Dan Denning

The issue with the recent robo-signing scandal is that clear title could disappear in the American mortgage market. Part of the outrage is that U.S. banks have been foreclosing on mortgages which they don’t even own. Part of the reality is that the convoluted process of securitisation means banks may not be able to prove at all they actually do own the mortgages.

Already large unions in the U.S are encouraging borrowers to challenge banks to prove they won your mortgage. They’ve set up a website asking the question, “Where’s your note?”

You can see where this is headed. No one in America wants to own a failure. The banks want to foreclose on homes and sell them and avoid taking losses. Borrowers (some of them, and some of them rightly) want to avoid paying a debt for an asset that’s worth less. No one wants to be responsible anymore because the most lucrative and least painful route is to abandon responsibility and your word.

This is a serious breakdown in one of the most basic elements of a functioning market: contract (doing what you said you’d do). People at every level appear to have cheated and lied during the housing boom. The borrowers who lied on their loan applications…the mortgage originators who made the loan without any documentation of work or income…the securitiser who packaged it up and sold it to investors…the ratings agency that rated the debt investment-grade…the insurance companies who sold default insurance against the bonds multiple times…and the government that encouraged home-ownership and subsidised the fraud with an implied guarantee on the bonds of Fannie Mae and Freddie Mac, the government-sponsored enterprises that bought a lot of the garbage bonds.

What is really at stake though?

Well, if borrowers challenge foreclosure proceedings, and if banks (as they have already begun to do) halt foreclosure proceedings nationwide, the process of establishing a market-clearing price in the U.S. house market is frozen. Buyers can’t buy and sellers can’t sell if the ownership of the underlying collateral — the house itself — is in doubt. What sane person would enter a market like this with prices effectively having completely broken down?

As if that’s not bad enough — and it’s nearly as bad as it gets — don’t forget that that there is a whole universe of financial instruments whose value derives from the underlying collateral. Mortgage backed securities…collateralised debt obligations…the value of any instrument whose value is derived from the underlying asset is now suddenly in doubt.

It’s hard to understate what this could mean for financial markets. It could mean another capital crisis in the financial world. It would make 2008 look quaint.

This is why this problem is rapidly escalating into another contest between the banks and the borrowers. The U.S. Congress chose to side with the banks by passing a law (H.R. 3808) which would have made it easier for the banks to foreclose on properties without having to go through the usual process of documentation. But U.S. President Obama — less than a month away from an election that’s become a referendum on his policies — simply ignored the resolution (a pocket veto). Who wants to be seen siding with bankers right now?

Now you have a situation where U.S. banks again face massive losses on their exposure to residential real estate. You have a growing popular movement to challenge the banks through the legal system — raising bank costs and eating into bank earnings (which are already pretty flimsy when you take away the boost to the net interest margin from low short-term rates).

But the biggest problem by far is that you have a growing ethos in the American mortgage market that everything is so upside down and backwards that the best thing to do is just stop playing by the rules and stop paying your mortgage. The whole market is on the verge of breaking down. Trust has evaporated. The rule of law itself now seems irrelevant.

Who is the government going to side with in this dispute? The banks, who will claim (perhaps correctly) that the crisis threatens their ability to loan, and perhaps their very existence? Or will it choose an increasingly angry populace who doesn’t want to again get sacrificed on the altar of saving the financial system?

Our guess is the government won’t choose either. It will choose both!

The easiest way to deal with debt — if you have no intention of paying and don’t want to inflate it away right away — is to simply repudiate it. A great debt amnesty is required!

Bankers must be allowed to sell everything they don’t want to the government, and probably at a price that suits the bank, even if it wouldn’t be borne by the market. And distressed homeowners must be allowed to refinance at a fixed-rate for 50 years through a government lender that will never foreclose on them, and is probably statutorily prohibited from doing so. No one takes a loss. No one loses a house. Voila!

Of course it can’t work that way. Huge amounts of capital have been misallocated in a credit boom. The recovery begins when the losses are taken and household and corporate balance sheets are returned to sanity. But no one wants to deal with that pain. So insanity ensues and a completely zombified mortgage market looms.

Regards,
Dan Denning
The Daily Reckoning Australia
Whiskey & Gunpowder

October 13, 2010

Dan Denning

Dan Denning is the author of 2005's best-selling The Bull Hunter. A specialist in small-cap stocks, Dan draws on his network of global contacts from his base in Melbourne, Australia, and is a frequent contributor to The Daily Reckoning Australia.

  • http://www.thetexasring.com Linda Brady Traynham

    Thanks, Dan! I needed a good chuckle. This IS funny. The chaos, the possibilities for bank troubles, and just think…we still have another round of house “values” dropping to go through and the unavoidable debacle in commercial real estate, too. Now, why do I suppose commercial has been sliced, diced, and tranched, too!

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  • http://myadventuresinselfreliance.blogspot.com/ Lynne

    I do agree with your analysis. Now I’m probably underwater on my Mortgage. I won’t walk away cause I gave my promise to pay. I think my home is worth fighting and working to pay off. Now if the SHTF and we have pandemonium rules may change. I’m well armed and have plenty of food, and a great old RV.
    I’m looking for some land with my Mom that we can get cheap or at least trade for some silver. Yes Linda I’m learning though I may challenge the teacher from time to time. I found a place, it’s abit pricey for my taste but the location is perfect. 17 acres on the Snake River and has a geo-thermal as well as a regular well. It has road access and power. Still less than 35 miles to the hospital. Soil is crap hard pan and alkali
    $98,000 is the asking price. I want to go out and take a look at it. If we could get the owner to go to a 5 acre parcel. It would be doable for us and cover the whole family. We could put the whole family on 1/2 acre lots and still run critters on the other 3 acres.
    Yeah they are slackers but if we build it they will come. Hell they will have to come. Mom will try to keep them alive cause that’s what Mom’s do. Even if they are idiots they are family.

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  • Inuvik NWT

    Interesting times, as usual.

    Buy now, pay later. It is now later, folks.

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  • Desertrat

    Even without “Foreclosuregate”, remember that a tremendous amount of this mortgage paper is being carried on the books at its value at the time of the loan. It’s not carried at present market value–which is one helluva lot less.

    Bank of America has some $900+ billion in loans, much of which is mortgage paper–and a high percentage of that is in California and Florida. Even a write-down of only 15% or so would bring them close to a wipe-out. And BOA is just one of quite a few of these critters which are in trouble.

    ‘Sall right. Us taxpayers will wind up with the tab…

  • Darin

    Right! Like everyone who took out a mortgage didn’t do it correctly and honestly. Well, I did. But because of the banking system corruption the economy collapsed causing me to lose my job; and at 65 years old, I can’t find a job, I’ve tried. Yet all I hear from people who write about the responsibility of the borrower is that they need to honor their obligations. Well, I’ve been doing all I can to do that, but in connection with my home, which is being foreclosed on because I don’t have enough money to pay the mortgage, don’t preach to people in my position to be a stand up person and honor the obligation. Right! I’m losing my home because of banking corruption, with banks being bailed out with the sums of billions of taxpayer dollars, and I can’t even get a job to pay my mortgage. But the Wall Street crowd continue to give out bailout billions in bonuses to each other.
    Talk about a slanted point of view in an article! For, I believe, a large portion of those underwater with their mortgages, the issue isn’t THEIR honor, but the lack of moral ethics and conscience on the part of the lenders, i.e., banks. They caused this mess with their own corruption, so let them fix it. They as well as people writing articles like this act as though every homeowner was and is a deadbeat with ulterior motives. Sorry, I resent that implication because I did everything right. I didn’t ask to be put in this situation, but the banks think that the playing field is still even. They can screw around, manipulate, cheat, lie, steal and commit outright fraud without consequences and yet we’re left holding the bag because we’re supposed to be honorable. Instead of bailing out the crooked banksters, how about bailing out all of us for a change? But that will never happen. Why? Because there wouldn’t be any profit in it for the crooks or fodder for writers to get on their soapboxes and remind us “lowlifes” that we need to honor OUR contracts.
    Right! Give me a break………..If you’re so honorable, how about helping me pay my mortgage, my bills and to put some food on my table……………………………….Yeah! I didn’t think so!

  • Sorry to have to say it

    Darin,
    Woe is you. Sorry about your luck. Do you know what a morgage is? Do you understand the comments regarding debt? Obama being elected tanked the economy and the Feds are holding it down by the throat. No magic answer is coming from Washington, they have done their part. This country is going down the tubes!
    In 1990 CA had a Real Estate bubble and I had to live in my house for 10 years because I was upside down. Lost my job. Had to get 2 roommates, and changed my whole single mother lifestyle. It started with a look in mirror then deciding what I wanted and letting the rest go. News flash, Life is hard. Put on your big boy pants and take care of YOURSELF and your family in as honest and ethical way as possible. Everyone who does otherwise because of the BOZOs, is helping the wrong side! Salt of the earth types will take back this country so work means something again. Put your hands to work instead of out.

  • steverino

    right! this is CA’s 2nd Joe Bazooka.
    people either hung tough or bailed the first time
    then, we did it again—this time in spades!
    darin—-Sorry, I resent that implication because I did everything right.—-stuff happens. do you recall one of the right things being “just say no” to the option: would you like to buy a policy that pays the mortgage if you lose your job? you only give enuf info to draw us into the pity. we ain’t goin along.
    if you lost the job thru no fault of your own you can get unemployment insurance payments.
    you could have been drawing soc. sec. since turning 62.
    you may be eligible for food stamps.
    i have a 70 y.o. friend who spent 8 years buying clothes and going on cruises after her husband, who worked for the Post Office and hated every day of his life there, died.
    then, her dastardly banker refused any more “home equity money” b/c the value of her home went south.
    now she must meet her expenses from her income, but it is sooo hard for her to stop spending money!
    and, she hasn’t been on a ship for years.
    she, too, did everything right; and, yup, she’s furious, too!
    she told me she owed $9K on a credit card, etc.
    about 6 weeks later, i stopped by to look at her gutters with her; we had coffee; i asked to see her credit card statement, something hadn’t seemed right to me abt what she’d told me. she showed it to me, sheepishly. the balance was $14K.
    poor baby!
    i was cracking up! i think i said: Reality is a river in Egypt.

  • steverino

    in fairness to mr. denning, he had been visiting the US; when he returned to australia, he was suffering from hallucinatory jet lag, hi-altitude alcohol poisoning, and some kind of withdrawal, possibly from Real Football. he wrote about it on the aussie version of the daily reckoning. here we see him is the final throes of his Search for Meaning from his visit. he’ll be fine.

  • Desertrat

    Darin, I don’t like to see anybody get hurt during economic hard times. Other folks’ problems certainly don’t help me at all.

    But beginning back around 2001 or 2002 when real estate prices started up, I began to figure that anybody who paid that kind of money for a house was covered all over with a severe case of the simples. When I learned of variable rate mortgages and interest-only mortgages, I thought that people had less common sense than God promised a goose.

    That said, I figure that self-preservation or family-preservation far and away supercedes anything set down on paper. IMO, there are situations where doing society’s idea of the right thing isn’t much different from taking a voluntary train ride to Auschwicz or Bergen-Belsen..

    Since I set myself up decades ago to not be at all vulnerable to any such problem as folks are having today, I don’t really know what I’d do were I fighting too much month at the end of the money. Odds are that I would have well before now bailed out of a too-expensive, moved into a travel trailer, and started greeting folks at Wal*Mart.

    But at age 65 I was still working backhoe and hauling gravel. At age 76 I still do, only just for my own needs and not commercially…

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  • sam

    If you buy a house, you pay for it. End of discussion. Sometimes you buy a coke at a supermarket, sometime at the gas station, and sometimes at the movie three. You will buy the same coke, they will vary greatly at each of these respective venues…for the same coke…in the same bottle…

    It is not fair if the idiots who bought their house at the peak, and knew the couldnt afford it, are still chillign in their house and not paying their mortgage, while there are other folks who actually are paying their mortgage.

    just graduated. doing banking right now. love securitisation. believe in it. its a beautiful technology. plan on hitting up law school, and then building this market back up, suing each bower one at a time for being such an idiot….

  • Sorry to have to say it

    Sam,

    You will find out in law school that there are no laws against being stupid. You can’t outlaw being human. If you haven’t screwed up bit time yet, it will happen.
    Don’t forget to go after all the ntitwits. Not just the non-moving targets of those sitting still in their houses, but the brokers who promoted the No-doc loans for non-traditional applicants, appraisers who overvalued property, Real Estate Brokers who looked the other way while closing questionable deals and loan processors who failed to uphold their end of the bargain. Don’t forget he banks who haven’t fulfilled their duties allowing the fingers to point their way relieving homeowners and others of their responsibility rendering the whole concept of homeownership in question and subject to nationalization. Eventually housing will just be dormatory in function. All owned by the collective government and regulated and controlled and standardized and not worth owning.
    Good Luck in school. Seriously.

  • Victim of Predatory Lending Practices

    Promise to make it my mission to bring Aurora Loan Services to justice. Aurora Loan Services lied, deceived me when pursing the Making Home Affordable Loan Modification. Aurora’s intent was to foreclose my home even after telling me that the foreclosure proceedings where on hold and that the Loan Modification application was in process; however, the reality was that Aurora isn’t in the business to do loan modifications but foreclose properties.

    I want to pursue legal action and bring those accountable to justice. Please reach out to me.

  • Sorry to say

    VoPLP and if you turn out to be accountable, what then? Just asking?

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  • http://www.manhattancalumet.com james moylan

    I have a web site where I research stocks under five dollars. I have many years of experience with these type of stocks. I would like to suggest an exchange traded fund that invests in stocks related to the housing market. ishares tr dow jones us home construction index symbol {ITB}

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