Journal: Why Bail-Out Has Not Reduced Foreclosures

03 Economy, 06 Family, Commerce, Commercial Intelligence, Ethics, Government, Law Enforcement
Chuck Spinney
Chuck Spinney

Assuming there is no fraud among the buyers and sellers in a market exchange, Caveat Emptor — the principle that the buyer alone is responsible for determining the quality and suitablity of goods or services before a purchase is made — is the cornerstone of free market ideology.  Implicit in this belief is the necessary albeit patently absurd condition in economic price theory that reliable information is freely available to the all the parties and potential parties to an economic exchange.  After all, if information were truly free, the data processing and data-free manipulation industry of the post industrial society and its contemporary successor, the post-information era (an era synthesized by the petri dish of Pentagon, but now acculturated by the media and Wall Street), would be a non sequiturs.  Today, for example, we have an economy where advertisers can profitably invest large sums of money in subliminally marketing their wares on reality TV, an invention to dumb down people, and make them more vulnerable to the subliminal marketing techniques they are being subjected to by conditioning viewers to substitute vicarious fantasy for realty.
Yet after 200 years, Caveat Emptor is still invoked repeatedly as a moral justification for all kinds of nefarious, albeit technically legal stratagems on the part the sellers.  If there is one thing the Great Financial Meltdown should make clear to even the most casual observer, it is that caveat emptor has gone too far and is now an quaint historical ornament in the hi-tech post-information society that is corrupting the 21st Century OODA loops* which, as night follows day, are shaping and debasing intellectual and moral behaviour in contemporary American culture, which then folds back on itself to make subsequent OODA loops even more vulnerable to further corruption.

Nowhere is the destructive irrelevance of the moral implications of Caveat Emptor more apparent than in the securitization of home mortgages which, when combined with corruption of their safety ratings by Moody’s, et al, has created a market interaction wherein the vast majority (but not all) of homeowners and investors alike have no idea of the obligations, rights, and risks implicit in their individual transactions.

For those readers who still think caveat emptor should remain the principle information regulator of fraud-free market transactions, try to sort through the devastating analysis by Edward Harrison, which first appeared on his blog at Creditwritedowns.com.


Chuck Spinney
Marmaris, Turkey

*Note for readers unfamiliar with theory of the OODA Loop: A brief introduction to its inventor and it essence can be found in my essay Genghis John.   More comprehensive but accessible descriptions can be found in the books by Robert Coram and James Fallows, and Chet Richards, among many others.  There is also a superficial entry in wikipedia.  For those readers who are interested in heavy intellectual lifting, I recommend Franz Ozinga‘s analysis of Boyd’s strategic thought (based on his PhD dissertation) or even better, that they study Boyd’s original papers, which can be found in the in the form of his original briefings and can be downloaded in various formats from Chet Richards’ website (www.d-n-i.net) here.

Why mortgages aren’t modified and what a ruling stopping foreclosures means
New Deal 2.0
October 23, 2009
Our colleague Edward Harrison of Credit Writedowns explains how mortgage servicers have financial incentives to prevent modifications that would help people keep their homes. Can a recent court ruling offer hope?
In August, the Kansas Supreme Court issued a ruling against a mortgage tracking service which may prove very costly to banks in foreclosure, leading to massive writedowns. It could be a life saver for many trapped in the foreclosure process. The case goes to the core of the functioning of massive markets in securitization and derivatives and has wide-ranging importance.
The service, MERS (Mortgage Electronic Registration System), is a privately-owned registry set up in 1997 by Fannie Mae, Freddie Mac and several large banks including JPMorgan Chase, Citigroup and Bank of America. In foreclosure, MERS is often the party which files on behalf of the lenders behind the mortgage against homeowners. The Kansas ruling effectively blocks MERS from bringing legal action on the lenders’ behalf in certain foreclosure situations, potentially putting the kibosh on MERS’ legal authority on the more than 60 million mortgages it holds and subjecting the lenders to huge losses.
This is a complicated but important case I want to break down for you below.
Securitization at fault
The crux of the case has to do with mortgage-backed securities and the process of securitization.
In a bygone era, almost all mortgages were held as loans on the books of the originating banks. In this case, if a mortgage went past due, it was a matter to be worked out between an individual homeowner and an individual mortgage holder.
However, when the mortgage-backed securities (MBS) market took off,
  • mortgages were sliced and diced into tranches and packaged into securities and sold on to investors.
  • These same securities were then sliced and diced and packaged with other securities into collateralized debt obligations (CDOs).
  • CDOs were often then sliced and diced further still into CDOs-squared – that is CDOs of CDOs.
Often times, the underlying mortgages in these instruments were high-risk, sub-prime mortgages. But the ratings agencies could still give them AAA ratings, which made them eligible for investment by risk-averse investors like teachers’ pension funds or municipalities. So, these securities were then sold on to investors around the world into remote places like small towns in Norway and banks in Germany. However, when the housing market fell, the value of these securities plummeted; and they fell much more than the house prices as the securities are derivatives and leveraged against the value of the underlying asset. The result was a financial crisis of epic proportions.
Making matters more complicated for the homeowner, the originating lender is often not the servicing agent of a mortgage. Payment from the homeowner and to investors who are the ultimate owners of the security is handled by a mortgage servicer who collects a fee for its work.
What this has meant is that there is considerable distance between a homeowner and a mortgage holder, such that in the event of foreclosure, it is not a matter of picking up the telephone and calling Mr. Smith at the local Bank. Often times, there is a byzantine web of originating bank, mortgage holder (if loan is sold), mortgage servicer, MBS pooling/securitizing agent, and investors.
Needless to say, the average person doesn’t have a clue as to who to call in order to get relief to avoid foreclosure. The obvious port of call is the mortgage servicer, who is the one party with whom a homeowner has ongoing contact.
Mortgage Servicer
Below is a research report written by the National Consumer Law Center just this past month on why consumers in jeopardy of suffering foreclosure cannot get loans modified.
It starts:
The country is in the midst of a foreclosure crisis of unprecedented proportions. Millions of families have lost their homes and millions more are expected to lose their homes in the next few years. With home values plummeting and layoffs common, homeowners are crumbling under the weight of mortgages that were often only marginally affordable when made.
One commonsense solution to the foreclosure crisis is to modify the loan terms. Lenders routinely lament their losses in foreclosure. Foreclosures cost everyone — the homeowner, the lender, the community-money. Yet foreclosures continue to outstrip loan modifications. Why?
Once a mortgage loan is made, in most cases the original lender does not have further ongoing contact with the homeowner. Instead, the original lender, or the investment trust to which the loan is sold, hires a servicer to collect monthly payments. It is the servicer that either answers the borrower’s plea for a modification or launches a foreclosure. Servicers spend millions of dollars advertising their concern for the plight of homeowners and their willingness to make deals. Yet the experience of many homeowners and their advocates is that servicers — not the mortgage owners — are often the barrier to making a loan modification.
See the problem? This is exactly why loan modifications are not happening in large enough numbers. This goes to incentives — mortgage servicers are not incentivized to make modifications. In fact the incentives go the other way — foreclosure.
Servicers have four main sources of income, listed in descending order of importance:
  1. *The monthly servicing fee, a fixed percentage of the unpaid principal balance of the loans in the pool;
  2. Fees charged borrowers in default, including late fees and “process management fees”;
  3. Float income, or interest income from the time between when the servicer collects the payment from the borrower and when it turns the payment over to the mortgage owner; and
  4. Income from investment interests in the pool of mortgage loans that the servicer is servicing.
Overall, these sources of income give servicers little incentive to offer sustainable loan modifications, and some incentive to push loans into foreclosure.
The monthly fee that the servicer receives based on a percentage of the outstanding principal of the loans in the pool provides some incentive to servicers to keep loans in the pool rather than foreclosing on them, but also provides a significant disincentive to offer principal reductions or other loan modifications that are sustainable on the long term. In fact, this fee gives servicers an incentive to increase the loan principal by adding delinquent amounts and junk fees. Then the servicer receives a higher monthly fee for a while, until the loan finally fails.

Fees that servicers charge borrowers in default

  • reward servicers for getting and keeping a borrower in default.
  • As they grow, these fees make a modification less and less feasible.
  • The servicer may have to waive them to make a loan modification feasible but is almost always assured of collecting them if a foreclosure goes through.
The other two sources of servicer income are less significant.
If servicers’ income gives no incentive to modify and some incentive to foreclose, through increased fees, what about servicers’ expenditures?
Servicers’ largest expenses are the costs of financing the advances they are required to make to investors of the principal and interest payments on nonperforming loans. Once a loan is modified or the home foreclosed on and sold, the requirement to make advances stops. Servicers will only want to modify if doing so stops the clock on advances sooner than a foreclosure would.
Worse, under the rules promulgated by the credit rating agencies and bond insurers, servicers are delayed in recovering the advances when they do a modification, but not when they foreclose. Servicers lose no money from foreclosures because they recover all of their expenses when a loan is foreclosed, before any of the investors get paid. The rules for recovery of expenses in a modification are much less clear and somewhat less generous.
In addition, performing large numbers of loan modifications would cost servicers upfront money in fixed overhead costs, including staffing and physical infrastructure, plus out-of-pocket expenses such as property valuation and credit reports as well as financing costs. On the other hand, servicers lose no money from foreclosures.
This is a very important document for anyone looking to do a loan modification. I strongly suggest you read it, download it and act upon it.
* Bank of America: $2.1 trillion, up from $530 billion a year earlier (via its acquisition of Countrywide – this is WHY bank of America bought Countrywide)
* Wells Fargo: $1.8 trillion, up from $1.5 trillion a year earlier
* JPMorgan Chase: $1.5 trillion, up from $795 billion a year ago (thanks in large part to its acquisition of Washington Mutual)
* CitiMortgage (a division of Citigroup): $792 billion, down from $799 billion a year earlier. Citi is hurting i everywhere)
* ResCap: $391 billion, down from $449 billion in the first quarter of 2008.
As you can see, consolidation has meant the big are getting bigger. Despite a recession, servicing fees are increasing, not decreasing.
You should DEFINITELY read my post “How refinancing helps the likes of Bank of America and Wells Fargo” because this demonstrates why these banks are going to rack up monster fees in mortgage servicing.
Landmark National Bank v. Boyd A. Kessler, Kan 2009, No. 98,489
That brings us to the Kansas case. According to the Kansas City Business Journal, the case can be summarized as follows:
A Ford County man went into bankruptcy in 2006. He had taken out two mortgages on the same property, one to Landmark National Bank and one to Millennia Mortgage Corp. Landmark foreclosed on its mortgage. Millennia had sold its mortgage, which eventually landed at Sovereign Bank, though that transaction never was recorded in Ford County.
Neither MERS nor Sovereign received notice when Landmark filed its foreclosure. That’s because the notice went to Millennia, still registered in Ford County, which is like telling someone that a stranger’s car is about to be towed.
Landmark won a default judgment, essentially wiping out Sovereign’s mortgage. MERS and Sovereign sued to set aside the judgment, arguing that MERS should have received notice. They lost at trial and on appeal.
Supreme Court justices had a difficult time accepting what MERS was and why it would be entitled to receive notice of a foreclosure when it was not a lender and had no stake in the property behind the mortgage. In addition, the court found, the original mortgage required notice only to the lender, not MERS.
This case was decided on 28 August 2009 in favor of the homeowner Boyd Kessler. The issue was predatory lending. But there was more wrong here. MERS does facilitate liquidity in the MBS market, but it does a lot of other things that could harm consumers

MERS also acts as a “corporate shield,” protecting lenders from legal action in cases of predatory lending.

– MERS can foreclose even though it is not the financial party with interest

– Because MERS is a distant intermediary, foreclosure can proceed without even producing an original mortgage note

– With MERS in control, consumers cannot access publicly available information to adequately determine who the holders of their note are.

If MERS is blocked from filing suit in many cases, there will be large losses accumulating at the holders of these notes. Expect to hear more about this very important case.
Edward Harrison blogs at Creditwritedowns.com, where this  piece originally appeared.

Phi Beta Iota: We are enlightened by the above.  In ELECTION 2008: Lipstick on the Pig, published in October 2008 we clearly observed that giving money to Wall Street was insane, and that instead we should be dong a moratorium on foreclosures and evictions, and insuring individuals from the bottom-up while capping interest rates.  Below, by Edward Harrison, from Chuck Spinney with highlights, explains how the distance from the homeowner to the “owner” of any given mortgage was so sliced and diced by Wall Street that it becomes virtually impossible to “produce the note” and even toughter–unless all the slicing and dicing is declared illegal and rolled back–to renegotiate the loan.    The home, and the homeowner, are the center of gravity, NOT Wall Street.  The failure of the two-party tyranny to honor its Constitutional obligations to act in the public interest, instead acting in favor of the special interests, has made our situation worse, not better.