Airs – Ian Lance Taylor

Foreclosures

There have been steadily growing reports of invalid paperwork being used to foreclose on mortgages. This has now built up to the point where some large banks are suspending their foreclosure proceedings pending a review of the paperwork. This seems to be a legacy of the fast moving mortgage market before the crash; the banks were buying and selling mortgages so quickly that they weren’t careful with the paperwork. Now, when they need it in court in order to foreclose, they can’t find it.

A couple of things strike me about this. The first is that a foreclosure is a poor choice for a bank. They should be encouraging a short sale. The last thing a bank needs is a house, especially a house which will be hard to sell. It certainly won’t sell for the full price of the loan, so they have to write part of it off anyhow. They should just write off part of it, sell the house, let the borrower carry on their lives. It will get the bad loan off the bank books and won’t leave them with a house. I have to assume that the only reason the banks aren’t doing that is that if they foreclose they can continue to carry the house as an asset at the price of the loan, rather than having to write part of it off. That might be a good short term choice but it’s a terrible long term one, and it’s not good for the neighborhood of the house. Perhaps there is another reason, but what is it?

The second thing that strikes me is that none of the articles I’ve seen talk about how people are getting away with not paying their mortgage. Now, some people were definitely deceived by mortgage brokers when they took out an adjustable rate loan; it’s hard to feel bad for the banks in cases like those. However, other people knew what they were doing, and they made a bad gamble. Those people really should be declaring bankruptcy, and the bank should be getting back whatever the house can be sold for today. The banks are not solely responsible for the fact that many people paid far too much for their houses.

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Ian Lance Taylor

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9 responses to “Foreclosures”

  1. etbe Avatar
    etbe

    There often isn’t much real choice about housing. People assumed that house prices would stay the same or keep going up – there is no reason why they shouldn’t after all the banks made the same assumption based on supposedly having expert knowledge! So the anticipation was that one could buy a house, and if their circumstances changed (EG losing their job) they could just sell it for what they paid and move. This wasn’t an unreasonable assumption.

    The situation is that well-informed bank managers and ill-informed home buyers made equal mistakes, it seems to me that more blame is deserved by the bank managers. But hardly anyone seems to support the idea of banks going bankrupt due to their mistakes. They say that the banks are too big and important to fail.

    I think that the middle-classes are too big and important to fail. Widespread bankruptcy which involves forced relocation, interrupting the education of children who are forced to move school, and further diminishing the prospects of future employment does a lot of long-term damage to a country.

    One way of simply solving this problem would be to put in place a new law stating that every property that is occupied by the owner must be immediately sold at auction if it is forclosed, and states which allow a bank to take more than the value of the house should have laws making home-owners only liable for the value of the house. Then a house that was forclosed would probably be immediately purchased by the former owner with a much smaller mortgage that they could afford to pay, this would give banks an incentive to avoid forclosing.

    I read an interesting blog post a while ago by a US soldier who had been compelled to make a house purchase that he might not otherwise have made due to where he was stationed. He considered himself the CEO of a company of whom the stockholders were his wife and children. Bank managers claim to be compelled to do things which would be considered immoral in person to person transactions for the benefit of the stockholders, he was considering doing the same to his bank for the benefit of his children (stockholders). I think that is a compelling argument.

  2. fche Avatar
    fche

    @ian “[Instead of foreclosing, the bank] should just write off part of it, sell the house, let the borrower carry on their lives.”

    How can the bank sell the house if they are not in possession of it after foreclosure?

    @etbe “Then a house that was foreclosed would probably be immediately purchased by the former owner with a much smaller mortgage that they could afford to pay,”

    OTOH someone whose mortgage was foreclosed probably would end up with crappy enough credit scores that another new mortgage won’t be available for a while.

  3. Ian Lance Taylor Avatar
    Ian Lance Taylor

    People should not have assumed that housing prices would continue to go up, and mortgage brokers should not have advised them that they would. I agree that people who received bad advice should have some recourse. The situation is unfortunately complicated by the fact that the banks which wind up holding the mortgage are often not the brokers who wrote the mortgage in the first place. The mortgage brokers were not too big too fail, and they have largely gone out of business.

    I agree that the banks are trying to apply some moral force to the argument that one should always repay one debts, but they do not feel that moral force for their own actions. But the fact remains that the situation must be resolved somehow.

    etbe: Your suggestion of forcing an immediate auction is an interesting one, but I agree with fche that few people will be willing to write a mortgage for a family which has failed to keep up with their payments. I wonder how that would play out. Offhand I’m not sure.

    fche: The banks can agree to a short sale without going through a foreclosure. In fact, the banks can go further, and arrange for it to happen, with or without the cooperation of the home owner. However, the banks seem to be generally rejecting short sales and choosing to foreclose instead.

  4. fche Avatar
    fche

    So by “short sale” you mean just selling the mortgage to some other bank, writing down some of the principal? I guess this would only apply to delinquent mortgages (else there is no incentive to take an outright loss). Else do you envision something like CDS’s ?

  5. etbe Avatar
    etbe

    Banks assumed that housing prices would continue to go up. That’s the only reason why they offered loans for the full value of properties to people who couldn’t reasonably be expected to repay a mortgage otherwise. The position of the banks was obviously stupid to people like us who understand how things work, but there’s no reason why we should expect average home owners to be less stupid than banks.

    While someone who had just had a home forclosed wouldn’t be given a large mortgage, it wouldn’t require a big one to win an auction in one of those depressed suburbs where there have been forclosures. I’ve been reading about houses selling for as little as $1000 – it’s really hard to sell a house when there are empty houses all around.

    Another possibility would be to enact new emergency legislation to force any bank that forcloses on a mortgage to rent the house to the former owner – and with the only possibilities for eviction being failure to pay a reasonable rent or the new owner wanting to live there. Then the value of a house would be $1000 per month in rent.

  6. Ian Lance Taylor Avatar
    Ian Lance Taylor

    fche: A short sale is when the owner sells the house for less than the amount of mortgage, the money goes to the bank, and the bank forgives the remainder of the loan or some percentage of it. The owner is back to zero and the bank has taken a loss.

    etbe: Somebody expected that housing prices would continue to go up, but I’m not sure it was the banks. The banks didn’t hold on to the mortgages they wrote, they securitized them and sold them. They saw a way to make easy money, and they took it. Their error was to not see that people would eventually stop buying the mortgage bonds. Well, I suppose that ties back to housing prices going up, though not quite so directly.

  7. fche Avatar
    fche

    “A short sale is when the owner sells the house for less than the amount of mortgage, the money goes to the bank, and the bank forgives the remainder of the loan or some percentage of it.”

    In this scenario, the borrower sells the “under-water” house, but to whom? To himself? (That’s a fatal conflict of interest.) To another person? (Likewise, just less obviously defrauded.) Since the borrower is presumed to be “under-water”, he cannot represent his own interests properly (since he has no equity at stake), nor the bank’s (since the bank would want to maximize the price), so I don’t see why the bank would ever want to stand aside and let the borrower try this one.

  8. Ian Lance Taylor Avatar
    Ian Lance Taylor

    The bank doesn’t have to permit a short sale unconditionally, but they could permit if the selling price were within some range of the assessed value of the house.

  9. etbe Avatar
    etbe

    If the banks sold derivatives with the expectation that they wouldn’t have any value then that would be fraud. If a bank sold such derivatives with the expectation that the entire market would fall then that would be gross stupidity due to the risk of counter-party bankruptcy (some of the banks lost money because the counter-parties in the derivatives deals went bankrupt before paying).

    If a mortgaged property was sold at public auction then the price that was obtained would be fair according to market conditions. If the bank didn’t want a sale at such a market price then they could refrain from kicking the resident out.

    I think it would be quite reasonable for a bank to auction a house where the mortgage couldn’t be paid and then allow the resident to remain there if the reserve price was not met.

    No-one benefits when a mortgage is forclosed, the bank gets no more interest payments, the former owner has no-where to live, and the neighborhood gets destroyed if there are too many empty houses.

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