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November 26, 2007 08:30 AM UTC

Foreclosing Financial Folly

  • by: JO

The more we learn about the wave of foreclosures, in Colorado and elsewhere, the more this has the distinctive smell of fresh…, well, let’s just say “fresh financial fraud.” To review: the underlying picture came about by a) finding lower-middle-class folks who yearned to own a house; b) giving them a mortgage with a monthly payment they could afford at first…except in a couple of years, when the rate jumped; even a rise of a couple of points meant monthly payments rose by 50% or more, a point of higher math not appreciated by everyone; c) bagging these loans in  packages sold as “securities” which meant investors-turned-lenders couldn’t closely examine the individual components and were eventually left holding the bag(s).

There are two suckers in this picture: folks who did not understand the details of their mortgages and/or did not foresee other bumps in the road ahead, such the Federal Reserve raising interest rates in general; and folks who went for the securitized mortgages sold by hucksters on Wall St. Let there be no doubt that this market was created by polyester hustlers who in another life (and maybe in a future life) were selling “perfect” used cars with, ahem, adjusted odometers and a fresh coat of paint.

Now, the focus is on the foreclosures, which tends to obscure the larger picture. It’s not just the defaulting borrowers who are bearing the burden. Yes, they will have to move, and yes, their financial dreams are postponed if not ruined for a few years. But what of their neighbors who are current on their loans, possibly at great sacrifice? They may now find themselves living next door to, if not in a neighborhood filled with, empty houses with absentee owners (a financial institution that often the lawyers can’t identify) who are not going to maintain their properties. The value of all these houses is already plummeting, removing a major incentive for other borrowers to keep current on their loans that now exceed the value of their houses. Broadly speaking, huge numbers of home owners/mortgage holders are suffering, even if the word “foreclosure” never enters their personal picture.

What to do? First, declare an emergency moratorium on all foreclosures.
Second, use the persuasive power of state government to assemble a consortium of financial institutions to “desecuritize” the defaulting loans, i.e. raise funds to negotiate a pay-off of the old mortgage and write a new one. The concept being to a) save the borrowers from foreclosure; b) preserve some cash flow on the houses in question; and, most important, c> stop the hemorrhaging of house prices for everyone.
Not a complete answer for the lenders, and maybe not perfect for all borrowers, but better than wave after wave of foreclosures now faced in Colorado especially.

I fully expect responses on this site along the lines: “Those subprime people gotta live with their mistakes, just like me!” Indeed, the very word “subprime” has a certain ring to it, does it not!

This form of thinking is, frankly, irrational and ill-informed. The number of people being hurt by this mess goes way, way beyond the defaulters, who are at most around 15% of the “subprime, variable-rate” borrowers. It’s the OTHER 85% who may be sucked in unless and until some definitive ACTION is taken pronto.

Are you listening Gov. Ritter?


9 thoughts on “Foreclosing Financial Folly

  1. Most subprime borrowers are effectively leasing their homes because they have little or no equity in them. The best idea I’ve heard is that the lenders should simply convert the mortgages to leases. When home values rise, the lenders can resell the homes and the tenants can move, having lost nothing but maybe some out-of-date stationery.

    To declare a moratorium on foreclosures would allow the huge percentage of subprime borrowers who lied on their applications for credit to get away scott free. And it would allow the speculators who used subprimes to finance homes they never planned to occupy before flipping them to profit from their dumb trades.

    Finally, while there certainly were mortgage brokers and bankers who encouraged people to take loans and home-equity refinancings they couldn’t afford, there also were lenders who were trying to help low-income people to buy homes. They shouldn’t be penalized for acting in good faith.

    The bottom line is that we need mortgage market reforms that don’t shut down the market. A freeze on foreclosures would make it very difficult for anyone to finance new homes or sell their existing ones.

    Reforms must be fair and balanced, to coin a phrase.  

    1. .

      and the RTC fire sale,

      I suppose I would have thought that was a good program,

      saving rich people from suffering the consequences of their bad decisions.  

      But I didn’t.  


      it would bother me if my neighbors who cashed out all their equity,

      and then some,

      to pay for bass boats and vacations and liposuction …

      got off Scot-free.  

      and I picked up the tab.


  2. …me understand the subtleties of this issue.

    If payments on someone’s variable-rate mortgage suddenly double, as a result of higher interest rates, and that mortgage can be renegotiated or replaced by an affordable mortgage, foreclosing foreclosure, how is it that YOU are left paying the tab? The tab for what?

    It’s news to me that home equity loans are at the heart of the housing crisis, or even on the periphery.

    On the other hand, if you are someone paying off a mortgage on time, and the foreclosure crisis results in reduced value for YOUR house (alongside everyone else’s), doesn’t this crisis leave YOU with reduced wealth? Maybe the inability to sell your house in a timely fashion, and/or for as much as you still owe on your mortgage?

    Blaming this crisis on liposuction is an entirely new concept for me. Do us all a favor and elaborate on this… and be sure to copy the editors of the Financial Times and WSJ, since it’s gone unnoticed by them as well! Framing this issue as the Liposuction Crisis puts a whole new light on it!

    As far as Another Sceptic’s comment that freezing foreclosures would make it difficult to finance house purchases and/or make it difficult to sell homes… does that not precisely describe the current situation? “Freezing foreclosures” is about providing breathing room so that these ill-advised loans can be renegotiated; it’s not about “failing out” anyone, except people whose houses are on the market for months on end, and/or whose properties have fallen in value precisely because of the rush to foreclose!

    Predictably, there arises a strong whiff of resentment that lower-income people were able to take out mortgages, and an eagerness to see them suffer–even if it means everyone else is stung as well!

    1. The mortgage markets are less liquid because of tremendous uncertainty about the size of the problem and because politicians are talking about fixes such as moratoriums on foreclosures that would make the problem even worst.

      People who have the money to make down payments along with decent credit ratings can get loans, but they have to work harder to get them. It’s more like pre-2004 than post 2004.

      Home equity loans were taken out to finance everything from new TVs to plastic surgery, credit card debt consolidation, vacations and new cars. How many of the home-equity loans were subprimes probably is unknown, which is a problem yet to be resolved. And this has been in the media. It is not news.

      There is no resentment that “lower-income people were able to take out mortgages.” There is resentment that many people lied on their applications for loans and now want bail outs. This is why subprimes are known in the trade as “liar loans.” The banks made it easy to lie, but that doesn’t mean the liars should get to keep their homes, which they really don’t own anyway because they’ve put no equity into their homes. A lot of subprimes were made in the last three or four years with no money down and requiring interest only payments.

      The first thing that has to be realized that a lot of people made mistakes and were too greedy for their own good, including mortgage bankers, Wall Street and home buyers who didn’t have the integrity or didn’t have the dicipline or ability to save until they had reasonable down payments before they “bought” homes.

      If you want to put the blame just on banks, Wall Street or buyers, not on all of them, you’re just a propagandist, not a problem solver.

      btw. I have no skin in this debate except that as a consumer, I don’t want to see the mortgage markets closed, and as a citizen, I don’t want to see cheaters rewarded. More important, I hope the problem can be resolved with out having exploited by politicians.

      1. I see that Another skeptic is in a rare moment of agreement with me on this issue, although it may not sound like it.

        He makes this point: some, perhaps many, of the defaulters don’t have any equity in their homes. No down payment, and any appreciation that might have created equity has almost certainly disappeared.

        So foreclosure, for them, is a wash: their monthly payments now look like rent. Nothing ventured, nothing lost. The only losers are holders of the mortgages, who have written off billions from their balance sheets, and millions of people who may well have equity at stake that is now threatened (if it hasn’t disappeared) by declining house prices. All reports suggest that the situation is far, far from over…or even at its peak!

        The act of foreclosure in effect costs the foreclosees nothing, but the wave of foreclosures has already done serious damage in the financial markets. Will more foreclosures improve the situation? I don’t think so.

        And while lying about income may have played a role, even a big role, it was tolerated if not encouraged at the retail level by loan brokers. So what? It’s not these defaulters who are suffering…it’s the entire home-owner population.

        1. Most homes are over priced, compared with historic means. So owners will suffer some disappointment as the values of homes around them decline for awhile before resuming their upward trend along with inflation.

          Highly recommended history of home prices: Irrational Exuberance (2nd ed) by Robert Shiller. His point is that for hundreds of years, housing prices have kept up with, not beat, inflation. The last 35 years have been wonderful for those of lucky enough to have bought in 1972. But that’s not the norm.

          And, yes, loan officers encouraged white lies, even those of us who had nothing to lie about.

          1. Perhaps AS can confirm or disabuse me of the notion that banks as we traditionally think of them … an institution down the street with a “loan officer” … were not at the heart of the mortgage fiasco, but rather sketchy organizations formed to grant mortgages on questionable terms, and then sell those mortgages (“unload them” might be more accurate) asap as securities and before the real risk was known (i.e., before the variable rates kicked in). Quite different from the notion of your local bank loan officer helping finance the local housing industry/market. Countrywide is a name that comes to mind here.

            1. As you know, there are plenty of articles about this problem out there that people can research. Here’s my view of the situation, and I’m no expert.

              Large lenders like Countrywide both write and buy mortgages for their portfolios.

              Smaller lenders, local banks and S&Ls, for example, can write more mortgages if they sell some or all of the deals they do to better-financed companies like Countrywide, Citigroup, etc. They make money on the spread and are, effectively mortgage brokers rather than bankers.

              Ambitious investment bankers on Wall Street invented collateralize debt obligations (CDOs) that they could buy from small lenders and resell to investors. They made big money on the deals while making more money available for home mortgages, especially subprimes.

              As a result, home ownership grew. Home sales boomed. More home equity loans were made.  Money obtained from home equity loans helped finance the strongest economy in history during the last four years.

              But, once again, bankers got greedy and careless. They loosened lending standards and encouraged borrowing by people who had no business buying homes or refinancing their home mortgages. The bankers bundled these loans into securities (CDOs) without really knowing the risks involved, relying on rating agencies to evaluate the securities. This proved to be a huge error.

              Meanwhile, housing prices boomed to bubble proportions. All bubbles burst sooner or later. The bubble burst was forecast for not only months but years, but the traders were in a state of denial. They were too greedy and didn’t know when to protect themselves.

              So when housing prices stalled and variable rate mortgages began to reset to higher interest rates, subprime borrowers began to default. And last summer, it hit the fan.

              This is how markets work. They always become too exhuberant and then too depressed. People make and lose money. Now, we have too many “homeowners” who have no equity and can’t pay higher monthly payments. Investors don’t know what they own and are having to mark their holdings to market—but no one is quite sure what “market” is, because the securities have suddenly become unattractive to investors.

              Thus, there is a buyers’ strike, so Merrill, Citi, Countrywide and other investors in the CDOs are stuck.

              And it appears that we’ll backslide three or four years to more conservative lending. This will depress home sales and the general economy. It probably will be a long time before we see home sales recover, because the number of qualified buyers has shrunk over night.

              There is little politicians can do about this without screwing up the rest of the economy. Punch the balloon in one place and it’ll pop out in others. Unforeseen consequences are the biggest risks of political reforms.

              Local bank officers will make fewer mortgage loans because they won’t be able to sell all the loans they could make to people who can’t make down payments or make no interest payments. It’s a new world, and nobody really knows what kind of world it is, yet.

              But we know your local loan officer is going to want to see borrowers’ down payments, tax returns and evidence they can afford the houses they’re buying and mortgages they are seeking.

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