Why U.S. House Prices Are Still FallingHousing-Market / US Housing Jun 27, 2011 - 08:51 AM GMT
In October 2007, CNBC's Diana Olick called me about Countrywide's so-called plan to modify mortgage loans scheduled to reset to higher rates. Subprime borrowers with a strong payment history would be able to refinance and possibly get prime FHA loans. Current paying borrowers with credit issues would be offered Fannie Mae or Freddie Mac loans under a new expanded program.
Mortgage Loans with Less than Zero Value
Mortgage modification programs, including HAMP, were abysmal failures. At the time I told Olick that mortgage servicers were selling loans for 3-6 cents on the dollar and they were happy to dump them:
"They work 13-hour days trying to salvage what they can, doing anything to avoid reporting a delinquency or foreclosure. They disclosed disturbing information unavailable even on trustee reports. The servicer asserted the rating agencies are incorrect in their optimism; recovery rates of 60% are unattainable. My average recovery rate assumption of 30% is also currently unattainable."
If loans couldn't be sold to a sucker, banks and their servicers walked away. Mortgage securitization complicated matters, and often homes are left vacant and not foreclosed upon. Looters strip vacant properties of pipes, fixtures, and anything of salvage value. The loans within the securitizations are worthless.
Why do banks and trustees pretend the loans have value? If banks and lenders foreclosed, it would be revealed that the cost to maintain the property before resale and the legal costs relative to the value of the property meant that they had negative equity.
At first this was a problem for loans with low loan balances, but as property values dropped, even loans with higher balances had the same problem. The problem spread, and it hasn't yet stopped spreading.
Triple Tragedy: Meltdown, Spreading Contagion, and Crime
This tragedy is echoed by similar problems in Ohio, Michigan and other subprime targets on the West Coast, Nevada, and in the South. Although some examples aren't as stark or depressing, the general idea of plummeting property values and vacant properties infecting a neighborhood and its surrounding areas still stands. Affected states have to carry the burden of these paralyzed limbs, and banks and their cronies that perpetrated this mess just walk away. This video, first reported by the Chicago Tribune is a stunning local example:
Since 2007, Chicago's Englewood and West Englewood areas slid into a sinkhole. Homes that once housed lower middle class and middle class families stand empty. Those with the means to move have fled. Those without the means have stayed while the prairie reclaims a large part of the south side of Chicago. More and more homes have been boarded up. Grass has grown so high in some formerly residential areas it obscures all but the tallest humans. Crime soared. Property values in surrounding neighborhoods are plummeting as the wasteland spreads to their doorsteps.
"Countrywide Broke the Law"
It would be easy to turn away from this and blame the borrowers. Some of the borrowers were absentee landlords who knew what they were doing. Some borrowers overreached. But in many cases, people were victimized by predatory lenders. For example, a complaint of alleged fraud against Goldman Sachs, includes allegations of fraudulent practices by Countrywide, now owned by Bank of America. A former Countrywide employee stated that approximately 90% of all "liars' loans, loans that allowed reduced documentation about borrowers' income and assets, sold out of a Chicago office had inflated incomes.
The borrowers weren't inflating the income. Countrywide routinely doubled the amount of the potential borrower's income to qualify borrowers for loans they couldn't afford so that Countrywide and its mortgage brokers could continue to earn fees and commissions. Prior to a settlement in which Countrywide paid a paltry $8 billion--the damage done is much greater-- to eleven states, Illinois Attorney General Lisa Madigan stated: "Countrywide broke the law, homeowners did not."
Fed's August 2007 Back Door Bail Out of Countrywide
In August 2007, investors shunned Countrywide's asset backed commercial paper (ABCP) backed by its mortgage loans and demanded much higher interest rates. In the ensuing panic, Countrywide wanted to borrow around $11.5 billion from banks on its credit card-like revolving credit lines, but the banks balked. The banks asked the Fed for concessions, and the Fed agreed.
The Fed deal appeared to have been leaked. On Thursday, August 16, 2007, the Dow fell more than 340 points when it appeared Countrywide was about to go under, but rebounded to close down only 15 points. The next morning the Fed announced its new bank lending concessions.
The Fed bailed out Countrywide and its affiliated banks through its back door. The Fed agreed to let banks borrow against private label mortgage loans with phony "AAA" ratings, cut the banks' discount rate from 6.25%* to 5.75%, and extended "overnight" borrowings to 30 days.
BofA, Wells Fargo, U.S. Bank, Deutsche Bank, and JPMorgan Cut and Run
Banks that supplied money -- and in some cases now own -- suspect mortgage lenders also packaged up and sold those loans to investors. They own or owned mortgage "servicers" that cannot recover foreclosure costs combined with the costs of maintaining and reselling the house. After pumping up appraisals and falsifying borrowers' income on applications, banks are walking away and sticking taxpayers with the bill.
According to the Woodstock Institute, the mortgage servicers and trustees linked to abandoned properties in Chicago are Bank of America, Wells Fargo, U.S. Bank, Deutsche Bank, and JPMorgan Chase.
Despite evidence of widespread interconnected mortgage lending, securitization, and foreclosure wrong-doing and fraud, there are no meaningful felony indictments of senior executives at mortgage lenders or of senior executives of banks bailed out by taxpayers.
*Corrected typo from 6.75% to 6.25%. The events surrounding episode and other bailouts are covered in detail my book on the financial crisis and the resulting economic stagflation: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street.
By Janet Tavakoli
web site: www.tavakolistructuredfinance.com
Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).
© 2011 Copyright Janet Tavakoli- All Rights Reserved
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