Thursday, 14 October 2010 12:58

Banks Will Be Forced to Forgo Certain Foreclosures, Even If the Borrower Has Admittedly Defaulted!

Summary: Without an economic incentive to foreclose, it would not be in the bank shareholders best interests to pursue foreclosure even though borrowers clearly defaulted & owe money to the lender. The economics of distressed assets in mortgage and commercial banking are quickly changing. I am quite open to discussing this in the mainstream media if any are interested in hearing the "Truth go Viral!" I want all to keep this in mind when pondering the release of reserves by the banks. My JPM quarterly review is still on its way, and I will share a substantial amount with the public.

About a week or so ago, I posed a controversial question, Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two! In that missive I warned that the recovery rate on many of the repossessed properties was not only at a historic low, but actually approaching zero, save a few blips from .gov bubble blowing and shenanigans by banks in the form of kicking cans down the road. I also said that the time may very well come when there may be no economic incentive for banks to foreclose on certain properties, and that pool of properties may grow larger than many could imagine. I know it is difficult for many to come to grips with this, but the math really ain't that hard.

Even Tyler Durden, whose controversial ZeroHedge site I read and contribute to with a passion, is being too optimistic. Yeah, that's right! You know things are bad when ZeroHedge is too optimistic! In his post "Quantifying The Full Impact Of Foreclosure Gate: Hundreds Of Billions To Start", he assumes there WILL be something to foreclose upon. I assert that in increasingly more common instances, there will be no economic interest to foreclose upon. It is starting at the fringes and the margin, but it is moving closer to the center faster than many think. And the longer, and deeper "Fraudclosure" investigations continue, the closer and faster to the center it will get. This is, of course, not even considering the fact that all of this investigating and shining the light in dark corners will reveal the true elephant in the room (and it is not hastily signed affidavits that can be quickly fixed) which is that many, if not most, high LTV mortgage originations were fraudulent to begin with. That means that not only would it not be cost effective to foreclose, but everybody and their momma will be scrambling to put the fraudulent loans back to the originating banks - see The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008! for my realistic take on the situation and the expenses that it entails. Yes, the elusive recovery rate is going to be pushed that much lower. Long story short, bank expenses will skyrocket, along with efficiency ratios, which were already increasing to begin with at the same time housing sales economic activity and prices will drop and credit losses will spike. Oh, what fun we have in store.

Here is and excerpt from Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two to refresh your collective memories and then I will run through an example that clearly shows a high LTV property in Nevada that the lender literally has no economic incentive to foreclose upon if there is litigation to be had.

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…“.

Now, taking the above into consideration, let's run through an example of a high LTV single mortgage home purchased in Nevada.

Sales price Loan, expenses Equity
$ 250,000 $ 312,500 $ (62,500) Starts off with negative equity
Current retail value $ 100,000 $ 300,000 $(200,000) prices drop
Distressed value $ 64,000 $ 300,000 $(236,000) distress discounts
Carrying costs/maintenance@5 m, taxes/utilities@24 m $ 12,480 $ 312,480 $(248,480) can't hold the property for free!
foreclosure costs $ 6,000 $ 318,480 $(254,480) cost to foreclose
Broker costs@6% $ 3,840 sales costs
Recovery to bank if sold withing 4 months and not drawn into litigation $ 41,680 net recovery in a perfect world
Recovery if marketing period=12M ~35000 recovery if sales continue to slow
Recovery if litigated (win or lose?) $ - If there is a legal battle (there cropping up all over the place), the bank is better off letting it go.


This example is not far fetched, and can take place in condos in Florida, California and New York where extra costs can drive down recovery, or the humid coastal regions (ex. Florida) where humidity can drive down recovery over time, or cold weather states, or high crime areas (theft, vandalism), etc.

Methinks it is time to start rethinking the dynamics of distressed real estate, foreclosures, REOs, and recoveries for the economics are definitely starting to morph on the margin and that morphing can quickly spread to the more mainstream.

More Reggie Middleton on residential real estate:

  1. As Earnings Season is Here, I Reiterate My Warning That Big Banks Will Pay for Optimism Driven Reduction of Reserves
  2. The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!
  3. The Truth Goes Viral, Pt 1: Housing Prices, Economic Sales and the State of Depression
  4. Pay Attention to the National Association of Realtors and Their Chief Marketing Agent At Your Own Risk!
  5. Those Who Blindly Follow Housing Prices Without Taking Other Metrics Into Consideration Are Missing the Housing Depression of the New Millennium.
  6. Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two!
  7. Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!
  8. More Doom and Gloom: Homebuilders Making Better Money as Hedge Funds than Home Builders
  9. Yes, Housing Prices Have Much Farther to Fall. We’re Talking Years…
  10. Even at Marquis Trump Properties, Your Lyin’ Eyes are Belying the Real Estate is Bottoming Mantra
Last modified on Thursday, 14 October 2010 13:55

17 comments

  • Comment Link John Ryskamp Friday, 15 October 2010 19:29 posted by John Ryskamp

    This is why everyone is talking Federal intervention. Once transactions start to get unwound, who will dare to buy a house, new or used? Who knows what's in its past?

    Let's put it this way: a house is a Ponzi scheme. By purchasing it you are participating in a Ponzi scheme and opening yourself up to liability.

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  • Comment Link John Ryskamp Friday, 15 October 2010 19:28 posted by John Ryskamp

    No one is going to hesitate to sue ANYONE once this thing gets rolling. You'll see that no one is innocent here. Wait til the homeowners sue the investors.


    The Federal Home Loan Bank of Chicago has sued several of the nation’s largest banks, including its biggest shareholder, Bank of America Corp., alleging that their failure to disclose lax mortgage underwriting standards led the Home Loan Bank to suffer losses after purchasing poor-quality mortgage-backed securities from them.

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  • Comment Link John Ryskamp Friday, 15 October 2010 19:27 posted by John Ryskamp

    See? This bank doesn't hesitate a bit to go after the banks. The only question, why don't they also name the homeowners as defendants? After all, the homeowners are just as much Ponzi participants as the banks.

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  • Comment Link John Ryskamp Friday, 15 October 2010 18:55 posted by John Ryskamp

    The homeowners, dealers, banks and REMICs illegally used the securities as collateral. This makes it clearer as a Ponzi scheme. In fact, this charge can be used by each of the parties against each other, with other assets.

    You'll find out that this is what the documents prove. There are no innocents in this, and they could all prevail against each other. Now, who gets the house?

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  • Comment Link Michael Christian Friday, 15 October 2010 15:03 posted by Michael Christian

    It shows? Yep, I'm a damn lawyer. I suspect John also is, and our exchange is an illustration of the fact that if you ask ten lawyers for an opinion about something, you may not get ten different opinions, but it will almost never be unanimous.

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  • Comment Link Reggie Middleton Friday, 15 October 2010 14:47 posted by Reggie Middleton

    Are you a lawyer?

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  • Comment Link Michael Christian Friday, 15 October 2010 14:10 posted by Michael Christian

    Aggh. I have no sentimentality for homeowners. I simply seek correct application of the rule of law. While I can't pretent to follow all of the skein of your argument, your posts suggests that you feel every defaulting borrower -- or, indeed, every borrower, whether defaulting or not -- engaged in fraud at the inception of the loan, and thereby "converted" the property. This is simply not true. The legal tests are not always mechanical, and fraud in particular involves proof of intent. In fact it is in part about whether the loans were correctly deposited into the trusts, and believe me, you will see this issue litigated vigorously. You still haven't told me what all of the borrowers misrepresented in order to "convert" title to the homes, although I assume you mean they all lied about their incomes. Again, while this was certainly true in some cases, it is not universal. My view on the foreclosure side of the issue (rather than the investor side) is simply that the rule of law demands that the true holder in due course of the note foreclose, not someone else who claims to be the holder but has no proof, AND that this truth will cause problems on the investor side.

    As for the original thesis of your posts, again, the investors own securities issued by the trusts, the trusts own the loans and the security interests in the properties (at least to the extent the loans were properly conveyed to the trusts). The trusts will "own" the properties to the extent they can successfully foreclose their security interests. While there will be lots and lots of claims among the competing players, there is no direct link from the purchasers of securities to the borrowers.

    Judging from your posts, I do not expect either of us to convince the other.

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  • Comment Link John Ryskamp Friday, 15 October 2010 12:58 posted by John Ryskamp

    You're in denial. Just look at the FACTUAL representations homeowners signed off on at various stages of their purchase--or sale! Contrary to your statement, fraud is not a bogeyman, neither is conspiracy. The prongs of these tests are quite straightforward. You say, "unless it could be shown that the originating bank’s claim for fraud was assigned to the sponsor, then the depositor, then the trustee, then the investor." This is not accurate, nor does it describe the factual reprsentations homeowners signed off on. You're making it sound difficult because your prejudice is that the homeowner is the "good guy," who was just innocently making his payments. Baloney. This is also wrong:
    "someone has a cause of action against a defaulting homeowner." I'm not just talking about DEFAULTING homeowners. This is also flat out wrong: "the REMIC investors have a cause of action against someone for securities fraud, and possibly against the trustee for breach of fiduciary ducy for not ensuring that all of the loans were correctly deposited." It is not an action for fraud. It is an action for conversion, such that the title holder (the "homeowner") is held to be a trustee for a constructive trust, the asset of which is title. Stick to the issue, don't hide the issue because it offends your prejudices. It is not about "correct deposit" of loans. It's about who holds title. Stick to the issue. Don't muddy it with your sentimentality. This also misstates the issue: "If your point is that that originating banks and homeowners conspired to commit fraud against the investors, in that both of them knew the loan was fraudulent, good luck." The issue is whether the title was converted. I remind you of the definition of the following terms:

    CONVERSION-Any unauthorized act that deprives an owner of personal property without his or her consent.

    FRAUD-A false representation of a matter of fact—whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed—that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury.

    CONSPIRACY-An agreement between two or more persons to engage jointly in an unlawful or criminal act, or an act that is innocent in itself but becomes unlawful when done by the combination of actors.

    And here's the final comment designed to scare us: "Proof of fraud requires clear and convincing evidence in most states, which is a high bar to get over."

    These legal tests are mechanical. The documentation is all there, the signatures, the representations and the acts (including the robosignatures) are all there. Look at what homeowners--through their legal arrangements--represented to be true facts. Then apply the law.

    They are conspirators, defrauders and converters. No MBS investor should have the slightest hesitation about proceeding against the homeowner in order to get title put in a constructive trust.

    Stop trying to protect these conniving homeowners. They conspired in this every step of the way.

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  • Comment Link Michael Christian Friday, 15 October 2010 10:26 posted by Michael Christian

    If the homeowners defrauded anyone, it was the originating banks, not the REMIC investors, who are far too remote to sue the homeowners directly, unless it could be shown that the originating bank's claim for fraud was assigned to the sponsor, then the depositor, then the trustee, then the investor. I agree that (a) someone has a cause of action against a defaulting homeowner; and (b) the REMIC investors have a cause of action against someone for securities fraud, and possibly against the trustee for breach of fiduciary ducy for not ensuring that all of the loans were correctly deposited. It's not the same claim, nor are the dots directly connected as between homeowner and REMIC investor. If your point is that that originating banks and homeowners conspired to commit fraud against the investors, in that both of them knew the loan was fraudulent, good luck. Certainly a small percentage of loan applicants were actively lying, but all had an appraisal -- the originating bank's problem, since it was driving the appraisal process -- that supported the loan, and most loan applicants were sheep drawn in by teaser rates and the like. Proof of fraud requires clear and convincing evidence in most states, which is a high bar to get over.

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  • Comment Link John Ryskamp Thursday, 14 October 2010 19:16 posted by John Ryskamp

    Think it through. Look at the factual representations the "homeowners" signed off on as they went through the purchase process, both to the lenders, those from whom they bought, and future purchasers. The system conveyed fraudulent titles to them. They then went and put fraudulent notes back into the system when they purchased another home. It's conversion. They put themselves right into an illegal system. If anyone has a right to the property, it is the Trust; the "homeowner" simply holds title as trustee for the trust. Sue the trust to get the "homeowner" to convey title back to the trust.

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  • Comment Link Michael Christian Thursday, 14 October 2010 17:14 posted by Michael Christian

    Meh...conspired at what? The REMIC investor bought a security issued by the REMIC, not the loans themselves. I don't see the avenue to a direct claim on the property, even equitable.

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  • Comment Link John Ryskamp Thursday, 14 October 2010 16:45 posted by John Ryskamp

    And just a reminder: from the point of view of the REMIC investor, "homeowners" are co-conspirators in the MERS system. And this applies to those who don't owe anything on their houses, whether or not their mortgages ever went through MERS: they conspired with their lender and originator.

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  • Comment Link John Ryskamp Thursday, 14 October 2010 16:41 posted by John Ryskamp

    Here is the disgruntled REMIC investor's argument:

    the "homeowner" holds title as a trustee in a constructive trust, for the beneficial owner, the REMIC investor. Under this scenario, the Court can order the trustee to convey title to the REMIC.

    This is in case you are wondering how homeowners can be seen as not holding title, when they have a piece of paper which seems to show that.

    Remember that from the point of view of the REMIC investor, the homeowner is not an innocent party. The homeowner is a co-conspirator in conspiracy to bilk the REMIC investor.

    By the way, this argument also applies to those who have supposedly paid off their mortgages and owe nothing.

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  • Comment Link Reggie Middleton Thursday, 14 October 2010 16:40 posted by Reggie Middleton

    Sounds about right to me. This is an interesting comment from ZH:

    posted this on another thread but now I see Reggie thread available, I'd like to know a conservative estimate on the hit to banks bottom line do to the best possible (for banks) outcome going forward
    repost:
    I'd like to see the real numbers if you figure some certain percentage of additional defaults if they don't find a political solution soon...and there will be no political solution til late Nov.
    Some numbers questions:
    1) so how many previously foreclosure takings of house will be contested?, maybe 1 out of 100? a lot of people never contested, a lot of people put keys in the mail etc...but some fought it and lost due to forged documents. So what does 1 out of 1000, 1 out of 100, 1 out of 50 houses already taken and sold now being contested in court, do to banks. And now that even not-contesting may not be an issue, what is the ratio?
    2) how much does this accelerate existing strategic defaults...what percentage of 11,000,000 underwater houses have already been strategically defaulting? how much does this increase that percentage, how much in certain states? While someone with equity and good credit would need high level of confidence to default as they have lot riding, someone way underwater has little to lose now by going for it and defaulting...even if realize they may never get their house for free, they now know, depending on their state and the type of loan they have, they may get house rent free for 2-3 years...thats a lot of encouragement. In addition, now the banks are shown publicly to be cheating, less moral reason to honor contract, gives people an excuse to quit their end. And strategic defaulting is contagious.
    I'd love to see what the datamining guys at the bank who are looking at loan performance in the next month, I bet there will be a huge spike in underwater folks stopping payment. Even if banks get these houses eventually, loss of income and great increase in expense in meantime.
    3) How much is this going to cost the banks in legal fees and additional staffing? Is this significant to their bottom line? Now foreclosures will be fought tenaciously by every laid-off lawyer in town. They will have to address the now-building back log. There will be class action law-suits, depositions of their staffs. The will be new legal challenges to previously foreclosed and closed loans. There is the AG and DOJ investigations to respond to and, and there is having to do more expensive, more thorough job on tracking title on all new sales.
    4) Plus, any foreclosed REO they try to sell make less as the REO will be brand tainted for some time, even if they are cleaned by political court action, individual homeowners will be wary, value of REOs will go even lower. How much?
    If you put some conservative estimates each of these increase costs/losses, even if we factor in some sort of political/court stick save for these too big to jail types, I bet we see a blood bath. And if there isn't a political save that holds up in court, ouch.
    Reggie, where are you, I need some numbers...
    …..
    Seems to me some people are missing the overall big picture. Moneymutt assumes only 1 in 50 or 1 in 100 houses in foreclosure can be successfully contested. From what I'm reading, with MERS etc all loan written from 2000 thru 2010 maybe be fraudulent in that the securitization, pooling, and selling are illegal. Thus all mortgages have broken chain of title. Not to mention that by using MERS, the purpose was to avoid having to constantly pay county registration and recording fees every time the property asset was sold. Which means MERS owes lots of money to every county. If MERS owes more than they make, bankruptcy may make things interesting. In my mortgage, MERS is the mortgagee, even though they gave no consideration. This mortgage issue goes way deeper than just foreclosed properties, its EVERY property.

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  • Comment Link Michael Christian Thursday, 14 October 2010 16:28 posted by Michael Christian

    I have been repeating this, over and over. The losses to the loan portfolios are only the beginning. MBS investors (in large part state and union pension funds which are severely underfunded and therefore highly motivated to sue) will sue the sponsor banks for securities fraud, and seek recovery of the loss of value of the securities (which may approach 100% if the market loses confidence in MBS again due to the systemic fraud), not merely the losses to the loan portfolios. These losses are in the hundreds of billions of dollars to north of a trillion, I believe. The states also will sue for back taxes (again, being highly motivated due to their budget deficits) upon concluding that the REMICs are not tax exempt due to the failure to properly deposit all loans. There will be the obvious homeowner foreclosure defense efforts, which will now multiply as the fraud becomes widely acknowledged and known. Some banks, unable to withstand assault on three fronts, will collapse, and their shareholders will lose the entire value of their investments in those banks. All of this combined will recirculate into the housing market and the economy generally, as there will be fewer financially able buyers, fewer existing and financially able lenders, and an endless supply of empty houses. This will go on for years and years. The question is how to profit from it, because we can see it coming.

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  • Comment Link Reggie Middleton Thursday, 14 October 2010 14:08 posted by Reggie Middleton

    "Next talk about REMICs. That’s where the real scandal is. Am I right?"

    Well, that;s where the next big fight will probably start as investors try to stem losses through legal means since they won't be able to do it the old fashion way - prudent investing.

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  • Comment Link JohnR Thursday, 14 October 2010 13:53 posted by JohnR

    Reggie,

    This is good. Two things:

    1. "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!"

    Yes, but who ORDERED them to lie? Tiny Tim.

    2. WE know that the U.S. has already, long ago, reached these conclusions and forgiven home mortgage debt. Where is the EVIDENCE that they have done so? Or is the entire fraud, from HAMP denials to REMIC to MERS, the evidence?

    I guess we will find this out in deposition. Where were the real orders given? In my opinion, by the IRS in connection with the REMICs. That's where the Treasury forgave everything and allowed every fraud. You'll see. And why? Because the Treasury realized that there was nothing to be gained from foreclosure, but a LOT to be gained by hiding bad bank debt.

    Next talk about REMICs. That's where the real scandal is. Am I right?

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