The Foreclosure Situation

By Brad Thomason, CPA

 

I don’t know if I should admit this or not (it’s a pretty old-school, non-modern way of doing things), but I have been a subscriber of Investors’ Business Daily for longer than I can remember, and I save all of the issues.  I probably have at least a decade’s worth of newspapers archived in our warehouse.  No joke.

True, this is an unusual behavior.  But it allows us to do research in a way that is difficult to do using digital means.  We can go back in time and see what was going on during a given period; not just related to the specific topic we are looking at, but broader economic conditions, political machinations, general sentiment, etc.

Well, foreclosure is on everyone’s mind these days, so this weekend I went back through a few months’ of back issues to get some perspective on the matter.  Despite the fact that this seems to have come out of nowhere, the story has actually been brewing beneath the surface for a while, and a lot of it comes down to what happens day in and day out in small court rooms all over the country.  I’ll get into that in a minute, but first a summary of related data (directly related or distantly related), as reported in IBD for the days indicated.

August 12, 2010 – Foreclosure rates continue to climb.  Obama administration announces using an additional $2B from the TARP funds to supply aid.  HUD will start a new program to loan money (at 0%) to the unemployed, to keep mortgages current.

August 13, 2010 – RealtyTrac reports that bank repossessions continued to climb in July: 92K units which is 9% more than a month earlier (June).  Expects total repos this year to hit 1M.

August 17, 2010 – Although mortgage credit had increasing troubles in July vs June, large banks report that the rate of new credit card delinquencies started dropping, as did the total uncollectable write-offs.

August 18, 2010 – Treasury Secretary Geithner states that Fannie and Freddie can’t stay as they are indefinitely, nor can they return to previous states.  Said that the private markets needed to lead the way in purchasing mortgage debt in the future.

August 23, 2010 – The rate of people dropping out of the government’s loan modification program rose again in July.  48% of the 1.3M people who entered have now dropped out; only 32% of those entering the program (beginning in March 2009) have received permanent modified terms.

August 27,2010 – The Mortgage Bankers’ Association reports that approximately 4.5% of all mortgages are involved in foreclosure, and that roughly 10% of all borrowers had missed at least one payment during both Q1 and Q2.

September 16, 2010 – The Federal Housing Finance Authority’s acting director says banks are obligated to take back bad mortgages sold to Fannie and Freddie.  Banks refused to take back $11B in loans over the summer.  Estimated total losses on all bad loans sold by the 4 largest banks total $42B.

October 1, 2010 – In Q2, one fourth of all home sales were foreclosure sales.  The head count was nearly 250K houses, though this was down 20% from a year ago, per RealtyTrac.  Average discount on homes in foreclosure was 26% vs those not in foreclosure.  The ratios were higher (of course…) in CA, AZ and NV.

October 7, 2010 – Spurred by Democrat Congressional leaders, Department of Justice will investigate published reports that improper foreclosure practices are being used.  Large lenders have halted foreclosures in 23 states. In a related story, RealtyTrac says that only about 20% of the 1.2 M houses in foreclosure are on the market to be sold.  Many speculate that the implied inventory will weigh on housing prices for years.

October 8, 2010 – President Obama refuses to sign a bill designed to streamline the foreclosure process, amidst the furor about shoddy foreclosure practices.

October 11, 2010 – Bank of America halts foreclosure sales nationwide, as Harry Reid called on lenders to stop foreclosures outright.

October 12, 2010 – Goldman’s mortgage service unit stops foreclosure processing of selected transactions.  Democrat leaders in Congress continue to call for an outright ban, though the proposal is not supported by the Whitehouse.

October 13, 2010 – Whitehouse spokesman Robert Gibbs say that banning foreclosures is a bad idea which could hurt the housing market.

October 14, 2010 – Attorneys General from all 50 states join the probe into whether or not banks falsified documents to expedite foreclosures.

October 15, 2010 – RealtyTrac reports that lender repossessions rose again in Q3, though they expect that the Q4 number could drop as a result of recent cessation in foreclosure processing.

October 18, 2010 – Bank stocks continue to fall over investor fears that the foreclosure mess could lead to large losses.

October 19, 2010 – BofA will resume foreclosure activity in some states, by 10/25.  Citi reports earnings, beating estimates, and reporting that losses due to problem loans declined 30% from a year earlier.  Stock price of both companies rose.

October 20, 2010 – The Fed will join the foreclosure probe, too.  In their regulatory role, they will examine whether or not banks acted illegally, or failed to comply with their own, internally-established policies and practices for foreclosure.

There’s quite a bit of fodder up there for comment, on a range of topics.  But I’ll try to stay focused today.  Hopefully this brief review helps to frame the environment in which all of this is taking place.  Now, on with the show…

The back story on all of this, as quickly as possible, is that a year or so ago an attorney in FL fired the first shot of this war, by asking a lender to produce the note in a foreclosure case.  They couldn’t, and the judge put the brakes on the foreclosure.  The reason they couldn’t is because about 4 different entities had owned the loan since its origination, and no one had any idea where the original loan file was.

The media actually reported this as something of a human interest story.  As a former bank auditor, I saw that this was far from a cute David-and-Goliath story on a quiet Friday afternoon, and I suspect bank executives all over the country had panic attacks, followed by lousy weekends.  It uncovered a systemic susceptibility: up to that point, no one ever went to a foreclosure hearing and said “prove I owe you the money.”  It was just taken for granted.

The story has rocked along under the radar, with the battle ground being the court rooms of the lower-tier judges who hear this type of thing.  As time moved along, more and more defense attorneys were playing the show-us-the-docs card, and more and more judges were getting annoyed with the lenders for clogging up the docket with cases they were not ready to try.  You have to understand that most of these judges feel the same way you would about throwing someone out of their home.  Even if they know that foreclosure is a vital component of our entire comprehension of how credit works, it doesn’t mean they look forward to it.  Our experience in similar situations (primarily related to tax lien foreclosures) is that the judge is going to give the property owner every opportunity to avoid losing the property (that is, they get another chance to repay the debt without the loss of the collateral; not that they are released from the obligation altogether).  Sometimes it’s unavoidable, but if there is any question at all it often become the legal version of the tie-goes-to-the –runner rule in baseball.  Judges also do not like having their time wasted by people being unprepared.  It is not hard to see what kind of force this would apply to the overall system (though the media seems to have largely missed this key component of the story).

Apparently the whole thing outgrew its containment, with enough proceedings being turned back upon filing or being called into question on appeal, and the large banks had to take a break.  The rest of the story is outlined above:  persistent weak conditions set the stage, the level of logistical difficulty behind the scenes hit critical mass, and once the story broke, every level of government and oversight hopped onto the media blitz to call for someone to blame.

Look, obviously the housing situation is a mess.  This particular episode gives us  a  classic view of people who need to be seen doing “something” trying to deal with a problem that is too large to be controlled, and – rather inconveniently (to put it mildly) for all involved – which is just going to have to runs its course.  Halting foreclosures isn’t going to fix anything, nor is much of anything else that can be done at this juncture.  But despite the clamoring, that’s not really being debated.

Despite some calls for an outright halt to foreclosures, no one thinks this is a good idea (I’d wager it was simple pandering going into election season).  No one in law enforcement, regulation or even the Whitehouse thinks that stopping foreclosures is the right response; just the opposite, in fact.  The president got this one right: banning foreclosures would be catastrophic.  There is probably some pressure from those frustrated judges, and I suspect you could probably find places where individual judges have more or less enacted their own moratoriums via their ability to control the docket.  But that’s probably the extent of it.

Which is why I think this is a temporary matter.  Once the banks have time to get their files in order, life will start to return to normal.  The government would be foolish to institute a ban, and they know that.  (Want proof?  This close to an election, if they really thought it was a good idea, they would have been flogging the horses to get it through.)  Closer to the ground, there will probably continue to be individual judges who are holding things up, but even that has to give way sooner or later.  The law is pretty clear cut when it comes to foreclosures.  Judges acting in isolation have only limited prerogative; a true change would require legislative action.  That’s the way the system works.

So my prediction is that there will be more saber-rattling, some fines and regulatory actions for misbehavior (as there probably should be), and eventually this will do like most news stories: you’ll just realize one day that it has left the cycle.  How long it will take – weeks or a few months – is anyone’s guess.  But at the end of the day, the entire notion of collateralized lending fails at its most fundamental level if the collateral becomes off-limits to those trying to protect their receivable.  I just don’t see that happening.

One final note: Some of you have asked us about what impact this is having in the tax lien arena (where we have a fairly significant practice).  To date, I’ve not heard of any similar issues.  Tax lien foreclosure follows a completely different set of laws in every state that I’m aware of.  And to the specific point of the problem over on the mortgage side, there are relatively few documents involved in the filing, and the vast majority of them are produced by the county tax office that issued the lien to begin with.  Whether or not the mortgage is in order is a nonissue in a tax lien foreclosure, because the tax lien jumps in front of the mortgage as the superior lien, and extinguishes the mortgage debt and any other liens by the time the process is all said and done.

So:  so far, this has not had any impact in the tax lien world.  I’ll post new information if that changes, but right now, beyond a similar name for the process, there’s not a lot of comparability.

Thanks for enduring a long post.  Please send me a note if you have any questions or feedback.

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