Friday, 01 October 2010 15:14

Is the US Government About to Forgive Mortgage Debt? Let's Crowdsource Our Way Through a Scenario or Two!

Is it possible for the US Government to choose to forgive mortgage debt? Sounds outrageous? Read on for the legal theory behind this claim and let me know what you think? I thought it was little esoteric as well, but as I looked deeper... Well, I'll let you be the judge.

A lot of attention accrued to Representative Grayson's calling out of foreclosure fraud, and for good reason. The story is absolutely amazing, and kudos to a member of congress that defends his constituency.

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It's not as if other entities have failed to take notice. ZeroHedge has its usual witty commentary regarding the possibility of foreclosure transactions potentially being unwound due to fraudulent foreclosure activity. The NYT ran an article stating that Fitch will look into lowering the credit rating of companies that participated in the submission of inappropriate foreclosure paperwork, which apparently seems to include an awful lot of companies. It goes on to state (as excerpted by Zerohedge):

Fitch Ratings said that Wednesday it was asking mortgage companies about their internal processes for executing foreclosure affidavits. If it finds the processes lacking, Fitch will consider downgrading the company’s rating.

The agency also said if the issue is widespread, the resulting delays and extra costs to foreclose could increase losses related to residential mortgage-backed securities.

Here's the twist. A lawyer who happens to have followed my writings over the years has suggested that most are missing the big picture in focusing on fraudulent foreclosure documents. He contends (and I'm paraphrasing here, these are not my words, per se) "that since the U.S. has ownership interest in many (if not most) delinquent and distressed mortgages, this fact will be counted as policy in litigation. As a consequence it matters A LOT if you can say that your client has a Fifth Amendment Due Process right (or third party beneficiary Federal common law right) to a HAMP modification which is in FACT a minimization of the risk of default (not that flaky 31% number) BECAUSE, among other things, the U.S. has no economic incentive to foreclose". Now, I am no lawyer and thus the legal issues are beyond my domain, but I must admit I found the theory interesting. So, I've decided to crowdsource this one in anticipation that some of the more astute legal minds can shed some light on the validity of the theory. I'll supply the financial stuff in this post, and I'll rely on the legal eagles to peer review the theory.

This all stemmed from a chart and "what if" scenario I post on the 23rd of September in which showed the increasing decline in recoveries from gross charge-offs from banks.

As a matter of fact, things are so bad that I believe banks will have a perverse incentive to actually walk away. Now wouldn’t that be something??? Next, we take a look into the home builder that makes more money doing distressed investing than it does building and selling homes.

The legal argument from the BoomBustBlogger in question is as follows:

Things are moving pretty fast now, especially since so many states are moving to ban home foreclosures, and since your comments on the lack of economic incentive to foreclose is coming to the fore. It's becoming a question of, Hey Uncle Sam, what is your policy?  This may result in actions to quiet title, against the banks and the United States. The basis will be that in fact, the United States has forgiven home mortgage indebtedness. Your own observation of the economics of foreclosure is part of the mix. But the entire argument that the U.S., has in FACT (no matter what it CLAIMS) forgiven home mortgage indebtedness, is this:

Through its

1. ownership stake in banks (creating Fifth Amendment Due Process rights to what is in FACT--not the arbitrary 31%--minimization of the risk of housing loss: see Huxtable v. Geithner Order on this (not the Order to Dismiss, sounds like a settlement was reached since Huxtable filed no opposition); 2. contracts with servicers (creating third party contract rights in borrowers--see Marques v. Wells Fargo); 3. mortgage principal reduction; 4. adjustments to gross income for principal reduction; and 5. loss of economic incentive to foreclose,

the United States has in fact forgiven home mortgage indebtedness.

And here is more on the topic...

The big divide in the United States District Courts, with regard to HAMP, is the language of HAMP which seems to give the Government discretion as to whether to modify or not.  Here is typical language from a court decision saying there is no right to a modification:

"Notably, the statute provides that loans may be modified “where appropriate” - a phrase that limits the Secretary’s obligation and evinces a Congressional intent to afford discretion in the decision whether to modify loans in certain circumstances."

The way to defeat this (as was done in Huxtable v. Geithner, before the case was settled or abandoned) is to show FACTS which demonstrate that the Government is actually enforcing a different policy.  In that case, it doesn't matter what the enabling language says, what decides the policy is what the government is DOING.  What OTHER facts show that the Government is pursuing this different policy?  That is where your observation comes in.

One of those facts is the factual conclusions the government ITSELF has come to.  What has it really concluded in the secret, back rooms?

This is why I was interested in your analysis of the returns on taking title to defaulting properties (the link being the Government ownership stake in these properties).  If the Government ITSELF has decided there is no further economic incentive to foreclose, then its policy can ONLY be to prevent foreclosures, because economics shows no facts in favor of going forward with foreclosing and taking title.  Government policy must be based on facts--if it is not, then the policy is simply prejudice, and the courts will not uphold factless prejudice.  It's a matter of determining what policy the Government is pursuing, as a process of eliminating all  those policy options for which there is no factual basis.  Weeding out one prejudice after another.  One such prejudice, I submit, is the idea that there is an economic incentive for the Government NOT to grant HAMP modification.  If there is no economic incentive to foreclose, then this supposed economic incentive is revealed to be a prejudice, and unenforceable.  A right to HAMP modification follows as a matter of elimination of other options.

That is where you come in.  It would greatly help if, on your site, you would give an estimate of the month/year on which the data clearly show that the economic incentive to foreclose is ZERO.  Once it became clear that the U.S. had no further economic incentive to foreclose, it would be very clear that the U.S. has in FACT forgiven home mortgage debt.  That is what zero incentive to foreclose, means.  It means that, in FACT, the debt has been forgiven.

I get the feeling that, privately, the U.S. is racing ahead based on this knowledge.  I would not be at all surprised to see Obama simply ban home foreclosures nationwide.  But we are still in limbo, because there is still this notion that robo-affidavits are the only problem with foreclosure documents, and once that is "cleared up" it's full speed ahead with foreclosures.

That is certainly not the case, and people need to realize that that is not the case.  Above all, their lawyers need more ammo, and the best ammo would be a detailed examination of the rapidly declining economic incentive to foreclose.

By the way, if you assume that the Government already knows we are fast approaching zero incentive to take title, what signs tell you that the Government is already acting on the idea that there is zero incentive to take title?  That is, what actions of the U.S. Government tell you that it has in FACT forgiven home mortgage debt, that it has ALREADY written it all off as a loss, and is now acting in the AFTERMATH of that writeoff.  Because I think that's where we are.  The United States is ahead of ALL of us on this.  They know how bad.  What I'm asking you is, where is evidence that they know there is nothing to be gained from foreclosure, and have moved ahead and have IMPLEMENTED that conclusion?

So if you could deal with that in some big public way, that would be best... That would attract the attention of every lawyer, judge and investor in the country--it would immediately resolve every legal question surrounding home foreclosures, and it would provide an opportunity to get more of the truth into court cases.  Even from the analysis you provided on 9/23, it is clear to me that it's game over for home mortgages.  They are simply not a part of the economy any more--they're social policy and the U.S. is dealing with them as social policy: but what IS the Government's new policy?  Well, what do the FACTS show it is?

Since you're not a lawyer, you greatly underestimate the importance of this observation. When the United States has a stake in a matter, facts relating to that matter are imputed to it as United States POLICY.

Well, he's right. I am not a lawyer. Actually far from it, but it does appear he is on to some creative legal theory. I invite any and all competent legal type to weigh in on this. There is even more on this topic, which at first sounds a bit far fetched, but actually congeals into a cogent argument as you read on...

It is a BIG mistake to read this as just a matter of cleaning up a few documents. These phony affidavits [as referenced above] were part of an effort to hide bad debt on banks’ books. It is also hiding something else, which is that the United States has forgiven home mortgage indebtedness. Look:

1. ownership stake in banks (creating Fifth Amendment Due Process rights to what is in FACT–not the arbitrary 31%–minimization of the risk of housing loss(on this prong, please see online the Huxtable v. Geithner Order (not the Order to Dismiss–sounds like a settlement was reached since Huxtable filed no opposition). The reasoning of Huxtable is sound and is pretty generally accepted now. There IS a Fifth Amendment Due Process right based on U.S. ownership of banks, and this Due Process right is a right to a modification based on what is in FACT the minimization of risk of default–this means that the 31% is simply the Government’s assertion on this point–it is LITIGABLE;

2. contracts with servicers (creating the same rights as above, but on a third party beneficiary theory–see Marques v. Wells Fargo–online). The reasoning of Judge Lorenz is also sound and is simply another basis for claiming a factual minimization of the risk of default, rather than simply accepting the Government’s 31%. Again, the 31% is going to be litigated. People have to get used to that–it’s not off limits anymore;

3. mortgage principal reduction through HAMP;

4. adjustments to gross income for principal reduction through HAMP; and

5. loss of economic incentive to foreclose (this is Reggie Middleton’s analysis on his blog). The Middleton analysis is new (it’s at, the September 23 story on housing prices). The return/chargeoff is rapidly hitting 0.

Litigants in HAMP will certainly have the right to civil discovery as to what the United States has concluded with respect to the economics of foreclosure.

It will probably turn out to be just what the facts show: that the policy is in FACT to minimize the risk of default because there is no economic incentive to foreclose.

Of course this seems impossible, unacceptable, blah blah blah. But if the economic facts bear it out, then the economic facts bear it out and you just have to wrap your head around it. What will happen next/is happening now:

1. litigants will sue to quiet title (among other causes of action such as fraud, conspiracy, Civil Rights violations, etc., naming Tiny Tim, the IRS commissioner and the United States, among others); and

2. the U.S. is scrambling right now to decide what to do if people who have a gazillion dollars and are sitting in a house which is soaring in value, nevertheless decide to simply stop paying on their mortgages.

Of course, the first instinct of Uncle Sam will be some sort of coercion. When that fails in court, the next gambit will be to try to provide some incentive to people to keep paying those damned mortgages. Who knows how this will end?

In any event, it’s Reggie Middleton’s analysis which broke the back of this. Indeed, I’m sure his analysis was already made in the dark of night at the Treasury Department.

The following charts of charge-off recoveries was sourced from the subscription document available to all Paying Subscribers (any who are interested in this extensive data set and analysis can subscribe here): Historical Bank Charge-offs and Recoveries 2Q10. There is also a more comprehensive mortgage, loss, demographic and credit template that was used in the original US (Don’t) Stress (US) tests, otherwise known as SCAP . We have taken the liberty to update the template on a periodic basis for the government, since it appears they are not forcing the banks to do so:-) , and it is available here: SCAP Assumptions Updated_09082010 Web Version. This model shows a weakness in the Case Shiller method of following prices (which I will illustrate in graphic detail at 4:30 pm on Bloomberg TV and in my blog later on today) in that the CS doesn’t include investment properties (usually the first to go into foreclosure), new construction, and REOs. As a matter of fact, Case Shiller actually looked slightly rosy as of late  compared to the facts on the ground (see ).

That’s been the entire tendency of this mortgage mess: to separate out what is in FACT the policy of the U.S., as opposed to what the U.S. SAYS its policy is. If you believe the latter, you don’t get your day in court. But if you assert the facts in court, then your house is free.

As this unrolls, it will sink the dollar. This will entirely change rights in housing in the United States. Among other things, it means that Lindsey v. Normet minimum scrutiny for housing is out the window, because the United States’ policy is a higher level of scrutiny for housing.

Of course, all of this prompted me to look a bit deeper into the economics of foreclosure from the lender's perspective in the near to intermediate future. For those thatdon't know, the US is the owner or at least underwriter of risk for the biggest lenders in the country. We outright own Fannie and Freddie, who process the bulk of conforming mortgages, and we underwote  the risk of Bear Stearn's rotting assets directly as a condition of their sale to Jamie Dimon/JP Morgan as well as partial ownership of Citi and AIG and the underwriting of untold risk through Fannie and Freddie insurance programs. There is no telling how much is underwritten indirectly. For a hint, see as well as Reggie Middleton’s Overview of the Public-Private Investment Program and I’m headed back to DC, with blogger’s opinions in hand! for examples of the government giving out 0%, non-recourse loans to buy failed assets.

This is the chart that originally sparked the conversation. It is a rough chart that is annual and encompasses several loan categories.

So, I decided to dig back in and make the charts more granular in both loan categories (concentrating on residential housing, as per the legal theory above) and the time periods in question. As you can see, the charge-offs on 1-4 family residential housing skyrocketed nearly 1,500% (yes, that is a lot) from the bursting of the bubble in '06.

Both recoveries have increased and the charge-offs decrease, giving us an increase in recovery rates over the last two quarters. Now, before we get all giddy about the improvement in the credit situation in residential real estate finance and blow out all of our provisions, let's take a more careful look at the chart. For one, although the recoveries have increased very slightly, it is the drop in the charge-offs that has served to boost the recovery rate. So, that leads us to ask "What has changed so positively in the market to cause such a drop in charge-offs?" Well, for one the Case Shiller Index has shown a rise in prices. Of course, BoomBustBloggers don't really go for that, because the Case Shiller Index rise fails to capture many of the elements that are causing aggregate housing values sold to fall on an economic basis. See Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading! then reference this chart below.

I will make the analytical model that created this chart available to all paying subscribers in my next post on this topic, which will drill down on why a lagged, highly filtered price model (no matter how sophisticated, and they did do a good job on it) will often mislead you in regards to the true economic direction of assets as such as housing. You must measure sales activity (which has slowed to a level that nearly approximate 1963 levels) as well as sales prices - and those prices have to capture all aspects of housing. The CS index excludes the most distressed categories, which causes it to have an optimistic skew.

So, if it is not the rising prices of indicated by the Case Shiller index that caused the drop in charge-offs, then what was it? Well, I believe it was something much more old fashioned and mundane. It's called LYING! See

Why are Banks Hiding High End Residential Real Estate? Courtesy of the Real Estate Channel:

  • Without the FTB tax credit, the housing market is receiving artificial demand and price support from the FHA loan guarantees and banks sitting on mortgages of homes once valued at $300,000
  • Banks in areas that were severely damaged by the downturn in domestic real estate (Cook County, Illinois, Miami-Dade County, Florida, Orange County, California) have significant inventories of homes worth more than $300,000 that they will not put on the market, even after foreclosures lasting more than 2 years

If that doesn't get you going, reference “They ARE trying to kick the bad mortgages down the road, here’s proof!” and “More on kicking that housing can down the road…“. After that, remember to ask yourself, "Are we in Japan yet???!!!" As excerpted from the REIT Performance Heatmap article for subscribers:

Don't let those who don't run the numbers tell you otherwise. We are following damn near (save some differences in structural rigidity) lockstep in their path. Okay, I'm busted! Not exactly lockstep. Our property decline is probably STEEPER! Look at the second leg.


"Wait a minute buddy!" is being shouted at me from behind the Internet pundit's bullish keyboard. We are in the midst of a recovery, and GDP is forecasted to increase. You know, forecasted by the same guys who somehow missed the biggest stock market and economic drop of a lifetime. Yeah, I know… The GDP thang! Well, wasn't GDP humming right along when all of this mess started. This is about assets and liabilities, not revenue inflows and outflows. I hope you guys have been practicing the use of your chopsticks, cause here we go, GDP increase and all!!!


Now, the US government has, in an attempt to prevent the country from becoming Japan just created a Japanese scenario for us. Instead of forcing banks to recognize losses up front, banks were allowed to play hide the sausage (beware that Japanese banks constituted over 80% of the global banks before their bust, and now despite 20 years of QE, there is only one left on that list and that is in name only - Nomura). Instead of allowing natural supply and demand pricing as a market clearing mechanism, the government attempted to reblow the bubble - just like Japan. I believe we will be able to draw a US chart in the future similar to the one above - just like Japan.

So, if I am fight and all of this future demand pull results in reduced future demand, then things will be getting materially worse in the near future. As it stands now, even with rampant government intervention and the legislatation of lying about your assets and liabilities, we still have historically high charge-offs as a percentage of loans.

As the BoomBustBlogger commented above in his legal analysis, if I am able to draw correlations between the deflationary Japanese experience and the US, so can the government. If I can read past the faux improvements in charge-offs and stare into the abyss of what may come to pass, so can the government, and it probably already has. All they really had to do was read my blog. So, what is the legal analysis and conclusion in regards to government policy? That one is beyond me, but I am sure there are many smart lawyers out there who can chime in.

The government has already issued moratoriums on foreclosure, created HAMP and myriad of other programs to prevent foreclosure, purposely tampered with mortgage rates by buying MBS directly using the policy tools known as Fannie and Freddie, among many other things. It can't be said that they have not taken steps in the direction of banning, or at least attempting to mitigate foreclosure.

I know I definitely believe the banks have jumped the gun in their optimistic zeal by prematurely releasing provisions against losses - 

Three banks particularly BofA, JPM and WFI have witnessed a massive decline in their provisions-to-charge offs ratio in 2Q10 to 84.8%, 58.9% and 49.5%, respectively. from 153.7%, 133.4% and 155.2% in 2Q09.

After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”

JPM is leaving no stone unturned to prop up the operational performance and give out green signals, even if it involves the most unsustainable measures. While in 1Q10, trading income came to the rescue of the sagging core operations, in 2Q10, it was management’s over-exuberance (defying logic and rationality, to some extent) resulting in drastic reduction in loan loss provisioning and beefing up the bottom line. Although the credit quality has shown slight improvement (thanks to the enormous fiscal and monetary stimulus), it does not completely warrant for JPM’ unhealthy and hasty decision to substantially pare its loss provisions. I know many financial pundits second guess management as arm chair coaches, but when management error is egregious, well let’s let the numbers speak through graphics….

More real estate and banking from Reggie:

Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…

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Because 105% LTV On Depreciating Property Wasn’t Good Enough for the US Taxpayer…

I Told You Housing Was Going to Take a Downturn for the Worse. I’ll Tell You Something Else, We Are in a Housing Depression! It’ll Get Worse Until Market Forces Rule Over Government Bubble Blowing!

As I Made Very Clear In March, US Housing Has a Way to Fall

It’s Official: The US Housing Downturn Has Resumed in Earnest

The Great Global Macro Experiment, BoomBust Cycles, and the Refusal to See the Truth: Bubble Economics in the Mainstream Media

An Independent Look into JP Morgan (subscription content free preview!)

The JP Morgan Professional Level Forensic Report (subscription only)

The JP Morgan Retail Level Forensic Report (subscription only)

If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 – JP Morgan

Is JP Morgan Taking Realistic Marks On Its WaMu Portfolio Purchase? Doubtful!

Anecdotal observations from the JP Morgan Q2-09 conference call

Reggie Middleton on JP Morgan’s Q309 results

Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results

A picture is worth a thousand words…


Last modified on Friday, 01 October 2010 15:59