First an apology. I wrote this article on October 14, and seem to have overlooked it. Still, better late than never.
I have been warning people to stay away from the US property market since 2005, and I suggested getting out of it during 2006. My views have not changed. In fact, the US market is shaping up for one heck of a mess.
We all know that a few years ago a few bright sparks decided they had discovered a great way to spread risk in the real estate and insurance markets. It all revolved around the highly dubious practice of selling mortgages in bundles of investment packages to pension funds. It was considered to be such a great wheeze that the lunatics who thought up the idea were given Nobel prizes.
The banks were going to sell on the mortgages so they weren’t really interested in whether the houses were worth what they sold for. They weren’t interested in whether the buyers could pay. All they were interested in was the commission fee for selling on the investment bundle.
Houses were built, buyers came along, mortgages were granted, the mortgages were bundled up and sold on to pension funds. Then came the housing crash.
Now the fun begins. Houses are now worth considerably less than the buyers paid for them. This means the investment bundle isn’t worth what it was sold for. That means the pension fund is sitting on a duff asset which is still depreciating. That means that people who have invested part of their income into that pension fund are looking at a lower return, and therefore a smaller pension. So much for risk being spread. That’s how it was spread. All over the planet. It was spread away from the issuing bank, which ought to have shouldered any risk, and onto ordinary people’s pension provisions, and those folks are now having to pay for the banks’ recklessness.
The banks did not do due diligence. The rating agencies gave the investments AAA credit ratings, and there was a whole lot of mis-selling.
As the houses are now worth less than the money owing on them there is no incentive for the buyers to carry on paying the mortgage. It is estimated that about 25% of all these under-water mortgages are in default, very often a strategic default. That means that although the buyer could pay the mortgage he sees no point in doing so, and just stops paying, thus living rent free in his nice new home.
This means not only is the underlying value of the investment asset going down, but the return on that investment has ceased, and the likelihood of the money ever being paid back has just taken a dive.
Generally, this should mean the bank forecloses on the non-performing loan. But hold on. The bank sold on the mortgage as part of an investment package. Which package was that particular mortgage a part of? Can it be untangled from the investment unit that was sold on? Very often the answer is ‘no’ or ‘dont know’.
So, now what? The bank may not be the right entity to foreclose as it has sold on its rights with that investment package. So who is going to foreclose?
A buyer who wants to stop paying his mortgage and stay in the house now looks to be in a very strong position.
That’s bad news for the banks, because the banks lent out the money and now they have another non-performing loan on their books. It’s bad news for the pension funds who bought the investment package. They now have only a remote chance of getting their money back. And it’s also bad news for rather a lot of pensioners who thought their pensions were safe.
This also means that we now have two more problems with US real estate. The first is, we have a locked-up market. These non-performing mortgages have put the sale of these properties out of the question for some time until someone can sort out who is entitled to do what. They have also put in doubt the legality of the sale of previously foreclosed homes. Did you buy one? If so I hope you took out title insurance. Even if you did, I seriously wonder when all the dust has settled whether the insurers will still be standing.
Apparently the banks hired people who knew nothing about the business to deal with the massive backlog of foreclosures. Many of these people were barely literate and now admit they didn’t know what a mortgage was, or what an affidavit was, and so on. This means the depositions that were the basis of the foreclosures are fraudulent.
In any case, how do you foreclose on a home when you can’t figure out who owns it because the original mortgage is part of a derivatives package that has been sliced and diced so many ways and then sold on that its legal ownership is often unrecognizable? Apparently no less than 65 million homes in question are tied to a computerized program called the national Mortgage Electronic Registration Systems (MERS), and that is often identified in foreclosure proceedings as the owner.
Wait a minute….. the computer program owns the house? I beg your pardon? Heck, I couldn’t make this up, could I?
Adam Levitin, a Georgetown University Law professor who specializes in mortgage finance and financial regulatory issues was recently quoted on CNBC as saying….
The mortgage is still owed, but there’s going to be a problem figuring out who actually holds the mortgage, and they would be the ones bringing the foreclosure. You have a trust that has been getting payments from borrowers for years that it has no right to receive. So you might see borrowers suing the trusts saying give me my money back, you’re stealing my money. You’re going to then have trusts that don’t have any assets that have been issuing securities that say they’re backed by a whole bunch of assets, and you’re going to have investors suing the trustees for failing to inspect the collateral files, which the trustees say they’re going to do, and you’re going to have trustees suing the securitization sponsors for violating their representations and warrantees about what they were transferring.
Attorney Richard Kessler recently conducted a study in which he found “serious errors” in approximately 75 percent of the court filings related to home repossessions that he examined.
“Defective documentation has created millions of blighted titles that will plague the nation for the next decade.”
See what I mean about buying real estate in foreclosure in the US? See what I mean about having title insurance? See what I mean about the US property market probably being in a total mess for at least the next decade?
This situation leads to one more massive problem. Let me quote John Carney of CNBC:
“The most damaging thing that could happen to banks would be the discovery that they simply cannot prove they hold a mortgage on a house. In that case, the loan would probably have to be written down to near zero. Even for current loans, the regulatory reserve requirements would double as the loan would no longer be a functional mortgage but an ordinary consumer loan. Depending on the size of the “no docs” portion of the loan portfolio, this might be a minor blip or require a bank to raise new capital to fill the hole in the balance sheet.”
This all came from a wonderful theory about how to spread risk for which the inventors got nobel prizes. Spreading risk is one thing, but it sounds more like muck spreading to me.
As I have said before: welcome to the upside-down world of the new normal. You’d better learn to live with it. It is going to be here for some time.
Do yourself a favour: dont buy real estate in the US. And dont look at a chart of the US$. The currency is dropping like a brick. It’ll give you nightmares. Short term it’s down about 18%, long term it is down so much it is embarrassing. And god knows how far it will fall after QE2.