Quantum Pranx


Massive foreclosure errors will collapse the housing market

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by Justice Litle
Editorial Director, Taipan Publishing Group
Posted originally October 06, 2010

THE WORST EXCESSES OF THE HOUSING MARKET BUBBLE AND BUST ARE COMING BACK to haunt us. Now is the time to prepare for another home price collapse, with fresh rounds of “quantitative easing” sure to follow.It would be hilarious were it not so tragic. Come to think of it, it’s hilarious anyway. The country has not yet paid for the idiotic shenanigans of the late great housing market bubble. The latest debacle virtually ensures that the U.S. housing market will collapse

“Wait a minute,” you may ask. “Hasn’t the housing market ALREADY collapsed?” Well, yes. But the collapse isn’t over yet. There is another implosion coming – a crushing leg down that will pulverize all hopes of recovery into talcum powder. And another tidal wave of public outrage will likely come with it… all thanks to our wonderful friends in Washington and on Wall Street. I wish I were exaggerating here, but I’m not. We have flat-out Disaster coming with a capital “D.”

Follow along and you’ll understand why.To first set the stage, let’s briefly cycle back in time to the glory days of the housing bubble…How It All Got StartedOne of the reasons the housing market bubble inflated so fast, and so recklessly, was the rising popularity of “mortgage-backed securities,” or MBS. The embrace of MBS enabled Wall Street to “securitize” mortgages, bundling up giant packages of loans and selling them to yield-hungry investors.

This phenomenon, in turn, created what George Soros identified as “a principal-agent problem,” in which reward and risk were completely separated. Mortgage lenders had every incentive to lend to any homebuyer who could fog a mirror because they were passing the buck on repayment risk. Instead of keeping the mortgages they wrote, lenders would pass off the loan in an MBS bundle. A big ratings agency like Moody’s or S&P would then stamp “triple A” on this bundle, and some gullible institutional investor would buy it for yield.

This whole process was pump-primed and kick-started by the flood of liquidity pumped into the system via “Easy Al” Greenspan, who dropped interest rates below 1% and kept them there for over a year. Ben “Helicopter” Bernanke then followed in the Maestro’s footsteps. And of course, the entire cycle was enhanced and reinforced by the nimrods who swore housing wasn’t in a bubble because home prices could never go down. These people should be publicly flogged for lack of common sense, but I digress.

Point being, at the peak of the greed frenzy, common sense went out the window. In addition to NINJA loans – no income, no job, no assets – you had mortgages getting written up and bundled so fast that it was impossible for human staff to keep up. Risk protocols and proper documentation procedures were utterly abandoned in the mad dash for cash.

The Ugly Truth Arises
It is only now, in the extended aftermath of a boom turned to bust, that we are getting a handle on the rotten mechanics of the MBS racket.Among the big lenders there was such a frenzy to pump out home loans, the paperwork on hundreds of thousands (millions?) of such loans has been lost – or perhaps was never created in the first place. As a result of this, now that upside-down homeowners are foreclosing left and right, the major lenders are facing up to a waking nightmare – the foreclosures are not legal because the paperwork is not documented. “Bank of America is delaying foreclosures in 23 states,” the AP reports, “as it examines whether it rushed the foreclosure process for thousands of homeowners without reading the documents.”

Nor is it just of Bank of America. Last week, the Office of the Comptroller of the Currency (OCC) revealed that JP Morgan is freezing proceedings on 56,000 foreclosures – fifty-six thousand! – due to potentially false documentation. According to John Walsh, acting director of the OCC, “seven of the nation’s largest lenders” are reviewing their foreclosure procedures. This is a serious monkey wrench in the gears – a major-league snafu that threatens to seize up an already vulnerable housing market.

Learning to Fight Back
Meanwhile, foreclosed homeowners like Israel Machado are learning to fight back. As The Wall Street Journal reports, Israel Machado’s foreclosure started out as a routine affair. In the summer of 2008, as the economy began to soften, Mr. Machado’s pool-cleaning business suffered and like millions of other Americans, he fell behind on his $400,000 mortgage. But Mr. Machado’s response was unlike most other Americans’. Instead of handing his home over to the lender, IndyMac Bank FSB, he hired Ice Legal LP in nearby Royal Palm Beach to fight the foreclosure. The law firm researched the history of Mr. Machado’s loan and found two interesting facts. First, the affidavits IndyMac used to file the foreclosure were signed by a so-called robo-signer named Erica A. Johnson-Seck, who routinely signed 6,000 documents a week related to foreclosures and bankruptcy. That volume, the court decided, meant Ms. Johnson-Seck couldn’t possibly have thoroughly reviewed the facts of Mr. Machado’s case, as required by law.

Secondly, IndyMac (now called OneWest Bank) no longer owned the loan – a group of investors in a securitized trust managed by Deutsche Bank did. Determining that IndyMac didn’t really have standing to foreclose, a judge threw out the case and ordered IndyMac to pay Mr. Machado’s $30,000 legal bill… The “robo-signer” scandal is another huge, HUGE problem for the major lenders. As related in the piece above, robo-signers like Erica Johnson-Seck were signing off on thousands of foreclosure documents a week – far too many to actually read.

One robo-signer reportedly averaged ten thousand foreclosure sign-offs per week. Generously assuming a 60-hour work week (12 hours a day), that’s 166 documents per hour! Anyone in danger of losing their house (or who has already lost a house) in such a process can theoretically fight back for negligence and fraud, and possibly even recoup damages. You think a jury will buy the speed-read defense? I don’t.

Buyers Beware
Says Florida attorney Richard Kessler: “Defective documentation has created millions of blighted titles that will plague the nation for the next decade.” Kessler estimates that as many as three-quarters of all filings related to home repossessions may contain serious errors. Some Pollyanna optimists have timidly advanced the theory that this monstrous mess could be bullish for the economy, in that a whole sea of foreclosure victims will have the ability to stay in their homes longer, with the heavy burden of the debacle placed on the shoulders of the lenders. But the reality is that an inability to sort out who owns what is the equivalent of a hundred-mile traffic jam in the mortgage and title markets. Let’s say a new foreclosed home comes on the market at an attractive price. How do you buy it if you can’t be sure the process is legal? What’s more, how do you get mortgage insurance – typically a necessity for securing the necessary financing – if the title company can’t be sure there is a right of legal transfer?

“It’s a nightmare scenario,” says Professor John Vogel of the Tuck School of Business. “There are lots of land mines related to title issues that may come to light long after we think we’ve solved the housing problem.” Solved the problem? Buddy, we haven’t even wrapped our heads around the problem yet!

Credit Meltdown Redux
As observers are pointing out, there are many parallels here to the credit meltdown that rocked financial markets in late 2008. A big contributor to the meltdown was the crazy profusion of risky derivatives contracts and undocumented counterparty trading liabilities – Credit Default Swaps, CDOs and CMOs, CDOs “squared” and the like – with the back offices of the major players drowned in an impossible deluge of paperwork.

Think of a snarled ball of Christmas tree lights taller than the Empire State Building. There was no easy fix for the credit meltdown confusion that ensued, and there will be no easy fix for the same chaos and confusion that has engulfed the functionality of ownership and property rights as related to the U.S. housing market.

The bottom line is this: When a market jams up, the buyers go away. The inability to track ownership adds a huge new risk premium to the act of buying a foreclosed property. And even if there are buyers willing and able to step up, mortgage insurance providers may find that the title-related liabilities are too great. Plus, on top of that, if the nation’s major lenders are forced to eat gargantuan losses as a result of this Homerically epic screw-up, what do you think will happen to their general risk-taking and lending capacity in other areas? Bye-bye recovery. Hello disaster.

But wait! It gets worse!
In keeping with our “so tragic it’s comic” theme, it is worthwhile to consider how bleak the housing market outlook already was WITHOUT the fabulous foreclosure clusterbomb. (Feel free to substitute “bomb” with a less family-friendly word.) One popular measure of the housing market’s health is the Case Shiller Index, or CS Index. The overall message of the CS Index has not been good. In fact you could say it’s been outright gloomy. But analyst Reggie Middleton points out multiple reasons why, in spite of the fact that the Case Shiller Index is forecasting another downturn, things are even worse than the index suggests: Much of the foreclosure and distressed inventory came from investors who walked away from their investment when it became cash flow negative or sank underwater.

Guess what? The CS index doesn’t capture investment properties, only owner occupied homes. Guess what? The CS index doesn’t capture multi-family housing, only single family detached/semi-detached housing. Care to hazard a guess of whether banked-owned REOs are included in the Case Shiller index calculation? Guess what? The Case Shiller index has a minimum holding period to be included in the index which excludes practically all of these investor flips, which also tend to double count sales, when in reality only one real organic sale occurred.

Ah, the Irony
In a classic dose of irony, the horrible reality of our jammed-up housing market may give Wall Street short-term reason to cheer. Why? Because the economic pain that is coming all but guarantees the Federal Reserve will be shoving its chips “all in” for another round of “QE2” (quantitative easing revisited). Yes, just as has been the case for the past few years, the violent financial bloodletting endured by homeowners and the middle class may be ample reason for the Federal Reserve to try and juice risk assets further, in the persistent hope of creating new windstorms to make turkeys fly.And thus, as I put the finishing touches on this note to you, it is really no surprise that a glance at my trading screens shows gold to be up a whopping $24 per ounce on the day.

The men of Washington and Wall Street are dangerous, arrogant fools whose stupidity and greed know no bounds. If you have not been convinced of this by now, you likely will not ever be. These men are bound and determined to run the U.S. economy aground, like the Titanic headed straight for an iceberg, in the pig-headed pursuit of their own short-term interests. Even if you keep all your money in a mattress – or perhaps ESPECIALLY if you do that – the powers that be are fully capable of destroying your financial life, perhaps even your ability to keep up with the nominal cost of living, for the sake of their own backroom gain. There are only two options now – fight back or find yourself a victim. Steel yourself, and prepare.


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