The American Housing Market Is Headed for Total Destruction
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.
October 13, 2010