Affordable Housing Institute : US

[Continued from yesterday's Part 1.]

 

Yesterday I chided the New York Times for suggesting that the evil financial technology of ’securitization’ was responsible for the inability of Ms. Brimmage to stay in her home. 

 

Securitization works better with rubber gloves

 

As they try to restructure their loans, they are often thwarted, lawyers say, by strict protections put in place for investors who bought the mortgage pools.

 

(Never mind that Ms. Brimmage used refinancing to consolidate other delinquent debts, or that nothing bad has happened to her yet — she was still living in her home.)

 

The Times uses one to stand for all, and generalizes into the conditional:

 

This impasse could exacerbate the housing slump, pushing more homeowners into foreclosure.

 

Everyone in the mortgage value chain is well aware that a gross oversupply of inventory would flood the market, depressing prices. 

 

That would lead to a bigger glut of properties for sale, depressing home prices further.

 

Quite naturally, most lenders, servicers, and securities holders are refraining from foreclosures.  This condition of suspended animation will not last forever, of course, but in the meantime, there is no pell-mell judgment to the courthouse auction steps.

 

Not like 1873 … yet

 

 “Securitization led to this explosion of bad loans, and now it is harder to unwind and modify them even where it is in the best interests of both the borrower and the investors,” Kurt Eggert, an associate professor at the Chapman University School of Law in Orange, Calif., said in an interview.

 

Fair enough, but Professor Eggert is not a financier, he’s a lawyer and consumer advocate:

 

Professor Eggert is a Professor of Law and Director of Clinical Legal Education. He also runs Chapman’s Alona Cortese Elder Law Center, and teaches both clinical and doctrinal classes. His scholarship has focused on several different areas, among them predatory lending, consumer credit, gambling regulation, and elder abuse. He has testified to Congress on predatory lending issues and is a member of the Federal Reserve Board’s Consumer Advisory Council, where he chairs the subcommittee on Consumer Credit.

 

Naturally, his focus is on the borrowers:

 

“The thing that caused the problem is making it harder to solve the problem.”

 

What does constitute ’solving the problem’?  In Professor Eggert’s view, it is restructuring loans to leave current residents in place.  Perhaps; that’s one solution, to be used some of the time.  Sometimes the right answer is to foreclose, because foreclosure neither ends a tenure nor destroys a home.  Because foreclosure sounds so ominous, few people think their way past the deed transfer.  What actually happens or doesn’t happen?  

                 

      

 

When thinking about foreclosure and workouts, we must always distinguish three things:

 

     

 

How many people live in this box after it’s foreclosed?

 

I distinguish these because the crisis now gripping the subprime mortgage industry (and spreading into more standard lending) is one of value.  People living in the homes cannot afford them, in large part because the loans had low pay rates and now have higher pay rates (either because of an interest rate step-up or the expiration of an interest-only or other concessionary period).  Neither of these changes affects the fundamental dynamics of housing, but they have gigantic implications for the value of mortgage instruments, particularly derivatives, which I previously called risk moonshine.

 

We have seen something like this in the weakening residential home market and its followup consequence, the subprime shakeout.  The housing market’s crumple zone has dispersed risk both among participants and over time, so that although it’s clearly caused localized harm, there has been no systemic or structural failure.

 

So far credit derivatives have proved a triumph of the financial sector’s ingenuity. By dividing the bond market into digestible chunks, they have increased investors’ appetite for corporate debt. That may well have lowered the cost of capital—good for the economy, since it should allow companies to invest more over the long run.

 

I’ll give the Economist its caution, but it seems inescapable to conclude that better risk allocation expands capitalization and contributes to a lowering of interest rates. 

 

But credit derivatives have yet to face a really bracing test. They have grown in a time of low interest rates and narrow credit-spreads (an extra yield over government bonds to offset risk).

 

Everyone looks like a world-class bicyclist when pedaling downhill.

 

No dopes here, just athletes

 

At one end of the value chain, people like Ms. Brimmage cannot pay their current loans. 

 

Creating difficulties is the complex design of mortgage securities.

 

At the other are securities holders, hostage to the payments of thousands of Ms. Brimmages, impacted directly like the last ball in Newton’s cradle, that staple executive soma of thirty years ago:

 

Now, let’s start by having a borrower default

 

Knowing the ball-clack is coming, what should the lenders do?

 

From the standpoint of workouts, it really doesn’t matter whether the default is caused by broker fraud, borrower fraud, adverse markets, bad luck, or a plague of locusts — in a workout, what matters is simply the answer to two questions:

 

Riddle me this, Batman!

 

1. What action maximizes the property’s long-term value?
2. Is the current occupant/ owner as good an occupant/ owner as we could realistically expect?

Equally important is this: who gets to answer those questions?

 

Here lies the rub of securitization: at the moment, nobody wants to raise his hand.

 

Don’t ask me, I’ve got too much paperwork to do

 

Some homeowners have problems simply identifying who holds their mortgages. Others find the companies that handle their loan payments, known as servicers, are unresponsive –

 

Sure enough.

 

– partly because modifying loans cuts into profits.

 

Wrong!

 

 

It’s about at this point that I started scrawling unkind and intemperate phrases in the article’s margin, because what follows from here is completely wrong about motivations and blockages.

 

[Continued tomorrow in Part 3.]

Send post as PDF to