating in favor of the settlement it seems fair to say that it’s probably bank friendly. But the truth is that’s a wild guess: we don’t even know what we don’t know, much less the answers.
There is no rationale basis to be in favor or against the agreement given what’s publicly known about its terms .. nothing.
Here’s a radical solution. To speed the agreement along, why not open it up?
I know that settlements are always held in secret, but there’s no rule that they need to be. Since banks obviously want to bring close this deal, and since they must believe the terms are reasonable, let them open the drafts, the debates, and the entire process.
If the settlement terms are reasonable they might find opponents of the settlement change their position, or at least grumble that they can unhappily live with the terms, which is oftentimes how both parties to a good settlement feel. If the terms are unfair or nonsensical — for example, reports that CA which has 10.39% of the country’s housing would receive over 50% of the money — public reaction might help both sides smooth over some of these issues.
If the public understood the constraints that all parties were under they might be more willing to flex.
For example, banks allegedly (everything with this settlement is alleged) argue they cannot pay one more cent so let them show that; bank financials are public records. Similarly, if the public feels that the settlement inadequately reimburses injured homeowners and those who were foreclosed upon let them show that; those figures are also well-known.
There are already too many mysteries tied to housing. As I’ve repeated before, the 2010 census reports there are 52.2 million owner-occupied homes with mortgages, whereas the OCC reports about the same number of total mortgaged properties, including owner-occupied homes, rentals, and abandoned properties. Adding yet another mystery is not helping either side.
I’ve written before that working with housing data is like looking through a dirty window. I use technology to pull together, to aggregate, large amounts of information from a wide variety of sources in an effort to see through the data.
There are may players involved in the mortgage and foreclosure crisis, so the data is incomplete, and what is there is scattered in many places. In contrast, there are far fewer parties involved in the AG settlement and they’re all well-known.
Given the difficult time they’re having agreeing upon a deal, given the stakes involved, and given that the situation seems to become more politically volatile by the day, maybe it’s time to try something different: open up the process and shine some light in.
Apparently the seven symptoms of a Vitamin D deficiency are obesity, bone problems, a weak immune system, depression, high blood pressure, and asthma. It isn’t hard to see the economic equivalent of each regarding this settlement. But there’s an easy cure .. more sunlight.
Update: while I was writing this piece my friend and colleague Abigail Field was writing a great piece on almost exactly the same subject, Attorney General Champs, Chumps, and Eric Schneiderman.
Principal writedown, erasing part of a mortgage debt usually to avert foreclosures, has become a raging debate.
There is nothing new about the concept of principal writedown. In many ways it remains the core tenant of Chapter 11 and 13 bankruptcy, the former usually for businesses and the latter for individuals. Chapter 11 is oftentimes not even referred to as “bankruptcy” but by the gentler name “reorganization.” In contrast, Chapter 7 is liquidation, where the assets of an individual or a company are sold, their debt eliminated, and the business shuts its doors or the individual theoretically starts over again.
Principal writedown is a growing but still seldom-used method used to modify mortgages, typically when the value of a house is substantially worth less than the amount owed.
Let’s examine some interesting figures from the latest quarter report from the Office of the Comptroller of the Currency (OCC), entitled “OCC Mortgage Metrics.” I’ve uploaded some of the data tables in the report to a downloadable spreadsheet, here.
Principal writedown is present in 7.8% of the 137,539 Q3, 2011 mortgage modifications. Only private lenders cut principal, probably because the notion tends to leave neighbors livid even if it’s the right solution. Private bankers make rational economic decisions, whereas government officials are clearly bound by political constraints based upon what the neighbors think.
It’s in the neighbors best interest to reduce principal and avoid foreclosures, since it keeps their own property values propped up, though it irrationally leaves them livid.
Before examining principal writedown itself, let’s look at various types of loan modification the OCC reports on: capitalization, interest rate reduction, interest rate freezing, term extension, principal reduction, and principal deferral. [Note as we walk through the numbers: since mods often involve more than one aspect figures often sum up above 100%.]
Capitalization is, by far, the most common loan modification method used in 88.5% of all mods in Q3, 2011. Capitalization is troubling in that it takes a borrower who is already in trouble and puts them in worse trouble by adding missed payments and fees to their already unaffordable balance.
Increasing zombie-debt sounds like exactly the wrong thing to do for both bank and borrower, but thanks especially to Fannie Mae, Freddie Mac, and other government-guaranteed loan modifications capitalization is the most common element of all modifications.
Capitalization was used in 86.6% of Q3, 2011 modifications for prime loans, 89.5% of Alt-A mods, 88.3% of subprime mods, and 93.4% of the large but nebulously named “Other” loan type. In contrast, principal reduction was used in 5.5% of prime mods, 8.7% of Alt-A mods, 12.3% of Subprime mods, and 4.6% of “Other” loan types.
Private investors are more willing to modify a loan to see if it will perform, probably on the notion that if restructuring will not work the debt should be written off. That is, they’re more likely to encourage either positive or negative resolution. Private banks appear wary of zombies.
In contrast, government-backed loans appear more likely to favor measures to keep the loan “alive,” without reducing principal. We’ve heard of zombie-like bureaucrats in DC; it stands to reason that they’re comfortable with their financial equivalents. Fannie, Freddie, and government guaranteed (FHA, VHA, etc..) mods included capitalization at 96.8%, 99.1%, and 98.3% respectively. In contrast, 85.3% of loans held by private investors and 67.4% of loans held in portfolios involved capitalizations.
Jammed-up government-backed borrowers are more likely to receive term extensions. Fannie, Freddie, and government-backed term extensions exist in 68.1%, 69.5%, and 84.4% of their respective mods. In contrast, just 24.2% and 36.5% of portfolio loans involve term extensions. This suggests the private market prefers their loans either alive or dead; they’re trying to move beyond extend and pretend.
None of the government-backed loans agree to reduce principal whereas 15.3% of loans by private investors and 18.4% of portfolio loans involve principal reduction. Similarly, principal deferral — the process of moving principal later in the life of a loan when the house might have more value — is present in 25.6% of Fannie’s mods, 18.2% of Freddie’s, and .1% of those guaranteed by the government (that’s not a typo). However, this more borrower-friendly method for making loans affordable is present in 23% of loans held by private investors and 29.2% of portfolio loans.
Modification success is broken into two series of reports, one towards the top of the report that summarizes success over all time periods lumped together and a more useful series, buried further down, that breaks down success using more granular time-based reporting.
Even with lousier borrowers, it’s clear the private market does a better job making mods.
For 2008-2010 modifications the success rate — the rate where borrowers did not re-default after a year — was 61.6% , 46.8%, and 26.4% for GSE and government-backed loans. In contrast, private and portfolio loan 12-month re-default rates were 50.6%, 38.6%, and 23.7%.
The summary report, lumping together all times, paints a rosier picture for the government for 12-month re-default rates. Fannie and Freddie both report a 28.2% re-default rate, government-guaranteed loans had a 50.8% re-default rate, private portfolio loans come in at 48.3% re-default rate, and portfolio loans suffer a 25.2% rate.
However, those all-time modifications statistics include the much higher private loan 12-month re-default rates for the 2008 modifications, at 61.2%. Given that these loans were often to substantially riskier borrowers — think corner-stores where mortgage brokers purchased “Wite-Out” by the case — it’s amazing they lowered their 12-month re-defaults to 29% for the 2010-era mods.
Although private lenders do offer principal reduction, they do so comparatively low rates making it difficult to adequately quantify what effect principal reduction has on modified loans. [Note: remember again that that most modifications offer some combination of terms, meaning the percentages of loan modified by type of modification exceeds 100% of all modification types.]
In Q3, 2011, lenders offered principal reduction in 10,722 modifications. In contrast, 121,716 modifications included capitalization, 112,819 included a rate freeze, 79,536 contained a term extension, and 28,133 included principal deferral.
Overall, there were 137,539 loan modifications in Q3, 2011, according to the OCC, so 7.8% contained an element of principal reduction. That figure is low enough, and the OCC data coarse enough, that it is impossible to draw a definitive conclusion.
Around the web we find colorful depictions of how to slay zombies, or bring them back to life. It’s apparent that the private market has a good track record of making the right long-term decision when forced to shoulder the downside risk of its own decisions. Being a basic tenant of capitalism, this shouldn’t be a surprise but it’s still happening all too seldom.
Arguably, the most important factor for the US economy is the number of shadow inventory loans, loans that are now or are likely to wind up in foreclosure.
Economists might argue the US debt matters more, or unemployment, or our trade deficit, but the US economy is driven by the middle-class and, for the overwhelming majority of that same middle-class, their house is their largest asset.
If the value of our homes is being artificially inflated by poor data the psychological effect once the invisible hand steps in to correct those prices could be devastating.
CoreLogic suggests there’s just over a million homes headed for the auction block. If they’re right, which I’m reasonably sure they are not, then we’ll probably be fine: it’d be a great time to buy a house. Laurie Goodman, of Amherst Securities, argues that figure is closer to 11 million homes. If Goodman is correct that same house becomes a terrible investment.
An increase by a factor of ten is referred to as an order of magnitude, so Amherst’s 11 million figure is about an order of magnitude higher than CoreLogic’s 1.2 million estimate. I’ve estimated, in coordination with others (especially Abigail Field), that there are about 9.8 million shadow properties.
As the size of a sample grows the amount of guesswork should shrink, especially if the sample is easily measureable. Estimates about the number of shadow inventory loans, from leading experts, should come nowhere close to differing by an order of magnitude.
It should be easy to compute the total number of houses with mortgages; these are large loans tied to real property. We’re counting elephants, not ants.
My shadow inventory analysis is based upon census data, which uses substantially different base figures than those released by other government agencies and relied upon by analysts as a base. According to the 2010 census, a $13 billion study, there are 76.4 million owner-occupied homes, and 52.2 million which have at least one mortgage.
While that sounds straightforward enough the Office of the Comptroller of the Currency (OCC) reports that there are about the same number of mortgaged homes total for first-lien residential mortgages.
During the real-estate boom it was common for ordinary people to become back-yard real-estate moguls; they’d buy and rent a house or condo or two while the loans were easy and cheap. Predictably, the census reports there are 37.5 million rentals. Further, there are 17 million vacant properties. Since it appears irrational that a person would abandon a property they own outright it’s fair to say that some number of those rentals and a large number of those abandoned properties are mortgaged.
If the OCC has been reporting only owner-occupied houses with mortgages as the total pool of mortgages, and if government agencies and financial analysts have been relying upon this figure, we’re in serious trouble.
When a property hits the auction block it does not matter whether the former owner lived there, rented it out, or even if the property was vacant. At auction, it’s just one more house vying for a limited number of buyers and a limited pool of capital. Increased supply and flat demand mean lower prices.
Something is profoundly wrong when government, consumers, and even the banks are left guessing about the most basic metrics used to gauge economic health.
Data is akin to a map, and the US continues to sail through dangerous waters. We can have intelligent and vehement debates about how we ended up here, and how best to navigate to a more sustainable place. However, the placement of rocks and the depth of the ocean should not be open for debate.
We know that the market for multi-family rentals is booming; constructions starts are up as investors rush to build apartment complexes, despite the high number of vacant properties. This rush to expand rental housing — the willingness of investors and bankers to bet money on an ongoing lack of willingness to purchase homes — speaks louder than the rosier forecasts.
Over the long-run the market is always right: the invisible hand is an unbeatable, unstoppable force of nature that can’t be tricked indefinitely.
Something is amiss if economists, bankers, and consumers have been using a map altered either by incompetence or politics while working in good faith to steer an already injured US economy to safer harbors. Conversely, there’s a different but probably equally dire problem if we spent $13 billion on the census and cannot accurately count the number of houses in the country.
This is a case where, for the sake of the economy, I hope that my analysis is incorrect, though I suspect that I am right. But since releasing those sky-high figures nobody has proffered any explanation, rational or otherwise, refuting the significantly higher figures or explaining the discrepancy.
Originally posted Jan. 11, 2012 on nakedcapitalism.com, here http://www.nakedcapitalism.com/2012/01/michael-olenick-10-million-shadow-inventory-says-housing-market-is-a-long-way-from-the-bottom.html
“Shadow inventory,” the number of homes that are either in foreclosure or are likely to end up in foreclosure, creates substantial but hidden pressure on housing prices and potential losses to banks and investors. This is a critical figure for policymakers and financial services industry executives, since if the number is manageable, that means waiting for the market to digest the overhang might not be such a terrible option. But if shadow inventory is large, housing prices have a good bit further to go before they hit bottom, which has dire consequences for communities, homeowners, and the broader economy.
Yet estimates of shadow inventory, and even the definition of what constitutes shadow inventory property, vary widely. For example, the Wall Street Journal published a Nov. 11, 2011 article, “How Many Homes Are In Trouble?” where values varied from 1.6 million (CoreLogic), to “about 3 million” (Barclays Capital), to 4 million (LPS Applied Analytic), to 4.3 million (Capital Economics), to LPS Applied Analytics, to between 8.2 million and 10.3 million (Laurie Goodman, Amherst Securities).
Why do these numbers vary so much? Even though CoreLogic is generally considered to have one of the best databases of loans, its estimates of loan performance and odds of default are based on credit scores, which is a badly lagging indicator. Laurie Goodman is seen by many as having the most carefully though out model, even though industry insiders are keen to attack her bearsish-looking forecast.
I have a large database of my own, and am familiar with housing and mortgage information sources. I’ve come up with my own tally of shadow inventory and have also tried to analyze — OK — take a stab at – what I call “shadow liability,” meaning the amount of money taxpayers, investors, banks, will be lose if those homes are liquidated. Assumptions using those terms are also in the attached spreadsheet. My analysis comes up with a total close to that of Goodman’s range, 9.8 million using a narrower definition than Goodman’s of what constitutes shadow inventory.
Put more simply, things are actually worse than any of the prevailing estimates indicates, although Goodman is very close to the mark. Current loss experience suggests that this figure is staggering, easily in the $1 trillion range.
Why aren’t those losses more visible yet? Well, evidence suggests that servicers are stalling the foreclosure process, not taking title to and selling these houses. For the lenders, such delay likely allows them avoid the write-offs of both the negative equity as well as the worthless second liens. More generally, it keeps the trillion dollar losses hidden. Lenders aren’t acknowledging their stall tactics, however. When people notice how slowly foreclosures are progressing from initial steps to resale, lenders point at their foreclosure fraud related dysfunction. Lenders conveniently don’t mention that such dysfunction was self-induced, instead blaming borrowers and courts.
My data comes from several sources. Default information is from the October, 2011 LPS Mortgage Monitor. Housing information, including the number of houses with mortgages, comes from the US 2010 US Census and the 2009 Statistical Abstract. Median home prices — the likely value of the loans that are either in foreclosure or will be soon, is from the FHFA; specifically the Q2, 2006 state-by-state median home prices, when many of the bubble loans were written. Note: these prices are used to approximate the principal value of the loans, not what the properties are currently worth.
Because not all this data overlaps entirely some extrapolation was necessary; when required to extrapolate I tried to do so conservatively. An example is how I arrived at the number of mortgages in the US, a step on the way to calculating the number of mortgages in default.
The first step was figuring out how many housing units with residential mortgages America has. According to the 2010 census, America is home to 131.7 million housing units. Of these, 76.4 million are owner-occupied, 37.5 million are rental units, and the remaining 17.2 million are vacant, and the remaining 600K are houseboats or other exotic housing. Of the 37.5 million rentals, some are in apartment buildings that would be financed with commercial mortgages, not residential ones. Commercial loans are structured differently than residential loans, and are easier to renegotiate, so they I’ve excluded from this analysis.
To be conservative—to exclude more loans as commercial than actually are, rather than risk leaving commercial loans in the analysis—I’ve assumed that any building with 5 or more housing units is in a building that either has a commercial loan or no mortgage at all.
According to the National Multi-Housing Council, using 2011 Census data, has determined that nationally, 42% of renters live in buildings with 5 or more units. Applying that percentage to the 37.5 million rental units, and subtracting that from total renters, I end up with 21.8 million rental housing units that could have residential mortgages.
In total, then, I have 76.4 million owner-occupied homes, 21.8 million residential rental units, 17.2 million vacant homes (which includes, among other things, vacation homes and abandoned ones) and 16.3 million other, mainly units in commercial properties. All in all I end up with just over 115 million homes that could have a residential mortgage on them. But how many of them? Well, the Census reports that in 2010, 68% of owner-occupied units had at least one mortgage. I used this same 68% for investment (residential rental) properties and vacant (primarily vacation and abandoned single family homes) properties.
I believe this 68% figure is appropriate for two reasons. First, a person who has a mortgage on their own home is unlike to buy a vacation house or an investment property with cash. Indeed, even a homeowner living free and clear in their own home might need a mortgage to buy second property. So assuming the mortgage rate for investment and vacation homes is the same as owner occupied surely understates the number of mortgages. Second, the mortgage rate on abandoned homes surely is nearly 100%; why abandon a home if it’s not in foreclosure?
Using that math, I came up with 78.6 million mortgaged properties. This figure is substantially higher than many other estimates, including Goodman’s Amherst study, though the likely reason is that the census data the analysis relies upon is relatively new. Goodman’s study uses 53.7 million mortgaged homes, though the census reports 52.2 million owner-occupied loans alone, in additional to rental properties, mobile homes, and vacant properties. Given that the census cost $13 billion to produce — an amount no private organization could afford — and 2010 results were not available at this level of granularity until relatively recently, I would not be surprised to see upward revisions to other base housing unit figures in the future.
To estimate shadow inventory, I used the delinquency data from LPS Analytics. They add up loans that are delinquent, loans that are in foreclosure, then come up with a state-by-state percentage of “non-current” — loans that are, or are likely, to end up in foreclosure. There is some ambiguity in LPS’ figures; specifically the definition of “delinquent,” and whether they are counting homes or loans.
To illustrate a potential problem with these assumptions, let’s take a theoretical example of 100 houses. Let’s assume 68% have mortgages, a figure from the census, so 68 houses have mortgages. Then let’s assume these homes are in FL and 22.9%, or 23 houses, are either in foreclosure or likely to end up there soon. I’m assuming this means that 45 houses are current, 23 houses in trouble, and 32 houses paid-off, though I concede that it could mean 12 houses with two mortgages are in trouble, 32 are paid off, and 56 are fine.
This methodology differs from Goodman’s, which relies upon predicting both likely defaults and re-defaults for non-sustainable modifications, as well as a small number of homes likely to strategically default as liquidations begin and home value plummets. Conversely, my model assumes all 90-day delinquent loans will result in foreclosure and liquidation — and I’ve yet to see enough good-faith modifications to assume otherwise — whereas Amherst’s believes the figure is likely to be 80-90%. However, I do not allow for strategic defaults, which more than offsets my skeptical assessment of the mortgage mods now begin offered (my assumption is that when people default suddenly, it is really an anticipatory default: the borrower could see he was going to hit the wall, but defaulted before he was completely broke. Given the job market costs of having a foreclosure or bankruptcy on your credit record, I don’t regard that as a bad assumption). Goodman has three buckets of current loans that she anticipates will produce defaults: badly underwater loans (loan to value ratios of over 120%), moderately underwater loans (LTVs of 100% to 120%) and loans with equity borrowers will default upon anyway (LTVs less than 100%). She estimated those three groups would produce eventual foreclosures of 2.8 to 3.7 million of her total. Thus my somewhat smaller tally is actually more dire, because it consists of borrowers who are having trouble making payments now, as opposed to borrowers who are anticipated to default at some undetermined point in the future.
That being said, except for the lower housing unit loan base Goodman’s analysis seems rock-solid, though it would mushroom if used with my higher base housing unit figures and more pessimistic view of servicer’s ability to mitigate defaults. Together they would paint a devastating picture of the future, so I won’t try to reconcile them .. at least not yet.
Using the assumptions above, and applying the LPS data state-by-state, there are 9,800,000 houses in shadow inventory.
If these loans were taken out for the median value of a state-by-state home price, using data from the FHFA, for Q2, 2006, there is $2.3 trillion of home values at near the market peak. The mortgage balances are going to be lower than that, but given how widespread equity extraction came to be (and it is probably that the most levered homes are hitting the wall), it is not unreasonable to assume LTV ratios relative to peak values of 80%. Loss severities on prime mortgages are running at roughly 50% and are 70% on subprime (note that with more borrowers fighting foreclosures, and given that loss severities on a contested foreclosure can come in at 200% or even higher, so using these assumption is certain to understate actual results). $2.3 trillion x 80% x 50% = $900 billion.
These losses will be distributed across the GSEs (meaning taxpayers), banks that have second liens (with the biggest losers being Bank of America, Citibank, JP Morgan, and Wells Fargo), investors in private label (non GSE) mortgage securities, and other US and foreign banks. Balanced against this liability is some amount figure for the underlying asset, the house. Given that servicer advances, foreclosure costs and servicer fees come close to and even exceed the value of the property, comparatively little of this $2.3 trillion will be recovered in property liquidations.
It is unclear where the money from these write-offs will come from, or whether they losses have been adequately budgeted. Obvious sources are Fannie Mae, Freddie Mac, European and US banks, none of which have reported anywhere near this level of reserves. We know that the Federal Reserve has been buying up MBS and related instruments in bulk; maybe the central bank plans to print more money to cover the losses and enable the foreclosures. Printing this much money, for this purpose, in this political environment, in secret, seems unlikely.
In support of the conclusion that banks cannot afford to recognize this shadow liability is the sharp decrease of foreclosure filings in 2011 and the seeming unwillingness of banks to move foreclosures through the system. They file foreclosures, then let them linger, not taking homes even when every possible borrower defense is exhausted. Some of this slowdown may be due to more scrutiny of foreclosure documentation, particularly in judicial foreclosure states, but there is clearly more at work. In the most obvious example, servicers are reluctance of banks to take title to the homes after obtaining a judgment; even after the judgment is a year old and cannot be challenged.
For example, filing volume in Palm Beach County, FL, started to increase towards the end of 2010 but judgments remained flat and certificates of title — where a bank actually takes title to a house, recognizing the underlying financial loss and evicting the family — actually slowed down despite an enormous backlog of judgments. This contrasts to the banks incessant complaints of a broken court system, because a judgment more than one year old in FL cannot be challenged for fraud. This leads to the conclusion that it is the banks — who are unwilling or unable to absorb the losses — rather than the courts or homeowners that are actually slowing down liquidations.
Let’s walk through these figures. In Palm Beach County, the number of Certificates of Title issued for Q1-4, 2011, was 1,594, 1,886, 1,413, and 1,299 respectively; the number of judgments was 289, 480, 281, and 367 respectively. Let’s compare that to 2010, when there were 3,105, 9,704, 7,259, 1,033 judgments in Q1-4 respectively and 1,534, 2,207, 3,065, and 2,738 titles transferred.
Many of these cases are uncontested; yet it is not uncommon in foreclosure court to see bank lawyers arguing vehemently for delays with nobody on the other side.
Let’s review more figures: in Palm Beach County there are 10,794 more final judgments of foreclosure that are at least a year old than there are certificates of title issued. Again, there is nothing anybody can do to challenge a judgment after one year. Servicers appear to be milking ongoing costs and fees from investors. Cross-referencing that to a softer data point I’m reminded of a worker, in my home state of FL, sent by a company I hired to perform a home repair. He’s a young man who said he purchased a condo, lost a prior job that paid better, and stopped paying for his condo for which, he noted, similar models were selling for at a 80% discount to what he owed. He filed no defense to his foreclosure whatsoever — he was positively clueless about the judicial system and did not hire a lawyer — but he ran to his truck to show me a Notice of Voluntary Dismissal of his foreclosure, asking what it meant. It’s clear that while some homeowners do their best to avoid the auction block, even those who do nothing all have a statistically good chance of staying put.
There is other anecdotal evidence suggesting banks do not want these houses or, more accurately, do not want the write-offs that actually taking the houses would force:
- Foreclosure defense lawyers have clients who have not paid their mortgage in years, but face neither a foreclosure nor even a negative mark on their credit report. I recently received a call from a man who said he had not paid his $1.6 million mortgage in two years but his servicer has not foreclosed, and he faces no derogatory information on his credit report; he was frustrated because he is retired and just wants to move to a cottage. This phenomenon, which apparently isn’t rare, might explain why shadow inventory reports that rely on credit reports to extrapolate shadow inventory are often dramatically lower than these calculations.
- Every year the Republican dominated Florida legislature introduces legislation to speed along foreclosures, and every year the legislation fails. I personally believe this legislation to be both immoral and arguably illegal. However, it is impossible to believe this bank beholden governmental body is willing to repeatedly bite the hand that feeds them .. unless their master makes it quietly clear that they do not actually wish to accelerate liquidations but cannot publicly admit as much.
- It is common for foreclosure mill lawyers to argue for delays in selling a home when nobody is representing a borrower. Judges, who want to clear their dockets, will rail at bank lawyers about the age of the case even while bank lawyers argue for yet another delay, while the other table — where the borrower, the defendant, is supposed to sit — is empty.
- Bank-instituted delay tactics are not limited to Florida. Not long ago I spent the day with Sean O’Toole, CEO of foreclosureradar.com. Sean knows the foreclosure world and his data is, literally, the best in the Western states he covers. He noted the same effect in CA; lender-initiated delay after delay after delay selling a home. In CA, after three delays both parties must approve a further delay but Sean said banks routinely file stipulated delays when, in fact, borrowers just want to literally move on.
- There is the well-known tendency of servicers to “lose” paperwork, where borrowers beg for mortgage modifications, short-sales, or deeds-in-lieu. These delay tactics — rather than just answering “no” to a request — make sense in this context because leaving a house in foreclosure limbo, forever, is the only solution that delays the inevitable balance sheet busting write-offs.
- Lastly is the unwillingness of banks to agree to principal reductions, or even modifications with principal balloon payments, which would yield more long-term money than a foreclosure. Servicers appear to want these homes in the higher-yielding default status, even if they are reluctant to actually push the homes to liquidation, to take title on behalf of investors.
We’ve written relentlessly about servicer abuses, but we’ve almost always contextualized these abuses through their effect on borrowers. Staring through data, especially data at this scale, complexity, and with strong economic ramifications, is like looking through a dirty window. But as we wipe away layer after layer of schmutz the picture is becoming clearer. Yes, servicers continue to prey upon ordinary Americans. But evidence suggests that they’re also preying on investors. Individual American families do not deserve to suffer these behaviors, that increase the losses while delaying the uncertainty, and neither do pension funds, European villages, municipalities, or other unsuspecting entities who actually funded these loans.
Few people are going to complain when they’re not paying their mortgage that there is no mark on their credit-report nor a foreclosure; a few of the more perplexed ones — or those that want to bring a bad mortgage to resolution — may speak out, but most remain silent.
Similarly, many investors, and surely the banks themselves, know about these figures. But as both sides spin their wheels, the problem continues to spiral out of control.
Finally, there is government behavior that makes no sense, especially from the Obama Administration. We have repeatedly seen federal intervention when it is inappropriate and unwelcome, and we’ve seen no intervention when it is warranted. For example, the Administration has actively intervened in the multistate Attorney General settlement talks even though this is, by definition, a state issue. However, they have done nothing to prosecute overt and clearly proven interstate crimes surrounding document forgery.
There is a strong argument that campaign donations are at work, but given the lopsided donations from the financial services industry to Republicans one would think Obama would send a message by taking firm control over the FHFA, the FDIC, the SEC, the OCC, the Treasury, the Justice Department, and strong-arming the Federal Reserve into offering substantive help to borrowers and investors. Yet, at every level, the President has failed ordinary Americans. Even the most egregious behavior results in dead silence .. we don’t even get a yawn. Every program has been an unmitigated disaster, especially HAMP. When Administration figures do intervene their influence is overtly skewed in favor of the banks.
Surely Obama and his advisers realize these problems. It seems inevitable that we will soon face either widespread bank failures and a staggering loss in home values (although arguably an increase in middle-class liquidity), or another much larger bailout; a fraud bailout. Either option is likely to sink President Obama’s popularity rating in much the same way it is likely to sink individual home values. Despite this, the president continues to play Kick the Can, presumably hoping these problems won’t be widely recognized prior to the election in November, while the banks continue to kick everybody else.
Market manipulation used to be illegal, especially in cases where there was asymmetrical information or unequal bargaining power. Pundits use the term “heads we win, tails you lose,” but that actually understates the problem because it implies that there still exists individual parties and counter-parties. Our more modern arrangement looks more like an aristocracy, where there isn’t a genuine market at all but rather a pseudo-market operating like a private ancient tax collector, demanding the increasingly poor peasants feed the monarchs and his cronies rather than feeding their own children.
I’m often told that people don’t care about deadbeats who haven’t paid their mortgages. But people fail to realize that this affects everybody. Ordinary Americans see the effects of this manipulation every day; it affects them profoundly, even if they don’t understand it. All but the most irresponsible aristocrats throughout history realized there were boundaries. Their motivations may have differed — some cared about the well-being of the peasantry while others feared the guillotine — but for millennia all but the stupidest acknowledged and avoided pushing the populace too far. If we’re going to live under an American Nuevo-Feudal system, the least we deserve are overlords at least as smart as the despots they’re trying to imitate.