Foreclosure crisis a 'cancer': Christopher Whalen on impact on banks, housing market, economy
Tuesday, October 19, 2010; 12:00 PM
Christopher Whalen, managing director of Institutional Risk Analytics, was online Tuesday, Oct. 19, at Noon ET to discuss the impact of U.S. mortgage foreclosures on banks and the housing market and the outlook for the economy.
Whalen is the author of "Inflated: How Money and Debt Built the American Dream."
Tampa, Fla.: Are you surprised at the back-office shambles of the banks with mortgages? Do you attempt to quantify this risk? If so, how?
Christopher Whalen: No, the back office problems at banks are no real surprise. Problems vary depending on the institution. The cost of fixing issues of mortgage recordation, etc. is not going to kill the banks. But the cost of dealing with failed properties and other expenses will be very large. May require government help again.
Out-of-the-Box Solution for Underwater Houses: Simply put, several "underwater" homes and foreclosures mean houses are overpriced. To reduce foreclosures substantially, to qualify for federal guarantees the federal government should require: 1) mortgage holders to share equity in these houses with homeowners in exchange for federally-backed new financing; and, 2) the equity amount to be set as the underwater amount, be split equally between lender and homeowner, and become a secondary property lien paid-off only when the house is sold or refinanced "conventionally." This approach is faster than waiting for market forces to play out.
Mortgage lenders and banks helped create the housing crisis by approving risky home loans (e.g., stated income programs) and bundling mortgages that were sold in packages as highly-rated securities. Borrowers took-on too much debt. Equity-sharing lets homeowners and lenders share responsibility for the crisis and future risks. For example, under a 40 percent equity-stake program, a house with a $500,000 loan balance that's $150,000 underwater would qualify for a $300,000 new loan. The lender and homeowner would negotiate the $200,000 equity split. And local property taxes should be adjusted downward too.
Christopher Whalen: Your solution implies insolvency/restructuring for many banks and localities.
Concord, N.H.: Are the recent expansions to the Making Home Affordable program actually being reviewed and processed by mortgage holders? The latest one would allow people who meet certain financial criteria (i.e., you are current on your mortgage, the loan is underwater in terms of current property value, you make a certain amount of money, etc.) to refinance into lower interest rates.
I am concerned that so much attention is being paid to the foreclosure debacle that mortgage holders won't be open to revising loans per those HUD programs. They must be taking a big hit with the foreclosure freeze. I would imagine that most of those foreclosures would have been approved.
Christopher Whalen: The main problem with foreclosures and refinancing are the fees added to many mortgages by Fannie Mae, Freddie Mac and the originating lenders. During the boom years, banks worked for as little as half a point on a mortgage. Today fees and extra spreads for higher credit standards make refinancing very expensive more many households. This means that liquidity is not "trickling down" to households.
Delray Beach, Fla.: According to recent reports, Florida has an unemployment rate of close to 14 percent. In addition, it is not being declared the epicenter of foreclosure "mills."
That said, I was surprised to read Dean Baker's statement that "Ninety percent of Americans are employed and more than 90 percent of homeowners pay their mortgages, Hart noted, but "the real issue is the space it takes in peoples' fear and uncertainty."
Is this true? Where is he getting his numbers?
Christopher Whalen: The unemployment and loan default rates are about right. A 10% default rate on residential mortgages is not good, more than 2x the long-term average for losses on these types of loans. My fear is that another 10% will default next year due to unemployment.
Orange, Calif.: If the FED decides to follow Japan, as your colleague Nouriel Roubini assumes, what are the ramifications for the dollar? Nouriel was calling for nationalization of the banks back in early 2009. If they didn't do it back then what makes you think they will do it now?
Christopher Whalen: The US and Japan are not the same. In Japan, the society had vast savings to dump into the furnace to fund giant government deficits. But there was little restructuring. In the US, we pretend to buy time but the process of liquidation grinds on in the courts. One way or another, we will liquidate the housing bubble in the US. I don't think QE by the Fed helps or delays this process. Buys some time for the banks, but is killing savers.
Portland, Oregon: Chris,
I'd like to go straight to the end game and ask you about the big banks and the effect of investor lawsuits, repurchase claims, put backs. The losses are accumulating. Securitization reveals itself as imperfect and leaky. Combine that with the decline in net interest margin and other sources of income for the big banks and the scenario looks quite dire.
So when and how are these banks going to begin to realize these losses and to what end when they do?
It seems from that perspective that QE has been a crude form of quasi-fiscal subsidy for the banks. What a price to pay for the lack of regulatory authority and political will for receivership, etc.
Christopher Whalen: Yes, there are several subsidies for the banks. QE and boosted net interest margin from the Fed are the first. Enhanced fees and spreads on mortgage originations is another subsidy. Investors pay this vig directly in premium pricing for MBS. As with the BAC call today, the question is how fast do the operational and financial expenses rise? I don't think foreclosure document mess is the real issue; selling REO and servicing real property over the long term is. REIT is new model.
Arlington, Va.: A freeze on foreclosures puts individuals with a DOD security clearance or an individual trying to obtain a DOD security clearance in a position where their clearance will be denied or revoked.
If the property is foreclosed or sold this is mitigation needed to resolve this issue. If the property is involved in a freeze it is still a delinquent debt that has not been resolved. DOD may have no other choice but to deny or revoke the security clearance. The law of unintended consequences comes into play.
I have yet to [see] a foreclosure that was a result of fraud. They are a result of folks not paying their mortgage.
Christopher Whalen: Yes, sadly bad documentation does not change the fact that the loan is bad. People need to recall (or learn) that we dealt with this issue in the 1950s by subjecting the mortgage NOTE to the UCC. When a bona fide note holder shows up in court, they win. If more than one person was sold a note secured by a given property, the judge devides equitably. But the state of the MORTGAGE documentation ultimate is a clerical issue and not determinative in the question of foreclosure.
Why so soon?: Why are banks attempting to restart foreclosure proceedings already after these problems became so widely known? Do they think that they have solved all the issues or are they just hoping that the people being foreclosed upon won't contest it in court?
Christopher Whalen: Your question assumes that they actually stopped foreclosures. Given the backlog of foreclosures, in many states months or even years, saying you are standing down to let your people review procedures does not amount to a real change in the process. Think of it as a vacation with legal benefits.
Impact of low mortgage rates: I hate knowing that my savings accounts at the bank are earning next to nothing. But, at the same time, I enjoy paying a relatively low rate on my mortgage. Since most mortgages are for 30 years and banks can't pay out more than they bring in, does this mean that the interest rates can't go up more than a point or two for the next dozen years.
Christopher Whalen: Good question. I have an eight-year old LIBOR floater that I have never considered refinancing. My guess is that the Fed must let rates go up soon or they will destroy individual and corporate savings. There is a big difference between 0.5% and 2.0 compounded. The Fed is taxing consumers and business about $750 billion annually because of low interest rates. Banks are also being hurt as their portfolios reprice.
Anonymous: I have my mortgage at Bank of America and they're my regular bank. They just posted a $7.3 billion loss. Should I be worried?
Christopher Whalen: No, BAC is my business bank. I have other relationships, however. I encourage all consumers to have more than one banking relationship, especially if you own a small business. We helped Arianna Huffington's Move Your Money effort with a free lookup tool that gives you A+ though B banks via a zip code search: http:/
Christopher Whalen: The key thing we all need to understand is that clearing foreclosures and selling homes to viable borrowers is how we protect our communities. At the end of the day, we don't want to see states enacting foreclosure moratoria to protect their tax bases. Prompt sales are the answer and why we are not going to be like Japan.
washingtonpost.com: Move Your Money
washingtonpost.com: Bank of America posts $7.3 billion quarterly loss (Post, Oct. 19)
Seattle, Wash.: Walk me through why banks can't or won't agree with homeowners to take a haircut on the mortgage in return for agreeing to perfect the paperwork. Property law in the U.S. is extremely touchy on the subject of paperwork.
Christopher Whalen: The issue of a haircut is different from the paper work.
The banks will perfect the lien on the mortgage prior to foreclosure. JPM withdrew from MERS months ago. Remember that the MORTAGE and the NOTE are two different documents. All the lender needs to foreclose is the NOTE. You may delay a foreclosure with bad recordation of the title and lien, but at the end of the day, the note holder will prevail.
Often writing down principal is a good deal for the lender and the borrower. Trouble is that a 30% haircut implies a capital loss for the bank. Banks have 8% capital to assets, so when you take $30 of loss on a loan with an original face value of $100, that is killing the bank.
Re: Why so soon?: My question was more about re-tarting new cases after anyone paying attention to the news now has ammunition to fight their foreclosure, which would cost the bank more, long run, than anything else. And that assumes that the bank wins out.
Christopher Whalen: Unless the borrower has actually been defrauded by a lender and is NOT in default, I would advise a short sale. The fact that the court documents are a mess is a problem, but it will not usually be sufficient to win a foreclosure fight. As I said before, most times the banks/note holders win. I fear that unscrupulous attorneys are telling consumer they can win such fights when they are already in default and have few real options. What is best for the home owner is the real question every lawyer must ask in my view.
Wilmington, N.C. : Are you aware of any penalties that the banks will be subjected to for hiring the so-called "yes" employees who were used to get the refinancing done by just making sure they knew their names and numbers and no mortgage/lending education of experience? Thank you for taking my question.
Christopher Whalen: There have been a number of truth in lending and similar claims brought against subprime lenders. The real issue is suitability, namely was the borrower real able to understand and fulfill the obligation? You see far more care today than in years gone by, which shows very starkly in the better loan default experience of recent production.
Ashburn, Va.: I'd love to hear your thoughts on this idea. We're trying to save homes of people who can't afford them, often because they are out of work. I am underwater, but am current on my mortgage. There are almost no programs that help me even though any reduction in my monthly payments will mean more discretionary funds that can help stimulate the economy. There are millions of people like me who are the safest bets out there, but no one seems to have a way to help make my life easier. What would you say to a program to help underwater mortgages that are current get lower rates?
Christopher Whalen: We should be doing refis now for viable borrowers, even those underwater. I hate to see consumer leaving real estate when we face the certainty of inflation in the years ahead.
The real question is whether unemployment is going to send loan defaults and foreclosures higher. My guess is yes and for precisely the reason your example suggests. There is a huge floating inventory of homes not yet in default that should either be sold voluntarily or subject to a short-sale.
New York: I feel for anyone who is in the process of or at risk of losing one's home to foreclosure. However, in reading about the debacle, it seems that those who cannot afford to pay their mortgages is a separate issue from banks not processing the paperwork properly or robo-signing documents. I believe that procedures must be followed, but does that let those who bought homes they could not afford completely off the hook?
Christopher Whalen: No, as note before, a bad record keeping job at the court house regarding the lien on the property mortgage does not win against a valid note holder. The holder of the note almost always wins and will be required by the courts to correct any deficiency in the record.
Re: Seattle: And yet, bankers appearing in Congress insist that 8 percent is a straightjacket and anything more would be killing them. Is there any group of people more currently reviled?
Christopher Whalen: No, banksters are currently seen as the lowest form of life. But remember that we all created this problem via government intervention in the housing marketplace. My friend Josh Rosner talks about this at length in my new book:
Inflated: How Money and Debt Built the American Dream
John Wiley/December 2010
Cleveland, Ohio: Thanks for taking questions. An Ohio attorney here. You take pains to distinguish the Note and the Mortgage with regard to the ability to foreclose. However, as JPMorgan noted with MERS, there can be a question of the adequacy of the transfer history of the note, casting doubt on the proper holder. While technically the chain of transfer does not matter for notes as it does for mortgages (i.e., it's who holds the note now that matters), some judges have taken a keen interest in this. I guess this is simply a long winded comment that the note/mortgage distinction isn't quite so simple.
Christopher Whalen: No, that is a good and separate question. If you the investor in a residential mortgage backed security have doubts as to whether the note was delivered to the trustee of the deal, then you have other issues that are potentially far more significant that the recordation issues for the mortgage. JPM apparently did this right on their production, but the legacy Bear Stearns book is probably another matter. SIGTARP just issued a report detailing multiple instances where loans were pledged to more than one securitization. Lawyers will be employed for many years on this one.
Anonymous : Nouriel Roubini was calling for nationalization of the U.S. banks? Really. What exactly does that mean? That is awfully strange and disappointing. Thank you.
Christopher Whalen: My friend Nouriel reflects my view that the liabilities facing the largest banks are far bigger than their capital. Restructuring fixes this problem and gets us back on track for growth, Muddle along protects the jobs of bankers and politicians, and kills growth. SO I support Nouriel's view not of nationalization but of the need for government-led restructuring. Good news is that the Dodd-Frank legislation (pronounced Doo-fus) gives FDIC the legal power to restructure banks.
RE: Your Response to Out-of-the-Box Solution for Underwater Houses:: Given current property values, aren't banks and localities already insolvent? This proposed solution provides an immediate path to restructuring without the long uncertain process of bankruptcy, requires the parties responsible for this situation to share responsibility and extends the amount of funds available for refinancing. Otherwise we have to wait years for the market of adjuct if ever.
Christopher Whalen: Agree. I am in favor of the quick painfull path of restructuring. Obama is repeating many of the errors of Hoover and FDR by embracing muddle along strategy of Summers and Geithner. Quite remarkable really.
See our comment this week: http:/
washingtonpost.com: The Metastasis of Residential Mortgage Backed Securities: Interview with Joe Mason (Institutional Risk Analyst)
For Ashburn: I submitted a question that you kindly answered earlier re: whether mortgage holders were being held to promises by HUD to restructure loans if you were current and met other criteria, which is what the poster from Ashburn was asking about.
The Ashburn poster (and anyone else interested in trying to restructure your current, yet underwater mortgage) should do a search for Mortagee Letter 2010-23. It is supposed to help homeowners like us. My original question was whether mortgage holders were actually going to follow through the program terms.
Christopher Whalen: Good question. The re-default rate on mortgage holders is quite high. I went through a chapter seven years ago related to litigation, but reaffirmed by primary mortgage and HELOC, so I am considered "cured." Banks are hiding real defaults in the "cured" bucket at present. That is next year's surprise. ;)
Re: Viable Home Owners: With unemployment at 10 percent and not really dropping, and housing prices still above the normal rate for rentals, how many people are looking to buy a home? Especially with banks scared and not really trustworthy and now, hidden paperwork issues, do you really think there's a large glut of renters suddenly looking for a huge investment?
Christopher Whalen: Good question about shrinking buyer pool. One reason I am so bearish on housing and large banks in 2011 is shrinking poor of buyers. The buyer of a foreclosure is a cash buyer, no leverage. More than half of all sales today are involuntary sales by banks and the GSEs. There are some investors with leverage in the mix, but recovery rates are below 10% industry wide.
Anonymous: You state that "clearing foreclosures and selling homes to viable borrowers is how we protect our communities." I tend to agree. But how could that be possible without sorting out the back-office mess? The documentation deficiencies extend to millions of loans. That will take years, regardless of the costs. And time is money.
Further, the banks seem to be shooting themselves in their collective feet when they foreclose on homes while negotiating restructuring the mortgage debt. One hand doesn't know or care what the other is doing.
And even so, the banks are scared to death of reducing principal lest their auditors start forcing them to mark down their assets to realistic values. Not only would it impair capital, it could even lead to suspending dividends or, in the worst case scenario, repricing stock option.
How can the banks possibly surmount all three of these hurdles?
Christopher Whalen: Good question. I see a good bank/bad bank approach a la the 1930s/1980s as the eventual solution. Our political class is still running away from our past decisions, but the arithmetic is compelling and unavoidable. The thing I worry about is that the size of the mess is so much larger than the 1990s that the states will enact unilateral moritoria a la the 1930s and tell their people to pay their property taxes and stuff the banks.
Insurance: Are people required to take out insurance so if one of the borrowers dies the insurance will pay the balance due? Is there any insurance for job loss that would cover payments?
Also do you think the problem is not just people overreaching to buy the house but getting home equity loans on top of the primary loan?
Christopher Whalen: Yes you can get credit life cover for a mortgage. There are some insurance products that cover loss of income as well.
Christopher Whalen: Thanks for the excellent questions. I think the level of discussion is very encouraging. By the end of this year, we are even going to teach every American how to price a mortgage. Read by posts on Reuters if you want to learn more on this mess. I am writing a new post on the documentation issue.
washingtonpost.com: In a new period of instability, Obama becomes Hoover (Reuters, Oct. 7)
Editor's Note: washingtonpost.com moderators retain editorial control over Discussions and choose the most relevant questions for guests and hosts; guests and hosts can decline to answer questions. washingtonpost.com is not responsible for any content posted by third parties.